**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-K**

 

**(MarkOne)**

 

| **x**                                                | **Annual Report Pursuant to Section 13 or 15(d) of the  Securities Exchange Act of 1934**     |
|------------------------------------------------------|---------------------------------------------------------------------------------------------------------|
|                                                 |
| **For the fiscal year ended December 31, 2009** |
|                                                 |
| **or**                                               |
|                                                 |
| **o**                                                | **Transition Report Pursuant to Section 13 or 15(d) of the  Securities Exchange Act of 1934** |

 

**For the transition period from           to          **

 

**Commission file number 001-33065**

 

**TIDELANDS BANCSHARES, INC.**

(Exact name of registrant as specified in its charter)

 

| **South  Carolina**                                             | ** ** | **02-0570232**                        |
|-----------------------------------------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction or incorporation of organization) |       | (I.R.S. Employer  Identification No.) |
|                                                            |       |                                  |
| **875  Lowcountry Blvd., Mount Pleasant, South Carolina**       | ** ** | **29464**                             |
| (Address of  principal executive offices)                       |       | (Zip Code)                            |

 

Telephone number: **(843) 388-8433**

 

Securities registered pursuant to Section 12(b) ofthe Exchange Act:

 

| **Title of each class:**  | ** ** | **Name of each exchange on which registered:** |
|------------------------------------------|------------|------------------------------------------------------------------------------|
| Common Stock,  $0.01 par value per share |       | NASDAQ Global  Market                                                        |

 

Securities registered under Section 12(g) of the ExchangeAct:  **None**

 

Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities Act.

Yes o                                    No  x

 

Indicate by check mark ifthe registrant is not required to file reports pursuant to Section 13 or Section 15(d) ofthe Exchange Act.

Yes o                                    No  x

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.

Yes x                                    No  o

 

Indicate by checkmark whether the registrant has submitted electronically and posted on itscorporate 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).

Yes o                                    No  x

 

Indicate by checkmark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-Kis not contained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to this Form 10-K.

o

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).

Yes o                                    No  x

 

As of June 30, 2009,the aggregate market value of the registrant’s common stock held bynon-affiliates of the registrant was $6,178,786 based on the closing sale priceof $2.90 per share as reported on the NASDAQ Global Market.

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company.  See the definitions of “large acceleratedfiler,” “accelerated filer” and “smaller reporting company” in Rule 12b-2of the Exchange Act.  (Check one):

 

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

 

The number of sharesoutstanding of the issuer’s common stock, as of February 22, 2010 was4,277,176.

 

**DOCUMENTSINCORPORATED BY REFERENCE**

 

Proxy Statement for theAnnual Meeting of Shareholders to be held on April 12, 2010    Part III(Items 10-14)

 

 

 

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**PART I**

 

**Item 1.  Description of Business.**

 

This report contains statements which constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.  Forward-looking statements may relate to our financial condition, results of operation, plans, objectives, or future performance.  These statements are based on many assumptions and estimates and are not guarantees of future performance.  Our actual results may differ materially from those projected in any forward-looking statements, as they will depend on many factors about which we are unsure, including many factors which are beyond our control.  The words “may,” “would,” “could,” “will,” “expect,” “anticipate,” “believe,” “intend,” “plan,” and “estimate,” as well as similar expressions, are meant to identify such forward-looking statements.  Potential risks and uncertainties include, but are not limited to those described below under “Risk Factors” and the following:

 

·                  general economic conditions (both generally and in our markets) may be less favorable than expected, resulting in, among other things, a continued deterioration in credit quality, a further reduction in demand for credit and/or a further decline in real estate values;

·                  the general decline in the real estate and lending market, particularly in our market areas, may continue to negatively affect our financial results;

·                  our ability to raise additional capital may be impaired if current levels of market disruption and volatility continue or worsen;

·                  the results of our most recent external, independent review of our credit risk assets may not accurately predict the adverse effects on our financial condition if the economy were to continue to deteriorate;

·                  restrictions or conditions imposed by our regulators on our operations, including the terms of the informal Memorandum of Understanding (“MOU”) with the South Carolina State Board of Financial Institutions (the “South Carolina Banking Department”) and the Federal Deposit Insurance Corporation (the “FDIC”), may make it more difficult for us to achieve our goals;

·                  legislative or regulatory changes, including changes in accounting standards and compliance requirements, may adversely affect the businesses in which we are engaged;

·                  competitive pressures among depository and other financial institutions may increase significantly;

·                  changes in the interest rate environment may reduce margins or the volumes or values of the loans we make;

·                  competitors may have greater financial resources and develop products that enable those competitors to compete more successfully than we can;

·                  our ability to attract and retain key personnel can be affected by the increased competition for experienced employees in the banking industry;

·                  adverse changes may occur in the bond and equity markets;

·                  war or terrorist activities may cause further deterioration in the economy or cause instability in credit markets;

·                  economic, governmental or other factors may prevent the projected population, residential and commercial growth in the markets in which we operate; and

·                  we will or may continue to face the risk factors discussed from time to time in the periodic reports we file with the SEC.

 

**General Overview**

 

We area South Carolina corporation organized in 2002 to serve as the holding companyfor Tidelands Bank, a state-chartered banking association under the laws ofSouth Carolina headquartered in Mount Pleasant. We opened Tidelands Bank in October 2003 and operate seven fullservice banking offices located along the coast of South Carolina.  We are primarily engaged in the business ofaccepting demand, savings and time deposits insured by the FDIC and providingcommercial, consumer and mortgage loans to the general public.  Since our inception, we have focused onserving the banking needs of professionals, entrepreneurs, small businessowners and their family members in our South Carolina coastal markets.  As of December 31, 2009, we had totalassets of $775.9 million, net loans of $475.5 million, deposits of $591.5million and shareholders’ equity of $38.9 million.

 

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**OurMarket Area**

 

Our primary market areais the South Carolina coast, including the Charleston (Charleston, Dorchesterand Berkeley counties), Myrtle Beach (Horry and Georgetown County) and HiltonHead (Beaufort and Jasper County) markets areas.  Our main office is located at 875 LowcountryBoulevard, Mount Pleasant, South Carolina.

 

In addition to our mainoffice, we have six full service banking offices.  In August 2004, we opened a loanproduction office in Summerville, South Carolina.  Due to the success of this loan productionoffice, we converted it to a temporary full service branch in April 2005,and in April 2007, we opened the permanent full service banking office inSummerville.  In January 2005, weopened a loan production office in Myrtle Beach, South Carolina, which weconverted into a temporary full service branch in October 2005 and openedour permanent facility in June 2007. We opened a new full service banking office in the Park West area ofMount Pleasant in May 2007 and converted our loan production office in theWest Ashley area of Charleston to a full service banking office in July 2007.  We also opened a loan production office inBluffton, in the Hilton Head market area, in October 2006, which weconverted into a temporary full service banking office in September 2007and then opened a permanent full service banking office in May 2008.  Finally, we opened a new full service bankingoffice in Murrells Inlet, in the Myrtle Beach market area, in July 2008.

 

The following table showskey demographic information about our market areas:

 
| **Tidelands Bank**         | ** ** | **Total  Market Area**            | ** ** |
|----------------------------|------------|-----------------------------------|------------|
| ** **                 | ** ** | **As of  December 31, 2009** | ** ** | **Total  Deposits in** | ** ** | ** ** | ** ** | ** ** | ** ** | **Projected** | ** ** | **Median** | ** ** | **Projected  Growth in  Median** | ** ** |
| **Market**                 | ** ** | **Retail**                        | ** ** | **Net** | ** ** | **Market** | ** ** | **Deposit** | ** ** | **2009** | ** ** | **Population** | ** ** | **Household** | ** ** | **Household** | ** ** |
| **Area(1)**                | ** ** | **Deposits**                      | ** ** | **Loans** | ** ** | **Area(2)** | ** ** | **Growth(3)** | ** ** | **Population(4)** | ** ** | **Growth(5)** | ** ** | **Income(4)** | ** ** | **Income(5)** | ** ** |
| ** **                 | ** ** | **($ in millions)**     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Charleston  (4 branches)   |       | $                                 | 232.5      |   | $ | 350.6 |   | $ | 9.6B |   | 123 | % | 645,729 |   | 8.31 | % | $ | 52,646 |   | 5.73 | % |
| Hilton  Head (1 branch)    |       | $                                 | 67.6       |   | $ | 45.4 |   | $ | 3.7B |   | 90 | % | 180,977 |   | 10.71 | % | $ | 57,813 |   | 3.43 | % |
| Myrtle  Beach (2 branches) |       | $                                 | 101.5      |   | $ | 79.5 |   | $ | 6.7B |   | 100 | % | 327,354 |   | 13.89 | % | $ | 46,077 |   | 5.11 | % |
| Total                      |       | $                                 | 401.6      |   | $ | 475.5 |   |   |   |   |   |   |   |   |   |   |   |   |   |

 

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(1)       The Charleston market area iscomprised of Charleston County, Dorchester County and Berkeley County; theHilton Head market area is comprised of Beaufort County and Jasper County; andthe Myrtle Beach market area is comprised of Horry County and GeorgetownCounty.

(2)  Based on FDIC data as of June 30, 2009.

(3)  Based on FDIC data for the period June 30,2000 through June 30, 2009.

(4)  As of 2009, per SNL Financial.

(5)  Projected for the period 2009-2014; per SNL Financial.

 

Markets in the UnitedStates, including our market areas, have experienced extreme volatility anddisruption for more than 18 months. According to the National Bureau of Economic Research, the United Statesentered an economic recession in December 2007.  Declining real estate values and rising unemploymentlevels have strained most sectors of the economy.  Although not immune from these economicrealties, we believe that the Charleston economy remains diverse and wellpositioned for recovery.  According tothe Charleston Metro Chamber of Commerce, each year more than four millionpeople visit Charleston because of its world class shopping and dining andhistorical attractions.  For the 17th consecutiveyear, readers of Condé Nast Traveler magazine honored Charleston as a Top 10travel destination in the U.S. with the No. 2 slot - topped only by SanFrancisco.  This ranking maintainsCharleston’s spot as a premier east coast destination.

 

Recent economic expansionin the manufacturing sector includes Boeing’s plan to build a second finalassembly plant for the new 787 Dreamliner. The company broke ground on the 584,000-square-foot facility near itsexisting factory in early 2010 with assembly production expected to begin in2011.  GE Aviation and the SKF Group, oneof the world’s largest producers of jet engine bearings, recently opened a newfacility in Charleston to 

 

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manufacture and repairjets.  In October 2008, Googleopened a new $600 million data center facility in the Charleston area thatemployees approximately 200 people.  Inlate 2007, DuPont announced a planned $500 million investment at its facilityin Berkeley County to significantly expand production of high-performanceKevlar® para-aramid brand fiber for industrial and military uses.

 

Charleston is also hometo a number of academic institutions, including the Medical University of SouthCarolina, The Citadel, The College of Charleston, Charleston SouthernUniversity and The Charleston School of Law. Charleston also hosts military installations for the U.S. Navy, U.S. AirForce, U.S. Army and U.S. Coast Guard.

 

The Hilton Head market area, located in BeaufortCounty, approximately 45 miles north of Savannah, Georgia and 90 miles south ofCharleston, is an internationally recognized retirement and vacationdestination famous for its championship golf courses, beaches and resorts.  The Hilton Head Chamber of Commerce estimatesthat the year-round tourism industry accounts for more than 60% of local jobsand contributes in excess of $1.5 billion annually to the Hilton Head economy.

 

The Myrtle Beach area, also known as South Carolina’s Grand Strand, is a 60-mile stretch of coastline extending from the South Carolina state line at Little River (Horry County) south to Pawleys Island (Georgetown County).  In recent years, both The Wall Street Journal and Money magazine rated the Grand Strand as one of the nation’s top retirement locations.  Myrtle Beach was listed in the Top Ten destinations for families looking for a cool and affordable vacation in 2008 by Ask.com.  In recent years, the American Automobile Association has ranked the area as the nation’s second most popular tourist destination.  In 2007, the Myrtle Beach Chamber of Commerce estimated that over 15.2 million people visited the area.  Because tourism for the budget conscious traveler plays such a vital role in its local economy, we anticipate that Myrtle Beach will be our slowest market to recover from the recent economic downturn.

 

As economic conditions improve, we believe the combination of full-time residents and visitors will continue to support businesses such as real estate development, construction, manufacturing, healthcare and education in our market areas.

 

**Our Strengths**

 

Since our founding in2002, we have focused on our core operating strength of relationship bankingand have established the necessary infrastructure to support the expansion ofour franchise.  The cornerstone of ourrelationship banking model is the hiring and retention of professional bankingofficers who know their customers and focus on their customers’ bankingneeds.  By leveraging our bankingofficers’ experience and personal contacts, we have been able to withstand thedifficulties of this economic environment by focusing on building bankingrelationships with professionals, entrepreneurs, small business owners andtheir family members in our markets. This relationship banking model enables us to generate both repeatbusiness from existing customers as well as new business from customerreferrals.

 

We have assembled anexperienced senior management team, combining extensive market knowledge withan energetic and entrepreneurial culture. The members of our management team have close ties to, and are activelyinvolved in, the communities where we operate, which is critical to ourrelationship banking focus.  We believethis experienced senior management team has implemented the necessary riskmanagement processes to allow us to manage nonperforming assets while we continueto diversify our loan portfolio and increase retail deposits in our localmarkets.  As market conditions improve,we are also optimistic that we are well positioned to enhance our franchise andreinvigorate our earnings stream without needing to add additional executivepositions.

 

As we move beyondour sixth anniversary, we have established a community banking franchiseconsisting of seven full service banking offices in selected markets along thecoast of South Carolina.  We have beencareful to expand by opening new facilities only after we have identified anattractive market and hired experienced local bankers to manage ouroperations.  Six of our seven fullservice banking offices have opened since April 2007 and, as of December 31,2009, these offices averaged approximately $57.4 million in retaildeposits.  During the fourth quarter of2009, we generated $51.5 million in local retail deposits through our branchnetwork.

 

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Our goal is tocontinue to reduce our dependence on wholesale deposits and increase retaildeposits in our local markets to fund our future growth.  The amount of wholesale deposits was $189.9million, or 32.1% of total deposits, at December 31, 2009, compared to$284.1 million, or 50.6% of total deposits, at December 31, 2008.  Going forward, we believe retail depositgrowth will be the primary component of our funding sources.  For example, retail deposits increased overfive times as fast as loans for the year ended December 31, 2009, withretail deposits increasing $124.6 million compared to $23.6 million in totalloans.  Our retail deposits increased to$401.6 million at December 31, 2009 from $277.1 million at December 31,2008, and represented 67.9% of our total deposits at December 31, 2009compared to 49.4% of our total deposits at December 31, 2008.

 

We believe that our coastal markets need institutions that provide banking services to small businesses and local residents that the larger financial institutions are not well positioned to provide.  We anticipate that some of our competitors may be unable to survive the severity of this downturn.  Population growth projections for our markets suggest that for those financial institutions that emerge from this economic crisis, there is substantial opportunity to capture additional market share and enhance franchise value.

 

We believe ourrelationship banking model, management team and branch infrastructure hasallowed us to weather this economic storm and positions us to take advantage offuture market dislocation, consolidation and reduced competition for lendingactivities when the economy in our markets improves.  Although we have no definitive plans forexpansion, we may also engage in strategic acquisitions if attractive opportunitiesarise.

 

**LendingActivities**

 

*General.* We emphasize a range of lending services, including commercial andresidential real estate mortgage loans, real estate construction loans,commercial and industrial loans and consumer loans.  Our customers are generally individuals andsmall to medium-sized businesses and professional firms that are located in orconduct a substantial portion of their business in our market areas.  We have focused our lending activitiesprimarily on the professional market, including doctors, dentists, smallbusiness owners and commercial real estate developers.  At December 31, 2009, we had total loansof $485.6 million, representing 66.7% of our total earning assets.  The average loan size was approximately$272,000.  As of December 31, 2009,we had 67 nonperforming loans totaling approximately $21.3 million, or 4.4% oftotal loans.  The average size of ournon-performing loans at December 31, 2009 was approximately $318,000.

 

At December 31,2009, our loan portfolio was comprised of the following:

 
| ** **                 | ** ** | **Loans**                       | ** ** | **Nonperforming Assets** | ** ** |
|----------------------------|------------|---------------------------------|------------|--------------------------|------------|
| ** **                 | ** ** | **Balance  December  31, 2009** | ** ** | **% of  Loans**          | ** ** | **Non-  accrual  Loans** | ** ** | **Other  Real  Estate** | ** ** | **Total Non-  performing  Assets** | ** ** |
| ** **                 | ** ** | **(dollars in thousands)**      | ** ** |
| Real  estate mortgage      |       | $                               | 335,831    |                     | 69.2       | % | $ | 10,813 |   | $ | 1,743 |   | $ | 12,556 |   |
| Real  estate construction  |       | 118,183                         |       | 24.3                     | %          | 10,059 |   | 3,726 |   | 13,785 |   |
| Commercial  and industrial |       | 26,687                          |       | 5.5                      | %          | 423 |   | 1,396 |   | 1,819 |   |
| Consumer                   |       | 4,854                           |       | 1.0                      | %          | — |   | — |   | — |   |
|                       |       | $                               | 485,555    |                     | 100.0      | % | $ | 21,295 |   | $ | 6,865 |   | $ | 28,160 |   |

 

*RealEstate Mortgage Loans*.  Loans secured by real estatemortgages are the principal component of our loan portfolio.  Real estate loans are subject to the samegeneral risks as other loans and are particularly sensitive to fluctuations inthe value of real estate.  Fluctuationsin the value of real estate, as well as other factors arising after a loan hasbeen made, could negatively affect a borrower’s cash flow, creditworthiness andability to repay the loan.  We obtain asecurity interest in real estate whenever possible, in addition to any otheravailable collateral, in order to increase the likelihood of the ultimaterepayment of the loan.

 

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As of December 31,2009, loans secured by first or second mortgages on real estate comprisedapproximately $335.8 million, or 69.2%, of our loan portfolio.** **These loans willgenerally fall into one of two categories: residential real estate loans orcommercial real estate loans.

 

At December 31,2009, our real estate mortgage loan portfolio was comprised of the following:

 
| ** **                           | ** ** | **Loans**                       | ** **  | **Nonperforming Assets** | ** ** |
|--------------------------------------|------------|---------------------------------|-------------|--------------------------|------------|
| **Real  Estate Mortgage Loans**      | ** ** | **Balance  December  31, 2009** | ** **  | **% of  Loan  Category** | ** ** | **% of  Total  Loans** | ** ** | **Non-  accrual  Loans** | ** ** | **Other  Real  Estate** | ** ** | **Total Non-  performing  Assets** | ** ** |
| ** **                           | ** ** | **(dollars  in thousands)**     | ** **  |
| Residential  Real Estate             |       |                            |        |                     |       |   |   |   |   |   |   |   |   |
| Income  Producing Properties         |       | $                               | 53,304      |                     | 15.9       | % | 11.0 | % | $ | 3,883 |   | $ | 1,114 |   | $ | 4,997 |   |
| Owner-occupied                       |       |                            |        |                     |       |   |   |   |   |   |   |   |   |
| First  Lien                          |       | 50,104                          |        | 14.9                     | %          | 10.3 | % | 1,929 |   | 492 |   | 2,421 |   |
| Junior  Lien                         |       | 43,685                          |        | 13.0                     | %          | 9.0 | % | 1,091 |   | — |   | 1,091 |   |
| Speculative                          |       | 18,170                          |        | 5.4                      | %          | 3.7 | % | 3,376 |   | — |   | 3,376 |   |
| Total  Residential Real Estate       |       | 165,263                         |        | 49.2                     | %          | 34.0 | % | 10,279 |   | 1,606 |   | 11,885 |   |
| Commercial  Real Estate              |       |                            |        |                     |       |   |   |   |   |   |   |   |   |
| Income  Producing Properties         |       | 78,004                          |        | 23.2                     | %          | 16.1 | % | 400 |   | — |   | 400 |   |
| Owner-occupied                       |       |                            |        |                     |       |   |   |   |   |   |   |   |   |
| First  Lien                          |       | 71,659                          |        | 21.4                     | %          | 14.7 | % | 134 |   | 137 |   | 271 |   |
| Junior  Lien                         |       | 4,085                           |        | 1.2                      | %          | 0.9 | % | — |   | — |   | — |   |
| Speculative                          |       | 6,792                           |        | 2.0                      | %          | 1.4 | % | — |   | — |   | — |   |
| Multi-family                         |       | 10,028                          |        | 3.0                      | %          | 2.1 | % | — |   | — |   | — |   |
| Total  Commercial Real Estate        |       | 170,568                         |        | 50.8                     | %          | 35.2 | % | 534 |   | 137 |   | 671 |   |
| **Total Real Estate Mortgage Loans** | ** ** | **$**                           | **335,831** | ** **               | **100.0**  | **%** | **69.2** | **%** | **$** | **10,813** | ** ** | **$** | **1,743** | ** ** | **$** | **12,556** | ** ** |

 

·                  Residential Real Estate Loans.  We generally originate and hold short-termfirst mortgages and traditional second mortgage residential real estate loansand home equity lines of credit.  Withrespect to fixed and adjustable rate long-term residential real estate loanswith terms of up to 30 years, we typically only originate these loans forthird-party investors.  At December 31,2009, residential real estate mortgage loans amounted to $165.3 million, or34.0% of our loan portfolio.  Included inthese loans was $93.8 million, or 56.8% of our residential real estate loanportfolio, in first and second mortgages on individuals’ homes, of which $43.7million, or 26.4% of our residential real estate loan portfolio, was in homeequity loans.  At December 31, 2009,non owner-occupied loans amounted to $71.4 million, or 43.2% of our residentialreal estate portfolio, of which $53.3 million, or 32.3% of our residential realestate portfolio, was in income producing properties.  At December 31, 2009, our residentialreal estate loans balances ranged from approximately $1,000 to $4.3 million,with an average loan balance of approximately $262,000.  The majority of these loans are made onowner-occupied properties.  The nonowner-occupied loans had an average size of approximately $309,000.  Generally, at the inception of the loan, welimit the loan-to-value ratio on our residential real estate loans to 85%.  At December 31, 2009, our owner-occupiedresidential real estate secured by first and second mortgages ranged up toapproximately $3.1 million, with an average balance of approximately$234,000.  Our underwriting criteria for,and the risks associated with, home equity loans and lines of credit aregenerally the same as those for first mortgage loans.  Home equity lines of credit typically haveterms of 15 years or less and we generally limit the extension of credit toless than 90% of the available equity of each property, although in certainexceptions we may extend up to 100% of the available equity.

 

·                  Commercial Real Estate Loans. At December 31,2009, commercial real estate mortgage loans amounted to $170.6 million, orapproximately 35.2% of our loan portfolio. Included in these loans was $75.7 million, or 44.4% of our commercialreal estate loan portfolio, in first and second liens.  At December 31, 2009, non owner-occupiedloans amounted to $94.8 million, or 55.6% of our 

 

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commercial realestate portfolio, of which $78.0 million, or 45.7% of our commercial realestate portfolio, was in income producing properties.  At December 31, 2009, the outstandingbalances on individual commercial real estate loans ranged from approximately$9,000 to $5.7 million.  The nonowner-occupied loans ranged from approximately $10,000 to $5.7 million, with anaverage size of approximately $817,000. At December 31, 2009, our owner-occupied commercial real estateloans secured by first and second mortgages ranged from approximately $9,000 to$4.2 million, with an average balance of approximately $592,000.  We maintain loan relationships in excess ofthis size but have participated credits to correspondent banks to reduce ourexposure to single large lending relationships. The average commercial real estate loan balance was approximately$654,000.  These loans generally haveterms of five years or less, although payments may be structured on a longeramortization basis.  We evaluate eachborrower on an individual basis and attempt to determine the business risks andcredit profile of each borrower.  Weattempt to reduce credit risk in the commercial real estate portfolio byemphasizing loans on owner-occupied office buildings where the loan-to-valueratio, established by independent appraisals, does not exceed 85%.  We also generally require that a borrower’scash flow exceeds 125% of monthly debt service obligations.  In order to ensure secondary sources ofpayment and liquidity to support a loan request, we typically review all of thepersonal financial statements of the principal owners and require theirpersonal guarantees.

 

*RealEstate Construction Loans. *We offer fixed and adjustable rateresidential and commercial construction loans to builders and developers and toconsumers who wish to build their own homes. The term of our construction and development loans generally is limitedto 18 months, although payments may be structured on a longer amortizationbasis.  Construction and developmentloans generally carry a higher degree of risk than long-term financing ofexisting properties because repayment depends on the ultimate completion of theproject and usually on the subsequent sale of the property.  Specific risks include:

 

·                  cost overruns;

·                  mismanaged construction;

·                  inferior or improper constructiontechniques;

·                  economic changes or downturns duringconstruction;

·                  a downturn in the real estate market;

·                  rising interest rates which may preventsale of the property; and

·                  failure to sell completed projects in atimely manner.

 

We attempt to reduce therisk associated with construction and development loans by obtaining personalguarantees and by keeping the loan-to-value ratio of the completed project ator below 85%.  Generally, we do not haveinterest reserves built into loan commitments but require periodic cashpayments for interest from the borrower’s cash flow.

 

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At December 31,2009, our real estate construction loans amounted to $118.2 million, or 24.3%of our total loan portfolio, and were comprised of the following:

 
| ** **                          | ** ** | **Loans**                       | ** **  | **Nonperforming Assets** | ** ** |
|-------------------------------------|------------|---------------------------------|-------------|--------------------------|------------|
| **Real  Estate Construction Loans** | ** ** | **Balance  December  31, 2009** | ** **  | **% of  Loan  Category** | ** ** | **% of  Total  Loans** | ** ** | **Non-  accrual  Loans** | ** ** | **Other  Real  Estate** | ** ** | **Total Non-  performing  Assets** | ** ** |
| ** **                          | ** ** | **(dollars  in thousands)**     | ** **  |
| Residential                         |       |                            |        |                     |       |   |   |   |   |   |   |   |   |
| Land                                |       |                            |        |                     |       |   |   |   |   |   |   |   |   |
| R/E  Vacant Land - Commercial       |       | $                               | 11,770      |                     | 10.0       | % | 2.4 | % | $ | 1,413 |   | $ | 213 |   | $ | 1,626 |   |
| R/E  Vacant Land - Consumer         |       | 340                             |        | 0.3                      | %          | 0.1 | % | — |   | — |   | — |   |
| R/E  Lot Loan - Commercial          |       | 936                             |        | 0.8                      | %          | 0.2 | % | 722 |   | 227 |   | 949 |   |
| R/E  Lot Loan - Consumer            |       | 1,007                           |        | 0.9                      | %          | 0.2 | % | 76 |   | — |   | 76 |   |
| LTV  Lot Loan Dev - Commercial      |       | 1,467                           |        | 1.2                      | %          | 0.3 | % | 346 |   | — |   | 346 |   |
| LTV  Lot Loan Dev - Consumer        |       | 3,832                           |        | 3.2                      | %          | 0.8 | % | 226 |   | — |   | 226 |   |
| Speculative                         |       | 47,534                          |        | 40.2                     | %          | 9.8 | % | 3,424 |   | 2,225 |   | 5,649 |   |
| Total  Land                         |       | 66,886                          |        | 56.6                     | %          | 13.8 | % | 6,207 |   | 2,665 |   | 8,872 |   |
| Construction                        |       |                            |        |                     |       |   |   |   |   |   |   |   |   |
| Owner-occupied                      |       |                            |        |                     |       |   |   |   |   |   |   |   |   |
| R/E  Pre-sold - Commercial          |       | 237                             |        | 0.2                      | %          | 0.0 | % | — |   | — |   | — |   |
| R/E  Res - Consumer                 |       | 8,081                           |        | 6.9                      | %          | 1.7 | % | — |   | 264 |   | 264 |   |
| Speculative                         |       |                            |        |                     |       |   |   |   |   |   |   |   |   |
| R/E  Speculative - Commercial       |       | 6,422                           |        | 5.4                      | %          | 1.3 | % | 480 |   | — |   | 480 |   |
| R/E  Speculative - Consumer         |       | 1,455                           |        | 1.2                      | %          | 0.3 | % | 1,455 |   | — |   | 1,455 |   |
| Total  Construction                 |       | 16,195                          |        | 13.7                     | %          | 3.3 | % | 1,935 |   | 264 |   | 2,199 |   |
| Total  R/E Residential Construction |       | 83,081                          |        | 70.3                     | %          | 17.1 | % | 8,142 |   | 2,929 |   | 11,071 |   |
| Commercial                          |       |                            |        |                     |       |   |   |   |   |   |   |   |   |
| Land                                |       |                            |        |                     |       |   |   |   |   |   |   |   |   |
| Vacant  Land                        |       | 1,126                           |        | 0.9                      | %          | 0.2 | % | — |   | — |   | — |   |
| Speculative                         |       | 28,111                          |        | 23.8                     | %          | 5.8 | % | 1,917 |   | 517 |   | 2,434 |   |
| Construction                        |       |                            |        |                     |       |   |   |   |   |   |   |   |   |
| Owner-occupied                      |       | 947                             |        | 0.8                      | %          | 0.2 | % | — |   | — |   | — |   |
| Speculative                         |       | 4,918                           |        | 4.2                      | %          | 1.0 | % | — |   | 280 |   | 280 |   |
| Total  R/E Commercial Construction  |       | 35,102                          |        | 29.7                     | %          | 7.2 | % | 1,917 |   | 797 |   | 2,714 |   |
| **Total Real Estate Construction**  | ** ** | **$**                           | **118,183** | ** **               | **100.0**  | **%** | **24.3** | **%** | **$** | **10,059** | ** ** | **$** | **3,726** | ** ** | **$** | **13,785** | ** ** |

 

Residential land loansare made to both commercial entities and consumer borrowers for the purpose offinancing land upon which to build a residential home.  At December 31, 2009, total real estateconstruction loans ranged from approximately $4,000 to $3.7 million, with anaverage balance of approximately $356,000.

 

Residential land loansare reclassified as residential construction loans once construction of theresidential home commences.  These loansare further categorized as (i) pre-sold commercial, which is a loan to acommercial entity with a pre-identified buyer for the finished home, (ii) owner-occupiedconsumer, which is a loan to an individual who intends to occupy the finishedhome and (iii) non owner-occupied commercial (speculative), which is aloan to a commercial entity intending to lease or sell the finished home.  At December 31, 2009, residential landloans ranged from approximately $11,000 to $3.0 million, with an averagebalance of approximately $288,000.  At December 31,2009, residential construction loans ranged from approximately $4,000 to $3.3million, with an average balance of approximately $450,000.

 

Commercial land loans aremade to commercial entities for the purpose of financing land upon which tobuild a commercial project.  These loansare for projects that typically involve small and medium sized single andmulti-use commercial buildings.  At December 31,2009, these loans ranged from approximately $30,000 to $3.7 million, with anaverage balance of approximately $522,000.

 

Commercial constructionloans are made to the borrower for the purpose of financing the construction ofa commercial development.  These loansare further categorized depending on whether the borrower intends to occupy 

 

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the finished development(owner-occupied) or whether the borrower intends to lease or sell the finisheddevelopment (non owner-occupied).  At December 31,2009, these loans ranged from approximately $195,000 to $2.7 million, with anaverage balance of approximately $733,000.

 

*Commercialand Industrial Loans*.  At December 31, 2009, these loansamounted to $26.7 million, or 5.5% of our total loan portfolio.  At December 31, 2009, outstandingbalances on these loans ranged from $2,000 to $1.5 million, with an averageloan balance of approximately $95,000. We make loans for commercial purposes in various lines of businesses,including the manufacturing industry, service industry and professional serviceareas.  These loans are generallyconsidered to have greater risk than first or second mortgages on real estatebecause these loans may be unsecured or, if they are secured, the value of thecollateral may be difficult to assess and more likely to decrease than realestate.

 

We are eligible to offersmall business loans utilizing government enhancements such as the SmallBusiness Administration’s (“SBA”) 7(a) program and SBA’s 504programs.  These loans typically arepartially guaranteed by the government, which helps to reduce their risk.  Government guarantees of SBA loans do notexceed, and are generally less than, 80% of the loan.  As of December 31, 2009, we had notoriginated any small business loans utilizing government enhancements.

 

*ConsumerLoans*.  At December 31, 2009, consumer loansamounted to $4.9 million, or 1.0% of our loan portfolio.  At December 31, 2009, the outstandingbalance on our individual consumer loans ranged up to approximately $498,000,with an average loan balance of approximately $17,000.  We make a variety of loans to individuals forpersonal and household purposes, including secured and unsecured installmentloans and revolving lines of credit. Consumer loans are underwritten based on the borrower’s income, currentdebt level, past credit history and the availability and value ofcollateral.  Consumer rates are bothfixed and variable, with negotiable terms. Our installment loans typically amortize over periods up to 60months.  Although we typically requiremonthly payments of interest and a portion of the principal on our loanproducts, we will offer consumer loans with a single maturity date when aspecific source of repayment is available. Consumer loans are generally considered to have greater risk than firstor second mortgages on real estate because they may be unsecured, or, if theyare secured, the value of the collateral may be difficult to assess and morelikely to decrease in value than real estate.

 

*Loan PortfolioComposition*.  We provide loans for various uses, includingcommercial and residential real estate, business purposes, personal use, homeimprovement, automobiles, as well as letters of credit and home equity lines ofcredit.  Historically, we had aconcentration of commercial real estate and acquisition, development andconstruction loans.  Our strategy goingforward is to diversify our loan portfolio by focusing on increases in ourowner-occupied lending.  We will alsostrive to continue to limit the amount of our loans to any singlecustomer.  At December 31, 2009, wehad approximately 1,788 loans, with an average loan balance of approximately$272,000.  As of December 31, 2009,our 10 largest customer loan relationships represented approximately $65.3million, or 13.4% of our loan portfolio. We believe that operating in three separate and distinct market areasalong the South Carolina coast will provide long-term loan portfoliodiversification.  At December 31,2009, our loan portfolio was positioned within our major markets as follows:Charleston — 73.7%; Myrtle Beach — 16.7%; Hilton Head — 9.6%.  As market conditions improve, we believe thatthe diversity of economic activity in our primary markets will tend to mitigateeconomic volatility, which, together with the variety of purposes for which wemake loans, will reduce our risks of loss.

 

*Underwriting. *When we opened our bank, we introduced a strong creditculture based on traditional credit measures and our veteran bankers’ intimateknowledge of our markets.  We have adisciplined approach to underwriting and focus on multiple sources ofrepayment, including personal guarantees. Our underwriting standards vary for each type of loan.  While we generally underwrite the loans inour portfolio in accordance with our own internal underwriting guidelines andregulatory supervisory guidelines, in certain circumstances we have made loanswhich exceed either our internal underwriting guidelines, supervisoryguidelines, or both.   We are permittedto hold loans that exceed supervisory guidelines up to 100% of bank capital, or$58.0 million at December 31, 2009. As such, $77.4 million, or 15.9%, of our loans had loan-to-value ratiosthat exceeded regulatory supervisory guidelines, of which 64 loans totalingapproximately $23.2 million at inception had loan-to-value ratios of 100% ormore.  In addition, supervisory limits oncommercial loan-to-value exceptions are set at 30% of capital.  At December 31, 2009, $39.3 million ofour commercial loans, or 67.8% of the bank’s capital, exceeded the 

 

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supervisory loan-to-valueratio.  The exceptions are approved basedon a combination of debt service ability, liquidity and overall balance sheetstrength of the borrower.  The frequencyof pre-approved exceptions has decreased due to the erosion in potentialborrowers’ balance sheet strength, liquidity and income due to the currenteconomic conditions.  The bank expectsthis trend to continue while economic conditions remain recessionary.  Recently, however, the bank has experiencedan increase in unintended loan-to-value exceptions in existing bank loans dueto updated appraisals on loans, where the value of the applicable collateral,has decreased.

 

*LoanApproval.*  Certain credit risks are inherent in makingloans.  These include prepayment risks,risks resulting from uncertainties in the future value of collateral, risksresulting from changes in economic and industry conditions, and risks inherentin dealing with individual borrowers.  Weattempt to mitigate repayment risks by adhering to internal credit policies andprocedures.  These policies andprocedures include officer and customer lending limits, a multi-layeredapproval process for larger loans, documentation examination and follow-upprocedures for any exceptions to credit policies.  Our loan approval policies provide forvarious levels of officer lending authority. When the amount of aggregate loans to a single borrower exceeds anindividual officer’s lending authority, the loan request will be reviewed by anofficer with a higher lending authority. Between the Chief Executive Officer, Senior Credit Officer and ChiefCredit Officer, any two may combine their authority to approve credits up to$1.5 million.  If the loans exceed $1.5million, then a loan committee comprised of Mr. Coffee and four outsidedirectors may approve the loans up to 10% of the bank’s capital andsurplus.  All loans in excess of thislending limit will be submitted for approval to the entire board of directorsof the bank.  We do not make any loans toany director, executive officer, or principal shareholder, and the relatedinterests of each, of the bank unless the loan is approved by the disinterestedmembers of the board of directors of the bank and is on terms not morefavorable to such person than would be available to a similarly situated personnot affiliated with the bank.

 

*CreditAdministration and Loan Review.*  We maintain acontinuous loan review process.  We applya credit grading system to each loan, and utilize an independent consultant ona semi-annual basis to review the loan underwriting on a test basis to confirmthe grading of each loan.  Each loanofficer is responsible for each loan he or she makes, regardless of whetherother individuals or committees joined in the approval.  This responsibility continues until the loanis repaid or until the loan is officially assigned to another officer.  We also maintain a separate construction loanmanagement department that operates independently from our lenders and isresponsible for authorizing draws and the continuing oversight during theconstruction process.

 

Webelieve that our robust credit administration and risk management programs thatwe implemented at the portfolio level have allowed us to identify problem areasand respond quickly, decisively, and more aggressively than some of our peerinstitutions.  In response to thedeteriorating economic conditions, we took several steps during the firstquarter of 2009 to improve credit administration.  We designated a special assets officer tomanage problem loans, instituted weekly meetings between senior credit managersand regional executives to discuss action plans for past due credits, andinitiated monthly criticized/classified asset meetings between executivemanagement and all lending officers.  Atthe monthly criticized/classified asset meetings, specific action plans arediscussed with respect to each loan rated “special mention” or worse.  We have also aggressively pursued updatedappraisals, and where appropriate, modified loan terms to facilitate continuedperformance of the credit.

 

*LendingLimits.*  Our lending activities are subject to avariety of lending limits imposed by federal law.  In general, the bank is subject to a legallimit on loans to a single borrower equal to 15% of the bank’s capital andunimpaired surplus.  This limit willincrease or decrease as the bank’s capital increases or decreases.  Based upon the capitalization of the bank at December 31,2009, our legal lending limit was approximately $8.7 million.  Even though our legal lending limit was $8.7million, we maintained an internal lending limit of $5.2 million.  Historically, we have been able to sellparticipations in our larger loans to other financial institutions, which hasallowed us to manage the risk involved in these loans and to meet the lendingneeds of our customers requiring extensions of credit in excess of theselimits.  In the current economicenvironment, however, it has been difficult to sell participations to otherfinancial institutions.  We expect tosell participations only on a limited basis going forward.

 

**Deposit Products**

 

We offer a full range ofdeposit services that are typically available in most banks and savings institutions,

 

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including checkingaccounts, commercial accounts, savings accounts and other time deposits ofvarious types, ranging from daily money market accounts to longer-termcertificates of deposit.  Transactionaccounts and time deposits are tailored to and offered at rates competitive tothose offered in our primary market areas. In addition, we offer certain retirement account services, such as IRAs.  We solicit accounts from individuals,businesses, associations, organizations and governmental authorities.  We believe that our branch infrastructurewill assist us in obtaining retail deposits from local customers in thefuture.  Our retail deposits haveincreased to $401.6 million at December 31, 2009 from $277.1 million at December 31,2008.  Our retail deposits at December 31,2009 were 67.9% of our total deposits compared to 49.4% of our total depositsat December 31, 2008.

 

The following table showsour deposit mix at December 31, 2009 and December 31, 2008:

 
| ** **                           | ** ** | **At  December 31, 2009** | ** ** | **At  December 31, 2008** | ** ** | **Year-Over-Year  Growth** | ** ** | **Average  Rate at**     | ** ** |
|--------------------------------------|------------|--------------------------------|------------|--------------------------------|------------|----------------------------|------------|--------------------------|------------|
| ** **                           | ** ** | **Amount**                     | ** ** | **Percentage  of Total**       | ** ** | **Amount**                 | ** ** | **Percentage  of Total** | ** ** | **Amount** | ** ** | **Percentage** | ** ** | **December 31,  2009** | ** ** |
| ** **                           | ** ** | **(dollars  in thousands)**    | ** ** |
| Retail  Deposits                     |       |                           |       |                           |       |                       |       |                     |       |   |   |   |   |   |   |
| Noninterest  bearing demand deposits |       | $                              | 16,971     |                           | 2.9        | %                          | $          | 12,133                   |       | 2.2 | % | $ | 4,838 |   | 39.9 | % | — | % |
| Interest  bearing demand deposits    |       | 29,688                         |       | 5.0                            | %          | 46,987                     |       | 8.4                      | %          | (17,299 | ) | (36.8 | )% | 1.58 | % |
| Savings  and money market accounts   |       | 160,773                        |       | 27.2                           | %          | 34,971                     |       | 6.2                      | %          | 125,802 |   | 359.7 | % | 1.87 | % |
| Time  deposits less than $100,000    |       | 89,944                         |       | 15.2                           | %          | 92,400                     |       | 16.5                     | %          | (2,456 | ) | (2.7 | )% | 3.39 | % |
| Time  deposits greater than $100,000 |       | 104,257                        |       | 17.6                           | %          | 90,577                     |       | 16.1                     | %          | 13,680 |   | 15.1 | % | 3.32 | % |
| Total Retail Deposits                |       | 401,633                        |       | 67.9                           | %          | 277,068                    |       | 49.4                     | %          | 124,565 |   | 45.0 | % | 2.63 | % |
| Wholesale  Deposits                  |       |                           |       |                           |       |                       |       |                     |       |   |   |   |   |   |   |
| Savings  and money market accounts   |       | 76,817                         |       | 13.0                           | %          | 147,885                    |       | 26.3                     | %          | (71,068 | ) | (48.1 | )% | 1.59 | % |
| Time  deposits less than $100,000    |       | 111,381                        |       | 18.8                           | %          | 134,024                    |       | 23.9                     | %          | (22,643 | ) | (16.9 | )% | 2.45 | % |
| Time  deposits greater than $100,000 |       | 1,718                          |       | 0.3                            | %          | 2,248                      |       | 0.4                      | %          | (530 | ) | (23.6 | )% | 3.32 | % |
| Total Wholesale Deposits             |       | 189,916                        |       | 32.1                           | %          | 284,157                    |       | 50.6                     | %          | (94,241 | ) | (33.2 | )% | 2.04 | % |
| Total Deposits                       |       | $                              | 591,549    |                           | 100.0      | %                          | $          | 561,225                  |       | 100.0 | % | $ | 30,324 |   | 5.4 | % | 2.37 | % |

 

**Other Banking Services**

 

We also offerother bank services including safe deposit boxes, traveler’s checks, directdeposit, United States Savings Bonds and banking by mail.  We are associated with the Cirrus,Master-Money, Pulse and Subswitch ATM networks,****whichare available to our customers throughout the country.  We believe that by being associated with ashared network of ATMs, we are better able to serve our customers and are ableto attract customers who are accustomed to the convenience of using ATMs,although we do not believe that maintaining this association is critical to oursuccess.  In addition, we offer courierdeposit service for commercial customers and banking hours, from 8:30 a.m.to 5:00 p.m. daily.  We also offerinternet banking services, bill payment services and cash management services,along with remote deposit capture and ACH origination.  We currently exercise trust powers as trusteefor the Tidelands Bancshares, Inc. Employee Stock Ownership Plan, but donot expect to exercise retail trust powers during our next few years ofoperation.

 

**Competition**

 

The banking business is highly competitive, and weexperience competition in our market areas from many 

 

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other financial institutions.  Competition among financial institutions isbased upon interest rates offered on deposit accounts, interest rates chargedon loans, other credit and service charges relating to loans, the quality andscope of the services rendered, the convenience of banking facilities, and, inthe case of loans to commercial borrowers, relative lending limits.  We compete with commercial banks, creditunions, savings institutions, mortgage banking firms, consumer financecompanies, securities brokerage firms, insurance companies, money market fundsand other mutual funds, as well as other super-regional, national andinternational financial institutions that operate offices in our market areasand elsewhere.

 

As of June 30, 2009, there were 29 financialinstitutions other than us in the Charleston market area, 29 in the MyrtleBeach market area and 24 in the Hilton Head market area.  We compete with these institutions both inattracting deposits and in making loans. In addition, we have to attract our customer base from other existingfinancial institutions and from new residents. Many of our competitors are well-established, larger financialinstitutions, such as BB&T, Bank of America, Wells Fargo, Carolina FirstBank and South Carolina Bank & Trust. These institutions offer some services, such as extensive andestablished branch networks and trust services, which we do not provide.  In addition, many of our non-bank competitorsare not subject to the same extensive federal regulations that govern bankholding companies and federally insured banks.

 

**Employees**

 

As of December 31,2009, we had 83 full-time employees and 3 part-time employees.

 

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**SUPERVISIONAND REGULATION**

 

Both Tidelands Bancshares, Inc.and Tidelands Bank are subject to extensive state and federal bankingregulations that impose restrictions on and provide for general regulatoryoversight of their operations.  Theselaws generally are intended to protect depositors and not shareholders.  The following summary is qualified byreference to the statutory and regulatory provisions discussed.  Changes in applicable laws or regulations mayhave a material effect on our business and prospects.  Our operations may be affected by legislativechanges and the policies of various regulatory authorities.  We cannot predict the effect that fiscal ormonetary policies, economic control or new federal or state legislation mayhave on our business and earnings in the future.

 

The following discussionis not intended to be a complete list of all the activities regulated by thebanking laws or of the impact of such laws and regulations on ouroperations.  It is intended only tobriefly summarize some material provisions. Please refer to Management’s Discussion and Analysis or Plan ofOperation for a discussion of regulatory updates in the section entitled, “Recent Legislative and Regulatory Initiativesto Address Financial and Economic Crises.”

 

**Tidelands Bancshares, Inc.**

 

We own 100% of theoutstanding capital stock of the bank, and therefore we are required to beregistered as a bank holding company under the federal Bank Holding Company Actof 1956 (the “Bank Holding Company Act”). As a result, we are primarily subject to the supervision, examinationand reporting requirements of the Board of Governors of the Federal Reserve(the “Federal Reserve”) under the Bank Holding Company Act and its regulationspromulgated thereunder.  As a bankholding company located in South Carolina, the South Carolina State Board ofFinancial Institutions also regulates and monitors all significant aspects ofour operations.

 

***Permitted Activities.***  Under the Bank Holding Company Act, a bankholding company is generally permitted to engage in, or acquire direct orindirect control of more than 5% of the voting shares of any company engagedin, the following activities:

 

·                  banking or managing or controlling banks;

 

·                  furnishing services to or performingservices for our subsidiaries; and

 

·                  any activity that the Federal Reservedetermines to be so closely related to banking as to be a proper incident tothe business of banking.

 

Activities that theFederal Reserve has found to be so closely related to banking as to be a properincident to the business of banking include:

 

·                  factoring accounts receivable;

 

·                  making, acquiring, brokering or servicingloans and usual related activities;

 

·                  leasing personal or real property;

 

·                  operating a non-bank depositoryinstitution, such as a savings association;

 

·                  trust company functions;

 

·                  financial and investment advisoryactivities;

 

·                  conducting discount securities brokerageactivities;

 

·                  underwriting and dealing in governmentobligations and money market instruments;

 

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·                  providing specified management consultingand counseling activities;

 

·                  performing selected data processingservices and support services;

 

·                  acting as agent or broker in sellingcredit life insurance and other types of insurance in connection with credittransactions; and

 

·                  performing selected insuranceunderwriting activities.

 

As a bank holding company we also can elect to be treated as a “financialholding company,” which would allow us to engage in a broader array ofactivities.  In sum, a financial holdingcompany can engage in activities that are financial in nature or incidental orcomplementary to financial activities, including insurance underwriting, salesand brokerage activities, providing financial and investment advisory services,underwriting services and limited merchant banking activities.  We have not sought financial holding companystatus, but may elect such status in the future as our business matures.  If we were to elect in writing for financialholding company status, each insured depository institution we control wouldhave to be well capitalized, well managed and have at least a satisfactoryrating under the CRA (discussed below).

 

The Federal Reserve hasthe authority to order a bank holding company or its subsidiaries to terminateany of these activities or to terminate its ownership or control of anysubsidiary when it has reasonable cause to believe that the bank holdingcompany’s continued ownership, activity or control constitutes a serious riskto the financial safety, soundness or stability of it or any of its banksubsidiaries.

 

***Change in Control****. *Inaddition, and subject to certain exceptions, the Bank Holding Company Act andthe Change in Bank Control Act, together with regulations promulgated thereunder, require Federal Reserve approval prior to any person or companyacquiring “control” of a bank holding company. Control is conclusively presumed to exist if an individual or companyacquires 25% or more of any class of voting securities of a bank holdingcompany.  Following the relaxing of theserestrictions by the Federal Reserve in September 2008, control will berebuttably presumed to exist if a person acquires more than 33% of the totalequity of a bank or bank holding company, of which it may own, control or havethe power to vote not more than 15% of any class of voting securities.

 

***Sourceof Strength****.*  In accordance with Federal Reserve Boardpolicy, we are expected to act as a source of financial strength to the bankand to commit resources to support the bank in circumstances in which we mightnot otherwise do so.  If the bank were tobecome “undercapitalized” (see below “Tidelands Bank - Prompt Corrective Action”),we would be required to provide a guarantee of the bank’s plan to return tocapital adequacy.  Additionally, underthe Bank Holding Company Act, the Federal Reserve Board may require a bankholding company to terminate any activity or relinquish control of a nonbanksubsidiary, other than a nonbank subsidiary of a bank, upon the Federal ReserveBoard’s determination that such activity or control constitutes a serious riskto the financial soundness or stability of any depository institutionsubsidiary of the bank holding company. Further, federal bank regulatory authorities have additional discretionto require a bank holding company to divest itself of any bank or nonbanksubsidiaries if the agency determines that divestiture may aid the depositoryinstitution’s financial condition. Further, any loans by a bank holding company to a subsidiary bank aresubordinate in right of payment to deposits and certain other indebtedness ofthe subsidiary bank.  In the event of abank holding company’s bankruptcy, any commitment by the bank holding companyto a federal bank regulatory agency to maintain the capital of a subsidiarybank at a certain level would be assumed by the bankruptcy trustee and entitledto priority payment.

 

***CapitalRequirements.***  The Federal Reserve Board imposes certaincapital requirements on the bank holding company under the Bank Holding CompanyAct, including a minimum leverage ratio and a minimum ratio of “qualifying”capital to risk-weighted assets.  Theserequirements are essentially the same as those that apply to the bank and aredescribed below under “Tidelands Bank — Prompt Corrective Action.”  Subject to our capital requirements andcertain other restrictions, we are able to borrow money to make a capitalcontribution to the bank, and these loans may be repaid from dividends paidfrom the bank to the company.  Ourability to pay dividends depends on the bank’s ability to pay dividends to us,which is subject to regulatory restrictions as described below in 

 

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“Tidelands Bank —Dividends.”  We are also able to raisecapital for contribution to the bank by issuing securities without having toreceive regulatory approval, subject to compliance with federal and statesecurities laws.

 

***SouthCarolina State Regulation.***  As a SouthCarolina bank holding company under the South Carolina Banking and BranchingEfficiency Act, we are subject to limitations on sale or merger and toregulation by the South Carolina State Board of Financial Institutions.  We are not required to obtain the approval ofthe South Carolina Board prior to acquiring the capital stock of a nationalbank, but we must notify them at least 15 days prior to doing so.  We must receive the South Carolina Board’sapproval prior to engaging in the acquisition of a South Carolina state charteredbank or another South Carolina bank holding company.

 

**Tidelands Bank**

 

The bank operates as astate bank incorporated under the laws of the State of South Carolina and issubject to examination by the South Carolina State Board of FinancialInstitutions and the Federal Deposit Insurance Corporation (the “FDIC”).  Deposits in the bank are insured by the FDICup to a maximum amount, which is currently $250,000 for each non-retirementdepositor (though December 31, 2013) and $250,000 for certain retirement-accountdepositors.  The bank is participating inthe FDIC’s Temporary Liquidity Guarantee Program, which is discussed in greaterdetail above under the heading “RecentLegislative and Regulatory Initiatives to Address Financial and EconomicCrises, which, in part, fully insures non-interest bearing transactionaccounts.

 

The South Carolina StateBoard of Financial Institutions and the FDIC regulate or monitor virtually allareas of the bank’s operations, including:

 

·                  security devices and procedures;

 

·                  adequacy of capitalization and loss reserves;

 

·                  loans;

 

·                  investments;

 

·                  borrowings;

 

·                  deposits;

 

·                  mergers;

 

·                  issuances of securities;

 

·                  payment of dividends;

 

·                  interest rates payable on deposits;

 

·                  interest rates or fees chargeable on loans;

 

·                  establishment of branches;

 

·                  corporate reorganizations;

 

·                  maintenance of books and records; and

 

·                  adequacy of staff training to carry on safe lending and depositgathering practices.

 

The South Carolina StateBoard of Financial Institutions requires the bank to maintain specified capitalratios and imposes limitations on the bank’s aggregate investment in realestate, bank premises, and furniture and 

 

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fixtures.  The South Carolina State Board of FinancialInstitutions also requires the bank to prepare quarterly reports on the bank’sfinancial condition in compliance with its minimum standards and procedures.

 

All insured institutionsmust undergo regular on site examinations by their appropriate bankingagency.  The cost of examinations ofinsured depository institutions and any affiliates may be assessed by theappropriate agency against each institution or affiliate as it deems necessaryor appropriate.  Insured institutions arerequired to submit annual reports to the FDIC, their federal regulatory agency,and their state supervisor when applicable. The FDIC has developed a method for insured depository institutions toprovide supplemental disclosure of the estimated fair market value of assetsand liabilities, to the extent feasible and practicable, in any balance sheet,financial statement, report of condition or any other report of any insureddepository institution.  The FDICImprovement Act also requires the federal banking regulatory agencies toprescribe, by regulation, standards for all insured depository institutions anddepository institution holding companies relating, among other things, to thefollowing:

 

·                  internal controls;

 

·                  information systems and audit systems;

 

·                  loan documentation;

 

·                  credit underwriting;

 

·                  interest rate risk exposure; and

 

·                  asset quality.

 

***Prompt Corrective Action. ***As aninsured depository institution, the bank is required to comply with the capitalrequirements promulgated under the Federal Deposit Insurance Act and theregulations thereunder, which set forth****five capitalcategories, each with specific regulatory consequences.  Under these regulations, the categories are:

 

·                  Well Capitalized — The institution exceeds the required minimum levelfor each relevant capital measure.  Awell capitalized institution is one (i) having a total capital ratio of10% or greater, (ii) having a tier 1 capital ratio of 6% or greater, (iii) havinga leverage capital ratio of 5% or greater and (iv) that is not subject toany order or written directive to meet and maintain a specific capital levelfor any capital measure.

 

·                  Adequately Capitalized — The institution meets the required minimumlevel for each relevant capital measure. No capital distribution may be made that would result in the institutionbecoming undercapitalized.  An adequatelycapitalized institution is one (i) having a total capital ratio of 8% orgreater, (ii) having a tier 1 capital ratio of 4% or greater and (iii) havinga leverage capital ratio of 4% or greater or a leverage capital ratio of 3% orgreater if the institution is rated composite 1 under the CAMELS (Capital,Assets, Management, Earnings, Liquidity and Sensitivity to market risk) ratingsystem.

 

·                  Undercapitalized — The institution fails to meet the required minimumlevel for any relevant capital measure. An undercapitalized institution is one (i) having a total capitalratio of less than 8% or (ii) having a tier 1 capital ratio of less than4% or (iii) having a leverage capital ratio of less than 4%, or if theinstitution is rated a composite 1 under the CAMELS rating system, a leveragecapital ratio of less than 3%.

 

·                  Significantly Undercapitalized — The institution is significantly belowthe required minimum level for any relevant capital measure.  A significantly undercapitalized institutionis one (i) having a total capital ratio of less than 6% or (ii) havinga tier 1 capital ratio of less than 3% or (iii) having a leverage capitalratio of less than 3%.

 

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·                  Critically Undercapitalized — The institution fails to meet a criticalcapital level set by the appropriate federal banking agency.  A critically undercapitalized institution isone having a ratio of tangible equity to total assets that is equal to or lessthan 2%.

 

If the FDIC determines, after notice and an opportunity for hearing,that the bank is in an unsafe or unsound condition, the regulator is authorizedto reclassify the bank to the next lower capital category (other thancritically undercapitalized) and require the submission of a plan to correctthe unsafe or unsound condition.

 

If the bank is not wellcapitalized, it cannot accept brokered deposits without prior FDICapproval.  Even if approved, raterestrictions apply governing the rate the bank may be permitted to pay on thebrokered deposits.  In addition, a bankthat is undercapitalized cannot offer an effective yield in excess of 75 basispoints over the “national rate” paid on deposits (including brokered deposits,if approval is granted for the bank to accept them) of comparable size andmaturity.  The “national rate” is definedas a simple average of rates paid by insured depository institutions andbranches for which data are available and is published weekly by the FDIC.  Institutions subject to the restrictions thatbelieve they are operating in an area where the rates paid on deposits arehigher than the “national rate” can use the local market to determine theprevailing rate if they seek and receive a determination from the FDIC that itis operating in a high-rate area. Regardless of the determination, institutions must use the national rateto determine conformance for all deposits outside their market area.

 

Moreover, if the bank becomes less than adequately capitalized, it mustadopt a capital restoration plan acceptable to the FDIC.  The bank also would become subject toincreased regulatory oversight, and is increasingly restricted in the scope ofits permissible activities.  Each companyhaving control over an undercapitalized institution also must provide a limitedguarantee that the institution will comply with its capital restorationplan.  Except under limited circumstancesconsistent with an accepted capital restoration plan, an undercapitalizedinstitution may not grow.  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.  The appropriate federal banking agency maytake any action authorized for a significantly undercapitalized institution ifan undercapitalized institution fails to submit an acceptable capitalrestoration plan or fails in any material respect to implement a plan acceptedby 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 depository institution may not pay a management fee to abank holding company controlling that institution or any other person havingcontrol of the institution if, after making the payment, the institution, wouldbe undercapitalized.  In addition, aninstitution cannot make a capital distribution, such as a dividend or otherdistribution that is in substance a distribution of capital to the owners ofthe institution if following such a distribution the institution would beundercapitalized.  Thus, if payment ofsuch a management fee or the making of such would cause the bank to becomeundercapitalized, it could not pay a management fee or dividend to us.

 

As of December 31, 2009, the bank was deemed to be “wellcapitalized.”

 

***Transactionswith Affiliates and Insiders.***  The company isa legal entity separate and distinct from the bank and its othersubsidiaries.  Various legal limitationsrestrict the bank from lending or otherwise supplying funds to the company orits non-bank subsidiaries.  The companyand the bank are subject to Sections 23A and 23B of the Federal Reserve Act andFederal Reserve Regulation W.  Section 23Aof the Federal Reserve Act places limits on the amount of loans or extensionsof credit to, or investments in, or certain other transactions with, affiliatesand on the amount of advances to third parties collateralized by the securitiesor obligations of affiliates.  Theaggregate of all covered transactions is limited in amount, as to any oneaffiliate, to 10% of the bank’s capital and surplus and, as to all affiliatescombined, to 20% of the bank’s capital and surplus.  Furthermore, within the foregoing limitationsas to amount, each covered transaction must meet specified collateralrequirements.  The bank is forbidden topurchase low quality assets from an affiliate.

 

Section 23B of theFederal Reserve Act, among other things, prohibits an institution from engagingin certain transactions with certain affiliates unless the transactions are onterms substantially the same, or at least as 

 

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favorable to suchinstitution or its subsidiaries, as those prevailing at the time for comparabletransactions with nonaffiliated companies.

 

Regulation W generallyexcludes all non-bank and non-savings association subsidiaries of banks fromtreatment as affiliates, except to the extent that the Federal Reserve Boarddecides to treat these subsidiaries as affiliates.  The regulation also limits the amount ofloans that can be purchased by a bank from an affiliate to not more than 100%of the bank’s capital and surplus.

 

The bank is also subjectto certain restrictions on extensions of credit to executive officers,directors, certain principal shareholders, and their related interests.  Such extensions of credit (i) must bemade on substantially the same terms, including interest rates and collateral,as those prevailing at the time for comparable transactions with third partiesand (ii) must not involve more than the normal risk of repayment orpresent other unfavorable features.

 

***Branching****.*  Under currentSouth Carolina law, we may open branch offices throughout South Carolina withthe prior approval of the South Carolina State Board of FinancialInstitutions.  In addition, with priorregulatory approval, the bank will be able to acquire existing bankingoperations in South Carolina. Furthermore, federal legislation has been passed that permits interstatebranching by banks if allowed by state law, and interstate merging bybanks.  However, South Carolina law, withlimited exceptions, currently permits branching across state lines only throughinterstate mergers.

 

***Anti-TyingRestrictions***.  Under amendments to the Bank Holding CompanyAct and Federal Reserve regulations, a bank is prohibited from engaging incertain tying or reciprocity arrangements with its customers.  In general, a bank may not extend credit,lease, sell property, or furnish any services or fix or vary the considerationfor these on the condition that (i) the customer obtain or provide someadditional credit, property, or services from or to the bank, the bank holdingcompany or subsidiaries thereof or (ii) the customer may not obtain someother credit, property, or services from a competitor, except to the extentreasonable conditions are imposed to assure the soundness of the creditextended.  Certain arrangements arepermissible: a bank may offer combined-balance products and may otherwise offermore favorable terms if a customer obtains two or more traditional bankproducts; and certain foreign transactions are exempt from the generalrule.  A bank holding company or any bankaffiliate also is subject to anti-tying requirements in connection withelectronic benefit transfer services.

 

***CommunityReinvestment Act****.*  The Community Reinvestment Act requires that,in connection with examinations of financial institutions within theirrespective jurisdictions, a financial institution’s primary regulator, which isthe FDIC for the bank, shall evaluate the record of each financial institutionin meeting the credit needs of its local community, including low and moderateincome neighborhoods.  These factors arealso considered in evaluating mergers, acquisitions and applications to open abranch or facility.  Failure toadequately meet these criteria could impose additional requirements andlimitations on our bank.  Additionally,we must publicly disclose the terms of various Community ReinvestmentAct-related agreements.

 

***FinanceSubsidiaries.***  Under the Gramm-Leach-Bliley Act (the “GLBA”),subject to certain conditions imposed by their respective banking regulators,national and state-chartered banks are permitted to form “financialsubsidiaries” that may conduct financial or incidental activities, therebypermitting bank subsidiaries to engage in certain activities that previouslywere impermissible.  The GLBA imposesseveral safeguards and restrictions on financial subsidiaries, including thatthe parent bank’s equity investment in the financial subsidiary be deductedfrom the bank’s assets and tangible equity for purposes of calculating the bank’scapital adequacy.  In addition, the GLBAimposes new restrictions on transactions between a bank and its financialsubsidiaries similar to restrictions applicable to transactions between banksand non-bank affiliates.

 

***ConsumerProtection Regulations.*** Activities ofthe bank are subject to a variety of statutes and regulations designed toprotect consumers.  Interest and other chargescollected or contracted for by the bank are subject to state usury laws andfederal laws concerning interest rates. The bank’s loan operations are also subject to federal laws applicableto credit transactions, such as the:

 

·                  The federal Truth-In-Lending Act, governing disclosures of credit termsto consumer borrowers;

 

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·                  The Home Mortgage Disclosure Act of 1975, requiring financialinstitutions to provide information to enable the public and public officialsto determine whether a financial institution is fulfilling its obligation tohelp meet the housing needs of the community it serves;

 

·                  The Equal Credit Opportunity Act, prohibiting discrimination on thebasis of race, creed or other prohibited factors in extending credit;

 

·                  The Fair Credit Reporting Act of 1978, as amended by the Fair andAccurate Credit Transactions Act, governing the use and provision ofinformation to credit reporting agencies, certain identity theft protectionsand certain credit and other disclosures;

 

·                  The Fair Debt Collection Act, governing the manner in which consumerdebts may be collected by collection agencies; and

 

·                  The rules and regulations of the various federal agencies chargedwith the responsibility of implementing these federal laws.

 

The deposit operations ofthe bank also are subject to:

 

·                  the Right to Financial Privacy Act, which imposes a duty to maintainconfidentiality of consumer financial records and prescribes procedures for complyingwith administrative subpoenas of financial records; and

 

·                  the Electronic Funds Transfer Act and Regulation E issued by theFederal Reserve Board to implement that Act, which governs automatic depositsto and withdrawals from deposit accounts and customers’ rights and liabilitiesarising from the use of automated teller machines and other electronic bankingservices.

 

***EnforcementPowers.***  The bank and its “institution-affiliatedparties,” including its management, employees, agents, independent contractors,and consultants such as attorneys and accountants and others who participate inthe conduct of the financial institution’s affairs, are subject to potentialcivil and criminal penalties for violations of law, regulations or writtenorders of a government agency.  Thesepractices can include the failure of an institution to timely file requiredreports or the filing of false or misleading information or the submission ofinaccurate reports.  Civil penalties maybe as high as $1,375,000 a day for such violations.  Criminal penalties for some financialinstitution crimes have been increased to 20 years.  In addition, regulators are provided withgreater flexibility to commence enforcement actions against institutions andinstitution-affiliated parties.  Possibleenforcement actions include the termination of deposit insurance.  Furthermore, banking agencies’ power to issuecease-and-desist orders were expanded. Such orders may, among other things, require affirmative action tocorrect any harm resulting from a violation or practice, including restitution,reimbursement, indemnifications or guarantees against loss.  A financial institution may also be orderedto restrict its growth, dispose of certain assets, rescind agreements orcontracts, or take other actions as determined by the ordering agency to beappropriate.

 

***Anti-MoneyLaundering.***  Financial institutions must maintainanti-money laundering programs that include established internal policies,procedures and controls; a designated compliance officer; an ongoing employeetraining program; and testing of the program by an independent auditfunction.  The company and the bank arealso prohibited from entering into specified financial transactions and accountrelationships and must meet enhanced standards for due diligence and “knowingyour customer” in their dealings with foreign financial institutions, foreigncustomers and other high risk customers. Financial institutions must take reasonable steps to conduct enhancedscrutiny of account relationships to guard against money laundering and toreport any suspicious transactions, and recent laws provide law enforcementauthorities with increased access to financial information maintained bybanks.  Anti-money laundering obligationshave been substantially strengthened as a result of the USA PATRIOT Act,enacted in 2001 and renewed in 2006. Bank regulators routinely examine institutions for compliance with theseobligations and are required to consider compliance in connection with theregulatory review of applications.  Theregulatory authorities have been active in imposing “cease and desist” ordersand money 

 

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penalty sanctions againstinstitutions found to be violating these obligations.

 

## ***USA PATRIOTAct.***** The USA PATRIOT Act becameeffective on October 26, 2001, amended, in part, the Bank Secrecy Act, andprovides, in part, for the facilitation of information sharing amonggovernmental entities and financial institutions for the purpose of combatingterrorism and money laundering by enhancing anti-money laundering and financialtransparency laws, as well as enhanced information collection tools andenforcement mechanics for the U.S. government, including: (i) requiringstandards for verifying customer identification at account opening; (ii) rules topromote cooperation among financial institutions, regulators and lawenforcement entities in identifying parties that may be involved in terrorismor money laundering; (iii) reports by nonfinancial trades and businessesfiled with the Treasury Department’s Financial Crimes Enforcement Network fortransactions exceeding $10,000; and (iv) filing suspicious activitiesreports by brokers and dealers if they believe a customer may be violating U.S.laws and regulations and requires enhanced due diligence requirements forfinancial institutions that administer, maintain, or manage private bankaccounts or correspondent accounts for non-U.S. persons.  Bank regulators routinely examineinstitutions for compliance with these obligations and are required to considercompliance in connection with the regulatory review of applications.

## ** **

Under the USA PATRIOT Act, the Federal Bureau of Investigation (“FBI”)can send our banking regulatory agencies lists of the names of personssuspected of involvement in terrorist activities.  The bank can be requested, to search itsrecords for any relationships or transactions with persons on those lists.  If the bank finds any relationships ortransactions, it must file a suspicious activity report and contact the FBI.

 

***The Office of Foreign Assets Control***.  The Office ofForeign Assets Control (“OFAC”), which is a division of the U.S. Department ofthe Treasury, is responsible for helping to insure that United States entitiesdo not engage in transactions with “enemies” of the United States, as definedby various Executive Orders and Acts of Congress.  OFAC has sent, and will send, our bankingregulatory agencies lists of names of persons and organizations suspected ofaiding, harboring or engaging in terrorist acts.  If the bank finds a name on any transaction,account or wire transfer that is on an OFAC list, it must freeze such account,file a suspicious activity report and notify the FBI.  The bank has appointed an OFAC compliance officerto oversee the inspection of its accounts and the filing of anynotifications.  The bank actively checkshigh-risk OFAC areas such as new accounts, wire transfers and customer files.  The bank performs these checks utilizingsoftware, which is updated each time a modification is made to the listsprovided by OFAC and other agencies of Specially Designated Nationals andBlocked Persons.

 

***Privacy and Credit Reporting*****. **Financialinstitutions are required to disclose their policies for collecting and protectingconfidential information.  Customersgenerally may prevent financial institutions from sharing nonpublic personalfinancial information with nonaffiliated third parties except under narrowcircumstances, such as the processing of transactions requested by the consumeror when the financial institution is jointly sponsoring a product or servicewith a nonaffiliated third party. Additionally, financial institutions generally may not disclose consumeraccount numbers to any nonaffiliated third party for use in telemarketing,direct mail marketing or other marketing to consumers.  It is the bank’s policy not to disclose anypersonal information unless required by law.

 

Like other lendinginstitutions, the bank utilizes credit bureau data in its underwritingactivities.  Use of such data isregulated under the Federal Credit Reporting Act on a uniform, nationwidebasis, including credit reporting, prescreening, sharing of information betweenaffiliates, and the use of credit data. The Fair and Accurate Credit Transactions Act of 2003 (the “FACT Act”)authorizes states to enact identity theft laws that are not inconsistent withthe conduct required by the provisions of the FACT Act.

 

***Payment of Dividends.***  A SouthCarolina state bank may not pay dividends from its capital.  All dividends must be paid out of undividedprofits then on hand, after deducting expenses, including reserves for lossesand bad debts.  The bank is authorized topay cash dividends up to 100% of net income in any calendar year withoutobtaining the prior approval of the South Carolina State Board of FinancialInstitutions, provided that the bank received a composite rating of one or twoat the last federal or state regulatory examination.  The bank must obtain approval from the SouthCarolina Board of Financial Institutions prior to the payment of any other cashdividends.  In addition, under theFederal Deposit Insurance Corporation Improvement Act, the bank may not pay adividend if, after paying the dividend, the bank would be undercapitalized.

 

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***Check21.***  The Check Clearing for the 21st Century Actgives “substitute checks,” such as a digital image of a check and copies madefrom that image, the same legal standing as the original paper check.  Some of the major provisions include:

 

·                  allowing check truncation without making it mandatory;

 

·                  demanding that every financial institution communicate toaccountholders in writing a description of its substitute check processingprogram and their rights under the law;

 

·                  legalizing substitutions for and replacements of paper checks withoutagreement from consumers;

 

·                  retaining in place the previously mandated electronic collection andreturn of checks between financial institutions only when individual agreementsare in place;

 

·                  requiring that when accountholders request verification, financialinstitutions produce the original check (or a copy that accurately representsthe original) and demonstrate that the account debit was accurate and valid;and

 

·                  requiring the re-crediting of funds to an individual’s account on thenext business day after a consumer proves that the financial institution haserred.

 

***Effectof Governmental Monetary Policies*****.**  Our earnings are affected by domesticeconomic conditions and the monetary and fiscal policies of the United Statesgovernment and its agencies.  The FederalReserve Board’s monetary policies have had, and are likely to continue to have,an important impact on the operating results of commercial banks through itspower to implement national monetary policy in order, among other things, tocurb inflation or combat a recession. The monetary policies of the Federal Reserve Board have major effectsupon the levels of bank loans, investments and deposits through its open marketoperations in United States government securities and through its regulation ofthe discount rate on borrowings of member banks and the reserve requirementsagainst member bank deposits.  It is notpossible to predict the nature or impact of future changes in monetary andfiscal policies.

 

***Insurance of Accounts and Regulation by the FDIC.**** *Our deposits are insured up to applicable limits bythe Deposit Insurance Fund of the FDIC. The Deposit Insurance Fund is the successor to the Bank Insurance Fundand the Savings Association Insurance Fund, which were merged effective March 31,2006.  As insurer, the FDIC imposesdeposit insurance premiums and is authorized to conduct examinations of and torequire reporting by FDIC insured institutions. It also may prohibit any FDIC insured institution from engaging in anyactivity the FDIC determines by regulation or order to pose a serious risk tothe insurance fund.

 

Due to the large number of recent bank failures,and the FDIC’s new Temporary Liquidity Guarantee Program, the FDIC adopted a revised risk-baseddeposit insurance assessment schedule in February 2009, which raiseddeposit insurance premiums.  The FDIC alsoimplemented a five basis point special assessment of each insured depositoryinstitution’s assets minus Tier 1 capital as of June 30, 2009, whichspecial assessment amount was capped at 10 basis points times the institution’sassessment base for the second quarter of 2009. In addition, the FDIC recently announced a rule that requiresfinancial institutions like us to prepay their estimated quarterly risk-basedassessments for the fourth quarter of 2009 and for all of 2010 through andincluding 2012 to re-capitalize the Deposit Insurance Fund.  The FDIC may exercise its discretion assupervisor and insurer to exempt an institution from the prepayment requirementif the FDIC determines that the prepayment would adversely affect the safetyand soundness of the institution.  We didnot request exemption from the prepayment requirement.  During 2009, we paid $4.8 million in deposit insurance,which included regular premiums, the special assessment and the prepayment forall of 2010 through and including 2012. The rule also provides for increasing the FDIC-assessment rates bythree basis points effective January 1, 2011.

 

FDIC insured institutionsare required to pay a Financing Corporation assessment, in order to fund theinterest on bonds issued to resolve thrift failures in the 1980s.  For the first quarter of 2009, the Financing 

 

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Corporation assessmentequaled 1.14 basis points for domestic deposits.  These assessments, which may be revised basedupon the level of deposits, will continue until the bonds mature in the years2017 through 2019.

 

The FDIC may terminatethe deposit insurance of any insured depository institution, including thebank, if it determines after a hearing that the institution has engaged inunsafe or unsound practices, is in an unsafe or unsound condition to continueoperations or has violated any applicable law, regulation, rule, order orcondition imposed by the FDIC or the OCC. It also may suspend deposit insurance temporarily during the hearingprocess for the permanent termination of insurance, if the institution has notangible capital.  If insurance of accountsis terminated, the accounts at the institution at the time of the termination,less subsequent withdrawals, shall continue to be insured for a period of sixmonths to two years, as determined by the FDIC. Management of the bank is not aware of any practice, condition orviolation that might lead to termination of the bank’s deposit insurance.

 

***ProposedLegislation and Regulatory Action*****.**  New regulations and statutes are regularlyproposed that contain wide-ranging proposals for altering the structures,regulations and competitive relationships of the nation’s financialinstitutions.  We cannot predict whetheror in what form any proposed regulation or statute will be adopted or theextent to which our business may be affected by any new regulation or statute.

 

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**Item 1A.  Risk Factors.**

 

### **RISK FACTORS**

### ** **

***Difficultmarket conditions in our coastal markets and economic trends have adverselyaffected our industry and our business and may continue to do so.***

 

Our business has beendirectly affected by market conditions, trends in industry and finance,legislative and regulatory changes, and changes in governmental monetary andfiscal policies and inflation, all of which are beyond our control.  The current economic downturn, increase inunemployment and other events that have negatively affected both household andcorporate incomes, both nationally and locally, have decreased the demand forloans and our other products and services and have increased the number ofcustomers who fail to pay interest and/or principal on their loans.  As a result, we have experienced significantdeclines in our coastal real estate markets with decreasing prices andincreasing delinquencies and foreclosures, which have negatively affected thecredit performance of our loans and resulted in increases in the level of ournonperforming assets and charge-offs of problem loans.  At the same time, competition amongdepository institutions for deposits and quality loans has increasedsignificantly.  Bank and bank holdingcompany stock prices have been negatively affected, as has the ability of banksand bank holding companies to raise capital or borrow in the debt marketscompared to recent years.  These marketconditions and the tightening of credit have led to increased deficiencies inour loan portfolio, increased market volatility and widespread reduction ingeneral business activity.

 

Ourfuture success significantly depends upon the growth in population, incomelevels, deposits and housing starts in the Charleston, Myrtle Beach and HiltonHead market areas.  Unlike many largerinstitutions, we are not able to spread the risks of unfavorable economicconditions across a large number of diversified economies and geographiclocations.  If the markets in which weoperate do not recover and grow as anticipated or if prevailing economicconditions locally or nationally do not improve, our business may continue tobe negatively impacted.

 

***A significant portion of our loan portfoliois secured by real estate, and events that negatively affect the real estate marketcould hurt our business.***

 

Beginningin the second half of 2007 and continuing through 2009, the financial marketswere beset by significant volatility associated with subprime mortgages,including adverse impacts on credit quality and liquidity within the financialmarkets.  The volatility has beenexacerbated by a significant decline in the value of real estate in our coastalmarkets.  As of December 31, 2009,approximately 69.2% of our loans were secured by real estate mortgages.  The real estate collateral for these loansprovides an alternate source of repayment in the event of default by theborrower and may deteriorate in value during the time the credit isextended.  A further weakening of thereal estate market in our primary market areas could result in an increase inthe number of borrowers who default on their loans and a reduction in the valueof the collateral securing their loans, which in turn could have an adverseeffect on our profitability and asset quality. If we are required to liquidate the collateral securing a loan tosatisfy the debt during a period of reduced real estate values, our earningsand shareholder’s equity could be adversely affected.  Acts of nature, including hurricanes,tornados, earthquakes, fires and floods, which may cause uninsured damage andother loss of value to real estate that secures these loans, may alsonegatively impact our financial condition.

 

***Weare exposed to higher credit risk by commercial real estate, commercial andindustrial and construction lending.***

 

Commercial real estate,commercial and industrial and construction lending usually involves highercredit risks than that of single-family residential lending.  As of December 31, 2009, the followingloan types accounted for the stated percentages of our total loan portfolio:commercial real estate — 35.2%, commercial and industrial — 5.5%, residentialconstruction — 17.1%, and commercial construction — 7.2%.  These types of loans involve larger loanbalances to a single borrower or groups of related borrowers.  Commercial real estate loans may be affectedto a greater extent than residential loans by adverse conditions in real estatemarkets or the economy because commercial real estate borrowers’ ability torepay their loans depends on successful development of their properties, inaddition to the factors affecting residential real estate borrowers.  These loans also involve greater risk becausethey generally

 

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are not fully amortizingover the loan period, but have a balloon payment due at maturity.  A borrower’s ability to make a balloonpayment typically will depend on being able to either refinance the loan orsell the underlying property in a timely manner.

 

Commercial and industrialloans are typically based on the borrowers’ ability to repay the loans from thecash flow of their businesses.  Theseloans may involve greater risk because the availability of funds to repay eachloan depends substantially on the success of the business itself.  In addition, the collateral securing theloans have the following characteristics: (a) they depreciate over time, (b) theyare difficult to appraise and liquidate, and (c) they fluctuate in valuebased on the success of the business.

 

Risk of loss on a constructionloan depends largely upon whether our initial estimate of the property’s valueat completion of construction equals or exceeds the cost of the propertyconstruction (including interest), the availability of permanent take-outfinancing, and the builder’s ability to ultimately sell the property.  During the construction phase, a number offactors can result in delays and cost overruns. If estimates of value are inaccurate or if actual construction costsexceed estimates, the value of the property securing the loan may beinsufficient to ensure full repayment when completed through a permanent loanor by seizure of collateral.

 

Commercial real estate,commercial and industrial and construction loans are more susceptible to a riskof loss during a downturn in the business cycle.  Our underwriting, review and monitoringcannot eliminate all of the risks related to these loans.

 

As of December 31,2009, our outstanding commercial real estate loans were equal to 369% of ourtotal capital.  The banking regulatorsare giving commercial real estate lending greater scrutiny, and may requirebanks with higher levels of commercial real estate loans to implement improvedunderwriting, internal controls, risk management policies and portfolio stresstesting, as well as possibly higher levels of allowances for losses and capitallevels as a result of commercial real estate lending growth and exposures.

 

***Wehave entered into an informal Memorandum of Understanding under which ourregulators will require us to take certain actions.***

 

On November 16,2009, we entered into an informal MOU with the South Carolina BankingDepartment and the FDIC.  The failure tocomply with the terms of the MOU could result in significant enforcementactions against us of increasing severity, up to and including a regulatorytakeover of our bank subsidiary.  Underthe terms of the MOU, we are required to, among other things, (1) submit acapital plan to the supervisory authorities for increasing and maintaining aTier 1 leverage ratio at 8% and maintaining 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; and (4) reviewoverall liquidity objectives and develop plans and procedures aimed atimproving liquidity and reducing reliance on volatile liabilities to fundlonger-term assets.  We timely submittedthe requested plans to the regulators for their review on January 14,2010.  We may supplement these plans andreports in the future in response to comments and requests from ourregulators.  In connection with theseplans, the MOU requires us to provide status updates to the board of directorsof the bank and quarterly status updates to the South Carolina BankingDepartment and the FDIC.  While the MOUremains in place, we may not pay dividends without the prior written consent ofthe regulators and we may not extend any additional credit to any borrower thathas been charged off by the bank or classified as substandard, doubtful or lossin any report of examination as long as the credit remains uncollected.

 

Any material failure tocomply with the terms of the MOU could result in further enforcement action bythe supervisory authorities.  Sinceentering into the MOU, we have been actively pursuing the correctiveactions.  We intend to continue to takethe actions necessary to comply with the requirements of the MOU, although wemay be unable to do so.

 

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***If our allowance for loan losses is not sufficient to coveractual loan losses, or if credit delinquencies increase, our losses couldincrease.***

 

Our success depends, to asignificant extent, on the quality of our assets, particularly loans.  Like other financial institutions, we facethe risk that our customers will not repay their loans, that the collateralsecuring the payment of those loans may be insufficient to assure repayment, andthat we may be unsuccessful in recovering the remaining loan balances.  The risk of loss varies with, among otherthings, general economic conditions, the type of loan, the creditworthiness ofthe borrower over the term of the loan and, for many of our loans, the value ofthe real estate and other assets serving as collateral.  Management makes various assumptions andjudgments about the collectibility of our loan portfolio after consideringthese and other factors.  Based in parton those assumptions and judgments, we maintain an allowance for loan losses inan attempt to cover any loan losses that may occur.  In determining the size of the allowance, wealso rely on an analysis of our loan portfolio based on historical lossexperience, volume and types of loans, trends in classification, delinquenciesand nonaccruals, national and local economic conditions and other pertinentinformation, including the results of external loan reviews.  Despite our efforts, our loan assessmenttechniques may fail to properly account for potential loan losses, and, as aresult, our established loan loss reserves may prove insufficient.  If we are unable to generate income tocompensate for these losses, they could have a material adverse effect on ouroperating results.

 

In addition, federal andstate regulators periodically review our allowance for loan losses and mayrequire us to increase our allowance for loan losses or recognize further loancharge-offs, based on judgments different than those of our management.  Higher charge-off rates and an increase inour allowance for loan losses may hurt our overall financial performance andmay increase our cost of funds.  As of December 31,2009, we had 67 loans on nonaccrual status totaling approximately $21.3million, and our allowance for loan loss was $10.0 million.  For the year ended December 31, 2009, werecorded $14.7 million as a provision for loan losses, compared to $4.7 millionin 2008.  The increase was due primarilyto the $9.8 million increase in the level of nonperforming loans during2009.  Our current and future allowancesfor loan losses may not be adequate to cover future loan losses given currentand future market conditions.

 

***Institution-specificand/or broader industry-wide events may trigger a reduction in the availabilityof funding needed for day-to-day operations, resulting in a liquidity crisis.***

 

We require a certainlevel of available funding each day to meet the liquidity demands of ouroperations.  These demands includefunding for new loan production, funding available for customer withdrawalrequests and maturing time deposits not being renewed, and funding forsettlement of investment portfolio transactions.  Both institution specific events such asdeterioration in our credit ratings resulting from a weakened capital positionor from lack of earnings and industry-wide events such as a collapse of creditmarkets may result in a reduction of available funding sources sufficient tocover the liquidity demands.  Such acrisis could significantly jeopardize our ability to continue operations.

 

***Recent******legislativeand regulatory initiatives to address the current difficult market and economicconditions may not achieve the desired effect.***

 

Beginning in October 2008, a host of legislation andregulation has been enacted in response to the financial crises affecting thebanking system and financial markets and the threats to investment banks andother financial institutions.  Theseinclude the following:

 

·                  On October 3, 2008, President Bush signed into law EmergencyEconomic Stabilization Act (“EESA”), under which the U.S. Treasury Departmenthas the authority, among other things, to purchase up to $700 billion ofmortgages, mortgage-backed securities and certain other financial instrumentsfrom financial institutions under the Troubled Asset Relief Program for thepurpose of stabilizing and providing liquidity to the U.S. financial markets.

 

·                  On October 14, 2008, the Treasury Department announced the CapitalPurchase Plan under the EESA under which it would purchase senior preferredstock and warrants to purchase common stock from participating financialinstitutions.

 

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·                  On November 21, 2008, the FDIC adopted a Final Rule withrespect to its Temporary Liquidity Guarantee Program under which the FDIC willguarantee certain “newly-issued unsecured debt” of banks and certain holdingcompanies and also guarantee, on an unlimited basis, non-interest bearing banktransaction accounts.

 

·                  On February 10, 2009, the Treasury Department announced theFinancial Stability Plan under the EESA, which is intended to further stabilizefinancial institutions and stimulate lending across a broad range of economicsectors.

 

·                  On February 18, 2009, President Obama signed the American Recoveryand Reinvestment Act, a broad economic stimulus package that includedadditional restrictions on, and potential additional regulation of, financialinstitutions.

 

·                  On March 18, 2009, the Federal Reserve announced its decision topurchase as much as $300 billion of long-term treasuries in an effort tomaintain low interest rates.

 

·                  On March 23, 2009, the Treasury Department announced thePublic-Private Investment Program, which will purchase real estaterelated loans from banks and securities from the broader markets, and isintended to create a market for those distressed debt and securities.

 

Eachof these programs was implemented to help stabilize and provide liquidity tothe financial system.  However, the long-termeffect that these or any other governmental program may have on the financialmarkets or our business or financial performance is unknown.  A continuation or worsening of currentfinancial market conditions could materially and adversely affect our business,financial condition, results of operations, access to credit or the tradingprice of our common stock.

 

***Regulatoryreform of the U.S. banking system may adversely affect us.***

 

On June 17, 2009,the Obama Administration announced a comprehensive plan for regulatory reformof the financial services industry.  Theplan set forth five separate initiatives that will be the focus of theregulatory reform, including requiring strong supervision and appropriateregulation of all financial firms, strengthening regulation of core markets andmarket infrastructure, strengthening consumer protection, strengtheningregulatory powers to effectively manage failing institutions and improvinginternational regulatory standards and cooperation.

 

Other recent developments include:

 

·                  the Federal Reserve’s proposed guidance onincentive compensation policies at banking organizations; and

 

·                  proposals to limit a lender’s ability to forecloseon mortgages or make those foreclosures less economically viable, including byallowing Chapter 13 bankruptcy plans to “cram down” the value of certainmortgages on a consumer’s principal residence to its market value and/or resetinterest rates and monthly payments to permit defaulting debtors to remain intheir home.

 

These initiatives mayincrease our expenses or decrease our income by, among other things, making it harder for us to foreclose on mortgages.  Further, the overall effects of these andother legislative and regulatory efforts on the financial markets remainuncertain, and they may not have the intended stabilization results.  These efforts may even have unintendedharmful consequences on the U.S. financial system and our business.  Should these or other legislative orregulatory initiatives have unintended effects, our business, financialcondition, results of operations and prospects could be materially andadversely affected.

 

In addition, we may need to modify ourstrategies and business operations in response to these changes. We may alsoincur increased capital requirements and constraints or additional costs tosatisfy new regulatory requirements. Given the volatile nature of the current market and the uncertaintiesunderlying efforts to mitigate or 

 

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reverse disruptions, we may not timelyanticipate or manage existing, new or additional risks, contingencies ordevelopments in the current or future environment.  Our failure to do so could materially andadversely affect our business, financial condition, results of operations and prospects.

 

***Becauseof our participation in the Treasury Department’s Capital Purchase Program, weare subject to several restrictions including restrictions on compensation paidto our executives and other employees.***

 

Under the terms of theCPP Purchase Agreement between us and the Treasury, we adopted certainstandards for executive compensation and corporate governance for the periodduring which the Treasury holds the equity we issued or may issue to theTreasury, including the common stock we may issue under the CPP Warrant.  These standards generally apply to our ChiefExecutive Officer, Chief Financial Officer and the three next most highlycompensated senior executive officers. The standards include (1) ensuring that incentive compensation forsenior executives does not encourage unnecessary and excessive risks thatthreaten the value of the financial institution; (2) required clawback ofany bonus or incentive compensation paid to a senior executive and the next 20most highly compensated employees based on statements of earnings, gains orother criteria that are later proven to be materially inaccurate; (3) prohibitionon making golden parachute payments to senior executives and the next five mosthighly compensated employees; and (4) agreement not to deduct for taxpurposes executive compensation in excess of $500,000 for each seniorexecutive.  In particular, the change tothe deductibility limit on executive compensation will likely increase theoverall cost of our compensation programs in future periods and may make itmore difficult to attract suitable candidates to serve as executive officers.

 

***Legislation or regulatory changes could cause us to seek torepurchase the preferred stock and warrant that we sold to the U.S. Treasuryunder the Capital Purchase Program.***

 

Legislation andregulation that have been adopted after we closed on our sale of Series TPreferred Stock and warrants to the Treasury for $14.4 million under the CPP onDecember 19, 2008, or any legislation or regulations that may be implementedin the future, may have a material effect on the terms of our CPP transactionwith the Treasury.  If we determine thatany such legislation or any regulations alter the terms of our CPP transactionwith the Treasury in ways that we believe are adverse to our ability toeffectively manage our business, then we may seek to unwind, in whole or inpart, the CPP transaction by repurchasing some or all of the preferred stockand the warrant that we sold to the Treasury. If we were to repurchase all or a portion of the preferred stock orwarrant, then our capital levels could be materially reduced.

 

***Our continued operations andfuture growth may require us to raise additional capital in the future, butthat capital may not be available when we need it.***

 

We are required byfederal and state regulatory authorities to maintain adequate levels of capitalto support our operations.  We may atsome point need to raise additional capital to support our operations and any futuregrowth, as well as to protect against any further deterioration in our loanportfolio.  In addition, we intend toredeem the Series T Preferred Stock that we issued to the Treasury underthe CPP before the dividends on the Series T Preferred Stock increase from5% per annum to 9% per annum in 2014, and we may need to raise additionalcapital to do so.  We may be unable toraise additional capital, if and when needed, on terms acceptable to us, or atall.  If we cannot raise additionalcapital when needed, our ability to continue our current operations or furtherexpand our operations through internal growth and acquisitions could bematerially impaired.  In addition, if wedecide to raise additional equity capital, your interest could be diluted.

 

***Alarge percentage of the loans in our portfolio currently include exceptions toour loan policies and supervisory guidelines.***

 

All of the loans that wemake are subject to written loan policies adopted by our board of directors andto supervisory guidelines imposed by our regulators.  Our loan policies are designed to reduce therisks associated with the loans that we make by requiring our loan officers,before closing a loan, to take certain steps that vary depending on the typeand amount of the loan.  These stepsinclude making sure the proper liens are documented and perfected on propertysecuring a loan, and requiring proof of adequate insurance coverage on propertysecuring loans.  Loans that do not fullycomply with our loan policies are known as “exceptions.”  While we generally underwrite the loans

 

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in our portfolio inaccordance with our own internal underwriting guidelines and regulatorysupervisory guidelines, in certain circumstances we have made loans whichexceed either our internal underwriting guidelines, supervisory guidelines, orboth.  We categorize exceptions as policyexceptions, financial statement exceptions and collateral exceptions.  Interagency guidelines for real estatelending policies allow institutions to originate loans in excess of thesupervisory loan to value limits, however, the aggregate amount of such loansshould not exceed 100% of total capital.

 

Asof December 31, 2009, approximately $77.4 million of our loans, or 133.5%of our bank’s capital, had loan-to-value ratios that exceeded regulatorysupervisory guidelines, of which 64 loans totaling approximately $23.2 millionhad loan-to-value ratios of 100% or more. In addition, supervisory limits on commercial loan to value exceptionsare set at 30% of a bank’s capital.  At December 31,2009, $39.3 million of our commercial loans, or 67.8% of our bank’s capital,exceeded the supervisory loan to value ratio. As of December 31, 2009, approximately 13.8% of the loans in ourportfolio included collateral exceptions to our loan policies, which exceedsthe 10% suggested by regulatory guidance. As a result of these exceptions, those loans may have a higher risk ofloss than the other loans in our portfolio that fully comply with our loanpolicies.  In addition, we may be subjectto regulatory action by federal or state banking authorities if they believethe number of exceptions in our loan portfolio represents an unsafe bankingpractice.  Although we have taken stepsto reduce the number of exceptions in our loan portfolio, we may not besuccessful in reducing the number of exceptions in our loan portfolio.

 

***Our net interest income could be negatively affected by thelower level of short-term interest rates, recent developments in the credit andreal estate markets and competition in our primary market area.***

 

As a financialinstitution, our earnings significantly depend upon our net interest income,which is the difference between the income that we earn on interest-earningassets, such as loans and investment securities, and the expense that we pay oninterest-bearing liabilities, such as deposits and borrowings.  Therefore, any change in general marketinterest rates, including changes resulting from changes in the Federal Reserve’sfiscal and monetary policies, affects us more than non-financial institutionsand can have a significant effect on our net interest income and net income.

 

The Federal Reservereduced interest rates on three occasions in 2007 by a total of 100 basispoints, to 4.25%, and by another 400 basis points, to a range of 0% to 0.25%,during 2008.  Rates remained steady for2009.  On March 18, 2009, theFederal Reserve announced its decision to purchase as much as $300 billion oflong-term treasuries in an effort to maintain low interest rates.  Approximately 56.2% of our loans werevariable rate loans at December 31, 2009. The interest rates on a significant segment of these loans decrease whenthe Federal Reserve reduces interest rates, while the interest that we earn onour assets may not change in the same amount or at the same rates.  Accordingly, increases in interest rates mayreduce our net interest income.  Inaddition, an increase in interest rates may decrease the demand for loans.  Furthermore, increases in interest rates willadd to the expenses of our borrowers, which may adversely affect their abilityto repay their loans with us.

 

Increased nonperformingloans and the decrease in interest rates reduced our net interest income during2009 and could cause additional pressure on net interest income in futureperiods.  This reduction in net interestincome may also be exacerbated by the high level of competition that we face inour primary market areas.  Any significantreduction in our net interest income could negatively affect our business andcould have a material adverse effect on our capital, financial condition andresults of operations.

 

***Higher FDIC Deposit Insurance premiums andassessments that we are required to pay could have an adverse effect on ourearnings and our ability to pay our liabilities as they come due.***

 

As a member institutionof the FDIC, we are required to pay quarterly deposit insurance premiumassessments to the FDIC.  Due to thelarge number of recent bank failures, and the FDIC’s new Temporary LiquidityGuarantee Program, theFDIC adopted a revised risk-based deposit insurance assessment schedule in February 2009,which raised deposit insurance premiums.  TheFDIC also implemented a five basis point special assessment of each insureddepository institution’s assets minus Tier 1 capital as of June 30, 2009,which special assessment amount was capped at 10 basis points times theinstitution’s assessment base for the second quarter of 2009.  In addition, the FDIC recently announced a rule thatrequires financial institutions like us to prepay their 

 

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estimated quarterlyrisk-based assessments for the fourth quarter of 2009 and for all of 2010through and including 2012 to re-capitalize the Deposit Insurance Fund.  The FDIC may exercise its discretion assupervisor and insurer to exempt an institution from the prepayment requirementif the FDIC determines that the prepayment would adversely affect the safetyand soundness of the institution.  We didnot request exemption from the prepayment requirement.  During 2009, we paid $4.8 million in deposit insurance,which included regular premiums, the special assessment and the prepayment forall of 2010 through and including 2012. The rule also provides for increasing the FDIC-assessment rates bythree basis points effective January 1, 2011.  If FDIC deposit insurance premiums andassessments continue to increase, these higher payments could adversely affectour financial condition.

 

***Wedepend on key individuals, and o******ur continuedsuccess depends on our ability to identify and retain individuals withexperience and relationships in our markets. T******he loss of one or more of these key individuals could curtail ourgrowth and adversely affect our prospects.***

 

Robert E. Coffee, Jr.,our president and chief executive officer, has extensive and long-standing tieswithin our market areas and substantial experience with our operations, whichhas contributed significantly to our business. If we lose the services of Mr. Coffee, he would be difficult toreplace, and our business and development could be materially and adverselyaffected.

 

To succeed in ourmarkets, we must identify and retain experienced key management members withlocal expertise and relationships in these markets.  We expect that competition for qualifiedmanagement in our markets will be intense and that there will be a limitednumber of qualified persons with knowledge of and experience in the communitybanking industry in these markets.  Inaddition, the process of identifying and recruiting individuals with thecombination of skills and attributes required to carry out our strategyrequires both management and financial resources and is often lengthy.  Our inability to identify, recruit and retaintalented personnel to manage our offices effectively would limit our growth andcould materially adversely affect our business, financial condition and resultsof operations.  The loss of the servicesof several key personnel could adversely affect our strategy and prospects tothe extent we are unable to replace them.

 

***Weface strong competition for customers, which could prevent us from obtainingcustomers or may cause us to pay higher interest rates to attract customerdeposits****.*

 

The banking business is highly competitive, and weexperience competition in our markets from many other financialinstitutions.  Customer loyalty can beeasily influenced by a competitor’s new products, especially offerings thatcould provide cost savings or a higher return to the customer.  Moreover, this competitive industry couldbecome even more competitive as a result of legislative, regulatory andtechnological changes and continued consolidation.  We compete with commercial banks, creditunions, savings and loan associations, mortgage banking firms, consumer financecompanies, securities brokerage firms, insurance companies, money market fundsand other mutual funds, as well as super-regional, national and internationalfinancial institutions that operate offices in our primary market areas and elsewhere.

 

We compete with these institutions both in attracting deposits and inmaking loans.  In addition, we have toattract our customer base from other existing financial institutions and fromnew residents.  Many of our competitorsare well-established, larger financial institutions, such as BB&T, Bank ofAmerica, Wells Fargo, Carolina First Bank and South Carolina Bank &Trust.  These institutions offer someservices that we do not provide, such as extensive and established branchnetworks and trust services.  We alsocompete with local community banks in our market.  We may not be able to compete successfullywith other financial institutions in our market, and we may have to pay higherinterest rates to attract deposits, accept lower yields on loans to attractloans and pay higher wages for new employees, resulting in reducedprofitability.  In addition, competitorsthat are not depository institutions are generally not subject to the extensiveregulations that apply to us.

 

***Wemay not be able to compete with our larger competitors for larger customersbecause our lending limits are lower than theirs.***

 

We are limited in theamount we can loan a single borrower by the amount of the bank’s capital.  Our legal lending limit is 15% of the bank’scapital and surplus, or $8.7 million at December 31, 2009.  Our internal lending 

 

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limit was $5.2 million atDecember 31, 2009.  This issignificantly less than the limit for our larger competitors and may affect ourability to seek relationships with larger businesses in our market areas.  We have been able to sell participations inour larger loans to other financial institutions, which has allowed us to meetthe lending needs of our customers requiring extensions of credit in excess ofthese limits.  In the current economicenvironment, however, it has been difficult to sell participations to otherfinancial institutions.  We expect to sellparticipations only on a limited basis going forward.

 

***The costs of beingan SEC registered company are proportionately higher for smaller companies likeTidelands Bancshares because of the requirements imposed by the Sarbanes-OxleyAct.***

 

The Sarbanes-Oxley Act of2002 and the related rules and regulations promulgated by the SEC haveincreased the scope, complexity and cost of corporate governance, reporting anddisclosure practices.  These regulationsare applicable to our company.  We haveexperienced, and expect to continue to experience, increasing compliance costs,including costs related to internal controls, as a result of the Sarbanes-OxleyAct.  These necessary costs areproportionately higher for a company of our size and will affect ourprofitability more than that of some of our larger competitors.

 

***We will face risks with respectto future expansion and acquisitions or mergers.***

 

Although we do not have any current plans to do so, wemay seek to acquire other financial institutions or parts of thoseinstitutions.  We may also expand intonew markets or lines of business or offer new products or services.  These activities would involve a number ofrisks, including:

 

·                  the time and expense associated withidentifying and evaluating potential acquisitions and merger partners;

·                  using inaccurate estimates and judgmentsto evaluate credit, operations, management and market risks with respect to thetarget institution or assets;

·                  diluting our existing shareholders in anacquisition;

·                  the time and expense associated withevaluating new markets for expansion, hiring experienced local management andopening new offices, as there may be a substantial time lag between theseactivities before we generate sufficient assets and deposits to support thecosts of the expansion;

·                  taking a significant amount of timenegotiating a transaction or working on expansion plans, resulting inmanagement’s attention being diverted from the operation of our existingbusiness;

·                  the time and expense associated withintegrating the operations and personnel of the combined businesses;

·                  creating an adverse short-term effect onour results of operations; and

·                  losing key employees and customers as aresult of an acquisition that is poorly received.

 

Although our management team has acquisitionexperience at other institutions, we have never acquired another institutionbefore, so we lack experience as an organization in handling any of theserisks.  There is also a risk that anyexpansion effort will not be successful.

 

***Theaccuracy of our financial statements and related disclosures could be affectedbecause we are exposed to conditions or assumptions different from thejudgments, assumptions or estimates used in our critical accounting policies.***

 

The preparation offinancial statements and related disclosure in conformity with accountingprinciples generally accepted in the United States of America requires us tomake judgments, assumptions and estimates that affect the amounts reported inour consolidated financial statements and accompanying notes.  Our critical accounting policies, which wesummarize in our Annual Report on Form 10-K for the year ended December 31,2009, describe those significant accounting policies and methods used in thepreparation of our consolidated financial statements that we consider “critical”because they require judgments, assumptions and estimates about the future thatmaterially impact our consolidated financial statements and relateddisclosures.  For example, materialestimates that are particularly susceptible to significant change relate to thedetermination of the allowance for losses on loans, including valuationallowances for impaired loans, and the valuation of real estate acquired inconnection

 

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with foreclosures or insatisfaction of loans.  As a result, iffuture events differ significantly from the judgments, assumptions andestimates in our critical accounting policies, those events or assumptionscould have a material impact on our audited consolidated financial statementsand related disclosures.

 

***Weare exposed to the possibility that customers may prepay theirs loans to paydown loan balances, which could reduce our interest income and profitability.***

 

Prepayment rates stemfrom consumer behavior, conditions in the housing and financial markets,general United States economic conditions, and the relative interest rates onfixed-rate and adjustable-rate loans. Therefore, changes in prepayment rates are difficult to predict.  Recognition of deferred loan originationcosts and premiums paid in originating these loans are normally recognized overthe contractual life of each loan.  Asprepayments occur, the rate at which net deferred loan origination costs andpremiums are expensed will accelerate. The effect of the acceleration of deferred costs and premium amortizationmay be mitigated by prepayment penalties paid by the borrower when the loan ispaid in full within a certain period of time. If prepayment occurs after the period of time when the loan is subjectto a prepayment penalty, the effect of the acceleration of premium and deferredcost amortization is no longer mitigated. We recognize premiums paid on mortgage-backed securities as anadjustment from interest income over the expected life of the security based onthe rate of repayment of the securities.  Acceleration of prepayments on the loansunderlying a mortgage-backed security shortens the life of the security,increases the rate at which premiums are expensed and further reduces interestincome.  We may not be able to reinvestloan and security prepayments at rates comparable to the prepaid instrumentparticularly in a period of declining interest rates.

 

***Giventhe geographic concentration of our operations, we could be significantlyaffected by any hurricane that affects coastal South Carolina***.

 

Our operations areconcentrated in and our loan portfolio consists almost entirely of loans topersons and businesses located in coastal South Carolina.  The collateral for many of our loans consistsof real and personal property located in this area, which is susceptible tohurricanes that can cause extensive damage to the general region.  Disaster conditions resulting from anyhurricane that hits in this area would adversely affect the local economies andreal estate markets, which could negatively impact our business.  Adverse economic conditions resulting fromsuch a disaster could also negatively affect the ability of our customers torepay their loans and could reduce the value of the collateral securing theseloans.  Furthermore, damage resultingfrom any hurricane could also result in continued economic uncertainty thatcould negatively impact businesses in those areas.  Consequently, our ability to continue tooriginate loans may be impaired by adverse changes in local and regionaleconomic conditions in this area following any hurricane.

 

***We must respond to rapid technological changes, which may bemore difficult or expensive than anticipated.***

 

If our competitorsintroduce new products and services embodying new technologies, or if newindustry standards and practices emerge, our existing product and serviceofferings, technology and systems may become obsolete.  Further, if we fail to adopt or develop newtechnologies or to adapt our products and services to emerging industrystandards, we may lose current and future customers, which could have amaterial adverse effect on our business, financial condition and results ofoperations.  The financial servicesindustry is changing rapidly, and to remain competitive, we must continue toenhance and improve the functionality and features of our products, servicesand technologies.  These changes may bemore difficult or expensive than we anticipate.

 

***Ourability to pay dividends on and repurchase our common stock is restricted.***

 

Since our inception, wehave not paid any cash dividends on our common stock, and we do not intend topay cash dividends in the foreseeable future. However, the ability of our bank to pay cash dividends to our holdingcompany is currently prohibited by the restrictions of the MOU with the SouthCarolina Banking Department and the FDIC. Even if we decide to pay cash dividends in the future and our regulatorspermit us to do so, our ability to do so will be limited by the regulatoryrestrictions described in the following sentence, by the bank’s ability to paycash dividends to us based on its capital position and profitability, and byour need to maintain sufficient capital to support the bank’s operations.  The ability of the bank to pay cash dividendsto us is limited by its obligations to 

 

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maintain sufficientcapital and by other restrictions on its cash dividends that are applicable toSouth Carolina state banks and banks that are regulated by the FDIC.  If we do not satisfy these regulatoryrequirements, we will be unable to pay cash dividends on our common stock.

 

In addition, the CPP PurchaseAgreement provides that before December 19, 2011, unless we have redeemedthe Series T Preferred Stock or the Treasury has transferred the Series TPreferred Stock to a third party, we must obtain the consent of the Treasury to(1) declare or pay any dividend or make any distribution on our commonstock, or (2) redeem, purchase or acquire any shares of our common stockor other equity or capital securities, other than in connection with benefitplans consistent with past practice and certain other circumstances specifiedin the purchase agreement.  Theserestrictions, together with the potentially dilutive impact of the warrantdescribed in the next risk factor, could have a negative effect on the value ofour common stock.

 

***The warrant we issued to the Treasury may be dilutive toholders of our common stock.***

 

The ownership interest ofthe existing holders of our common stock will be diluted to the extent the CPPWarrant is exercised.  The shares ofcommon stock underlying the warrant represent approximately 11.8% of the sharesof our common stock outstanding as of February 22, 2010 (including theshares issuable upon exercise of the warrant in total shares outstanding).  Although Treasury has agreed not to vote anyof the shares of common stock it receives upon exercise of the warrant, atransferee of any portion of the warrant or of any shares of common stock acquiredupon exercise of the warrant will not be bound by this restriction.

 

***The holders of our junior subordinateddebentures have rights that are senior to those of our common shareholders.***

 

We have supported ourcontinued growth through the issuance of trust preferred securities from twospecial purpose trusts and an accompanying sale of $14.4 million juniorsubordinated debentures to these trusts. We have conditionally guaranteed payments of the principal and intereston the trust preferred securities of these trusts.  We must make payments on the juniorsubordinated debentures before we can pay any dividends on our commonstock.  In the event of our bankruptcy,dissolution or liquidation, the holders of the junior subordinated debenturesmust be satisfied before any distributions can be made on our commonstock.  We have the right to deferdistributions on the junior subordinated debentures (and the related trustpreferred securities) for up to five years, during which time we cannot pay anydividends on our common stock.

 

**Item 1B.  Unresolved Staff Comments.**

 

Not applicable

 

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**Item 2.  Properties.**

 

The following table setsforth the location of our main banking office, banking offices and operationscenter, as well as certain information relating to these facilities.

 
| **Type  of Office**                      | ** ** | **Location**                                                | ** ** | **Year Opened**        | ** ** | **Total Retail********Deposits as of********December 31, 2009** | ** ** | **Leased or  Owned** |
|------------------------------------------|------------|-------------------------------------------------------------|------------|------------------------|------------|----------------------------------------------------------------------|------------|----------------------|
| Main Office                              |       | 875  Lowcountry Boulevard in Mount Pleasant, South Carolina |       | 2004                   |       | $104,699,000                                                         |       | Leased               |
| Summerville Branch Office                |       | 1510  Trolley Road in Summerville, South Carolina           |       | 2007                   |       | $54,400,000                                                          |       | Owned                |
| Myrtle Beach Branch Office               |       | 1312  Professional Drive in Myrtle Beach, South Carolina    |       | 2007                   |       | $60,232,000                                                          |       | Leased               |
| Park West Branch Office - Mount Pleasant |       | 1100  Park West Blvd. in Mount Pleasant, South Carolina     |       | 2007                   |       | $23,295,000                                                          |       | Owned                |
| West Ashley Branch Office - Charleston   |       | 946  Orleans Road in Charleston, South Carolina             |       | 2007                   |       | $50,083,000                                                          |       | Leased               |
| Bluffton Branch Office                   |       | 52  Burnt Church Road in Bluffton, South Carolina           |       | 2008                   |       | $67,649,000                                                          |       | Leased               |
| Murrells Inlet Branch Office             |       | 11915  Plaza Drive in Murrells Inlet, South Carolina        |       | 2008                   |       | $41,275,000                                                          |       | Leased               |
| Operations Center                        |       | 840  Lowcountry Boulevard in Mount Pleasant, South Carolina |       | 2007                   |       | N/A                                                                  |       | Owned                |
| Corporate Headquarters                   |       | 830  Lowcountry Boulevard in Mount Pleasant, South Carolina |       | UnderConstruction  (1) |       | N/A                                                                  |       | Leased               |
| Okatie CrossingBranch Office             |       | 15  Baylor Brooke Drive in Bluffton, South Carolina         |       | ConstructionPending    |       | N/A                                                                  |       | Owned                |

 

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(1)    Estimated construction costsare approximately $4.5 million.

 

**Item3.  Legal Proceedings.**

 

Neither the company northe bank is a party to, nor is any of their property the subject of, anymaterial pending legal proceedings incidental to the business of the company orthe bank.

 

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**Item4.  Reserved.**

 

**PART II**

 

**Item5.  Market for Registrant’s Common Equityand Related Stockholder Matters and Small Business Issuer Purchases of EquitySecurities.**

 

In connection with ourpublic offering in October 2006, our common stock was approved for listingon The NASDAQ Global Market under the symbol “TDBK.”  Prior to October 2006, our common stockwas quoted on the OTC Bulletin Board under the symbol “TDBK.OB.”  As of December 31, 2009, we hadapproximately 472 shareholders of record.

 

The following table shows the reported high and lowclosing prices for shares of our common stock published by NASDAQ beginningwith the first quarter of 2008.

 
| ** **      | ** ** | **High** | ** ** | **Low** | ** ** |
|-----------------|------------|----------|------------|---------|------------|
| **2009**        |       |     |       |    |       |
| Fourth  Quarter |       | $        | 4.24       |    | $          | 2.80 |   |
| Third  Quarter  |       | 3.40     |       | 2.75    |       |
| Second  Quarter |       | 3.90     |       | 2.80    |       |
| First  Quarter  |       | 4.10     |       | 2.50    |       |
|            |       |     |       |    |       |
| **2008**        |       |     |       |    |       |
| Fourth  Quarter |       | $        | 6.51       |    | $          | 2.49 |   |
| Third  Quarter  |       | 8.95     |       | 5.80    |       |
| Second  Quarter |       | 10.50    |       | 8.50    |       |
| First  Quarter  |       | 11.46    |       | 9.00    |       |

 

We have notdeclared or paid any cash dividends on our common stock since ourinception.  For the foreseeable future wedo not intend to declare cash dividends. We intend to retain earnings to grow our business and strengthen ourcapital base.  Our ability to paydividends depends on the ability of our subsidiary, Tidelands Bank, to paydividends to us.  As a South Carolinastate bank, Tidelands Bank may only pay dividends out of its net profits, afterdeducting expenses, including losses and bad debts.  In addition, the bank is prohibited fromdeclaring a dividend on its shares of common stock until its surplus equals itsstated capital.  If and when cashdividends are declared, they will be largely dependent upon our earnings,financial condition, business projections, general business conditions,statutory and regulatory restrictions and other pertinent factors.  Further, under an informal MOU with the SouthCarolina Banking Department and the FDIC, the bank may not pay dividendswithout the prior written consent of each supervisory authority.

 

In addition, theCPP Purchase Agreement provides that before December 19, 2011, unless we haveredeemed the Series T Preferred Stock or the Treasury has transferred the Series TPreferred Stock to a third party, we must obtain the consent of the Treasury todeclare or pay any dividend or make any distribution on our common stock.

 

Our ability to pay cashdividends is further subject to our continued payment of interest that we oweon our junior subordinated debentures. As of December 31, 2009, we had approximately $14.4 million ofjunior subordinated debentures outstanding. We have the right to defer payment of interest on the juniorsubordinated debentures for a period not to exceed 20 consecutivequarters.  If we defer, or fail to make,interest payments on the junior subordinated debentures, we will be prohibited,subject to certain exceptions, from paying cash dividends on our common stockuntil we pay all deferred interest and resume interest payments on the juniorsubordinated debentures.

 

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**EquityCompensation Plan Information**

 

Thefollowing table sets forth the equity compensation plan information at December 31,2009.  All stock option information hasbeen adjusted to reflect all prior stock splits and dividends.

 
| **Plan  Category**                                          | ** ** | **Number of securities  to be issued upon exercise  of outstanding options,  warrants and rights(a)** | ** ** | **Weighted-average  exercise price of  outstanding options,  warrants and rights (b)** | ** ** | **Number of securities  remaining available for  future issuance under  equity compensation plans  (c) (excluding securities  reflected in column(a))** | ** ** |
|-------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
|                                                        |       |                                                                                                  |       |                                                                                   |       |                                                                                                                                                         |       |
| Equity  compensation plans approved by security holders (1) |       | 742,060                                                                                               |       | $                                                                                      | 10.28      |                                                                                                                                                         | 41,446     |   |
|                                                        |       |                                                                                                  |       |                                                                                   |       |                                                                                                                                                         |       |
| Equity  compensation plans not approved by security holders |       | —                                                                                                |       | —                                                                                 |       | —                                                                                                                                                       |       |
|                                                        |       |                                                                                                  |       |                                                                                   |       |                                                                                                                                                         |       |
| Total                                                       |       | 742,060                                                                                               |       | $                                                                                      | 10.28      |                                                                                                                                                         | 41,446     |   |

 

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(1)                The number of shares available for issuance under our 2004 StockIncentive Plan automatically increases each time we issue additional shares ofstock so that the total number of shares issuable under the plan at all timesequal 20% of the then outstanding shares of stock.  Each of our organizersreceived an option to purchase one share of common stock for $8.80 per sharefor every three shares they purchased in our initial public offering, up to amaximum of 12,500 shares per organizer, and the issuance of options wasratified by our shareholders.

 

**Item6.  Selected Financial Data.**

 

Not applicable

 

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**Item7.  Management’s Discussion and Analysisor Plan of Operation.**

 

*The following discussion reviewsour results of operations and assesses our financial condition.  You should read the following discussion andanalysis in conjunction with our consolidated financial statements and therelated notes included elsewhere in this report.  Our discussion and analysis for the yearsended December 31, 2009, 2008 and 2007 is based on our audited financialstatements for such periods.  Thefollowing discussion describes our results of operations for the year ended December 31,2009 as compared to December 31, 2008 and 2007, and also analyzes our financialcondition as of December 31, 2009 as compared to December 31, 2008.*

 

**Overview**

 

We were incorporated in March 2002to organize and serve as the holding company for Tidelands Bank.  As of December 31, 2009, we had totalassets of $775.9 million, loans of $485.6 million, deposits of $591.5 million,and shareholders’ equity of $38.9 million.

 

The following table setsforth selected measures of our financial performance for the periods indicated.

 
| ** **                                          | ** ** | **For the Years Ended December 31,** | ** ** |
|-----------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                          | ** ** | **2009**                                  | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                          | ** ** | **(dollars in thousands)**                | ** ** |
| Net  income (loss) available to common shareholders |       | $                                         | (11,183    | ) | $ | (4,955 | ) | $ | 413 |   |
| Total  assets                                       |       | 775,930                                   |       | 715,182 |   | 512,270 |   |
| Total  net loans                                    |       | 475,507                                   |       | 454,332 |   | 387,192 |   |
| Total  deposits                                     |       | 591,549                                   |       | 561,225 |   | 388,169 |   |
| Shareholders’  equity                          |       | 38,925                                    |       | 51,959 |   | 40,995 |   |
|                                                     |            |                                           |            |  |  |  |  |  |  |  |

 

Like most community banks, we derive the majority ofour income from interest received on our loans and investments.  Our primary source of funds for making theseloans and investments is our deposits, on which we pay interest, and advancesfrom the Federal Home Loan Bank of Atlanta (FHLB).  Consequently, one of the key measures of oursuccess is net interest income, or the difference between the income on ourinterest-earning assets, such as loans and investments, and the expense on ourinterest-bearing liabilities, such as deposits and advances from the FHLB.  Another key measure is the spread between theyield we earn on these interest-earning assets and the rate we pay on our interest-bearingliabilities, which is called our net interest spread.

 

We have included a number of tables to assist in ourdescription of these measures.  Forexample, the “Average Balances, Income and Expenses, and Rates” tables show forthe periods indicated the average balance for each category of our assets andliabilities, as well as the average yield we earned or the average rate we paidwith respect to each category.  A reviewof these tables show that our loans historically have provided higher interestyields than our other types of interest-earning assets, which is why we haveinvested a substantial percentage of our earning assets into our loanportfolio.  Similarly, the “Rate/VolumeAnalysis” tables help demonstrate the impact of changing interest rates andchanging volume of assets and liabilities during the periods shown.  We also track the sensitivity of our variouscategories of assets and liabilities to changes in interest rates, and we haveincluded “Interest Sensitivity Analysis” tables to help explain this.  Finally, we have included a number of tablesthat provide detail about our investment securities, our loans, our depositsand other borrowings.

 

There are risks inherent in all loans, so we maintainan allowance for loan losses to absorb probable losses on existing loans thatmay become uncollectible.  We maintainthis allowance by charging a provision for loan losses against our operatingearnings for each period.  In the “Loans”and “Allowance for Loan Losses” sections, we have included a detaileddiscussion of this process, as well as several tables describing our allowancefor loan losses.

 

In addition to earning interest on our loans andinvestments, we earn income through fees and other charges to ourcustomers.  We describe the variouscomponents of this noninterest income, as well as our noninterest expense, inthe “Noninterest Income” and “Noninterest Expense” sections.

 

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**Recent Legislative and RegulatoryInitiatives to Address Financial and Economic Crises**

 

Markets in the UnitedStates and elsewhere have experienced extreme volatility and disruption formore than 18 months.  These circumstanceshave exerted significant downward pressure on prices of equity securities andvirtually all other asset classes, and have resulted in substantially increasedmarket volatility, severely constrained credit and capital markets,particularly for financial institutions, and an overall loss of investorconfidence.  Loan portfolio performanceshave deteriorated at many institutions resulting from, among other factors, aweak economy and a decline in the value of the collateral supporting theirloans.  Dramatic slowdowns in the housingindustry, due in part to falling home prices and increasing foreclosures andunemployment, have created strains on financial institutions.  Many borrowers are now unable to repay theirloans, and the collateral securing these loans has, in some cases, declinedbelow the loan balance.  Specifically,deterioration in residential and commercial real estate values and a reductionin the level of tourism in our coastal markets has materially increased ourlevel of nonperforming assets and past due loans.  These market conditions and the tightening ofcredit have also led to deficiencies in our loan portfolio, increased marketvolatility, a lower net interest margin, net losses and added pressure oncapital.  In response to the challengesfacing the financial services sector, several regulatory and governmentalactions have recently been announced including:

 

·                  The Emergency Economic Stabilization Actof 2008 (“EESA”), approved by Congress and signed by President Bush on October 3,2008, which, among other provisions, allowed the U.S. Treasury to purchase upto $700 billion of mortgages, mortgage-backed securities and certain otherfinancial instruments from financial institutions for the purpose ofstabilizing and providing liquidity to the U.S. financial markets.  EESA also temporarily raised the basic limitof FDIC deposit insurance from $100,000 to $250,000 through December 31,2013.

 

·                  On October 7, 2008, the FDICapproved 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 Troubled Asset ReliefProgram (the “TARP”) Capital Purchase Program (the “CPP”) that encourages andallows financial institutions to build capital through the sale of seniorpreferred shares to the U.S. Treasury on terms that are non-negotiable.

 

·                  On October 14, 2008, the FDICannounced the creation of the Temporary Liquidity Guarantee Program (the “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:

 

·                  The Transaction Account Guarantee Program(“TAGP”), which provides unlimited deposit insurance coverage through June 30,2010 for noninterest-bearing transaction accounts (typically business checkingaccounts) and certain funds swept into noninterest-bearing savingsaccounts.  Institutions participating inthe TAGP pay a 15 to 25 basis points fee (annualized), according to theinstitution’s risk category on the balance of each covered account in excess of$250,000, while the extra deposit insurance is in place; and

 

·                  The Debt Guarantee Program (“DGP”), underwhich the FDIC guarantees certain senior unsecured debt of FDIC-insuredinstitutions and their holding companies. The unsecured debt must be issued on or after October 14, 2008 andnot later than June 30, 2009, and the guarantee is effective through theearlier of the maturity date or June 30, 2012.  The DGP coveragelimit is generally 125% of the eligible entity’s eligible debt outstanding on September 30,2008 and scheduled to mature on or before June 30, 2009 or, for certaininsured institutions, 2% of their liabilities as of September 30,2008.  Depending on the term of the debtmaturity, the nonrefundable DGP fee ranges from 50 to 100 basis points(annualized) for covered debt outstanding until the earlier of maturity or June 30,2012.  The TAGP and DGP are in effect forall eligible entities, unless the entity opted out on or before December 5,2008.

 

·                  On February 17, 2009 President Obama signed intolaw The American Recovery and Reinvestment Act of 2009 (“ARRA”), more commonlyknown as the economic stimulus or economic recovery package. ARRA

 

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includes a wide varietyof programs intended to stimulate the economy and provide for extensiveinfrastructure, energy, health, and education needs.  In addition, ARRA imposes certain executivecompensation and corporate expenditure limits on all current and future TARPrecipients that are in addition to those previously announced by the U.S.Treasury. These new limits are in place until the institution has repaid theTreasury, which is now permitted under ARRA without penalty and without theneed to raise new capital, subject to the Treasury’s consultation with therecipient institution’s appropriate regulatory agency.

 

·                  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 not strictly limited toloans; however, what constitutes an eligible asset will be determined byparticipating banks, their primary regulators, the FDIC and the Treasury.  Under the Legacy Loan Program, the FDIC hassold certain troubled assets out of an FDIC receivership in two separatetransactions relating to the failed Illinois bank, Corus Bank, NA, and thefailed Texas bank, Franklin Bank, S.S.B. These transactions were completed in September 2009 and October 2009,respectively.

 

·                  The second planis the Securities Program, which is administered by the Treasury and involvesthe creation of public-private investment funds to target investments ineligible residential mortgage-backed securities and commercial mortgage-backedsecurities issued before 2009 that originally were rated AAA or the equivalentby two or more nationally recognized statistical rating organizations, withoutregard to rating enhancements (collectively, “Legacy Securities”).  Legacy Securities must be directly secured byactual mortgage loans, leases or other assets, and may be purchased only fromfinancial institutions that meet TARP eligibility requirements.  Treasury received over 100 uniqueapplications to participate in the Legacy Securities PPIP and in July 2009selected nine public-private investment fund managers.   As of December 31, 2009, public-privateinvestment funds have completed initial and subsequent closings on approximately$6.2 billion of private sector equity capital, which was matched 100% byTreasury, representing $12.4 billion of total equity capital.  Treasury has also provided $12.4 billion ofdebt capital, representing $24.8 billion of total purchasing power.  As of December 31, 2009, public-privateinvestment funds have drawn-down approximately $4.3 billion of total capitalwhich has been invested in certain non-agency residential mortgage backedsecurities and commercial mortgage backed securities and cash equivalentspending investment.

 

On December 19,2008, as part of the TARP CPP, we entered into a Letter Agreement andSecurities Purchase Agreement (collectively, the “CPP Purchase Agreement”) withthe Treasury Department, pursuant to which we sold (i) 14,448 shares ofour Fixed Rate Cumulative Perpetual Preferred Stock, Series T (the “Series TPreferred Stock”) and (ii) a warrant (the “CPP Warrant”) to purchase571,821 shares of our common stock for an aggregate purchase price of$14,448,000 million in cash.

 

The Series TPreferred Stock will qualify as Tier 1 capital and will be entitled tocumulative dividends at a rate of 5% per annum for the first five years, and 9%per annum thereafter.  We must consultwith the Federal Reserve before we may redeem the Series T Preferred Stockbut, contrary to the original restrictions in the EESA, will not necessarily berequired to raise additional equity capital in order to redeem this stock.  The CPP Warrant has a 10-year term and is immediatelyexercisable upon its issuance, with an exercise price, subject to anti-dilutionadjustments, equal to $3.79 per share of the common stock.  Please see the Form 8-K we filed withthe SEC on December 19, 2008, for additional information about the Series TPreferred Stock and the CPP Warrant.

 

We alsoparticipate in the TAGP and will participate in the extended TAGP.  We have not opted out of the DGP.  As a result of the enhancements to deposit insurance protection and theexpectation that there will be 

 

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demands on the FDIC’s deposit insurance fund, our deposit insurance costshave increased and will continue to increase during 2010.

 

It is likely thatfurther regulatory actions may arise as the Federal government continues toattempt to address the economic situation. Governmental interventionand new regulations under these programs could materiallyand adversely affect our business, financial condition and results ofoperations.  The following discussion andanalysis describes our performance in this challenging economicenvironment.  We encourage you to readthis discussion and analysis in conjunction with our financial statements andthe other statistical information included in this report.

 

#### **Critical Accounting Policies**

#### ** **

Wehave adopted various accounting policies that govern the application ofaccounting principles generally accepted in the United States and with generalpractices within the banking industry in the preparation of our financialstatements.  Our significant accountingpolicies are described in the footnotes to our audited consolidated financialstatements as of December 31, 2009. Management has discussed these critical accounting policies with theaudit committee.

 

Certainaccounting policies involve significant judgments and assumptions by us thathave a material impact on the carrying value of certain assets andliabilities.  We consider theseaccounting policies to be critical accounting policies.  The judgment and assumptions we use are basedon historical experience and other factors, which we believe to be reasonableunder the circumstances.  Because of thenature of the judgment and assumptions we make, actual results could differfrom these judgments and estimates that could have a material impact on the carryingvalues of our assets and liabilities and our results of operations.

 

Webelieve the allowance for loan losses is the critical accounting policy thatrequires the most significant judgments and estimates used in preparation ofour consolidated financial statements. Some of the more critical judgments supporting the amount of ourallowance for loan losses include judgments about the credit worthiness ofborrowers, the estimated value of the underlying collateral, the assumptionsabout cash flow, determination of loss factors for estimating credit losses,the impact of current events and conditions and other factors impacting thelevel of probable inherent losses.  Underdifferent conditions or using different assumptions, the actual amount ofcredit losses incurred by us may be different from management’s estimatesprovided in our consolidated financial statements.  Refer to the portion of this discussion thataddresses our allowance for loan losses for a more complete discussion of ourprocesses and methodology for determining our allowance for loan losses.

 

**Results of Operations**

 

***Income Statement Review***

 

*Summary*

 

Our net loss available to common shareholders wasapproximately $11.2 million for the year ended December 31, 2009, comparedto a net loss of $5.0 million for the year ended December 31, 2008 and netincome of $413,000 for December 31, 2007. The pre-tax loss for the year ended December 31, 2009 was $6.9million compared to $7.7 million for the year ended December 31, 2008 andpre-tax net income of $688,000 for the year ended December 31, 2007.  We recorded provisions for loan losses of$14.7 million, $4.7 million and $1.0 million for the years ended December 31,2009, 2008 and 2007, respectively.  The$6.2 million increase in the after tax net loss from 2008 to 2009 resulted froma $3.4 million charge for income tax expense in comparison to a $2.7 milliontax benefit in 2008.  Despite a net lossbefore income tax, the increase in tax expense for the year ended December 31,2009 was a result of the company providing for a $5.6 million deferred taxvaluation allowance based on our evaluation of the likelihood of our ability toutilize net operating losses in the near term.

 

In comparing December 31, 2009 and 2008, netinterest income before provision expense increased $3.6 million, noninterestincome increased from a loss of $2.8 million for the year ended December 31,2008 to a gain of $6.2 million for the year ended December 31, 2009 whilenoninterest expense increased $1.7 million. Noninterest 

 

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expenseincreased in 2009 primarily as a result of the $1.0 million increase in theFDIC assessment and $1.2 million increase in loan related expenses.  For the years ended December 31, 2008and 2007, the $8.3 million decrease in net income before tax expense resultedprimarily from apre-tax impairment charge of $4.6 million related to the government placing theFederal National Mortgage Association and the Federal Home Loan MortgageCorporation into conservatorship and our provisional expense for credit lossesof $4.7 million.  Excluding the $4.6million impairment and gains on securities taken during 2008 of $509,000,noninterest income remained steady at $1.3 million from 2007 to 2008.  Noninterest income decreased from $1.4million for the year ended December 31, 2007 to a loss of $2.8 million forthe year ended December 31, 2008.

 

*Net Interest Income*

 

Our level of net interestincome is determined by the level of earning assets and the management of ournet interest margin.  The growth in ourloan portfolio has historically been the primary driver of the increase in netinterest income.  During the years ended December 31,2009 and 2008, our loan portfolio increased $23.6 million and $70.6 million, respectively.  We anticipate the growth in loans will drivethe growth in assets and the growth in net interest income once economicconditions improve.  However, we do notexpect to sustain the same growth rate in our loan portfolio as we haveexperienced in the past.

 

The growth in our loan portfolio has created the needfor a higher level of capital and the need to increase deposits andborrowings.  This loan growth strategyalso resulted in a significant portion of our assets being in higher earningloans rather than in lower yielding investments.  At December 31, 2009, loans represented62.6% of total assets, while securities and federal funds sold represented32.0% of total assets.  While we plan tocontinue our focus on selectively increasing our loan portfolio, we alsoanticipate managing the size of the investment portfolio during the ongoingeconomic recession as loan demand remains soft and investment yields becomemore attractive on a relative basis.

 

The current interest rate environment, which is low byhistorical measures, has allowed us to obtain short-term borrowings andwholesale certificates of deposit at rates that were typically lower thancertificate of deposit rates being offered in our local market.  This funding strategy allowed us to continueto operate in a branch expansion environment, which in turn allowed us to focuson our loan portfolio.  At December 31,2009, retail deposits represented $401.6 million, or 54.8% of total funding,which includes total deposits plus borrowings. Borrowings represented $141.7 million, or 19.3% of total funding, andwholesale deposits represented $189.9 million, or 25.9% of total funding.

 

We plan to continue to offer competitive rates oninvestment checking and money market accounts. Our goal is to maintain a higher percentage of assets being funded byretail deposits and to increase the percentage of low-cost transaction accountsto total deposits.  No assurance can begiven that these objectives will be achieved. We operateseven full service banking offices located along the South Carolina coast.  Although we anticipate that our fullservice banking offices will assist us in meeting these objectives, we believethat the current deposit strategies and the opening of new offices had adampening effect on earnings.  However,we believe that over time these two strategies will provide us with additionalcustomers in our markets and will provide a lower alternative cost of funding.

 

In addition to the growth in both assets andliabilities, and the timing of the repricing of our assets and liabilities, netinterest income is also affected by the ratio of interest-earning assets tointerest-bearing liabilities and the changes in interest rates earned on ourassets and interest rates paid on our liabilities.  Despite difficult economic conditions in 2009,net interest income increased $3.6 million as the result of an increase in investment portfoliorevenue of $3.1 million,which offset a decline in loan revenue, and a decrease in funding costs of $2.8 million as compared to the prior period.  Our net interest income for the year ended December 31,2009 increased in part because we had more interest-earning assets thaninterest-bearing liabilities.  For theyears ended December 31, 2009, 2008 and 2007, average interest-earningassets exceeded average interest-bearing liabilities by $15.0 million, $18.2million, and $27.2 million, respectively.

 

The impact of the Federal Reserve’s interest rate cutssince August 2007 resulted in a decrease in both the yields on ourvariable rate assets and the rates that we pay for our short-term deposits andborrowings.  The net 

 

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interestmargin decreased to 2.45% during the year ended December 31, 2009, as aresult of the bank having higher average earning assets despite the increase inthe net interest spread.  The netinterest margin decreased as the net interest spread improved because we usedmore earning assets to generate the given revenue stream.  We believe the stress being extended on ourbalance sheet and consequently our earnings is the result of the currenteconomic environment.  Our net interestmargins for the years ended December 31, 2009, 2008 and 2007 were 2.45%,2.50% and 2.99%, respectively.  Duringthe year ended December 31, 2008, the net interest spread and net interestmargin decreased from comparable amounts in 2007 as a result of the bank havingfewer interest-earning liabilities than interest-bearing assets that repricedas market rates began to decrease over the period.

 

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*Years Ended December 31, 2009, 2008 and 2007*

 

The following table sets forth information related toour average balance sheet, average yields on assets, and average costs ofliabilities.  We derived these yields bydividing income or expense by the average balance of the corresponding assetsor liabilities.  We derived averagebalances from the daily balances throughout the periods indicated.  During the three years ended December 31,2009, 2008 and 2007, we had no securities purchased with agreements toresell.  All investments were owned at anoriginal maturity of over one year.

 

**AverageBalances, Income and Expenses, and Rates**

** **
| ** **                                       | ** ** | **For the  Year Ended  December 31, 2009** | ** ** | **For the  Year Ended  December 31, 2008** | ** ** | **For the  Year Ended  December 31, 2007** | ** ** |
|--------------------------------------------------|------------|-------------------------------------------------|------------|-------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                       | ** ** | **Average  Balance**                            | ** ** | **Income/  Expense**                            | ** ** | **Yield/  Rate**                                | ** ** | **Average  Balance** | ** ** | **Income/  Expense** | ** ** | **Yield/  Rate** | ** ** | **Average  Balance** | ** ** | **Income/  Expense** | ** ** | **Yield/  Rate** | ** ** |
| ** **                                       | ** ** | **(dollars  in thousands)**                     | ** ** |
| Earning  assets:                                 |       |                                            |       |                                            |       |                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest  bearing balances                       |       | $                                               | 2,440      |                                            | $          | 3                                               |       | 0.11 | % | $ | 251 |   | $ | 5 |   | 2.04 | % | $ | 283 |   | $ | 16 |   | 5.74 | % |
| Federal  funds sold                              |       | 9,573                                           |       | 26                                              |       | 0.27                                            | %          | 17,123 |   | 281 |   | 1.64 | % | 13,573 |   | 702 |   | 5.17 | % |
| Taxable  investment securities                   |       | 248,568                                         |       | 9,922                                           |       | 3.99                                            | %          | 119,238 |   | 6,805 |   | 5.71 | % | 42,885 |   | 2,463 |   | 5.74 | % |
| Non-taxable  investment securities.              |       | 3,760                                           |       | 148                                             |       | 3.95                                            | %          | 7,172 |   | 287 |   | 4.00 | % | 11,035 |   | 440 |   | 3.98 | % |
| Loans  receivable                                |       | 472,025                                         |       | 25,513                                          |       | 5.40                                            | %          | 433,629 |   | 27,379 |   | 6.31 | % | 339,774 |   | 27,805 |   | 8.18 | % |
| Total  earning assets                            |       | 736,366                                         |       | 35,612                                          |       | 4.84                                            | %          | 577,413 |   | 34,757 |   | 6.02 | % | 407,550 |   | 31,426 |   | 7.71 | % |
|                                             |       |                                            |       |                                            |       |                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Nonearning  assets:                              |       |                                            |       |                                            |       |                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash  and due from banks                         |       | 11,984                                          |       |                                            |       |                                            |       | 3,863 |   |   |   |   |   | 1,577 |   |   |   |   |   |
| Mortgage  loans held for sale                    |       | 986                                             |       |                                            |       |                                            |       | 510 |   |   |   |   |   | 1,640 |   |   |   |   |   |
| Premises  and equipment, net                     |       | 19,054                                          |       |                                            |       |                                            |       | 19,099 |   |   |   |   |   | 14,974 |   |   |   |   |   |
| Other  assets                                    |       | 27,828                                          |       |                                            |       |                                            |       | 18,844 |   |   |   |   |   | 12,256 |   |   |   |   |   |
| Allowance  for loan losses                       |       | (8,367                                          | )          |                                            |       |                                            |       | (4,889 | ) |   |   |   |   | (4,117 | ) |   |   |   |   |
| Total  nonearning assets                         |       | 51,485                                          |       |                                            |       |                                            |       | 37,427 |   |   |   |   |   | 26,330 |   |   |   |   |   |
| Total  assets                                    |       | $                                               | 787,851    |                                            |       |                                            |       |   | $ | 614,840 |   |   |   |   |   | $ | 433,880 |   |   |   |   |   |
|                                             |       |                                            |       |                                            |       |                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:                   |       |                                            |       |                                            |       |                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest  bearing transaction accounts           |       | $                                               | 40,761     |                                            | 643        |                                            | 1.58       | % | $ | 28,576 |   | 723 |   | 2.53 | % | $ | 6,718 |   | 240 |   | 3.58 | % |
| Savings &  money market                 |       | 197,356                                         |       | 3,357                                           |       | 1.70                                            | %          | 173,471 |   | 4,806 |   | 2.77 | % | 186,732 |   | 9,081 |   | 4.86 | % |
| Time  deposits less than $100,000                |       | 214,135                                         |       | 6,100                                           |       | 2.85                                            | %          | 203,217 |   | 8,624 |   | 4.24 | % | 131,130 |   | 6,936 |   | 5.29 | % |
| Time  deposits greater than $100,000             |       | 97,918                                          |       | 3,246                                           |       | 3.31                                            | %          | 63,180 |   | 2,635 |   | 4.17 | % | 10,418 |   | 562 |   | 5.39 | % |
| Junior  subordinated debentures                  |       | 14,434                                          |       | 774                                             |       | 5.36                                            | %          | 11,493 |   | 724 |   | 6.30 | % | 8,248 |   | 561 |   | 6.80 | % |
| Advances  from FHLB                              |       | 91,075                                          |       | 2,326                                           |       | 2.55                                            | %          | 40,915 |   | 1,436 |   | 3.51 | % | 20,575 |   | 1,012 |   | 4.92 | % |
| Securities  sold under repurchase agreement      |       | 63,090                                          |       | 1,053                                           |       | 1.67                                            | %          | 35,187 |   | 1,258 |   | 3.58 | % | 14,828 |   | 736 |   | 4.96 | % |
| Federal  funds purchased                         |       | 106                                             |       | 1                                               |       | 1.12                                            | %          | 187 |   | 8 |   | 4.25 | % | 856 |   | 47 |   | 5.50 | % |
| ESOP  borrowings                                 |       | 2,480                                           |       | 57                                              |       | 2.29                                            | %          | 2,774 |   | 116 |   | 4.17 | % | 854 |   | 60 |   | 7.02 | % |
| Other  borrowings                                |       | 45                                              |       | 2                                               |       | 3.99                                            | %          | 220 |   | 12 |   | 5.53 | % | — |   | — |   | — | % |
| Total  interest-bearing liabilities              |       | 721,400                                         |       | 17,559                                          |       | 2.43                                            | %          | 559,220 |   | 20,342 |   | 3.64 | % | 380,359 |   | 19,235 |   | 5.06 | % |
|                                             |       |                                            |       |                                            |       |                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Noninterest-bearing  liabilities:                |       |                                            |       |                                            |       |                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Demand  deposits                                 |       | 12,516                                          |       |                                            |       |                                            |       | 12,272 |   |   |   |   |   | 10,550 |   |   |   |   |   |
| Other  liabilities                               |       | 4,734                                           |       |                                            |       |                                            |       | 3,391 |   |   |   |   |   | 1,710 |   |   |   |   |   |
| Shareholders’  equity                       |       | 49,201                                          |       |                                            |       |                                            |       | 39,957 |   |   |   |   |   | 41,261 |   |   |   |   |   |
|                                             |       |                                            |       |                                            |       |                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total  liabilities and shareholders’ equity |       | $                                               | 787,851    |                                            |       |                                            |       |   | $ | 614,840 |   |   |   |   |   | $ | 433,880 |   |   |   |   |   |
| Net  interest income                             |       |                                            |       | $                                               | 18,053     |                                            |       |   |   |   | $ | 14,415 |   |   |   |   |   | $ | 12,191 |   |   |   |
| Net  interest spread                             |       |                                            |       |                                            |       | 2.41                                            | %          |   |   |   |   | 2.38 | % |   |   |   |   | 2.65 | % |
| Net  interest margin                             |       |                                            |       |                                            |       | 2.45                                            | %          |   |   |   |   | 2.50 | % |   |   |   |   | 2.99 | % |

 

----

(1) Includesnonaccruing loans

 

42

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Our net interest spread was 2.41%, 2.38% and 2.65% forthe years ended December 31, 2009, 2008 and 2007, respectively.  The net interest spread is the differencebetween the yield we earn on our interest-earning assets and the rate we pay onour interest-bearing liabilities.

 

The net interest margin is calculated as net interestincome divided by average interest-earning assets.  Our net interest margin for the years ended December 31,2009, 2008 and 2007 was 2.45%, 2.50% and 2.99%, respectively.  During 2009, interest-earning assets averaged$736.4 million, compared to $577.4 million in 2008 and $407.6 million in2007.  During the same periods, averageinterest-bearing liabilities were $721.4 million, $559.2 million and $380.4million, respectively.

 

Net interest income, the largest component of ourincome, was $18.1 million, $14.4 million and $12.2 million for the years ended December 31,2009, 2008 and 2007, respectively.  Theincrease in 2009 was a result of an increase in the net interest spread while incomparison, the increase in 2008 resulted from the net effect of higher levelsof both average earning assets and interest-bearing liabilities, rather thanfrom an increase in the net interest spread.

 

The $3.6 million increase in net interest income forthe year ended December 31, 2009, compared to the same period in 2008,resulted from a $3.1 million increase in investment portfolio revenue, whichoffset declining loan revenue, and a $2.8 million decrease in fundingcosts.  The $2.2 million increase in netinterest income for the year ended December 31, 2008, compared to the sameperiod in 2007, resulted from a $3.3 million increase in interest income offsetby a $1.1 million increase in interest expense.

 

Interest income for theyear ended December 31, 2009 was $35.6 million, consisting primarily of$25.5 million on loans, $10.1 million on investments and interest bearingbalances, and $26,000 on federal funds sold. Interest income for the year ended December 31, 2008 was $34.8million, consisting primarily of $27.4 million on loans, $7.1 million oninvestments and interest bearing balances, and $281,000 on federal fundssold.  Interest income for the year endedDecember 31, 2007 was $31.4 million, consisting primarily of $27.8 millionon loans, $2.9 million on investments and interest bearing balances, and$702,000 on federal funds sold.  Interestand fees on loans represented 71.6%, 78.8% and 88.5%, of total interest incomefor the years ended December 31, 2009, 2008 and 2007, respectively.  Income from investments, federal funds soldand interest bearing balances represented 28.4%, 21.2% and 11.5%, of totalinterest income for the years ended December 31, 2009, 2008 and 2007,respectively.  The high percentage ofinterest income from loans related to our strategy to maintain a significantportion of our assets in higher earning loans compared to lower yieldinginvestments.  Average loans represented64.1%, 75.1% and 83.4% of average interest-earning assets for the years ended December 31,2009, 2008 and 2007, respectively.  Asthe economic recession deepened in late 2008 and its impact on our loanportfolio became more certain, we began shifting our earning asset mix toinclude a higher percentage of investments rather than loans.

 

During 2009, we continued to shift our focus towardslocal retail deposits and away from deposits that are considered brokeredfunds.  Although local funds are moreexpensive than wholesale funds, the interest rate environment allowed us toreduce our dependence on wholesale funding and yet decrease our overall cost offunding by $2.8 million.  Interestexpense for the year ended December 31, 2009 was approximately $17.6million, consisting primarily of $13.3 million related to deposits, $2.3million related to FHLB advances, $1.1 million related to securities sold underrepurchase agreements, $774,000 related to junior subordinated debentures,$57,000 related to ESOP borrowings and $3,000 federal funds purchased and otherborrowings.  Interest expense for theyear ended December 31, 2008 was approximately $20.3 million, consistingprimarily of $16.8 million related to deposits, $1.4 million related to FHLBadvances, $1.3 million related to securities sold under repurchase agreements,$724,000 related to junior subordinated debentures, $116,000 related to ESOPborrowings and $20,000 federal funds purchased and other borrowings.  Interest expense for the year ended December 31,2007 was approximately $19.2 million, consisting primarily of $16.8 millionrelated to deposits, $736,000 related to securities sold under repurchaseagreements, $107,000 federal funds purchased and other borrowings, $561,000related to junior subordinated debentures and $1.0 million related to FHLBadvances.  Interest expense on depositsfor the years ended December 31, 2009, 2008 and 2007 represented 76.0%,82.5% and 87.4%, respectively, of total interest expense, while interestexpense on borrowings represented 24.0%, 17.5% and 12.6%, respectively, oftotal interest expense.  During the yearended December 31, 2009, average interest-bearing liabilities were higherby $162.2 

 

43

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millionthan for the same period in 2008, while other borrowings and federal fundspurchased averaged $256,000 lower, FHLB advances averaged $50.2 million higher,junior subordinated debentures averaged $2.9 million higher, ESOP borrowingsaveraged $294,000 lower and securities sold under repurchase agreement averaged$27.9 million higher than for the same period ended December 31, 2008.During the year ended December 31, 2008, average interest-bearingliabilities were higher by $178.9 million than for the same period in 2007,while other borrowings and federal funds purchased averaged $449,000 lower,FHLB advances averaged $20.3 million higher, junior subordinated debenturesaveraged $3.2 million higher, ESOP borrowings averaged $1.9 million higher andsecurities sold under repurchase agreement averaged $20.4 million higher thanfor the same period ended December 31, 2007.

 

*Rate/Volume Analysis*

 

Net interest income can be analyzed in terms of theimpact of changing interest rates and changing volume.  The following tables set forth the effectwhich the varying levels of interest-earning assets and interest-bearingliabilities and the applicable rates have had on changes in net interest incomefor the periods presented.

 
| ** **                                 | ** ** | **Year Ended********December 31, 2009 vs. December 31, 2008** | ** ** | **Year Ended********December 31, 2008 vs. December 31, 2007** | ** ** |
|--------------------------------------------|------------|-------------------------------------------------------------------------|------------|-------------------------------------------------------------------------|------------|
| ** **                                 | ** ** | **Increase (Decrease) Due to**                                          | ** ** | **Increase (Decrease) Due to**                                          | ** ** |
| ** **                                 | ** ** | **Volume**                                                              | ** ** | **Rate**                                                                | ** ** | **Rate/********Volume** | ** ** | **Total** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **Rate/********Volume** | ** ** | **Total** | ** ** |
| ** **                                 | ** ** | **(in thousands)**                                                      | ** ** |
| Interest income                            |       |                                                                    |       |                                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans                                      |       | $                                                                       | 2,424      |                                                                    | $          | (3,942 | ) | $ | (349 | ) | $ | (1,867 | ) | $ | 7,681 |   | $ | (6,352 | ) | $ | (1,755 | ) | $ | (426 | ) |
| Taxable investment securities              |       | 7,381                                                                   |       | (2,045                                                                  | )          | (2,219 | ) | 3,117 |   | 4,385 |   | (15 | ) | (27 | ) | 4,343 |   |
| Non-taxable investment securities          |       | (136                                                                    | )          | (4                                                                      | )          | 2 |   | (138 | ) | (154 | ) | 2 |   | (1 | ) | (153 | ) |
| Federal funds sold                         |       | (124                                                                    | )          | (235                                                                    | )          | 104 |   | (255 | ) | 183 |   | (480 | ) | (125 | ) | (422 | ) |
| Interest bearing balances                  |       | 45                                                                      |       | (5                                                                      | )          | (42 | ) | (2 | ) | (2 | ) | (10 | ) | 1 |   | (11 | ) |
| Total interest income                      |       | 9,590                                                                   |       | (6,231                                                                  | )          | (2,504 | ) | 855 |   | 12,093 |   | (6,855 | ) | (1,907 | ) | 3,331 |   |
|                                       |       |                                                                    |       |                                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest expense                           |       |                                                                    |       |                                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Deposits                                   |       | 2,929                                                                   |       | (5,424                                                                  | )          | (946 | ) | (3,441 | ) | 6,700 |   | (4,813 | ) | (1,917 | ) | (30 | ) |
| Junior subordinated debentures             |       | 185                                                                     |       | (108                                                                    | )          | (28 | ) | 49 |   | 221 |   | (41 | ) | (17 | ) | 163 |   |
| Advances from FHLB                         |       | 1,761                                                                   |       | (392                                                                    | )          | (480 | ) | 889 |   | 1,000 |   | (290 | ) | (286 | ) | 424 |   |
| Securities sold under repurchaseagreements |       | 998                                                                     |       | (671                                                                    | )          | (532 | ) | (205 | ) | 1,010 |   | (206 | ) | (282 | ) | 522 |   |
| Federal funds purchased                    |       | (3                                                                      | )          | (6                                                                      | )          | 2 |   | (7 | ) | (37 | ) | (11 | ) | 8 |   | (40 | ) |
| ESOP borrowings                            |       | (12                                                                     | )          | (52                                                                     | )          | 5 |   | (59 | ) | 135 |   | (24 | ) | (55 | ) | 56 |   |
| Other borrowings                           |       | (10                                                                     | )          | (3                                                                      | )          | 3 |   | (10 | ) | — |   | — |   | 12 |   | 12 |   |
| Total interest expense                     |       | 5,848                                                                   |       | (6,656                                                                  | )          | (1,976 | ) | (2,784 | ) | 9,029 |   | (5,385 | ) | (2,537 | ) | 1,107 |   |
|                                       |       |                                                                    |       |                                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest income                        |       | $                                                                       | 3,742      |                                                                    | $          | 425 |   | $ | (528 | ) | $ | 3,639 |   | $ | 3,064 |   | $ | (1,470 | ) | $ | 630 |   | $ | 2,224 |   |

 

*Provision for Loan Losses*

 

We have established an allowance for loan lossesthrough a provision for loan losses charged as an expense on our statement ofoperations.  We review our loan portfolioperiodically to evaluate our outstanding loans and to measure both theperformance of the portfolio and the adequacy of the allowance for loanlosses.  Please see the discussion belowunder “Balance Sheet Review - Provision and Allowance for Loan Losses” for adescription of the factors we consider in determining the amount of theprovision we expense each period to maintain this allowance.

 

Included in the statementof operations for the years ended December 31, 2009, 2008 and 2007 is anoncash expense related to the provision for loan losses of approximately $14.7million, $4.7 million and $1.0 million, respectively.  The allowance for loan losses wasapproximately $10.0 million, $7.6 million and $4.2 million, as of December 31,2009, 2008 and 2007, respectively.  Theallowance for loan losses as a percentage of gross loans was 2.07% at December 31,2009, 1.65% at December 31, 2008 and 1.06% at December 31, 2007.  At December 31, 2009, we had 67nonperforming loans totaling approximately $21.3 million compared to 25 loanstotaling $11.5 million at December 31, 2008.  For the year ended December 31, 2009,net charge offs totaled approximately $12.3 

 

44

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million compared toapproximately $1.2 million for 2008 and approximately $334,000 for 2007.

 

*Noninterest Income (Loss)*

 

The following table setsforth information related to our noninterest income:

 
| ** **                                                          | ** ** | **Years Ended December 31,** | ** ** |
|---------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                          | ** ** | **2009**                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                          | ** ** | **(in thousands)**                | ** ** |
| Service  fees on deposit accounts                                   |       | $                                 | 42         |   | $ | 36 |   | $ | 35 |   |
| Residential  mortgage origination fees                              |       | 356                               |       | 349 |   | 651 |   |
| Origination  income on mortgage loans sold                          |       | 49                                |       | 34 |   | 113 |   |
| Gain  on sale of investment securities                              |       | 4,857                             |       | 509 |   | 38 |   |
| Gain  (loss) on sale of other real estate                           |       | (86                               | )          | 5 |   | — |   |
| Gain  (loss) on sale of property and equipment                      |       | (5                                | )          | 8 |   | 10 |   |
| Other  service fees and commissions                                 |       | 522                               |       | 362 |   | 193 |   |
| Bank  owned life insurance                                          |       | 521                               |       | 484 |   | 290 |   |
| Other  than temporary impairment on securities available for sale   |       | —                            |       | (4,596 | ) | — |   |
| Other  than temporary impairment on nonmarketable equity securities |       | (123                              | )          | — |   | — |   |
| Other                                                               |       | 48                                |       | 33 |   | 25 |   |
| Total  noninterest income (loss)                                    |       | $                                 | 6,181      |   | $ | (2,776 | ) | $ | 1,355 |   |

 

Noninterest income forthe year ended December 31, 2009 was approximately $6.2 million, anincrease of $9.0 million, compared to noninterest loss of $2.8 million duringthe same period in 2008.  The increasewas attributable to an increase in gains on sales of investment securities of$4.3 million and other than temporary impairment of $4.6 million incurred duringthe same period in 2008.

 

Noninterest income (loss)for the year ended December 31, 2008 was approximately $2.8 million, adecrease of $4.1 million compared to noninterest income of $1.4 million duringthe same period in 2007.  The decreasewas attributable to the impairment of the bank’s preferred stocks in FederalNational Mortgage Association (“FNMA” or “Fannie Mae”) and Federal Home LoanMortgage Corporation (“FHLMC” or “Freddie Mac”).  As a result of recent actions by the U.S.Treasury Department and the Federal Housing Finance Agency, effective in thethird quarter of 2008, we recorded a pretax, non-cash impairment charge of $4.6million for the other-than-temporary impairment (“OTTI”) of its investments inperpetual preferred securities issued by Fannie Mae and Freddie Mac.

 

Residential mortgageorigination fees consist primarily of mortgage origination fees we receive onresidential loans funded and closed by a third party.  Residential mortgage origination fees were$356,000, $349,000 and $651,000 for the years ended December 31, 2009,2008 and 2007, respectively.  Theincrease of $7,000 in 2009 related primarily to a slight increase in volume inthe mortgage department.  The significantdecrease in 2008 was the result of the deteriorating economy.  Origination income on mortgage loans soldincludes the interest income collected on mortgage payments prior to sellingthese loans to investors.  We received$49,000 of origination income on mortgage loans sold in 2009, compared to$34,000 in 2008 and $113,000 in 2007.  Weanticipate that the level of mortgage origination fees will remain consistentif the mortgage refinancing business and economic conditions do notimprove.  Further, changes in state lawregarding the oversight of mortgage brokers and lenders could increase ourcosts of operations and affect our mortgage origination volume which couldnegatively impact our noninterest income in the future.

 

Service fees on depositsconsist primarily of service charges on our checking, money market, and savingsaccounts.  Deposit fees were $42,000,$36,000 and $35,000 for the years ended December 31, 2009, 2008 and 2007,respectively.  The additional $6,000 and$1,000 in income for 2009 and 2008, respectively, resulted from the largernumber of customer accounts.   Similarly,other service fees, commissions and the fee income received from customernon-sufficient funds (“NSF”) transactions increased $160,000 to $522,000 forthe year ended December 31, 2009 when compared to the same period in2008.  Other service fees, commissions,and the fee income received from customer NSF transactions increased $169,000to $362,000 for the year ended December 31, 2008 and 

 

45

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increased $49,000 to$193,000 for the year ended December 31, 2007.  The increase is attributed to the growingnumber of customers to whom we provide financial services.

 

An additional $37,000 and$194,000 in noninterest income was primarily attributable to the incomereceived from bank owned life insurance for the year ended December 31,2009 and 2008.  Other income consistsprimarily of fees received on debit and credit card transactions, income fromsales of checks, and the fees received on wire transfers.  Other income was $48,000, $33,000 and $25,000for the years ended December 31, 2009, 2008 and 2007, respectively.

 

*Noninterest Expense*

 

The following table setsforth information related to our noninterest expense.

** **
| ** **                                | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------------------------|------------|-----------------------------------|------------|
| ** **                                | ** ** | **2009**                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                | ** ** | **(in thousands)**                | ** ** |
| Salaries  and benefits                    |       | $                                 | 7,806      |   | $ | 8,322 |   | $ | 6,918 |   |
| Occupancy                                 |       | 1,574                             |       | 1,423 |   | 1,030 |   |
| Furniture  and equipment expense          |       | 855                               |       | 735 |   | 484 |   |
| Professional  fees                        |       | 1,234                             |       | 1,180 |   | 1,108 |   |
| Advertising  and marketing                |       | 462                               |       | 750 |   | 647 |   |
| Insurance                                 |       | 200                               |       | 200 |   | 121 |   |
| FDIC  assessment                          |       | 1,441                             |       | 484 |   | 239 |   |
| Data  processing and related costs        |       | 498                               |       | 448 |   | 275 |   |
| Telephone                                 |       | 199                               |       | 162 |   | 153 |   |
| Postage                                   |       | 21                                |       | 23 |   | 26 |   |
| Office  supplies, stationery and printing |       | 100                               |       | 151 |   | 171 |   |
| Loan  related expenses                    |       | 1,211                             |       | 110 |   | 81 |   |
| Other                                     |       | 766                               |       | 640 |   | 580 |   |
| Total  noninterest expense                |       | $                                 | 16,367     |   | $ | 14,628 |   | $ | 11,833 |   |

 

We incurred noninterestexpense of $16.4 million for the year ended December 31, 2009, compared to$14.6 million for the year ended December 31, 2008, and $11.8 million forthe year ended December 31, 2007. For the year ended December 31, 2009, the $1.1 million increase inother loan related expenses and $1.0 million increase in the FDIC assessmentprimarily accounted for the increase in noninterest expense for the year ended December 31,2009, compared to the same period in 2008. For the year ended December 31, 2009, the remaining differencesresulted primarily from increases of $151,000 in occupancy expense, $120,000 infurniture and equipment expense, $54,000 in professional fees, $50,000 in dataprocessing and $110,000 in other expense, offset by a decrease of $516,000 insalaries and benefits expense and $288,000 in marketing costs.

 

In 2005, managementcommitted to the expansion of the bank’s branch network, including theconstruction of new facilities in the Charleston, Hilton Head and Myrtle Beachmarkets.  Due to the variable timingassociated with the construction projects, the new facility constructionprojects during 2007, coincided with projects that were begun in 2006.  Accordingly, occupancy expenses were $1.0 millionand $1.4 million for years ended 2007 and 2008, respectively.  During 2009, occupancy expenses increased to$1.6 million.  These branch locationsprovide increased visibility and new customer traffic to the bank.  With these new customers, both loan anddeposit accounts increase, and additional revenue is generated through interestincome on loans and service charges on deposit accounts.

 

For the year ended December 31,2008, the $1.4 million increase in salaries and employee benefits and $393,000increase in occupancy expense accounted for 64.3% of the $2.8 million increasein noninterest expense, compared to the same period in 2007.  For the year ended December 31, 2008,the remaining $998,000 increase resulted primarily from an increase of $245,000in FDIC assessments, $72,000 in professional fees, $251,000 in furniture andequipment expense, $103,000 in marketing costs, $79,000 in insurance costs,$173,000 in data processing and related costs and $75,000 in other expense.  These increases were primarily related to theexpansion 

 

46

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of our services andfacilities.

 

Salary and benefitexpense was $7.8 million, $8.3 million and $6.9 million for the years ended December 31,2009, 2008 and 2007, respectively. Salaries and benefits represented 47.7%, 56.9% and 58.5% of our totalnoninterest expense for the years ended December 31, 2009, 2008 and 2007,respectively.  The $516,000 decrease insalaries and benefits expense in 2009 compared to 2008 resulted primarily fromdecreases of $276,000 in base compensation and $245,000 in stock compensationexpense offset by an increase of $5,000 in benefits costs.  The $1.4 million increase in salaries andbenefits expense in 2008 compared to 2007 resulted primarily from increases of$1.2 million in base compensation and $611,000 in benefits costs and a decreaseof $371,000 in additional incentive compensation.  The $1.2 million increase in basecompensation expense related to the cost of 9 additional employees hired in2008, a full year’s expense for the 27 people hired in 2007, as well as annualsalary increases.

 

Data processing andrelated costs were $498,000, $448,000 and $275,000 for the years ended December 31,2009, 2008 and 2007, respectively. During the year ended December 31, 2009, our data processing costsfor our core processing system were $426,000 compared to $347,000 for the yearended December 31, 2008 and $218,000 for the year ended December 31,2007.  We have contracted with an outsidecomputer service company to provide our core data processing services.  A significant portion of the fee charged byour third party processor is directly related to the number of loan and depositaccounts and the related number of transactions, all of which have grown commensuratewith the overall growth of the bank’s assets and liabilities.

 

Income tax expense wasapproximately $3.4 million for the year ended December 31, 2009 comparedto an income tax benefit of $2.7 million and income tax expense of $275,000 forthe year ended December 31, 2008 and 2007, respectively.  Income tax expense for 2009 includes theeffects of our establishing a valuation allowance for deferred tax assetspreviously recorded.

 

***BalanceSheet Review***

 

*General*

 

At December 31,2009, we had total assets of $775.9 million, consisting principally of $485.6million in loans, $617,000 in mortgage loans held for sale, $229.8 million ininvestment securities, $12.5 million in federal funds sold, $18.8 million innet premises, furniture and equipment, $13.9 million in bank owned lifeinsurance, and $2.5 million in cash and due from banks.  Our liabilities at December 31, 2009totaled $737.0 million, consisting principally of $591.5 million in deposits,$60.0 million in securities sold under agreements to repurchase, $14.4 millionin junior subordinated debentures, $65.0 million in FHLB advances, and $2.3million in borrowings related to the ESOP. At December 31, 2009, our shareholders’ equity was $38.9 million.

 

*Federal Funds Sold*

 

At December 31, 2009, our $12.5 million inshort-term investments in federal funds sold on an overnight basis comprised1.6% of total assets, compared to $40.4 million, or 5.6% of total assets, at December 31,2008.  We continue to monitor ourshort-term liquidity and closely manage our overnight cash positions in lightof the current economic environment.

 

*Investments*

 

At December 31, 2009, the $229.8 million in ouravailable for sale investment securities portfolio represented approximately29.6% of our total assets, compared to $171.8 million, or 24.0% of totalassets, at December 31, 2008.  Weheld U.S. government agency securities, securities of government sponsoredenterprises, municipal and mortgage-backed securities with a fair value of$229.8 million and an amortized cost of $231.6 million representing a netunrealized loss of $1.8 million.  During2009, we utilized the investment portfolio to provide additional income and toabsorb liquidity.  We anticipatemaintaining an investment portfolio to provide both increased earnings andliquidity.  As deposit growth outpacesour ability to lend to creditworthy customers, we anticipate maintaining therelative size of the investment portfolio and extinguishing additionalwholesale funding liabilities.

 

47

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Contractual maturities and yields on our investments atDecember 31, 2009 are shown in the following table.  Expected maturities may differ fromcontractual maturities because issuers may have the right to call or prepayobligations with or without call or prepayment penalties.

 
| ** **                         | ** ** | **One year  or less**       | ** ** | **After  one year through five years** | ** ** | **After  five years through ten years** | ** ** | **After  ten years** | ** ** | **Total**  | ** ** |
|------------------------------------|------------|-----------------------------|------------|----------------------------------------|------------|-----------------------------------------|------------|----------------------|------------|------------|------------|
| ** **                         | ** ** | **Amount**                  | ** ** | **Yield**                              | ** ** | **Amount**                              | ** ** | **Yield**            | ** ** | **Amount** | ** ** | **Yield** | ** ** | **Amount** | ** ** | **Yield** | ** ** | **Amount** | ** ** | **Yield** | ** ** |
| ** **                         | ** ** | **(dollars  in thousands)** | ** ** |
| Available  for Sale:               |       |                        |       |                                   |       |                                    |       |                 |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Government-  sponsored enterprises |       | $                           | —     |                                   | —     | %                                       | $          | —               |       | —     | %          | $ | 35,682 |   | 4.38 | % | $ | 52,931 |   | 4.72 | % | $ | 88,613 |   | 4.58 | % |
| Mortgage-backed  securities        |       | —                      |       | —                                 | %          | 2,932                                   |       | 1.91                 | %          | —     |       | — | % | 130,966 |   | 4.36 | % | 133,898 |   | 4.30 | % |
| Municipals                         |       | —                      |       | —                                 | %          | —                                  |       | —               | %          | 2,609      |       | 4.96 | % | 4,667 |   | 4.78 | % | 7,276 |   | 4.85 | % |
| Total                              |       | $                           | —     |                                   | —     | %                                       | $          | 2,932                |       | 1.91       | %          | $ | 38,291 |   | 4.42 | % | $ | 188,564 |   | 4.47 | % | $ | 229,787 |   | 4.43 | % |

 

At December 31, 2009, our investments includedGovernment sponsored enterprises, which consist of securities issued by theFederal Farm Credit Bank, Federal Home Loan Bank, Federal Home Loan MortgageCorporation and Federal National Mortgage Association with amortized costs ofapproximately $11.7 million, $36.5 million, $25.0 million, and $16.6 million,respectively.  Mortgage-backed securitiesconsist of securities issued by the Federal National Mortgage Association,Federal Home Loan Mortgage Corporation and Government National MortgageAssociation with amortized costs of approximately $125.6 million, $1.6 millionand $7.4 million, respectively. Municipals consist of securities issued by various differentmunicipalities with an amortized cost of $7.3 million.

 

At December 31, 2009, the fair value ofinvestments issued by the Federal Farm Credit Bank, Federal Home Loan Bank,Federal Home Loan Mortgage Corporation and Federal National MortgageAssociation was approximately $11.2 million, $35.9 million, $24.8 million, and$16.7 million, respectively. Mortgage-backed securities consist of securities issued by the FederalNational Mortgage Association, Federal Home Loan Mortgage Corporation andGovernment National Mortgage Association with fair value of approximately$124.9 million, $1.6 million and $7.4 million, respectively. Municipals consistof securities issued by various different municipalities with a fair value of$7.3 million.

 

Other nonmarketable equity securities at December 31,2009 consisted of Federal Home Loan Bank stock with a cost of $5.9 million andother investments of approximately $29,000.

 

The amortized costs and the fair value of ourinvestments at December 31, 2009, 2008 and 2007 are shown in the followingtable.

# ** **

| ** **                        | ** ** | **December 31, 2009** | ** ** | **December 31, 2008** | ** ** | **December 31, 2007** | ** ** |
|-----------------------------------|------------|----------------------------|------------|----------------------------|------------|----------------------------|------------|
| ** **                        | ** ** | **Amortized  Cost**        | ** ** | **Fair  Value**            | ** ** | **Amortized  Cost**        | ** ** | **Fair  Value** | ** ** | **Amortized  Cost** | ** ** | **Fair  Value** | ** ** |
| ** **                        | ** ** | **(in thousands)**         | ** ** |
| Available  for Sale:              |       |                       |       |                       |       |                       |       |   |   |   |   |   |   |
| Government-sponsored  enterprises |       | $                          | 89,774     |                       | $          | 88,613                     |       | $ | 61,106 |   | $ | 62,215 |   | $ | 47,272 |   | $ | 47,917 |   |
| Mortgage-backed  securities       |       | 134,535                    |       | 133,898                    |       | 102,615                    |       | 104,167 |   | 23,979 |   | 24,247 |   |
| Municipals                        |       | 7,319                      |       | 7,276                      |       | 5,595                      |       | 5,388 |   | 12,440 |   | 12,400 |   |
| Preferred  stock                  |       | —                     |       | —                     |       | —                     |       | — |   | 3,553 |   | 3,472 |   |
| Total                             |       | $                          | 231,628    |                       | $          | 229,787                    |       | $ | 169,316 |   | $ | 171,770 |   | $ | 87,244 |   | $ | 88,036 |   |

 

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# **Loans**

# ** **

Since loans typically provide higher interest yields thanother types of interest-earning assets, a substantial percentage of our earningassets are invested in our loan portfolio. Average loans for the years ended December 31, 2009 and 2008 were$472.0 million and $433.6 million, respectively.  Gross loans outstanding at December 31,2009 and 2008 were $485.6 million and $462.0 million, respectively.

 

Loans secured by real estate mortgages are theprincipal component of our loan portfolio. Most of our real estate loans are secured by residential or commercialproperty.  We do not generally originatetraditional long term residential mortgages for the portfolio, but we do issuetraditional second mortgage residential real estate loans and home equity linesof credit.  We obtain a security interestin real estate whenever possible, in addition to any other availablecollateral.  This collateral is taken toincrease the likelihood of the ultimate repayment of the loan.  Generally, we limit the loan-to-value ratioon loans we make to 85%.  Due to theshort time our portfolio has existed, the current mix may not be indicative ofthe ongoing portfolio mix.  We attempt tomaintain a relatively diversified loan portfolio to help reduce the riskinherent in concentration in certain types of collateral.

 

The following table summarizes the composition of our loan portfolio:

 
| ** **                               | ** ** | **2009**                    | ** ** | **2008**        | ** ** | **2007**   | ** ** | **2006**        | ** ** | **2005**   | ** ** |
|------------------------------------------|------------|-----------------------------|------------|-----------------|------------|------------|------------|-----------------|------------|------------|------------|
| ** **                               | ** ** | **(dollars  in thousands)** | ** ** |
| ** **                               | ** ** | **Amount**                  | ** ** | **% of  Total** | ** ** | **Amount** | ** ** | **% of  Total** | ** ** | **Amount** | ** ** | **% of  Total** | ** ** | **Amount** | ** ** | **% of  Total** | ** ** | **Amount** | ** ** | **% of  Total** | ** ** |
| *Commercial*                             |       |                        |       |            |       |       |       |            |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Commercial  and industrial               |       | $                           | 26,687     |            | 5.5        | %          | $          | 27,443          |       | 6.0        | %          | $ | 24,350 |   | 6.2 | % | $ | 24,631 |   | 9.0 | % | $ | 11,360 |   | 6.3 | % |
|                                     |       |                        |       |            |       |       |       |            |       |       |       |   |   |   |   |   |   |   |   |   |   |
| *Real Estate*                            |       |                        |       |            |       |       |       |            |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Mortgage                                 |       | 335,831                     |       | 69.2            | %          | 268,500    |       | 58.1            | %          | 204,068    |       | 52.2 | % | 124,715 |   | 45.7 | % | 85,025 |   | 47.3 | % |
| Construction                             |       | 118,183                     |       | 24.3            | %          | 161,298    |       | 34.9            | %          | 159,815    |       | 40.8 | % | 122,210 |   | 44.7 | % | 81,878 |   | 45.6 | % |
| Total  real estate                       |       | 454,014                     |       | 93.5            | %          | 429,798    |       | 93.0            | %          | 363,883    |       | 93.0 | % | 246,925 |   | 90.4 | % | 166,903 |   | 92.9 | % |
|                                     |       |                        |       |            |       |       |       |            |       |       |       |   |   |   |   |   |   |   |   |   |   |
| *Consumer*                               |       |                        |       |            |       |       |       |            |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Consumer                                 |       | 4,985                       |       | 1.0             | %          | 4,936      |       | 1.1             | %          | 3,467      |       | 0.9 | % | 1,901 |   | 0.7 | % | 1,708 |   | 1.0 | % |
| Deferred  origination fees, net          |       | (131                        | )          | (0.0            | )%         | (210       | )          | (0.1            | )%         | (350       | )          | (0.1 | )% | (247 | ) | (0.1 | )% | (311 | ) | (0.2 | )% |
|                                     |       |                        |       |            |       |       |       |            |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Total  gross loans, net of deferred fees |       | 485,555                     |       | 100.0           | %          | 461,967    |       | 100.0           | %          | 391,350    |       | 100.0 | % | 273,210 |   | 100.0 | % | 179,660 |   | 100.0 | % |
| Less  — allowance for loan losses   |       | (10,048                     | )          |            |       | (7,635     | )          |            |       | (4,158     | )          |   |   | (3,467 | ) |   |   | (2,245 | ) |   |   |
| Total  loans, net                        |       | $                           | 475,507    |            |       |       | $          | 454,332         |       |       |       | $ | 387,192 |   |   |   | $ | 269,743 |   |   |   | $ | 177,415 |   |   |   |

 

49

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*Maturities and Sensitivity of Loans to Changes in InterestRates*

 

The information in the following table is based on thecontractual maturities of individual loans, including loans that may be subjectto renewal at their contractual maturity. Renewal of such loans is subject to review and credit approval, as wellas modification of terms upon maturity. Actual repayments of loans may differ from the maturities reflectedbelow because borrowers have the right to prepay obligations with or withoutprepayment penalties.  The followingtable summarizes the loan maturity distribution by type and related interestrate characteristics at December 31, 2009:

 
| ** **                                 | ** ** | **One year  or less** | ** ** | **After one  but  within  five years** | ** ** | **After five  years** | ** ** | **Total** | ** ** |
|--------------------------------------------|------------|-----------------------|------------|----------------------------------------|------------|-----------------------|------------|-----------|------------|
| ** **                                 | ** ** | **(in thousands)**    | ** ** |
| Commercial                                 |       | $                     | 13,867     |                                   | $          | 11,869                |       | $         | 951        |   | $ | 26,687 |   |
| Real  estate                               |       | 179,458               |       | 221,880                                |       | 52,676                |       | 454,014   |       |
| Consumer                                   |       | 2,032                 |       | 2,367                                  |       | 586                   |       | 4,985     |       |
| Deferred  origination fees, net            |       | (4                    | )          | (131                                   | )          | 4                     |       | (131      | )          |
| Total  gross loans, net of deferred fees   |       | $                     | 195,353    |                                   | $          | 235,985               |       | $         | 54,217     |   | $ | 485,555 |   |
|                                       |       |                  |       |                                   |       |                  |       |      |       |
| Gross  loans maturing after one year with: |       |                  |       |                                   |       |                  |       |      |       |
| Fixed  interest rates                      |       |                  |       |                                   |       |                  |       | $         | 152,862    |   |
| Floating  interest rates                   |       |                  |       |                                   |       |                  |       | 137,467   |       |
| Total                                      |       |                  |       |                                   |       |                  |       | $         | 290,329    |   |

 

*Provision and Allowance for Loan Losses*

 

We have established an allowance for loan lossesthrough a provision for loan losses charged to expense on our statement ofoperations.  The allowance is maintainedat a level deemed appropriate by management to provide adequately for known andinherent losses in the portfolio.  Theallowance for loan losses represents an amount which we believe will beadequate to absorb probable losses on existing loans that may becomeuncollectible.  Our judgment as to theadequacy of the allowance for loan losses is based on a number of assumptionsabout future events, which we believe to be reasonable, but which may or maynot prove to be accurate.  Ourdetermination of the allowance for loan losses is based on evaluations of thecollectability of loans, including consideration of factors such as the balanceof impaired loans, the quality, mix, and size of our overall loan portfolio,economic conditions that may affect the borrower’s ability to repay, the amountand quality of collateral securing the loans, our historical loan lossexperience, and a review of specific problem loans.  We also consider subjective issues such aschanges in the lending policies and procedures, changes in the local/nationaleconomy, changes in volume or type of credits, changes in volume/severity ofproblem loans, quality of loan review and board of director oversight,concentrations of credit, and peer group comparisons.

 

More specifically, indetermining our allowance for loan losses, we review loans for specific andimpaired reserves based on current appraisals less estimated closingcosts.  General and unallocated reservesare determined using historical loss trends applied to risk rated loans groupedby FDIC call report classification code. The general and unallocated reserves are calculated by applying theappropriate historical loss ratio to the loan categories grouped by risk rating(pass, special mention, substandard and doubtful).  The quantitative value of the qualitativefactors, as described below, is then applied to this amount to estimate thegeneral and unallocated reserve for the specific loans within this ratingcategory and particular loan category. Impaired loans are excluded from this analysis as they are individuallyreviewed for valuation.  The sum of allsuch amounts determines our general and unallocated reserves.

 

We also track ourportfolio and analyze loans grouped by call report categories.  The first step in this process is to riskgrade each and every loan in the portfolio based on a common set of parameters.  These parameters include debt to worth,liquidity of the borrower, net worth, experience in a particular field andother factors.  Weight is also given tothe relative strength of any guarantors on the loan.  We have retained an independent consultant to

 

50

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review the loan files ona test basis to confirm the grading of each loan.

 

After risk grading eachloan, we then use fourteen qualitative factors to analyze the trends in theportfolio.  These fourteen factorsinclude both internal and external factors. The internal factors considered are the concentration of credit acrossthe portfolio, current delinquency ratios and trends, the experience level ofmanagement and staff, our adherence to lending policies and procedures, currentloss and recovery trends, the nature and volume of the portfolio’s categories,current nonaccrual and problem loan trends, the quality of our loan reviewsystem, policy exceptions, value of underlying collateral and other factors whichinclude insurance shortfalls, loan fraud and unpaid tax risk.  The external factors considered areregulatory and legal factors and the current economic and business environment,which includes indicators such as national GDP, pricing indicators, employmentstatistics, housing statistics, market indicators, financial regulatoryeconomic analysis, and economic forecasts from reputable sources.  A quantitative value is assigned to each ofthe fourteen internal and external factors, which, when added together, createsa net qualitative weight.  The netqualitative weight is then added to the minimum loss ratio.  Negative trends in the loan portfolioincrease the quantitative values assigned to each of the qualitative factorsand, therefore, increase the loss ratio. As a result, an increased loss ratio will result in a higher allowancefor loan loss.  For example, as generaleconomic and business conditions decline, this qualitative factor’squantitative value will increase, which will increase the net qualitativeweight and the loss ratio (assuming all other qualitative factors remainconstant).  Similarly, positive trends inthe loan portfolio, such as an improvement in general economic and businessconditions, will decrease the quantitative value assigned to this qualitativefactor, thereby decreasing the net qualitative weight (assuming all otherqualitative factors remain constant). These factors are reviewed and updated by the Bank’s Senior RiskCommittee on a quarterly basis to arrive at a consensus for our qualitativeadjustments.

 

We have shifted ourmethodology for determining our historical loss ratio to analyzing the mostrecent four quarters’ losses because we believe this period encompasses themost severe economic downturn and resulting credit losses in recenthistory.  The resulting historical lossfactor is used as a beginning point upon which we add our quantitativeadjustments based on the qualitative factors discussed above.  Once the qualitative adjustments are made, werefer to the final amount as the total. The total is then multiplied by the loans outstanding for the periodended, except for any loans classified as non-performing which are addressedspecifically as discussed below.

 

Separately, we review allimpaired loans individually to determine a specific allocation for each.  In our assessment of impaired loans, weconsider the primary source of repayment when determining whether or not loansare collateral dependent.  Impairment ofa loan is measured based on the present value of expected future cash flowsdiscounted at the loan’s effective interest rate or the fair value of thecollateral if the loan is collateral dependent. When management determines that a loan is impaired, the differencebetween our investment in the related loan and the present value of theexpected future cash flows, or the fair value of the collateral, is generallycharged against the allowance for loan losses.

 

Periodically, we adjust the amount of the allowancebased on changing circumstances.  Werecognize loan losses to the allowance and add back subsequent recoveries.  In addition, on a quarterly basis weinformally compare our allowance for loan losses to various peer institutions;however, we recognize that allowances will vary as financial institutions areunique in the make-up of their loan portfolios and customers, which necessarilycreates different risk profiles for the institutions.  We would only consider further adjustments toour allowance for loan losses based on this peer review if our allowance wassignificantly different from our peer group. To date, we have not made any such adjustment.  There can be no assurance that loancharge-offs of loans in future periods will not exceed the allowance for loanlosses as estimated at any point in time or that provisions for loan losseswill not be significant to a particular accounting period, especially considering the overallweakness in the commercial and residential real estate markets in our marketareas.

 

51

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The following table summarizes the activity related toour allowance for loan losses.

 
| ** **                                | ** ** | **December 31,**      | ** ** |
|-------------------------------------------|------------|----------------------------|------------|
| ** **                                | ** ** | **2009**                   | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                | ** ** | **(dollars in thousands)** | ** ** |
| Balance,  beginning of year               |       | $                          | 7,635      |   | $ | 4,158 |   | $ | 3,467 |   | $ | 2,245 |   | $ | 700 |   |
| Charge  offs, Commercial and Industrial   |       | (1,519                     | )          | (313 | ) | (116 | ) | — |   | — |   |
| Charge  offs, Real Estate Mortgage        |       | (5,629                     | )          | (756 | ) | — |   | — |   | — |   |
| Charge  offs, Real Estate Construction    |       | (5,104                     | )          | (73 | ) | (218 | ) | — |   | — |   |
| Charge  offs, Consumer                    |       | (204                       | )          | (47 | ) | (1 | ) | — |   | — |   |
| Recoveries,  Commercial and Industrial    |       | 12                         |       | 1 |   | 1 |   | — |   | — |   |
| Recoveries,  Real Estate Mortgage         |       | 57                         |       | — |   | — |   | — |   | — |   |
| Recoveries,  Real Estate Construction     |       | 53                         |       | — |   | — |   | — |   | — |   |
| Recoveries,  Consumer                     |       | 2                          |       | — |   | — |   | — |   | — |   |
| Provision  for loan losses                |       | 14,745                     |       | 4,665 |   | 1,025 |   | 1,222 |   | 1,545 |   |
| Balance,  end of year                     |       | $                          | 10,048     |   | $ | 7,635 |   | $ | 4,158 |   | $ | 3,467 |   | $ | 2,245 |   |
|                                      |       |                       |       |   |   |   |   |   |   |   |   |
| Total  loans outstanding at end of period |       | $                          | 485,555    |   | $ | 461,967 |   | $ | 391,350 |   | $ | 273,210 |   | $ | 179,660 |   |
| Allowance  for loan losses to gross loans |       | 2.07                       | %          | 1.65 | % | 1.06 | % | 1.27 | % | 1.25 | % |
| Net  charge-offs to average loans         |       | 2.61                       | %          | 0.27 | % | 0.10 | % | 0.00 | % | 0.00 | % |

 

*Nonperforming Assets*

 

The following table setsforth our nonperforming assets.

 
| ** **                                                  | ** ** | **December 31,**      | ** ** |
|-------------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                  | ** ** | **2009**                   | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                  | ** ** | **(dollars in thousands)** | ** ** |
| Nonaccrual  loans                                           |       | $                          | 21,295     |   | $ | 11,482 |   | $ | 389 |   | $ | 1,965 |   | $ | — |   |
| Loans  90 days or more past due and still accruing interest |       | —                     |       | — |   | — |   | — |   | — |   |
| Loans  restructured or otherwise impaired                   |       | —                     |       | — |   | — |   | — |   | — |   |
| Total  impaired loans                                       |       | 21,295                     |       | 11,482 |   | 389 |   | 1,965 |   | — |   |
| Other  real estate owned                                    |       | 6,865                      |       | 1,801 |   | — |   | — |   | — |   |
| Total  nonperforming assets                                 |       | $                          | 28,160     |   | $ | 13,283 |   | $ | 389 |   | $ | 1,965 |   | $ | — |   |
|                                                        | ** ** | ** **                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Nonperforming  assets to total assets                       |       | 3.63                       | %          | 1.86 | % | 0.08 | % | 0.58 | % | 0.00 | % |

 

During the fourth quarter of 2008, as the global economic environmentcrumbled, affecting our regional market, borrowers that had previouslysatisfactorily maintained their credit positions began to have difficulty withthe repayment of their obligations.  Asan institution concentrating in real estate lending, the slow down in theresidential and commercial real estate activities coupled with the sharpdecline in stock market values exacerbated the stress on the liquidity positionof our borrowers.  The resulting lack ofliquidity cushion manifested in our loans past due 30-89 days andnon-performing assets. Consequently, we experienced significant increases inloans on our watch list, past due loans, nonaccrual loans and other real estateowned.

 

The bank had 67nonperforming loans at December 31, 2009 totaling $21.3 million and 25nonperforming loans totaling $11.5 million at December 31, 2008.  As of December 31, 2007, we had threenonperforming loans totaling $389,000. Of the 67 nonperforming loans at December 31, 2009, it isanticipated that all 67 loans totaling approximately $21.3 million will move toother real estate owned through foreclosure or through the Bank’s acceptance ofa deed in lieu of foreclosure.  At December 31,2009, 2008, and 2007, the allowance for loan losses was $10.0 million, $7.6million and $4.2 million, respectively, or 2.07%, 1.65% and 1.06%,respectively, of outstanding loans.  Weremain committed to working with borrowers to help them overcome theirdifficulties and 

 

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will review loans on aloan by loan basis.  However, despite ourcommitment, resolution across the portfolio is dependent on improvements inemployment, housing, and overall economic conditions at the local, regional andnational levels.

 

Included in nonperforming loans at December 31,2009 are $10.8 million in residential properties, representing approximately50.9% of the Bank’s nonperforming loan total. As expected,collateral values have declined as a result of the current economicenvironment.  According to the FederalHousing Finance Agency’s Home Price index, home prices in the Charleston andMyrtle Beach, South Carolina markets declined 5.79% and 6.41%, respectively,during the 12 month period ended September 30, 2009.  This compares to declines during that periodfor the State of South Carolina and the country as a whole of 0.66% and 3.76%,respectively.  To determine currentcollateral values we obtain new appraisals on loan renewals and potentialproblem loans.  In the process ofestimating collateral values for non-performing loans, management evaluatesmarkets for stagnation or distress and discounts appraised values on a propertyby property basis.  Currently, managementdoes not review collateral values for properties located in stagnant ordistressed residential areas if the loan is performing and not up for renewal.

 

As of December 31,2009, we had 70 loans with a current principal balance of $37.2 million on thewatch list, compared to 59 loans with a current principal balance of $22.9million at December 31, 2008.  Thewatch list is the classification utilized by us when we have an initial concernabout the financial health of a borrower. We then gather current financial information about the borrower andevaluate our current risk in the credit. We will then either move it to “substandard” or back to its originalrisk rating after a review of the information. There are times when we may leave the loan on the “watch list,” if, inmanagement’s opinion, there are risks that cannot be fully evaluated withoutthe passage of time, and we want to review it on a more regular basis.  Loans on the watch list are not considered “potentialproblem loans” until they are determined by management to be classified assubstandard.

 

Loans past due 30-89 daysamounted to $10.1 million at December 31, 2009 as compared to $12.4million at December 31, 2008.  Pastdue loans are often regarded as a precursor to further credit problems whichwould lead to future increases in nonaccrual loans and other real estateowned.  At December 31, 2009, therewere no loans past due greater than 90 days that were not already placed onnonaccrual.  Generally, a loan is placedon nonaccrual status when it becomes 90 days past due as to principal orinterest, or when we believe, after considering economic and businessconditions and collection efforts, that the borrower’s financial condition issuch that collection of the loan is doubtful. A payment of interest on a loan that is classified as nonaccrual isapplied against the principal balance. During the years ended December 31, 2009, 2008 and 2007, wereceived approximately $709,000, $452,000 and $4,400, respectively, in interestincome in relation to loans that were on nonaccrual status at the respectiveyear end prior to them being placed on nonaccrual status.  Foregone interest income related to loans onnonaccrual status was approximately $892,000, $396,000 and $48,000 during theyears ended December 31, 2009, 2008 and 2007.

 

*Deposits*

 

Our primary source of funds for loans and investmentsis our deposits.  National and local markettrends over the past several years suggest that consumers have moved anincreasing percentage of discretionary savings funds into investments such asannuities, stocks and mutual funds. Accordingly, it has become more difficult to attract local deposits.  We have chosen to obtain a portion of moneymarket and certificates of deposits from outside of our market.  The deposits obtained outside of our marketareas generally have lower rates than rates being offered for similar depositproducts in our local market.  We alsoutilize wholesale deposits in certain instances to obtain deposits with morefavorable maturities than are readily available in our local market.  We anticipate that the ratio of wholesaledeposits to total deposits will continue to decline as our full service bankingoffices mature.  The amount of wholesaledeposits was $189.9 million, or 32.1% of total deposits, at December 31,2009, compared to $284.1 million, or 50.6% of total deposits, at December 31,2008.

 

We anticipate being able to either renew or replacethese wholesale deposits when they mature, although we may not be able toreplace them with deposits with the same terms or rates.  Our loan-to-deposit ratio was 82.0% and 82.3%at December 31, 2009 and 2008, respectively.

 

53

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The following table shows the average balance amountsand the average rates paid on deposits held by us for the years ended December 31,2009, 2008 and 2007.

 
| ** **                           | ** ** | **December 31, 2009**      | ** ** | **December 31, 2008** | ** ** | **December 31, 2007** | ** ** |
|--------------------------------------|------------|----------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                           | ** ** | **Amount**                 | ** ** | **Rate**              | ** ** | **Amount**            | ** ** | **Rate** | ** ** | **Amount** | ** ** | **Rate** | ** ** |
| ** **                           | ** ** | **(dollars in thousands)** | ** ** |
| Noninterest  bearing demand deposits |       | $                          | 12,516     |                  | —     | %                     | $          | 12,272 |   | — | % | $ | 10,550 |   | — | % |
| Interest  bearing demand deposits    |       | 40,761                     |       | 1.58                  | %          | 28,576                |       | 2.53 | % | 6,718 |   | 3.58 | % |
| Savings  and money market accounts   |       | 197,356                    |       | 1.70                  | %          | 173,471               |       | 2.77 | % | 186,732 |   | 4.86 | % |
| Time  deposits less than $100,000    |       | 214,135                    |       | 2.85                  | %          | 203,217               |       | 4.24 | % | 131,130 |   | 5.29 | % |
| Time  deposits greater than $100,000 |       | 97,918                     |       | 3.31                  | %          | 63,180                |       | 4.17 | % | 10,418 |   | 5.39 | % |
| Total  deposits                      |       | $                          | 562,686    |                  | 2.37       | %                     | $          | 480,716 |   | 3.49 | % | $ | 345,548 |   | 4.80 | % |

 

All of our time deposits are certificates ofdeposits.  The maturity distribution ofour time deposits of $100,000 or more at December 31, 2009, 2008 and 2007was as follows:

 
| ** **                     | ** ** | **2009**           | ** ** | **2008** | ** ** | **2007** | ** ** |
|--------------------------------|------------|--------------------|------------|----------|------------|----------|------------|
| ** **                     | ** ** | **(in thousands)** | ** ** |
| Three  months or less          |       | $                  | 21,620     |     | $          | 17,243   |       | $ | 7,344 |   |
| Over  three through six months |       | 44,829             |       | 43,867   |       | 20,111   |       |
| Over  six though twelve months |       | 34,826             |       | 17,514   |       | 1,183    |       |
| Over  twelve months            |       | 4,700              |       | 14,201   |       | 1,238    |       |
| Total                          |       | $                  | 105,975    |     | $          | 92,825   |       | $ | 29,876 |   |

 

The increase in time deposits of $100,000 or more forthe year ended December 31, 2009 compared to the same period in 2008resulted from our funding the growth of the bank with a variety of time depositproducts, including retail time deposits.

 

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**Borrowings and Other Interest-Bearing Liabilities**

 

The following table outlines our various sources ofborrowed funds during the years ended December 31, 2009, 2008, and 2007,and the amounts outstanding at the end of each period, the maximum amount for eachcomponent during the periods, the average amounts for each period, and theaverage interest rate that we paid for each borrowing source.  The maximum month-end balance represents thehigh indebtedness for each component of borrowed funds at any time during eachof the periods shown.

 
| ** **                                           | ** ** | **Ending**                  | ** ** | **Period  End** | ** ** | **Maximum  Month  End** | ** ** | **Average  for the Period** | ** ** |
|------------------------------------------------------|------------|-----------------------------|------------|-----------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                           | ** ** | **Balance**                 | ** ** | **Rate**        | ** ** | **Balance**             | ** ** | **Balance**                 | ** ** | **Rate** | ** ** |
| ** **                                           | ** ** | **(dollars  in thousands)** | ** ** |
| **At or for the year ended December 31, 2009:** |       |                        |       |            |       |                    |       |                        |       |   |   |
| Securities  sold under agreement to repurchase       |       | $                           | 60,000     |            | 1.55       | %                       | $          | 72,500                      |       | $ | 63,090 |   | 1.67 | % |
| Junior  subordinated debentures                      |       | 14,434                      |       | 4.97            | %          | 14,434                  |       | 14,434                      |       | 5.36 | % |
| Advances  from FHLB                                  |       | 65,000                      |       | 3.03            | %          | 100,800                 |       | 91,075                      |       | 2.55 | % |
| Federal  funds purchased                             |       | —                      |       | —          | %          | —                  |       | 106                         |       | 1.12 | % |
| ESOP  borrowings                                     |       | 2,300                       |       | 2.25            | %          | 2,600                   |       | 2,480                       |       | 2.29 | % |
| Other  borrowings                                    |       | —                      |       | —          | %          | —                  |       | 45                          |       | 3.99 | % |
| ** **                                           |       |                        |       |            |       |                    |       |                        |       |   |   |
| **At or for the year ended December 31, 2008:** |       |                        |       |            |       |                    |       |                        |       |   |   |
| Securities  sold under agreement to repurchase       |       | $                           | 20,000     |            | 3.76       | %                       | $          | 50,000                      |       | $ | 35,187 |   | 3.58 | % |
| Junior  subordinated debentures                      |       | 14,434                      |       | 6.98            | %          | 14,434                  |       | 11,493                      |       | 6.30 | % |
| Advances  from FHLB                                  |       | 60,800                      |       | 2.71            | %          | 60,800                  |       | 40,915                      |       | 3.51 | % |
| Federal  funds purchased                             |       | —                      |       | —          | %          | 2,963                   |       | 187                         |       | 4.25 | % |
| ESOP  borrowings                                     |       | 2,600                       |       | 2.25            | %          | 2,900                   |       | 2,774                       |       | 4.17 | % |
| Other  borrowings                                    |       | 616                         |       | 4.25            | %          | 616                     |       | 220                         |       | 5.53 | % |
|                                                 |       |                        |       |            |       |                    |       |                        |       |   |   |
| **At or for the year ended December 31, 2007:** |       |                        |       |            |       |                    |       |                        |       |   |   |
| Securities  sold under agreement to repurchase       |       | $                           | 41,040     |            | 4.54       | %                       | $          | 41,040                      |       | $ | 14,828 |   | 4.96 | % |
| Junior  subordinated debentures                      |       | 8,248                       |       | 6.61            | %          | 8,248                   |       | 8,248                       |       | 6.80 | % |
| Advance  from FHLB                                   |       | 29,000                      |       | 4.20            | %          | 30,000                  |       | 20,575                      |       | 4.92 | % |
| Federal  funds purchased                             |       | 2,428                       |       | 6.50            | %          | 2,428                   |       | 854                         |       | 7.02 | % |
| Other  borrowings                                    |       | —                      |       | —          | %          | 10,870                  |       | 856                         |       | 5.50 | % |

 

**Capital Resources**

 

Total shareholders’equity was $38.9 million at December 31, 2009 and $52.0 million at December 31,2008.  The decrease is attributable tothe net loss of $10.3 million for the year ended December 31, 2009, thepreferred stock dividend paid of $654,000, additional paid in capital relatedto the ESOP of $234,000, a decrease in the guarantee of ESOP borrowings of$319,000, net of current year reductions, a decrease of $2.7 million in thefair value of available for sale securities and stock-based compensationexpense of $455,000.  Since ourinception, we have not paid any cash dividends on our common shares.

 

The following table showsthe return on average assets (net income divided by average total assets),return on average equity (net income divided by average equity), and averageequity to average assets ratio (average equity divided by average total assets)for the years ended December 31, 2009, 2008 and 2007:

 
| ** **                | ** ** | **2009** | ** ** | **2008** | ** ** | **2007** | ** ** |
|---------------------------|------------|----------|------------|----------|------------|----------|------------|
| Return  on average assets |       | (1.30    | )%         | (0.81    | )%         | 0.10     | %          |
| Return  on average equity |       | (20.85   | )%         | (12.40   | )%         | 1.00     | %          |
| Equity  to assets ratio   |       | 6.24     | %          | 6.50     | %          | 9.51     | %          |

 

55

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The Federal Reserve andbank regulatory agencies require bank holding companies and financialinstitutions to maintain capital at adequate levels based on a percentage ofassets and off-balance sheet exposures, adjusted for risk weights ranging from0% to 100%.  Under the capital adequacyguidelines, regulatory capital is classified into two tiers.  These guidelines require an institution to maintaina certain level of Tier 1 and Tier 2 capital to risk-weighted assets.  Tier 1 capital consists of common shareholders’equity, excluding the unrealized gain or loss on securities available for sale,minus certain intangible assets.  Indetermining the amount of risk-weighted assets, all assets, including certainoff-balance sheet assets, are multiplied by a risk-weight factor of 0% to 100%based on the risks believed to be inherent in the type of asset.  Tier 2 capital consists of Tier 1 capitalplus the general reserve for loan losses, subject to certain limitations.  Our bank is required to maintain capital at aminimum level based on total average assets, which is known as the Tier 1leverage ratio.

 

To be considered “well-capitalized,” we must maintaintotal risk-based capital of at least 10%, Tier 1 capital of at least 6%, and aleverage ratio of at least 5%.  To beconsidered “adequately capitalized” under capital guidelines, we must maintaina minimum total risk-based capital of 8%, with at least 4% being Tier 1capital.  In addition, banking regulatorshave established a minimum Tier 1 leverage ratio of at least 4%.  It is anticipated that over the coming yearsbanking regulators will increase these minimum levels.

 

The following table sets forth the company’s variouscapital ratios at December 31, 2009 and 2008.  For all periods, the company was incompliance with regulatory capital requirements established by the FederalReserve Board’s Capital Adequacy Guidelines for Bank Holding Companies.

 

**Tidelands Bancshares, Inc.**

 
| ** **                       | ** ** | **2009** | ** ** | **2008** | ** ** |
|----------------------------------|------------|----------|------------|----------|------------|
| Leverage  ratio                  |       | 6.83     | %          | 9.03     | %          |
| Tier  1 risk-based capital ratio |       | 10.21    | %          | 12.96    | %          |
| Total  risk-based capital ratio  |       | 11.67    | %          | 14.20    | %          |

 

The following table sets forth the bank’s variouscapital ratios at December 31, 2009 and 2008.  For all periods, the bank was considered “well-capitalized.”

 

**Tidelands Bank**

** **
| ** **                       | ** ** | **2009** | ** ** | **2008** | ** ** |
|----------------------------------|------------|----------|------------|----------|------------|
| Leverage  ratio                  |       | 6.59     | %          | 7.49     | %          |
| Tier  1 risk-based capital ratio |       | 9.84     | %          | 10.77    | %          |
| Total  risk-based capital ratio  |       | 11.10    | %          | 12.02    | %          |

 

We intend to maintain acapital level for the bank that exceeds the FDIC requirements to be classifiedas a “well-capitalized” bank.  To providethe additional capital needed to support our bank’s growth in assets, duringthe first quarter of 2005 we borrowed $2.1 million under a short-term holdingcompany line of credit.  On March 31,2005, we completed a private placement of 1,712,000 shares at $9.35 to increasethe capital of the company and the bank. Net proceeds from the offering were approximately $14.9 million.  Upon closing the transaction, the holdingcompany line of credit was repaid in full. On February 22, 2006, Tidelands Statutory Trust, a non-consolidatedsubsidiary of the company, issued and sold floating rate capital securities ofthe trust, generating net proceeds of $8.0 million.  The trust loaned these proceeds to thecompany to use for general corporate purposes, primarily to provide capital tothe bank.  The junior subordinateddebentures qualify as Tier 1 capital under Federal Reserve Boardguidelines.  On October 10, 2006, weclosed a public offering in which 1,200,000 shares of our common stock wereissued at a purchase price of $15.00 per share. Net proceeds after deducting the underwriter’s discount and expenseswere $16.4 million.

 

On June 20, 2008,Tidelands Statutory Trust II (“Trust II”), a non-consolidated subsidiary of thecompany, issued and sold fixed/floating rate capital securities of the trust,generating proceeds of $6.0 million. Trust II loaned these proceeds to the company to use for generalcorporate purposes, primarily to provide capital to the bank.  The junior subordinated debentures qualify asTier I under Federal Reserve Board guidelines.

 

56

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On December 19, 2008, we entered into the CPP Purchase Agreementwith the Treasury, pursuant to which the company issued and sold to Treasury (i) 14,448shares of the company’s Series T Preferred Stock, having a liquidationpreference of $1,000 per share, and (ii) a ten-year warrant to purchase upto 571,821 shares of the company’s common stock, parvalue $0.01 per share, at an initial exercise price of $3.79 per share, for anaggregate purchase price of $14,448,000 in cash.  The Series T Preferred Stock qualifiesas Tier 1 capital under Federal Reserve Board guidelines.

 

**Effect of Inflation and Changing Prices**

 

The effect of relative purchasing power over time dueto inflation has not been taken into account in our consolidated financialstatements.  Rather, our financialstatements have been prepared on an historical cost basis in accordance withgenerally accepted accounting principles.

 

Unlike most industrial companies, our assets andliabilities are primarily monetary in nature. Therefore, the effect of changes in interest rates will have a moresignificant impact on our performance than will the effect of changing pricesand inflation in general.  In addition,interest rates may generally increase as the rate of inflation increases,although not necessarily in the same magnitude. As discussed previously, we seek to manage the relationships betweeninterest sensitive assets and liabilities in order to protect against wide ratefluctuations, including those resulting from inflation.

 

**Off-Balance Sheet Risk**

 

Commitments to extend credit are agreements to lend toa customer as long as the customer has not violated any material conditionestablished in the contract.  Commitmentsgenerally have fixed expiration dates or other termination clauses and mayrequire the payment of a fee.  At December 31,2009, unfunded commitments to extend credit were $28.4 million.  A significant portion of the unfundedcommitments related to consumer equity lines of credit.  Based on historical experience, we anticipatethat a significant portion of these lines of credit will not be funded.  We evaluate each customer’s credit worthinesson a case-by-case basis.  The amount ofcollateral obtained, if deemed necessary by us upon extension of credit, isbased on our credit evaluation of the borrower. The type of collateral varies but may include accounts receivable,inventory, property, plant and equipment, and commercial and residential realestate.

 

At December 31, 2009, there were commitmentstotaling approximately $467,000 under letters of credit.  The credit risk and collateral involved inissuing letters of credit is essentially the same as that involved in extendingloan facilities to customers.  Since mostof the letters of credit are expected to expire without being drawn upon, theydo not necessarily represent future cash requirements.

 

Except as disclosed in this report, we are not involvedin off-balance sheet contractual relationships, unconsolidated related entitiesthat have off-balance sheet arrangements, or transactions that could result inliquidity needs or other commitments that significantly impact earnings.

 

**Market Risk**

 

Market risk is the risk of loss from adverse changes inmarket prices and rates, which principally arises from interest rate riskinherent in our lending, investing, deposit gathering, and borrowingactivities.  Other types of market risk,such as foreign currency exchange rate risk and commodity price risk, do notgenerally arise in the normal course of our business.

 

We actively monitor and manage our interest rate riskexposure principally by measuring our interest sensitivity “gap,” and netinterest income simulations.  Interestsensitivity gap is the positive or negative dollar difference between assetsand liabilities that are subject to interest rate repricing within a givenperiod of time.  Interest ratesensitivity can be managed by repricing assets or liabilities, sellingsecurities available for sale, replacing an asset or liability at maturity, oradjusting the interest rate during the life of an asset or liability.  Managing the amount of assets and liabilitiesrepricing in this same time interval helps to hedge the risk and 

 

57

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minimizethe impact on net interest income of rising or falling interest rates.  We generally would benefit from increasingmarket rates of interest when we have an asset-sensitive gap position andgenerally would benefit from decreasing market rates of interest when we areliability-sensitive.  We are currentlyasset sensitive.

 

Approximately 56.2% of our loans were variable rateloans at December 31, 2009 and 85.4% of interest-bearing liabilitiesreprice within one year.  However,interest rate movements typically result in changes in interest rates on assetsthat are different in magnitude from the corresponding changes in rates paid onliabilities.  While a substantial portionof our loans reprice within the first three months of the year, a largermajority of our deposits will reprice within a 12-month period.   However, our gap analysis is not a preciseindicator of our interest sensitivity position. The analysis presents only a static view of the timing of maturities andrepricing opportunities, without taking into consideration that changes ininterest rates do not affect all assets and liabilities equally.  For example, rates paid on a substantialportion of core deposits may change contractually within a relatively shorttime frame, but those rates are viewed by us as significantly lessinterest-sensitive than market-based rates such as those paid on noncoredeposits.  Net interest income may beaffected by other significant factors in a given interest rate environment,including changes in the volume and mix of interest-earning assets andinterest-bearing liabilities.

 

**Liquidity and Interest Rate Sensitivity**

 

Liquidity represents the ability of a company toconvert assets into cash or cash equivalents without significant loss, and theability to raise additional funds by increasing liabilities.  Liquidity management involves monitoring oursources and uses of funds in order to meet our day-to-day cash flowrequirements while maximizing profits. Liquidity management is made more complicated because different balancesheet components are subject to varying degrees of management control.  For example, the timing of maturities of ourinvestment portfolio is fairly predictable and subject to a high degree ofcontrol at the time investment decisions are made.  However, net deposit inflows and outflows arefar less predictable and are not subject to the same degree of control.

 

At December 31, 2009 and 2008, our liquid assets,which consist of cash and due from banks and federal funds sold, amounted to$15.0 million and $42.8 million, or 1.9% and 6.0% of total assets,respectively.  Our available for salesecurities at December 31, 2009 and 2008 amounted to $229.8 million and$171.8 million, or 29.6% and 24.0% of total assets, respectively.  Investment securities traditionally provide asecondary source of liquidity since they can be converted into cash in a timelymanner.  However, approximately $110.0million of these securities are pledged against outstanding debt or borrowinglines of credit.  Therefore, the relateddebt would need to be repaid prior to the securities being sold in order forthese securities to be converted to cash.

 

Our ability to maintainand expand our deposit base and borrowing capabilities serves as our primarysource of liquidity.  We plan to meet ourfuture cash needs through the generation of deposits.  In addition, we receive cash upon thematurity and sale of loans and the maturity of investment securities.  We maintain four federal funds purchased linesof credit with correspondent banks totaling $27.0 million.  We are also a member of the Federal Home LoanBank of Atlanta, from which applications for borrowings can be made forleverage or liquidity purposes.  The FHLBrequires that securities, qualifying mortgage loans, and stock of the FHLBowned by the bank be pledged to secure any advances.  At December 31, 2009, we had $65.0million in total advances and letters of credit from the FHLB with a remainingcredit availability of $128.5 million and an excess lendable collateral valueof approximately $2.1 million.  Inaddition, we maintain a line of credit with the Federal Reserve Bank of $16.3million secured by certain loans in our loan portfolio.

 

Asset/liability management is the process by which wemonitor and control the mix and maturities of our assets and liabilities.  The essential purposes of asset/liabilitymanagement are to ensure adequate liquidity and to maintain an appropriatebalance between interest sensitive assets and liabilities in order to minimizepotentially adverse impacts on earnings from changes in market interestrates.  Our risk management committeemonitors and considers methods of managing exposure to interest rate risk.  The risk management committee is responsiblefor maintaining the level of interest rate sensitivity of our interestsensitive assets and liabilities within board-approved limits.

 

The following table sets forth information regardingour rate sensitivity, as of December 31, 2009, at each of the timeintervals.  The information in the tablemay not be indicative of our rate sensitivity position at other 

 

58

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pointsin time.  In addition, the maturitydistribution implied in the table may differ from the contractual maturities ofthe earning assets and interest-bearing liabilities presented due toconsideration of prepayment speeds under various interest rate change scenariosand other embedded optionality in the application of the interest ratesensitivity methods described above.

** **
| ** **                                       | ** ** | **Within  three  months**  | ** ** | **After three  but within  twelve months** | ** ** | **After one  but within  five years** | ** ** | **After  five  years** | ** ** | **Total** | ** ** |
|--------------------------------------------------|------------|----------------------------|------------|--------------------------------------------|------------|---------------------------------------|------------|------------------------|------------|-----------|------------|
| ** **                                       | ** ** | **(dollars in thousands)** | ** ** |
| Interest-earning  assets:                        |       |                       |       |                                       |       |                                  |       |                   |       |      |       |
| Federal  funds sold                              |       | $                          | 12,500     |                                       | $          | —                                |       | $                      | —     |      | $          | — |   | $ | 12,500 |   |
| Investment  securities                           |       | 6,242                      |       | 16,864                                     |       | 47,752                                |       | 158,929                |       | 229,787   |       |
| Loans                                            |       | 304,144                    |       | 82,279                                     |       | 92,552                                |       | 6,580                  |       | 485,555   |       |
| Total  interest-earning assets                   |       | $                          | 322,886    |                                       | $          | 99,143                                |       | $                      | 140,304    |      | $          | 165,509 |   | $ | 727,842 |   |
|                                             |       |                       |       |                                       |       |                                  |       |                   |       |      |       |
| Interest-bearing  liabilities:                   |       |                       |       |                                       |       |                                  |       |                   |       |      |       |
| Money  market and NOW                            |       | $                          | 128,319    |                                       | $          | —                                |       | $                      | —     |      | $          | — |   | $ | 128,319 |   |
| Regular  savings                                 |       | 138,959                    |       | —                                     |       | —                                |       | —                 |       | 138,959   |       |
| Time  deposits                                   |       | 81,688                     |       | 212,571                                    |       | 12,894                                |       | 147                    |       | 307,300   |       |
| Junior  subordinated debentures                  |       | 8,248                      |       | —                                     |       | —                                |       | 6,186                  |       | 14,434    |       |
| Securities  sold under agreements to repurchase  |       | 40,000                     |       | —                                     |       | 10,000                                |       | 10,000                 |       | 60,000    |       |
| Advances  from Federal Home Loan Bank            |       | —                     |       | —                                     |       | 56,000                                |       | 9,000                  |       | 65,000    |       |
| ESOP  borrowings                                 |       | 2,300                      |       | —                                     |       | —                                |       | —                 |       | 2,300     |       |
| Total  interest-bearing liabilities              |       | $                          | 399,514    |                                       | $          | 212,571                               |       | $                      | 78,894     |      | $          | 25,333 |   | $ | 716,312 |   |
|                                             |       |                       |       |                                       |       |                                  |       |                   |       |      |       |
| Period  gap                                      |       | $                          | (76,628    | )                                          | $          | (113,428                              | )          | $                      | 61,410     |      | $          | 140,176 |   | $ | 11,530 |   |
| Cumulative  gap                                  |       | $                          | (76,628    | )                                          | $          | (190,056                              | )          | $                      | (128,646   | )         | $          | 11,530 |   | $ | 11,530 |   |
|                                             |       |                       |       |                                       |       |                                  |       |                   |       |      |       |
| Ratio  of cumulative gap to total earning assets |       | (10.52                     | )%         | (26.11                                     | )%         | (17.67                                | )%         | 1.58                   | %          | 1.58      | %          |

** **

**Item 7A:  Quantitative and Qualitative Disclosure AboutMarket Risk.**

** **

**Not applicable**

** **

**59**

----

** **

**Item 8:  Financial Statements and Supplementary Data.**

** **

**INDEX TO AUDITED FINANCIALSTATEMENTS**

 
| **TIDELANDS  BANCSHARES, INC. AND SUBSIDIARY**                                                                                                       |   |
|------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                                                 |   |
| Report  of Independent Registered Public Accounting Firm                                                                                             | F-2    |
|                                                                                                                                                 |   |
| Consolidated  Balance Sheets as of December 31, 2009 and 2008                                                                                   | F-3    |
|                                                                                                                                                 |   |
| Consolidated  Statements of Operations for the years ended December 31, 2009, 2008 and  2007                                                    | F-4    |
|                                                                                                                                                 |   |
| Consolidated Statements of Changes in Shareholders’  Equity and Comprehensive Income for the years ended December 31, 2009,  2008 and 2007 | F-5    |
|                                                                                                                                                 |   |
| Consolidated Statements of Cash Flows for the years  ended December 31, 2009, 2008 and 2007                                                     | F-6    |
|                                                                                                                                                 |   |
| Notes to Consolidated Financial Statements                                                                                                           | F-7    |

 

F-1

----

 

## **REPORT OF INDEPENDENT REGISTEREDPUBLIC ACCOUNTING FIRM**

 

 

The Board of Directors

Tidelands Bancshares, Inc.

Mount Pleasant, SouthCarolina

 

We have audited theaccompanying consolidated balance sheets of Tidelands Bancshares, Inc. andits subsidiary as of December 31, 2009 and 2008 and the relatedconsolidated statements of operations, changes in shareholders’ equity andcomprehensive income, and cash flows for each of the three years in the periodended December 31, 2009.  Thesefinancial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinionon these financial statements based on our audits.

 

We conducted our auditsin accordance with the standards of the Public Company Accounting OversightBoard (United States).  Those standardsrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement.  An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financialstatements.  An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.  We believe that our audits provide areasonable basis for our opinion.

 

In our opinion, theconsolidated financial statements referred to above present fairly, in allmaterial respects, the financial position of Tidelands Bancshares, Inc.,and its subsidiary, as of December 31, 2009 and 2008 and the results of theiroperations and their cash flows for each of the three years in the period endedDecember 31, 2009, in conformity with U.S. generally accepted accountingprinciples.

 

We were not engaged toexamine management’s assessment of the effectiveness of Tidelands Bancshares, Inc.’sinternal control over financial reporting as of December 31, 2009 includedin the accompanying Management’s Report on Internal Control over FinancialReporting and, accordingly, we do not express an opinion thereon.

 

/s/ Elliott Davis, PLLC

Elliott Davis, PLLC

Charlotte, North Carolina

February 26, 2010

 

F-2

----

 

**TidelandsBancshares, Inc. and Subsidiary**

# **ConsolidatedBalance Sheets**

 
| ** **                                                                                                                                                                  | ** ** | **December 31,** | ** **      | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|-----------------|-----------------------|------------|
| ** **                                                                                                                                                                  | ** ** | **2009**              | ** **      | **2008**              | ** ** |
| **Assets:**                                                                                                                                                                 |       |                  |            |                  |       |
| Cash and cash equivalents:                                                                                                                                                  |       |                  |            |                  |       |
| Cash and due from banks                                                                                                                                                     |       | $                     | 2,493,227       |                  | $          | 2,471,797 |   |
| Federal funds sold                                                                                                                                                          |       | 12,500,000            |            | 40,375,000            |       |
| Total cash and cash equivalents                                                                                                                                             |       | 14,993,227            |            | 42,846,797            |       |
| Securities available-for-sale                                                                                                                                               |       | 229,786,787           |            | 171,769,851           |       |
| Nonmarketable equity securities                                                                                                                                             |       | 5,892,650             |            | 3,807,140             |       |
| Total securities                                                                                                                                                            |       | 235,679,437           |            | 175,576,991           |       |
| Mortgage loans held for sale                                                                                                                                                |       | 617,000               |            | 241,500               |       |
| Loans receivable                                                                                                                                                            |       | 485,555,288           |            | 461,967,217           |       |
| Less allowance for loan losses                                                                                                                                              |       | 10,048,015            |            | 7,635,173             |       |
| Loans, net                                                                                                                                                                  |       | 475,507,273           |            | 454,332,044           |       |
| Premises, furniture and equipment, net                                                                                                                                      |       | 18,802,701            |            | 19,411,592            |       |
| Accrued interest receivable                                                                                                                                                 |       | 3,283,931             |            | 3,337,660             |       |
| Bank owned life insurance                                                                                                                                                   |       | 13,856,165            |            | 13,335,170            |       |
| Other real estate owned                                                                                                                                                     |       | 6,865,461             |            | 1,800,604             |       |
| Other assets                                                                                                                                                                |       | 6,324,714             |            | 4,300,465             |       |
| Total assets                                                                                                                                                                | ** ** | **$**                 | **775,929,909** | ** **            | **$**      | **715,182,823** | ** ** |
|                                                                                                                                                                        |       |                  |            |                  |       |
| **Liabilities:**                                                                                                                                                            |       |                  |            |                  |       |
| Deposits:                                                                                                                                                                   |       |                  |            |                  |       |
| Noninterest-bearing transaction accounts                                                                                                                                    |       | $                     | 16,971,128      |                  | $          | 12,133,098 |   |
| Interest-bearing transaction accounts                                                                                                                                       |       | 29,688,124            |            | 46,987,209            |       |
| Savings and money market                                                                                                                                                    |       | 237,589,561           |            | 182,856,286           |       |
| Time deposits $100,000 and over                                                                                                                                             |       | 105,975,461           |            | 92,825,486            |       |
| Other time deposits                                                                                                                                                         |       | 201,324,905           |            | 226,423,397           |       |
| Total deposits                                                                                                                                                              |       | 591,549,179           |            | 561,225,476           |       |
|                                                                                                                                                                        |       |                  |            |                  |       |
| Securities sold under agreements to repurchase                                                                                                                              |       | 60,000,000            |            | 20,000,000            |       |
| Junior subordinated debentures                                                                                                                                              |       | 14,434,000            |            | 14,434,000            |       |
| Advances from Federal Home Loan Bank                                                                                                                                        |       | 65,000,000            |            | 60,800,000            |       |
| ESOP borrowings                                                                                                                                                             |       | 2,300,000             |            | 2,600,000             |       |
| Other borrowings                                                                                                                                                            |       | —                |            | 615,837               |       |
| Accrued interest payable                                                                                                                                                    |       | 1,359,861             |            | 2,841,473             |       |
| Other liabilities                                                                                                                                                           |       | 2,362,125             |            | 706,605               |       |
| Total liabilities                                                                                                                                                           |       | 737,005,165           |            | 663,223,391           |       |
|                                                                                                                                                                        |       |                  |            |                  |       |
| Commitments and contingencies                                                                                                                                               |       |                  |            |                  |       |
| ** **                                                                                                                                                                  |       |                  |            |                  |       |
| **Shareholders’ equity:**                                                                                                                                              |       |                  |            |                  |       |
| Preferred stock, $.01 par value and liquidation  value per share of $1,000, 10,000,000 shares authorized, 14,448 issued and  outstanding at December 31, 2009 and 2008 |       | 13,529,660            |            | 13,335,752            |       |
| Common stock, $.01 par value, 10,000,000 shares  authorized; 4,277,176 shares issued and outstanding at December 31, 2009  and 2008                                    |       | 42,772                |            | 42,772                |       |
| Common stock-warrants, 571,821 outstanding at  December 31, 2009 and 2008                                                                                         |       | 1,112,248             |            | 1,112,248             |       |
| Unearned ESOP shares                                                                                                                                                        |       | (2,204,073            | )               | (2,522,860            | )          |
| Capital surplus                                                                                                                                                             |       | 43,584,958            |            | 43,364,255            |       |
| Retained deficit                                                                                                                                                            |       | (16,010,476           | )               | (4,905,419            | )          |
| Accumulated other comprehensive income (loss)                                                                                                                               |       | (1,130,345            | )               | 1,532,684             |       |
| Total shareholders’ equity                                                                                                                                             |       | 38,924,744            |            | 51,959,432            |       |
| Total liabilities and shareholders’ equity                                                                                                                             | ** ** | **$**                 | **775,929,909** | ** **            | **$**      | **715,182,823** | ** ** |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

F-3

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**TidelandsBancshares, Inc. and Subsidiary**

**Consolidated Statements of Operations**

**For theyears ended December 31, 2009, 2008 and 2007**

** **
| ** **                                                 | ** ** | **2009**      | ** **      | **2008**      | ** ** | **2007**       | ** ** |
|------------------------------------------------------------|------------|---------------|-----------------|---------------|------------|----------------|------------|
| **Interest income:**                                       |       |          |            |          |       |           |       |
| Loans, including fees                                      |       | $             | 25,512,610      |          | $          | 27,378,906     |       | $ | 27,805,332 |   |
| Securities available-for-sale, taxable                     |       | 9,922,547     |            | 6,805,459     |       | 2,462,876      |       |
| Securities available-for-sale, non-taxable                 |       | 148,437       |            | 286,844       |       | 439,719        |       |
| Federal funds sold                                         |       | 25,803        |            | 280,973       |       | 701,701        |       |
| Other interest income                                      |       | 2,741         |            | 5,116         |       | 16,211         |       |
| Total interest income                                      |       | 35,612,138    |            | 34,757,298    |       | 31,425,839     |       |
| **Interest expense:**                                      | ** ** | ** **    | ** **      | ** **    | ** ** | ** **     | ** ** |
| Time deposits $100,000 and over                            |       | 3,245,973     |            | 2,634,756     |       | 562,024        |       |
| Other deposits                                             |       | 10,100,461    |            | 14,153,141    |       | 16,256,750     |       |
| Other borrowings                                           |       | 4,212,222     |            | 3,554,669     |       | 2,415,800      |       |
| Total interest expense                                     |       | 17,558,656    |            | 20,342,566    |       | 19,234,574     |       |
| **Net interest income**                                    |       | 18,053,482    |            | 14,414,732    |       | 12,191,265     |       |
| Provision for loan losses                                  |       | 14,745,000    |            | 4,665,000     |       | 1,025,000      |       |
| **Net interest income after****provision for loan losses** |       | 3,308,482     |            | 9,749,732     |       | 11,166,265     |       |
|                                                       |       |          |            |          |       |           |       |
| **Noninterest income (loss):**                             | ** ** | ** **    | ** **      | ** **    | ** ** | ** **     | ** ** |
| Service charges on deposit accounts                        |       | 41,605        |            | 36,340        |       | 35,476         |       |
| Residential mortgage origination income                    |       | 404,855       |            | 383,341       |       | 764,130        |       |
| Gain on sale of securities available-for-sale              |       | 4,857,395     |            | 509,373       |       | 37,637         |       |
| Gain (loss) on sale of real estate                         |       | (91,038       | )               | 12,865        |       | 9,488          |       |
| Other service fees and commissions                         |       | 522,289       |            | 362,029       |       | 192,697        |       |
| Bank owned life insurance                                  |       | 520,995       |            | 484,352       |       | 290,032        |       |
| Impairment on securities                                   |       | (122,890      | )               | (4,596,200    | )          | —         |       |
| Other                                                      |       | 48,180        |            | 32,352        |       | 25,407         |       |
| Total noninterest income (loss)                            |       | 6,181,391     |            | (2,775,548    | )          | 1,354,867      |       |
| **Noninterest expense:**                                   | ** ** | ** **    | ** **      | ** **    | ** ** | ** **     | ** ** |
| Salaries and employee benefits                             |       | 7,805,821     |            | 8,322,117     |       | 6,918,015      |       |
| Net occupancy                                              |       | 1,574,366     |            | 1,423,198     |       | 1,029,784      |       |
| Furniture and equipment                                    |       | 855,324       |            | 734,497       |       | 484,146        |       |
| Other operating                                            |       | 6,131,682     |            | 4,147,955     |       | 3,400,883      |       |
| Total noninterest expense                                  |       | 16,367,193    |            | 14,627,767    |       | 11,832,828     |       |
| **Earnings (loss) before income  taxes**                   |       | (6,877,320    | )               | (7,653,583    | )          | 688,304        |       |
| Income tax expense (benefit)                               |       | 3,379,655     |            | (2,699,000    | )          | 275,000        |       |
| **Net income (loss)**                                      |       | $             | (10,256,975     | )             | $          | (4,954,583     | )          | $ | 413,304 |   |
| Accretion of preferred stock to redemption value           |       | 193,908       |            | —        |       | —         |       |
| Preferred dividends accrued                                |       | 732,433       |            | —        |       | —         |       |
| **Net income (loss) available to  common shareholders**    | ** ** | **$**         | **(11,183,316** | **)**         | **$**      | **(4,954,583** | **)**      | **$** | **413,304** | ** ** |
| **Earnings (loss) per common  share**                      | ** ** | ** **    | ** **      | ** **    | ** ** | ** **     | ** ** |
| Basic earnings (loss) per share                            | ** ** | **$**         | **(2.75**       | **)**         | **$**      | **(1.22**      | **)**      | **$** | **0.10** | ** ** |
| Diluted earnings (loss) per share                          | ** ** | **$**         | **(2.75**       | **)**         | **$**      | **(1.22**      | **)**      | **$** | **0.10** | ** ** |
| **Weighted average common shares  outstanding**            | ** ** | ** **    | ** **      | ** **    | ** ** | ** **     | ** ** |
| Basic                                                      | ** ** | **4,071,313** | ** **      | **4,050,301** | ** ** | **4,214,910**  | ** ** |
| Diluted                                                    | ** ** | **4,071,313** | ** **      | **4,050,301** | ** ** | **4,270,005**  | ** ** |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

F-4

----

 

**TidelandsBancshares, Inc. and Subsidiary**

**Consolidated Statements of Changes in Shareholders’Equity and Comprehensive Income**

**For theyears ended December 31, 2009, 2008 and 2007**

 
| ** **                                                               | ** ** | **Preferred  Stock** | ** ** | **Common  Stock** | ** **     | **Common  Stock** | ** ** | **Unearned  ESOP** | ** ** | **Capital**   | ** ** | **Retained  Earnings** | ** ** | **Accumulated  other  comprehensive** | ** ** | ** **     | ** ** |
|--------------------------------------------------------------------------|------------|----------------------|------------|-------------------|----------------|-------------------|------------|--------------------|------------|---------------|------------|------------------------|------------|---------------------------------------|------------|----------------|------------|
| ** **                                                               | ** ** | **Shares**           | ** ** | **Amount**        | ** **     | **Warrants**      | ** ** | **Shares**         | ** ** | **Amount**    | ** ** | **Shares**             | ** ** | **Surplus**                           | ** ** | **(deficit)**  | ** ** | **income  (loss)** | ** ** | **Total** | ** ** |
| **Balance, December 31, 2006**                                      | ** ** | **—**           | ** ** | **$**             | **—**     | ** **        | **$**      | **—**         | ** ** | **4,272,385** | ** ** | **$**                  | **42,724** | ** **                            | **$**      | **—**     | ** ** | **$** | **42,045,551** | ** ** | **$** | **(364,140** | **)** | **$** | **96,319** | ** ** | **$** | **41,820,454** | ** ** |
| Proceeds  from exercise of stock options                                 |       |                 |       |              |           |              |       | 4,791              |       | 48            |       |                   |       | 43,151                                |       |           |       |   |   | 43,199 |   |
| Stock  based compensation expense                                        |       |                 |       |              |           |              |       |               |       |          |       |                   |       | 699,964                               |       |           |       |   |   | 699,964 |   |
| Guarantee  of ESOP borrowings, net                                       |       |                 |       |              |           |              |       |               |       |          |       | (2,427,500             | )          |                                  |       |           |       |   |   | (2,427,500 | ) |
| Net  income                                                              |       |                 |       |              |           |              |       |               |       |          |       |                   |       |                                  |       | 413,304        |       |   |   | 413,304 |   |
| Other  comprehensive income, net of taxes of $236,295                    | ** ** | ** **           |       |              | ** **     | ** **        | ** ** | ** **         |       |          |       |                   |       |                                  |       |           |       | 405,749 |   | 405,749 |   |
| Comprehensive  income                                                    |       |                 |       |              |           |              |       |               |       |          |       |                   |       |                                  |       |           |       |   |   | 819,053 |   |
| **Balance, December 31, 2007**                                      | ** ** | **—**           | ** ** | **$**             | **—**     | ** **        | **$**      | **—**         | ** ** | **4,277,176** | ** ** | **$**                  | **42,772** | ** **                            | **$**      | **(2,427,500** | **)**      | **$** | **42,788,666** | ** ** | **$** | **49,164** | ** ** | **$** | **502,068** | ** ** | **$** | **40,955,170** | ** ** |
| Allocation  of unearned ESOP shares                                      |       |                 |       |              |           |              |       |               |       |          |       |                   |       | (124,920                              | )          |           |       |   |   | (124,920 | ) |
| Stock  based compensation expense                                        |       |                 |       |              |           |              |       |               |       |          |       |                   |       | 700,509                               |       |           |       |   |   | 700,509 |   |
| Net  proceeds from issuance of preferred stock and common stock warrants |       | 14,448               |       | 13,335,752        |           | 1,112,248         |       |               |       |          |       |                   |       |                                  |       |           |       |   |   | 14,448,000 |   |
| Guarantee  of ESOP borrowings, net                                       |       |                 |       |              |           |              |       |               |       |          |       | (95,360                | )          |                                  |       |           |       |   |   | (95,360 | ) |
| Net  loss                                                                |       |                 |       |              |           |              |       |               |       |          |       |                   |       |                                  |       | (4,954,583     | )          |   |   | (4,954,583 | ) |
| Other  comprehensive income, net of taxes of $631,667                    | ** ** | ** **           |       |              | ** **     | ** **        | ** ** | ** **         |       |          |       |                   |       |                                  |       |           |       | 1,030,616 |   | 1,030,616 |   |
| Comprehensive  loss                                                      |       |                 |       |              |           |              |       |               |       |          |       |                   |       |                                  |       |           |       |   |   | (3,923,967 | ) |
| **Balance, December 31, 2008**                                      | ** ** | **14,448**           | ** ** | **$**             | **13,335,752** | ** **        | **$**      | **1,112,248**      | ** ** | **4,277,176** | ** ** | **$**                  | **42,772** | ** **                            | **$**      | **(2,522,860** | **)**      | **$** | **43,364,255** | ** ** | **$** | **(4,905,419** | **)** | **$** | **1,532,684** | ** ** | **$** | **51,959,432** | ** ** |
| Allocation  of unearned ESOP shares                                      |       |                 |       |              |           |              |       |               |       |          |       |                   |       | (234,462                              | )          |           |       |   |   | (234,462 | ) |
| Stock  based compensation expense                                        |       |                 |       |              |           |              |       |               |       |          |       |                   |       | 455,165                               |       |           |       |   |   | 455,165 |   |
| Preferred  stock, dividend paid                                          |       |                 |       |              |           |              |       |               |       |          |       |                   |       |                                  |       | (654,174       | )          |   |   | (654,174 | ) |
| Accretion  of discount on preferred stock                                |       |                 |       | 193,908           |           |              |       |               |       |          |       |                   |       |                                  |       | (193,908       | )          |   |   | — |   |
| Repayment  of ESOP borrowings                                            |       |                 |       |              |           |              |       |               |       |          |       | 318,787                |       |                                  |       |           |       |   |   | 318,787 |   |
| Net  loss                                                                |       |                 |       |              |           |              |       |               |       |          |       |                   |       |                                  |       | (10,256,975    | )          |   |   | (10,256,975 | ) |
| Other  comprehensive loss, net of taxes of $1,632,178                    | ** ** | ** **           |       |              | ** **     | ** **        | ** ** | ** **         |       |          |       |                   |       |                                  |       |           |       | (2,663,029 | ) | (2,663,029 | ) |
| Comprehensive  loss                                                      |       |                 |       |              |           |              |       |               |       |          |       |                   |       |                                  |       |           |       |   |   | (12,920,004 | ) |
| **Balance, December 31, 2009**                                      | ** ** | **14,448**           | ** ** | **$**             | **13,529,660** | ** **        | **$**      | **1,112,248**      | ** ** | **4,277,176** | ** ** | **$**                  | **42,772** | ** **                            | **$**      | **(2,204,073** | **)**      | **$** | **43,584,958** | ** ** | **$** | **(16,010,476** | **)** | **$** | **(1,130,345** | **)** | **$** | **38,924,744** | ** ** |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

F-5

----

 

**Tidelands Bancshares, Inc. and Subsidiary**

**Consolidated Statements of Cash Flows**

**For theyears ended December 31, 2009, 2008 and 2007**

 
| ** **                                                                                  | ** ** | **2009**     | ** **     | **2008**     | ** ** | **2007**       | ** ** |
|---------------------------------------------------------------------------------------------|------------|--------------|----------------|--------------|------------|----------------|------------|
| **Cash flows from operating  activities:**                                                  |       |         |           |         |       |           |       |
| Net income (loss)                                                                           |       | $            | (10,256,975    | )            | $          | (4,954,583     | )          | $ | 413,304 |   |
| Adjustments to reconcile net income (loss) to net  cash provided by operating activities:   |       |         |           |         |       |           |       |
| Provision for loan losses                                                                   |       | 14,745,000   |           | 4,665,000    |       | 1,025,000      |       |
| Depreciation and amortization expense                                                       |       | 962,146      |           | 883,785      |       | 575,079        |       |
| Discount accretion and premium amortization                                                 |       | 3,375,776    |           | (26,587      | )          | (36,236        | )          |
| Stock based compensation expense                                                            |       | 455,165      |           | 700,509      |       | 699,964        |       |
| Decrease (increase) in deferred income tax                                                  |       | 3,846,223    |           | (2,285,890   | )          | (211,396       | )          |
| Proceeds from sale of residential mortgages  held-for-sale                                  |       | 32,568,094   |           | 28,700,877   |       | 52,245,300     |       |
| Disbursements for residential mortgages  held-for-sale                                      |       | (32,943,594  | )              | (27,515,577  | )          | (51,114,666    | )          |
| (Increase) decrease in accrued interest receivable                                          |       | 53,729       |           | (173,536     | )          | (1,243,845     | )          |
| Increase (decrease) in accrued interest payable                                             |       | (1,481,612   | )              | 1,500,312    |       | 369,729        |       |
| Increase in cash surrender value of life insurance                                          |       | (520,995     | )              | (484,352     | )          | (290,032       | )          |
| (Gain) loss from sale of real estate                                                        |       | 91,038       |           | (12,865      | )          | (9,488         | )          |
| Gain from sale of securities available-for-sale                                             |       | (4,857,395   | )              | (509,373     | )          | (37,637        | )          |
| Write-down on other real estate owned                                                       |       | 153,249      |           | —       |       | —         |       |
| Other than temporary impairment on securities  available-for-sale                           |       | —       |           | 4,596,200    |       | —         |       |
| Other than temporary impairment on nonmarketable  equity securities                         |       | 122,890      |           | —       |       | —         |       |
| Increase in other assets                                                                    |       | (4,168,293   | )              | (529,889     | )          | (229,338       | )          |
| Increase (decrease) in other liabilities                                                    |       | 1,655,520    |           | (381,714     | )          | 688,818        |       |
| Net cash provided by operating activities                                                   |       | 3,799,966    |           | 4,172,317    |       | 2,844,556      |       |
| **Cash flows from investing  activities:**                                                  | ** ** | ** **   | ** **     | ** **   | ** ** | ** **     | ** ** |
| Purchases of nonmarketable equity securities                                                |       | (2,208,400   | )              | (1,746,200   | )          | (878,840       | )          |
| Purchases of securities available-for-sale                                                  |       | (575,472,552 | )              | (153,041,623 | )          | (64,389,788    | )          |
| Proceeds from sales of securities  available-for-sale                                       |       | 369,561,934  |           | 55,037,945   |       | 12,514,016     |       |
| Proceeds from calls and maturities of securities  available-for-sale                        |       | 145,080,093  |           | 11,871,982   |       | 2,059,570      |       |
| Net increase in loans receivable                                                            |       | (43,632,213  | )              | (73,885,256  | )          | (118,473,417   | )          |
| Purchase of bank owned life insurance                                                       |       | —       |           | (5,001,662   | )          | —         |       |
| Proceeds from sale of other real estate owned                                               |       | 2,337,821    |           | 279,153      |       | —         |       |
| Purchase of premises, furniture and equipment, net                                          |       | (358,236     | )              | (2,527,908   | )          | (9,540,078     | )          |
| Net cash used by investing activities                                                       |       | (104,691,553 | )              | (169,013,569 | )          | (178,708,537   | )          |
| **Cash flows from financing  activities:**                                                  | ** ** | ** **   | ** **     | ** **   | ** ** | ** **     | ** ** |
| Net increase in demand deposits, interest-bearingtransaction accounts and  savings accounts |       | 42,272,220   |           | 23,491,440   |       | 64,233,139     |       |
| Net increase (decrease) in certificates of deposit  and other time deposits                 |       | (11,948,517  | )              | 149,564,595  |       | 64,803,605     |       |
| Proceeds (repayments) on other borrowings                                                   |       | (615,837     | )              | 615,837      |       | —         |       |
| Proceeds from securities sold under agreements to  repurchase                               |       | 52,500,000   |           | —       |       | 31,040,000     |       |
| Repayments on securities sold under agreements to  repurchase                               |       | (12,500,000  | )              | (21,040,000  | )          | —         |       |
| Proceeds from junior subordinated debentures                                                |       | —       |           | 6,186,000    |       | —         |       |
| Proceeds from FHLB advances                                                                 |       | 40,000,000   |           | 31,800,000   |       | 13,000,000     |       |
| Repayments on FHLB advances                                                                 |       | (35,800,000  | )              | —       |       | —         |       |
| Proceeds from ESOP borrowings                                                               |       | —       |           | 472,500      |       | 2,527,500      |       |
| Repayment of ESOP borrowings                                                                |       | (300,000     | )              | (300,000     | )          | (100,000       | )          |
| Decrease (increase) in unearned ESOP shares                                                 |       | 84,325       |           | (220,280     | )          | (2,427,500     | )          |
| Proceeds from issuance of preferred stock, net                                              |       | —       |           | 13,335,752   |       | —         |       |
| Proceeds from issuance of common stock-warrants                                             |       | —       |           | 1,112,248    |       | —         |       |
| Preferred stock-dividends paid                                                              |       | (654,174     | )              | —       |       | —         |       |
| Proceeds from exercise of stock options                                                     |       | —       |           | —       |       | 43,199         |       |
| Net cash provided by financing activities                                                   |       | 73,038,017   |           | 205,018,092  |       | 173,119,943    |       |
| **Net increase (decrease) in cash  and cash equivalents**                                   |       | (27,853,570  | )              | 40,176,840   |       | (2,744,038     | )          |
| **Cash and cash equivalents,  beginning of period**                                         |       | 42,846,797   |           | 2,669,957    |       | 5,413,995      |       |
| **Cash and cash equivalents, end  of period**                                               | ** ** | **$**        | **14,993,227** | ** **   | **$**      | **42,846,797** | ** ** | **$** | **2,669,957** | ** ** |
| ** **                                                                                  | ** ** | ** **   | ** **     | ** **   | ** ** | ** **     | ** ** |
| **Supplemental cash flow  information:**                                                    | ** ** | ** **   | ** **     | ** **   | ** ** | ** **     | ** ** |
| Income taxes paid                                                                           |       | $            | 121,582        |         | $          | —         |       | $ | 160,107 |   |
| Interest paid on deposits and borrowed funds                                                |       | $            | 19,040,268     |         | $          | 18,842,254     |       | $ | 18,864,846 |   |
| Transfer of loans to foreclosed assets                                                      |       | $            | 7,641,984      |         | $          | 2,074,974      |       | $ | — |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

F-6

----

 

### **NOTE 1 - SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES**

 

**Organization** - Tidelands Bancshares, Inc. (the “Company”)was incorporated on January 31, 2002 to serve as a bank holding companyfor its subsidiary, Tidelands Bank (the “Bank”).  The Company operated as a development stagecompany from January 31, 2002 to October 5, 2003.  Tidelands Bank commenced business on October 6,2003.  The principal business activity ofthe Bank is to provide banking services to domestic markets, principally inCharleston, Dorchester, Berkeley, Horry and Beaufort counties in SouthCarolina.  The Bank is a state-charteredcommercial bank, and its deposits are insured by the Federal Deposit InsuranceCorporation.  The consolidated financialstatements include the accounts of the parent company and its wholly-ownedsubsidiary after elimination of all significant intercompany balances andtransactions. On February 22, 2006, the Company formed Tidelands StatutoryTrust I for the purpose of issuing trust preferred securities.  On June 20, 2008, the Company formedTidelands Statutory Trust II for the purpose of issuing trust preferredsecurities. In accordance with current accounting guidance, the Trusts are notconsolidated in these financial statements. As further discussed in Note 21, onDecember 19, 2008, as part of the Capital Purchase Program established bythe U.S. Department of the Treasury under the Emergency Economic StabilizationAct of 2008, Tidelands Bancshares, Inc. issued 14,448 preferred shares and571,821 warrants in return for $14.4 million in cash, to the U.S. Department ofTreasury.

 

**Management’s Estimates** - The preparation of consolidatedfinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of income and expenses during the reportingperiod.  Actual results could differ fromthose estimates.

 

Material estimates thatare particularly susceptible to significant change relate to the determinationof the allowance for losses on loans, including valuation allowances forimpaired loans, and the valuation of real estate acquired in connection withforeclosures or in satisfaction of loans. In connection with the determination of the allowances for losses onloans and foreclosed real estate, management obtains independent appraisals forsignificant properties.  Management mustalso make estimates in determining the estimated useful lives and methods fordepreciating premises and equipment.

 

While management usesavailable information to recognize losses on loans and foreclosed real estate,future additions to the allowances may be necessary based on changes in localeconomic conditions.  In addition,regulatory agencies, as an integral part of their examination process,periodically review the Bank’s allowance for losses on loans and valuation of foreclosedreal estate.  Such agencies may requirethe Bank to recognize additions to the allowances based on their judgmentsabout information available to them at the time of their examination.  Because of these factors, it is reasonablypossible that the allowance for losses on loans and valuation of foreclosedreal estate may change materially in the near term.

 

In preparing thesefinancial statements, subsequent events were evaluated through the time thefinancial statements were issued and all material subsequent events have beeneither recognized in the financial statements or disclosed in the notes to thefinancial statements.

 

**Concentrationsof Credit Risk**- Financial instruments, which potentially subject the Company toconcentrations of credit risk, consist principally of loans receivable,investment securities, federal funds sold and amounts due from banks.

 

The Company makes loansto individuals and small businesses for various personal and commercialpurposes primarily in the Charleston metropolitan area (which includesCharleston, Dorchester, and Berkeley counties), Horry and Beaufort counties,and additional markets along the South Carolina coast.  The Company’s loan portfolio is notconcentrated in loans to any single borrower or a relatively small number ofborrowers. Additionally, management is not aware of any concentrations of loansto classes of borrowers or industries that would be similarly affected byeconomic conditions.

 

In addition to monitoringpotential concentrations of loans to particular borrowers or groups ofborrowers, industries and geographic regions, management monitors exposure tocredit risk from concentrations of lending products and practices such as loansthat subject borrowers to substantial payment increases (e.g., principaldeferral periods, loans with initial interest-only periods, etc.), and loanswith high loan-to-value ratios.  Additionally, there are industry practices that could subject theCompany to increased credit risk should economic conditions change over thecourse 

 

F-7

----

 

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.  Therefore,management believes that these particular practices do not subject the Companyto unusual credit risk.

 

The Company’s investmentportfolio consists principally of obligations of the United States and itsagencies or its corporations.  In theopinion of management, there is no concentration of credit risk in itsinvestment portfolio.  The Company placesits deposits and correspondent accounts with and sells its federal funds tohigh quality institutions.  Managementbelieves credit risk associated with correspondent accounts is not significant.

### ** **

**Securities Available-for-Sale******- Securities available-for-sale are carried atamortized cost and adjusted to estimated market value by recognizing theaggregate unrealized gains or losses in a valuation account.  Aggregate market valuation adjustments arerecorded in shareholders’ equity net of deferred income taxes.  Reductions in market value considered bymanagement to be other than temporary are reported as a realized loss and areduction in the cost basis of the security. The adjusted cost basis ofinvestments available-for-sale is determined by specific identification and isused in computing the gain or loss upon sale.

 

**Nonmarketable Equity Securities** - Nonmarketable equity securitiesinclude the cost of the Company’s investment in the stock of the Federal HomeLoan Bank and stock in community bank holding companies.  The Federal Home Loan Bank stock has noquoted market value and no ready market exists. Investment in the Federal Home Loan Bank is a condition of borrowingfrom the Federal Home Loan Bank, and the stock is pledged to collateralize suchborrowings.  Dividends received on thisstock are included as interest income on securities available-for-sale.

 

**Loans Receivable** - Loans are stated at their unpaidprincipal balance.  Interest income onloans is computed based upon the unpaid principal balance.  Interest income is recorded in the period earned.

 

The accrual of interestincome is generally discontinued when a loan becomes contractually 90 days pastdue as to principal or interest. Management may elect to continue the accrual of interest when theestimated net realizable value of collateral exceeds the principal balance andaccrued interest. A payment of interest on a loan that is classified asnonaccrual is applied against the principal balance. Nonaccrual loans may berestored to performing status when all principal and interest has been keptcurrent for six months and full repayment of the remaining contractualprincipal and interest is expected.

### ** **

### **Loan origination and commitment fees are deferred andamortized to income over the contractual life of the related loans orcommitments, adjusted for prepayments, using the straight-line method, whichapproximates the interest method.**

 

Loans are defined asimpaired when it is probable that a creditor will be unable to collect allamounts due according to the contractual terms of the loan agreement.  All loans are subject to these criteriaexcept for smaller balance homogeneous loans that are collectively evaluatedfor impairment and loans measured at fair value or at the lower of cost or fairvalue.  The Company considers its consumerinstallment portfolio, credit card loans, and home equity lines as suchexceptions.

 

Impairment of a loan ismeasured based on the present value of expected future cash flows discounted atthe loan’s effective interest rate or the fair value of the collateral if theloan is collateral dependent.  Whenmanagement determines that a loan is impaired, the difference between theCompany’s investment in the related loan and the present value of the expectedfuture cash flows, or the fair value of the collateral, is generally chargedoff with a corresponding entry to the allowance for loan losses.  The accrual of interest is discontinued on animpaired loan when management determines the borrower may be unable to meetpayments as they become due.

 

**Allowance for Loan Losses******- An allowance for loan losses is maintained at alevel deemed appropriate by management to provide adequately for known andinherent losses in the loan portfolio. The allowance for loan losses represents an amount which the Companybelieves will be adequate to absorb probable losses on existing loans that maybecome uncollectible in the future.  TheCompany’s judgment as to the adequacy of the allowance for loan losses is basedon a number of assumptions about future events, which the Company believes tobe reasonable, but which may or may not prove to be accurate.  The Company’s determination of the allowancefor loan losses is based on evaluations of the collectibility of loans,including consideration of factors such as the 

 

F-8

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balance of impairedloans, the quality, mix, and size of the Company’s overall loan portfolio,economic conditions that may affect the borrower’s ability to repay, the amountand quality of collateral securing the loans, the Company’s historical loanloss experience, and a review of specific problem loans.  The Company also considers subjective issuessuch as changes in the lending policies and procedures, changes in thelocal/national economy, changes in volume or type of credits, changes involume/severity of problem loans, quality of loan review and board of directoroversight, concentrations of credit, and peer group comparisons.  Loans which are deemed to be uncollectibleare charged off and deducted from the allowance.  The provision for loan losses and recoveriesof loans previously charged off are added to the allowance. Our analysis inaccordance with generally accepted accounting principles (GAAP) indicates thatthe level of the allowance for loan losses is appropriate to cover estimatedcredit losses on individually evaluated loans as well as estimated creditlosses inherent in the remainder of the portfolio.

 

**ResidentialMortgage Loans Held-for-Sale** - The Company’s residential mortgage lendingactivities for sale in the secondary market are comprised of acceptingresidential mortgage loan applications, qualifying borrowers to standardsestablished by investors, funding residential mortgage loans and sellingmortgage loans to investors under pre-existing commitments.  Funded residential mortgages held temporarilyfor sale to investors are recorded at the lower of cost or market value.  Application and origination fees collected bythe Company are recognized as income upon sale to the investor.

 

The Company issues ratelock commitments to borrowers based on prices quoted by secondary marketinvestors.  When rates are locked withborrowers, a sales commitment is immediately entered (on a best efforts basis)at a specified price with a secondary market investor.  Accordingly, any potential liabilities associatedwith rate lock commitments are offset by sales commitments to investors.

 

**Premises, Furniture and Equipment** - Premises, furniture and equipment arestated at cost, less accumulated depreciation. The provision for depreciation is computed by the straight-line method,based on the estimated useful lives for furniture and equipment of five to 10years and buildings of 40 years. Leasehold improvements are amortized over the life of the leases, whichrange up to 40 years.  The cost of assetssold or otherwise disposed of and the related allowance for depreciation areeliminated from the accounts and the resulting gains or losses are reflected inthe income statement when incurred. Maintenance and repairs are charged to current expense.  The costs of major renewals and improvementsare capitalized.

 

**Other Real Estate Owned** - Other real estate is acquired through,or in lieu of, foreclosure and is held for sale. It is initially recorded atfair value less cost to sell at the date of foreclosure, establishing a newcost basis. Subsequent to foreclosure, valuations are periodically performed bymanagement and the assets are carried at the lower of carrying amount or fairvalue less cost to sell. Revenue and expenses from operations are includedwithin noninterest expense as part of other operating expense.

 

**Securities Sold Under Agreementsto Repurchase**- The Bank enters into sales of securities under agreements to repurchase.  Fixed-coupon repurchase agreements aretreated as financing, with the obligation to repurchase securities sold beingreflected as a liability and the securities underlying the agreements remainingas assets.

### ** **

**Income Taxes** - Income taxes are the sum of amountscurrently payable to taxing authorities and the net changes in income taxes payableor refundable in future years.  Incometaxes deferred to future years are determined utilizing a liabilityapproach.  This method givesconsideration to the future tax consequences associated with differencesbetween financial accounting and tax bases of certain assets and liabilitieswhich are principally the allowance for loan losses, depreciable premises andequipment, and the net operating loss carry forward. The Company believes thatits income tax filing positions taken or expected to be taken in its taxreturns will more likely than not be sustained upon audit by the taxingauthorities and does not anticipate any adjustments that will result in amaterial adverse impact on the Company’s financial condition, results ofoperations, or cash flow. Therefore, no reserves for uncertain income taxpositions have been recorded.

 

**Retirement Plan** - The Company has a 401(k) profitsharing plan, which provides retirement benefits to substantially all officersand employees who meet certain age and service requirements.  The plan includes a “salary reduction”feature pursuant to Section 401(k) of the Internal Revenue Code.  At its discretion, the Bank makes matchingcontributions of $.50 for every dollar contributed up to 6% of the participants’annual compensation. Additionally, the Company maintains supplementalretirement plans for certain highly compensated employees 

 

F-9

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designed to offset theimpact of regulatory limits on benefits under qualified pension plans. Thereare supplemental retirement plans in place for certain current employees.

 

**Bank Owned Life Insurance** - Bank owned life insurance (“BOLI”)represents life insurance on the lives of certain current and former employeeswho have provided positive consent allowing the Bank to be the beneficiary ofsuch policies. The Bank purchases BOLI in order to use its earnings to helpoffset the costs of the Bank’s benefit expenses including pre- andpost-retirement employee benefits. Increases in the cash surrender value (“CSV”)of the policies, as well as death benefits received net of any CSV, arerecorded in other non-interest income, and are not subject to income taxes. TheCSV of the policies are recorded as assets of the Bank. Any amounts owed toemployees from policy benefits are recorded as liabilities of the Bank. TheCompany reviews the financial strength of the insurance carriers prior to thepurchase of BOLI and annually thereafter. BOLI with any individual carrier islimited to 15% of tier one capital and BOLI in total is limited to 25% of tierone capital based on Company policy.

 

**Stock Option Plan** - On May 10, 2004, the Companyestablished the 2004 Tidelands Bancshares, Inc. Stock Incentive Plan (“StockPlan”) that provides for the granting of options to purchase 20% of theoutstanding shares of the Company’s common stock to directors, officers, oremployees of the Company.  The per-shareexercise price of incentive stock options granted under the Stock Plan may notbe less than the fair market value of a share on the date of grant and vestbased on continued service with the Company for a specified period, generallytwo to five years following the date of grant. The per-share exercise price of stock options granted is determined by acommittee appointed by the Board of Directors. The expiration date of any option may not be greater than 10 years fromthe date of grant.  Options that expireunexercised or are forfeited become available for reissuance.

 

**EmployeeStock Ownership Plan******- The Company established theTidelands Bancshares, Inc. Employee Stock Ownership Plan (“ESOP”) for theexclusive benefit of all eligible employees and their beneficiaries subject toauthority to amend, from time to time, or terminate, the ESOP. The ESOP isprimarily designed to invest in common stock of the Company and is permitted topurchase Company common stock with contributions to the ESOP made by theCompany.  Also, the ESOP is permitted toborrow money and use the loan proceeds to purchase Company common stock. Themoney and Company common stock in the ESOP is intended to grow tax free untilretirement, death, permanent disability or other severance of employment withthe Company.  When an employee retires,he/she will receive the value of the accounts that have been set up for thecontributions to the ESOP.  An employeemay also be eligible for benefits in the event of death, permanent disabilityor other severance from employment with the Company.  The employee must pay taxes when the money ispaid following one of these events or any other distributable event describedin the ESOP unless it is transferred to another tax-qualified retirement planor an IRA.

 

**Earnings (loss) per share** - Basic earnings (loss) per sharerepresent income available to common shareholders divided by theweighted-average number of common shares outstanding during the period.  Dilutive earnings (loss) per share reflectadditional common shares that would have been outstanding if dilutive potentialcommon shares had been issued.  Potentialcommon shares that may be issued by the Company relate solely to outstandingstock options and warrants and are determined using the treasury stockmethod.  Weighted average sharesoutstanding are reduced for shares encumbered by the ESOP borrowings.

 

### **ComprehensiveIncome**- Accountingprinciples generally require that recognized income, expenses, gains, andlosses be included in net income. Although certain changes in assets and liabilities, such as unrealizedgains and losses on available-for-sale securities, are reported as a separatecomponent of the equity section of the balance sheet, such items, along withnet income, are components of comprehensive income.

 

**Statements of Cash Flows** - For purposes of reporting cash flowsin the financial statements, the Company considers certain highly liquid debtinstruments purchased with a maturity of three months or less to be cashequivalents.  Cash equivalents includeamounts due from banks and federal funds sold. Generally, federal funds are sold for one-day periods.

 

Changes in the valuationaccount of securities available-for-sale, including the deferred tax effects,are considered noncash transactions for purposes of the statement of cash flowsand are presented in detail in the notes to the consolidated financialstatements.

 

**Off-Balance-Sheet FinancialInstruments** -In the ordinary course of business, the Company enters into off-

 

F-10

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balance-sheet financialinstruments consisting of commitments to extend credit and letters ofcredit.  These financial instruments arerecorded in the financial statements when they become payable by the customer.

 

**Recently IssuedAccounting Pronouncements**- The following is asummary of recent authoritative pronouncements that could impact theaccounting, reporting, and / or disclosure of financial information by theCompany.

 

In June 2009, the Financial AccountingStandards Board (“FASB”) issued guidance which restructured generally acceptedaccounting principles (“GAAP”) and simplified access to all authoritativeliterature by providing a single source of authoritave nongovernmentalGAAP.  The guidance is presented in atopically organized structure referred to as the FASB Accounting StandardsCodification (“ASC”). The new structure is effective for interim or annualperiods ending after September 15, 2009. All existing accounting standardshave been superseded and all other accounting literature not included isconsidered nonauthoritative.

 

The FASB issued new accounting guidance onaccounting for transfers of financial assets in June 2009.  The guidance limits the circumstances inwhich a financial asset should be derecognized when the transferor has nottransferred the entire financial asset by taking into consideration the transferor’scontinuing involvement.  The standardrequires that a transferor recognize and initially measure at fair value allassets obtained (including a transferor’s beneficial interest) and liabilitiesincurred as a result of a transfer of financial assets accounted for as asale.  The concept of a qualifyingspecial-purpose entity is no longer applicable. The standard is effective for the first annual reporting period thatbegins after November 15, 2009, for interim periods within the firstannual reporting period, and for interim and annual reporting periodsthereafter.  Earlier application isprohibited.  The Company does not expectthe guidance to have any impact on the Company’s financial statements.  The ASC was amended in December, 2009, toinclude this guidance.

 

In October, 2009, updated guidance was issuedto provide for accounting and reporting for own-share lending arrangementsissued in contemplation of a convertible debt issuance.  At the date of issuance, a share-lendingarrangement entered into on an entity’s own shares should be measured at fairvalue in accordance with prior guidance and recognized as an issuance cost,with an offset to additional paid-in capital. Loaned shares are excluded from basic and diluted earnings per shareunless default of the share-lending arrangement occurs.  The amendment also requires severaldisclosures including a description and the terms of the arrangement and thereason for entering into the arrangement. The effective dates of the amendment are dependent upon the date theshare-lending arrangement was entered into and include retrospectiveapplication for arrangements outstanding as of the beginning of fiscal yearsbeginning on or after December 15, 2009.  The Company has no plans to issue convertible debt and, therefore, doesnot expect the update to have an impact on its financial statements.

 

In January, 2010, guidance was issued toalleviate diversity in the accounting for distributions to shareholders thatallow the shareholder to elect to receive their entire distribution in cash orshares but with a limit on the aggregate amount of cash to be paid.  The amendment states that the stock portionof a distribution to shareholders that allows them to elect to receive cash orshares with a potential limitation on the total amount of cash that allshareholders can elect to receive in the aggregate is considered a shareissuance.  The amendment is effective forinterim and annual periods ending on or after December 15, 2009 and had noimpact on the Company’s financial statements.

 

Also in January, 2010, an amendment wasissued to clarify the scope of subsidiaries for consolidation purposes.  The amendment provides that the decrease inownership guidance should apply to (1) a subsidiary or group of assetsthat is a business or nonprofit activity, (2) a subsidiary that is abusiness or nonprofit activity that is transferred to an equity method investeeor joint venture, and (3) an exchange of a group of assets thatconstitutes a business or nonprofit activity for a noncontrolling interest inan entity.  The guidance does not applyto a decrease in ownership in transactions related to sales of in substancereal estate or conveyances of oil and gas mineral rights.  The update is effective for the interim orannual reporting periods ending on or after December 15, 2009 and had noimpact on the Company’s financial statements.

 

Other accounting standards that have beenissued or proposed by the FASB or other standards-setting bodies are notexpected to have a material impact on the Company’s financial position, resultsof operations or cash flows.

 

**Risks and Uncertainties** - In the normal course of its business,the Company encounters two significant types of 

 

F-11

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risks: economic andregulatory.  There are three maincomponents of economic risk:  interestrate risk, credit risk and market risk. The Company is subject to interest rate risk to the degree that itsinterest-bearing liabilities mature or reprice at different speeds, or ondifferent basis, than its interest-earning assets.  Credit risk is the risk of default on theloan portfolio that results from borrower’s inability or unwillingness to makecontractually required payments.  Marketrisk reflects changes in the value of collateral underlying loans receivableand the valuation of real estate held by the Company.

 

The Company is subject tothe regulations of various governmental agencies.  These regulations can and do changesignificantly from period to period.  Periodicexaminations by the regulatory agencies may subject the company to furtherchanges with respect to asset valuations, amounts of required loss allowancesand operating restrictions from the regulators’ judgments based on informationavailable to them at the time of their examination.

 

**Reclassifications** - Certain captions and amounts in the2007 and 2008 financial statements were reclassified to conform to the 2009presentation.

 

**NOTE2 - OTHER COMPREHENSIVE INCOME**

 

The change in thecomponents of other comprehensive income (loss) and related tax effects are asfollows:

 
| ** **                                                            | ** ** | **Year Ended December 31,** | ** **     |
|-----------------------------------------------------------------------|------------|----------------------------------|----------------|
| ** **                                                            | ** ** | **2009**                         | ** **     | **2008** | ** ** | **2007** | ** ** |
| Change  in unrealized gains (losses) on securities available-for-sale |       | $                                | 562,188        |   | $ | (2,424,544 | ) | $ | 679,681 |   |
| Reclassification  adjustment for gains realized in net income         |       | (4,857,395                       | )              | (509,373 | ) | (37,637 | ) |
| Impairment  on securities available-for-sale                          |       | —                           |           | 4,596,200 |   | — |   |
| Net  change in unrealized gains (losses) on securities                |       | (4,295,207                       | )              | 1,662,283 |   | 642,044 |   |
| Tax  effect                                                           |       | 1,632,178                        |           | (631,667 | ) | (236,295 | ) |
| Net-of-tax  amount                                                    | ** ** | **$**                            | **(2,663,029** | **)** | **$** | **1,030,616** | ** ** | **$** | **405,749** | ** ** |

** **

### **NOTE 3 - FAIRVALUE MEASUREMENTS**

 

The current accounting literature requires thedisclosure of fair value information for financial instruments, whether or notthey are recognized in the consolidated balance sheets, when it is practical toestimate the fair value.  The guidance defines a financial instrument ascash, evidence of an ownership interest in an entity or contractualobligations, which require the exchange of cash, or other financialinstruments.  Certain items are specifically excluded from the disclosurerequirements, including the Company’s common stock, premises and equipment,accrued interest receivable and payable, and other assets and liabilities.

 

The fair value of a financial instrument is the amountat which the asset or obligation could be exchanged in a current transactionbetween willing parties, other than in a forced or liquidation sale.  Fairvalue estimates are made at a specific point in time based on relevant marketinformation and information about the financial instruments.  Because nomarket value exists for a significant portion of the financial instruments,fair value estimates are based on judgments regarding future expected lossexperience, current economic conditions, risk characteristics of variousfinancial instruments, and other factors.

 

The Company has used management’s best estimate offair value based on the above assumptions.  Thus, the fair valuespresented may not be the amounts, which could be realized, in an immediate saleor settlement of the instrument. In addition, any income taxes or otherexpenses, which would be incurred in an actual sale or settlement, are nottaken into consideration in the fair values presented.

 

F-12

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The following methods and assumptions were used toestimate the fair value of significant financial instruments:

 

***Cashand Due from Banks*** - The carrying amount for cash and due from banks is a reasonableestimate of fair value.

 

***FederalFunds Sold*** -Federal funds sold are for a term of one day, and the carrying amountapproximates the fair value.

 

### ***SecuritiesAvailable-for-sale****—* Investment securitiesavailable-for-sale are recorded at fair value on a recurring basis.  Fairvalue measurement is based upon quoted prices, if available.  If quotedprices are not available, fair values are measured using independent pricingmodels or other model-based valuation techniques such as the present value offuture cash flows, adjusted for the security’s credit rating, prepaymentassumptions and other factors such as credit loss assumptions.

 

### **With respect to securities available-for-sale, Level 1includes those securities traded on an active exchange, such as the New YorkStock Exchange, U.S. Treasury securities that are traded by dealers or brokersin active over-the-counter markets and money market funds.  Level 2securities include mortgage-backed securities issued by government sponsoredentities, municipal bonds and corporate debt securities.  Securitiesclassified as Level 3 include asset-backed securities in less liquid markets.**

 

***NonmarketableEquity Securities*** - The carrying amount for nonmarketable equity securities approximatesthe fair value since no readily available market exists for these securities.

 

***MortgageLoans Held for Sale*** - The carrying value for mortgage loans held for sale is a reasonableestimate for fair value considering the short time these loans are carried onthe books.  Management determined thatonly minor fluctuations occurred in fixed rate mortgage loans; therefore thecarrying amount approximates fair value.

 

***LoansReceivable*******-For certain categories of loans, such as variable rate loans which are repricedfrequently and have no significant change in credit risk, fair values are basedon 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.  However, from time to time, a loan isconsidered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will notbe made in accordance with the contractual terms of the loan agreement areconsidered impaired.  The fair value of impaired loans is estimated usingone of several methods, including collateral value, market value of similardebt, enterprise value, liquidation value and discounted cash flows.  Thoseimpaired loans not requiring an allowance represent loans for which the fairvalue of the expected repayments or collateral exceed the recorded investmentsin such loans.

 

***Deposits*****- The fair value of demand deposits, savings, andmoney market accounts is the amount payable on demand at the reportingdate.  The fair values of certificates ofdeposit are estimated using a discounted cash flow calculation that appliescurrent interest rates to a schedule of aggregated expected maturities.

 

***SecuritiesSold Under Agreements to Repurchase*** - These repurchase agreements have a fixed rate.  Due to the minor change in interest rates,management estimated the fair value using a discounted cash flow calculationthat applies the Company’s current borrowing rate for the securities sold underagreements to repurchase.

 

***JuniorSubordinated Debentures***-******Thecarrying value of junior subordinated debentures approximates its fair valuesince a portion of the debentures were issued at a floating rate.

 

***Advancesfrom Federal Home Loan Bank***-******The fairvalues of fixed rate borrowings are estimated using a discounted cash flowcalculation that applies the Company’s current borrowing rate from the FederalHome Loan Bank.  The carrying amounts ofvariable rate borrowings are reasonable estimates of fair value because theycan be repriced frequently.

 

***EmployeeStock Ownership Plan Borrowings***- The carrying value of the ESOP borrowing is areasonable estimate of fair value because they can be repriced frequently.

 

F-13

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***OtherBorrowings*** -The carrying amounts of variable rate notes are reasonable estimates of fairvalue because they can be repriced frequently.

 

***Off-Balance-SheetFinancial Instruments*** - Fair values for off-balance sheet, credit-related financialinstruments are based on fees currently charged to enter into similaragreements, taking into account the remaining terms of the agreements and thecounterparties’ credit standing.

 

The carryingvalues and estimated fair values of the Company’s financial instruments are asfollows:

 
| ** **                                                          | ** ** | **December 31,  2009** | ** **  | **December 31,  2008**    | ** ** |
|---------------------------------------------------------------------|------------|-----------------------------|-------------|--------------------------------|------------|
| ** **                                                          | ** ** | **Carrying********Amount**  | ** **  | **Estimated  Fair Value**      | ** ** | **Carrying********Amount** | ** ** | **Estimated  Fair Value** | ** ** |
| **Financial Assets:**                                               |       |                        |        |                           |       |   |   |   |   |
| Cash  and due from banks                                            |       | $                           | 2,493,227   |                           | $          | 2,493,227 |   | $ | 2,471,797 |   | $ | 2,471,797 |   |
| Federal  funds sold                                                 |       | 12,500,000                  |        | 12,500,000                     |       | 40,375,000 |   | 40,375,000 |   |
| Securities  available-for-sale                                      |       | 229,786,787                 |        | 229,786,787                    |       | 171,769,851 |   | 171,769,851 |   |
| Nonmarketable  equity securities                                    |       | 5,892,650                   |        | 5,892,650                      |       | 3,807,140 |   | 3,807,140 |   |
| Mortgage  loans held for sale                                       |       | 617,000                     |        | 617,000                        |       | 241,500 |   | 241,500 |   |
| Loans  receivable                                                   |       | 485,555,288                 |        | 490,945,288                    |       | 461,967,217 |   | 472,328,217 |   |
| ** **                                                          |       |                        |        |                           |       |   |   |   |   |
| **Financial Liabilities:**                                          |       |                        |        |                           |       |   |   |   |   |
| Demand  deposit, interest-bearing transaction, and savings accounts |       | $                           | 284,248,813 |                           | $          | 284,248,813 |   | $ | 241,976,593 |   | $ | 241,976,593 |   |
| Certificates  of deposit and other time deposits                    |       | 307,300,366                 |        | 309,914,366                    |       | 319,248,883 |   | 327,521,000 |   |
| Securities  sold under agreements to repurchase                     |       | 60,000,000                  |        | 60,241,000                     |       | 20,000,000 |   | 21,497,856 |   |
| Junior  subordinated debentures                                     |       | 14,434,000                  |        | 15,615,503                     |       | 14,434,000 |   | 15,393,769 |   |
| Advances  from Federal Home Loan Bank                               |       | 65,000,000                  |        | 64,360,000                     |       | 60,800,000 |   | 62,021,000 |   |
| ESOP  borrowings                                                    |       | 2,300,000                   |        | 2,300,000                      |       | 2,600,000 |   | 2,600,000 |   |
| Other  borrowings                                                   |       | —                      |        | —                         |       | 615,837 |   | 615,837 |   |
|                                                                |       |                        |        |                           |       |   |   |   |   |
| ** **                                                          | ** ** | **Notional********Amount**  | ** **  | **Estimated  Fair Value** | ** ** | **Notional********Amount** | ** ** | **Estimated  Fair Value** | ** ** |
| **Off-Balance Sheet Financial Instruments:**                        |       |                        |        |                           |       |   |   |   |   |
| Commitments  to extend credit                                       |       | $                           | 28,429,383  |                           | $          | — |   | $ | 31,750,422 |   | $ | — |   |
| Letters  of credit                                                  |       | 466,739                     |        | —                         |       | 761,765 |   | — |   |

 

F-14

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In determining appropriate levels, the Companyperforms a detailed analysis of the assets and liabilities that are subject tofair value disclosures.  At each reporting period, all assets andliabilities for which the fair value measurement is based on significantunobservable inputs are classified as Level 3.

# ** **

# **Assets and liabilities that arecarried at fair value are classified in one of the following three categoriesbased on a hierarchy for ranking the quality and reliability of the informationused to determine fair value:**

 
| Level  1 — |   | Quoted prices in active  markets for identical assets or liabilities.                        |
|-----------------|--------|----------------------------------------------------------------------------------------------|
| Level  2 — |   | Observable market based  inputs or unobservable inputs that are corroborated by market data. |
| Level  3 — |   | Unobservable inputs  that are not corroborated by market data.                               |

 

Assets measured at fairvalue on a recurring basis are as follows as of December 31, 2009 and2008:

 
| ** **                                | ** ** | **Quoted market price  in active markets  (Level 1)** | ** ** | **Significant other  observable inputs  (Level 2)** | ** ** | **Significant  unobservable inputs  (Level 3)** | ** ** |
|-------------------------------------------|------------|-------------------------------------------------------|------------|-----------------------------------------------------|------------|-------------------------------------------------|------------|
| **December 31, 2009**                     |       |                                                  |       |                                                |       |                                            |       |
| Available-for-sale  investment securities |       | $                                                     | —     |                                                | $          | 229,786,787                                     |       | $ | — |   |
| Mortgage  loans held for sale             |       | —                                                |       | 617,000                                             |       | —                                          |       |
| Total                                     | ** ** | **$**                                                 | **—** | ** **                                          | **$**      | **230,403,787**                                 | ** ** | **$** | **—** | ** ** |
| **December 31, 2008**                | ** ** | ** **                                            | ** ** | ** **                                          | ** ** | ** **                                      | ** ** |
| Available-for-sale  investment securities |       | $                                                     | —     |                                                | $          | 171,769,851                                     |       | $ | — |   |
| Mortgage  loans held for sale             |       | —                                                |       | 241,500                                             |       | —                                          |       |
| Total                                     | ** ** | **$**                                                 | **—** | ** **                                          | **$**      | **172,011,351**                                 | ** ** | **$** | **—** | ** ** |

 

Assets measured at fairvalue on a nonrecurring basis are as follows as of December 31, 2009 and2008:

 
| ** **                 | ** ** | **Quoted market price  in active markets  (Level 1)** | ** ** | **Significant other  observable inputs  (Level 2)** | ** ** | **Significant  unobservable inputs  (Level 3)** | ** ** |
|----------------------------|------------|-------------------------------------------------------|------------|-----------------------------------------------------|------------|-------------------------------------------------|------------|
| **December 31, 2009**      |       |                                                  |       |                                                |       |                                            |       |
| Impaired  loans            |       | $                                                     | —     |                                                | $          | 21,294,897                                      |       | $ | — |   |
| Other  real estate owned   |       | —                                                |       | 6,865,461                                           |       | —                                          |       |
| Total                      | ** ** | **$**                                                 | **—** | ** **                                          | **$**      | **28.160.358**                                  | ** ** | **$** | **—** | ** ** |
| **December 31, 2008** | ** ** | ** **                                            | ** ** | ** **                                          | ** ** | ** **                                      | ** ** |
| Impaired  loans            |       | $                                                     | —     |                                                | $          | 11,481,559                                      |       | $ | — |   |
| Other  real estate owned   |       | —                                                |       | 1,800,604                                           |       | —                                          |       |
| Total                      | ** ** | **$**                                                 | **—** | ** **                                          | **$**      | **13,282,163**                                  | ** ** | **$** | **—** | ** ** |

 

The Company predominantlylends with real estate serving as collateral on a substantial majority ofloans. Loans which are deemed to be impaired are primarily valued at the fairvalues of the underlying real estate collateral.

 

The Company has no assetsor liabilities whose fair values are measured using level 3 inputs.

** **

**NOTE4 - CASH AND DUE FROM BANKS**

 

The Company maintainscash balances with its correspondent banks to meet reserve requirementsdetermined by the Federal Reserve.  At December 31,2009, the bank had $224,000 on deposit with the Federal Reserve Bank to meetthis requirement compared to $1.0 million on deposit at December 31, 2008.At December 31, 2009, the bank had $1.0 million in actual currency andcash on hand, $1.3 million in due from non-interest bearing balances and 

 

F-15

----

 

$168,000 in due frominterest bearing balances. At December 31, 2009, the Company maintainedcompensating balances totaling $100,000 with a correspondent bank.

 

**NOTE 5 - INVESTMENT SECURITIES**

 

The amortized cost andestimated fair values of securities available-for-sale were:

 
| ** **                        | ** ** | **Amortized** | ** **      | **Gross Unrealized** | ** ** | **Estimated** | ** ** |
|-----------------------------------|------------|---------------|-----------------|----------------------|------------|---------------|------------|
| ** **                        | ** ** | **Cost**      | ** **      | **Gains**            | ** ** | **Losses**    | ** ** | **Fair Value** | ** ** |
| **December 31, 2009**        |       |          |            |                 |       |          |       |   |   |
| Government-sponsored  enterprises |       | $             | 89,774,279      |                 | $          | 47,186        |       | $ | 1,208,700 |   | $ | 88,612,765 |   |
| Mortgage-backed  securities       |       | 134,534,637   |            | 160,950              |       | 797,032       |       | 133,898,555 |   |
| Municipals                        |       | 7,318,970     |            | 6,336                |       | 49,839        |       | 7,275,467 |   |
| Total                             | ** ** | **$**         | **231,627,886** | ** **           | **$**      | **214,472**   | ** ** | **$** | **2,055,571** | ** ** | **$** | **229,786,787** | ** ** |
| ** **                        | ** ** | ** **    | ** **      | ** **           | ** ** | ** **    | ** ** | ** ** | ** ** |
| **December 31, 2008**        | ** ** | ** **    | ** **      | ** **           | ** ** | ** **    | ** ** | ** ** | ** ** |
| Government-sponsored  enterprises |       | $             | 61,105,520      |                 | $          | 1,109,228     |       | $ | — |   | $ | 62,214,748 |   |
| Mortgage-backed  securities       |       | 102,615,332   |            | 1,784,042            |       | 232,486       |       | 104,166,888 |   |
| Municipals                        |       | 5,594,891     |            | 4,547                |       | 211,223       |       | 5,388,215 |   |
| Total                             | ** ** | **$**         | **169,315,743** | ** **           | **$**      | **2,897,817** | ** ** | **$** | **443,709** | ** ** | **$** | **171,769,851** | ** ** |

 

The amortized cost andestimated fair values of investment securities at December 31, 2009, bycontractual maturity dates, are shown in the following table.  Actual maturities may differ from contractualmaturities because borrowers may have the right to call or prepay obligationswith or without penalty. Mortgage-backed securities are presented as a separateline item since pay downs are expected before contractual maturity dates.

 
| ** **                              | ** ** | **Amortized Cost** | ** **      | **Fair Value** | ** ** |
|-----------------------------------------|------------|--------------------|-----------------|----------------|------------|
| Due  within one year                    |       | $                  | —          |           | $          | — |   |
| Due  after one year through five years  |       | —             |            | —         |       |
| Due  after five years through ten years |       | 38,607,823         |            | 38,290,493     |       |
| Due  after ten years                    |       | 58,485,426         |            | 57,597,739     |       |
| Subtotal                                |       | 97,093,249         |            | 95,888,232     |       |
| Mortgage-backed  securities             |       | 134,534,637        |            | 133,898,555    |       |
| Total  Securities                       | ** ** | **$**              | **231,627,886** | ** **     | **$**      | **229,786,787** | ** ** |

 

At December 31, 2009and December 31, 2008, investment securities with book values of$111,038,524 and $62,762,434 and market values of $110,043,275 and $64,093,923,respectively, were pledged as collateral for securities sold under agreementsto repurchase and Federal Home Loan Bank advances. Gross proceeds from the saleof investment securities totaled $369,561,934, $55,037,945and $12,514,016 forthe years ended December 31, 2009, 2008 and 2007, respectively. The grossrealized gain on the sale of investment securities totaled $5,085,640 withgross realized losses of $228,245 resulting in a net realized gain of$4,857,395 for the year ended December 31, 2009. The gross realized gainon the sale of investment securities totaled $633,070 with gross realizedlosses of $123,697 resulting in a net realized gain of $509,373 for the yearended December 31, 2008. The gross realized gain on the sale of investmentsecurities totaled $37,637 with no gross realized loss resulting in a netrealized gain of $37,637 for the year ended December 31, 2007. The cost ofinvestments sold is determined using the specific identification method.

 

For investments wherefair value is less than amortized cost the following table shows grossunrealized losses and fair value, aggregated by investment category, and lengthof time that individual securities have been in a continuous unrealized lossposition, at December 31, 2009 and 2008.

 

F-16

----

 

Securitiesavailable-for-sale:

 
| ** **                        | ** ** | **Less than  Twelve months** | ** **      | **Twelve months or more** | ** ** | **Total**      | ** ** |
|-----------------------------------|------------|------------------------------|-----------------|---------------------------|------------|----------------|------------|
| ** **                        | ** ** | **Fair value**               | ** **      | **Unrealized  losses**    | ** ** | **Fair value** | ** ** | **Unrealized  losses** | ** ** | **Fair value** | ** ** | **Unrealized  losses** | ** ** |
| **December 31, 2009**        |       |                         |            |                      |       |           |       |   |   |   |   |   |   |
| Government-sponsored  enterprises |       | $                            | 61,020,580      |                      | $          | 1,208,700      |       | $ | — |   | $ | — |   | $ | 61,020,580 |   | $ | 1,208,700 |   |
| Mortgage-backed  securities       |       | 90,910,751                   |            | 797,032                   |       | —         |       | — |   | 90,910,751 |   | 797,032 |   |
| Municipals                        |       | 4,879,928                    |            | 49,839                    |       | —         |       | — |   | 4,879,928 |   | 49,839 |   |
|                              | ** ** | **$**                        | **156,811,259** | ** **                | **$**      | **2,055,571**  | ** ** | **$** | — | ** ** | **$** | — | ** ** | **$** | **156,811,259** | ** ** | **$** | **2,055,571** | ** ** |

 
| ** **                        | ** ** | **Less than  Twelve months** | ** **     | **Twelve months or more** | ** ** | **Total**      | ** ** |
|-----------------------------------|------------|------------------------------|----------------|---------------------------|------------|----------------|------------|
| ** **                        | ** ** | **Fair value**               | ** **     | **Unrealized  losses**    | ** ** | **Fair value** | ** ** | **Unrealized  losses** | ** ** | **Fair value** | ** ** | **Unrealized  losses** | ** ** |
| **December 31, 2008**        |       |                         |           |                      |       |           |       |   |   |   |   |   |   |
| Government-sponsored  enterprises |       | $                            | —         |                      | $          | —         |       | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Mortgage-backed  securities       |       | 26,207,907                   |           | 232,486                   |       | —         |       | — |   | 26,207,907 |   | 232,486 |   |
| Municipals                        |       | 4,781,488                    |           | 211,223                   |       | —         |       | — |   | 4,781,488 |   | 211,223 |   |
|                              | ** ** | **$**                        | **30,989,395** | ** **                | **$**      | **443,709**    | ** ** | **$** | — | ** ** | **$** | — | ** ** | **$** | **30,989,395** | ** ** | **$** | **443,709** | ** ** |

 

Securities classified asavailable-for-sale are recorded at fair market value.  Of the securities in an unrealized lossposition, there were no securities in a continuous loss position for 12 monthsor more at December 31, 2009 and 2008. The Company does not intend to sellthese securities and it is more likely than not that the Company will not berequired to sell these securities before recovery of their amortized cost.  The Company believes, based on industryanalyst reports and credit ratings, that the deterioration in value isattributable to changes in market interest rates and not in the credit qualityof the issuer and therefore, these losses are not considered other-than-temporary.

 

Nonmarketable equitysecurities include the cost of the Company’s investment in the stock of theFederal Home Loan Bank and $28,750 of stock in community bank holding companiesas of December 31, 2009. During the year ended December 31, 2009, theCompany wrote down $122,890 after a valuation analysis reflected an other thantemporary impairment related to these non-marketable equity securities. At December 31,2008, the Company held $151,640 of stock in community bank holdingcompanies.  The Federal Home Loan Bankstock has no quoted market value and no ready market exists.  Investment in the Federal Home Loan Bank is acondition of borrowing from the Federal Home Loan Bank, and the stock ispledged to collateralize such borrowings. At December 31, 2009 and 2008, the Company’s investment in FederalHome Loan Bank stock was $5,863,900 and $3,655,500, respectively.

 

The Company reviews itsinvestment securities portfolio at least quarterly and more frequently wheneconomic conditions warrant, assessing whether there is any indication ofother-than-temporary impairment (“OTTI”). Factors considered in the reviewinclude estimated future cash flows, length of time and extent to which marketvalue has been less than cost, the financial condition and near term prospectsof the issuer, and our intent and ability to retain the security to allow foran anticipated recovery in market value. If the review determines that there is OTTI, then an impairment loss is recognizedin earnings equal to the difference between the investment’s cost and its fairvalue at the balance sheet date of the reporting period for which theassessment is made, or a portion may be recognized in other comprehensiveincome. The fair value of investments on which OTTI is recognized then becomesthe new cost basis of the investment.

 

As a result of actions bythe U.S. Treasury Department and the Federal Housing Finance Agency, effectivein the third quarter of 2008, the Company recorded a pretax, non-cashimpairment charge of $4,596,200 for the OTTI of its investments in perpetualpreferred securities issued by the Federal National Mortgage Association(Fannie Mae) and Federal National Mortgage Corporation (Freddie Mac).  The net-of-tax effect to earnings was$3,033,492.

 

F-17

----

 

### **NOTE 6 - LOANSRECEIVABLE**

 

Major classifications ofloans receivable are summarized as follows:

 
| ** **                      | ** ** | **December 31,** | ** **      |
|---------------------------------|------------|-----------------------|-----------------|
| ** **                      | ** ** | **2009**              | ** **      | **2008** | ** ** |
| Real  estate - construction     |       | $                     | 118,182,732     |   | $ | 161,298,108 |   |
| Real  estate - mortgage         |       | 335,830,858           |            | 268,499,717 |   |
| Commercial  and industrial      |       | 26,687,273            |            | 27,443,267 |   |
| Consumer  and other             |       | 4,985,427             |            | 4,935,890 |   |
| Deferred  origination fees, net |       | (131,002              | )               | (209,765 | ) |
| Total  loans receivable, gross  |       | 485,555,288           |            | 461,967,217 |   |
| Less  allowance for loan loss   |       | 10,048,015            |            | 7,635,173 |   |
| Total  loans receivable, net    | ** ** | **$**                 | **475,507,273** | ** ** | **$** | **454,332,044** | ** ** |

 

The composition ofgross loans by rate type is as follows:

 
| ** **           | ** ** | **December 31,** | ** **      |
|----------------------|------------|-----------------------|-----------------|
| ** **           | ** ** | **2009**              | ** **      | **2008** | ** ** |
| Variable  rate loans |       | $                     | 272,684,001     |   | $ | 262,145,232 |   |
| Fixed  rate loans    |       | 212,871,287           |            | 199,821,985 |   |
| Total  gross loans   | ** ** | **$**                 | **485,555,288** | ** ** | **$** | **461,967,217** | ** ** |

 

Transactions in theallowance for loan losses during 2009, 2008 and 2007 are summarized below:

 
| ** **                              | ** ** | **2009**    | ** **      | **2008**   | ** ** | **2007**        | ** ** |
|-----------------------------------------|------------|-------------|-----------------|------------|------------|-----------------|------------|
| Balance,  beginning of year             |       | $           | 7,635,173       |       | $          | 4,158,324       |       | $ | 3,467,000 |   |
| Provision  charged to operations        |       | 14,745,000  |            | 4,665,000  |       | 1,025,000       |       |
| Loan  charge offs                       |       | (12,456,461 | )               | (1,188,651 | )          | (334,426        | )          |
| Loan  recoveries                        |       | 124,303     |            | 500        |       | 750             |       |
| Balance,  end of year                   | ** ** | **$**       | **10,048,015**  | ** ** | **$**      | **7,635,173**   | ** ** | **$** | **4,158,324** | ** ** |
| Gross  loans outstanding, end of period | ** ** | **$**       | **485,555,288** | ** ** | **$**      | **461,967,217** | ** ** | **$** | **391,349,869** | ** ** |

### ** **

The following is a summary of information pertaining to impaired andnonaccrual loans at December 31:

 
| ** **                                                | ** ** | **2009**  | ** **     | **2008**   | ** ** | **2007**       | ** ** |
|-----------------------------------------------------------|------------|-----------|----------------|------------|------------|----------------|------------|
| Impaired  loans without a valuation allowance             |       | $         | 17,287,480     |       | $          | 5,662,064      |       | $ | 389,095 |   |
| Impaired  loans with a valuation allowance                |       | 4,007,417 |           | 5,819,495  |       | —         |       |
| Total  impaired loans                                     | ** ** | **$**     | **21,294,897** | ** ** | **$**      | **11,481,559** | ** ** | **$** | **389,095** | ** ** |
| Valuation  allowance related to impaired loans            |       | $         | 1,250,889      |       | $          | 1,675,496      |       | $ | — |   |
| Average  of impaired loans during the year                |       | $         | 15,294,975     |       | $          | 12,364,627     |       | $ | 606,480 |   |
| Total  nonaccrual loans                                   |       | $         | 21,294,897     |       | $          | 11,481,559     |       | $ | 389,095 |   |
| Total  loans past due 90 days and still accruing interest |       | $         | —         |       | $          | —         |       | $ | — |   |

### ** **

### **The allowance for loan losses, as a percent of gross loansoutstanding, was 2.07%, 1.65% and 1.06% at December 31, 2009, 2008 and2007, respectively.  At December 31,2009, the Bank had sixty-seven impaired loans totaling $21,294,897, or 4.39% ofgross loans, in nonaccrual status, of which $4,142,694 were deemed to betroubled debt restructurings.  At December 31,2008, the Bank had twenty-five loans totaling $11,481,559, or 2.49% of grossloans, in nonaccrual status.  There wereno loans contractually past due 90 days or more still accruing interest at December 31,2009 or 2008. In addition, there were no loans restructured or otherwiseimpaired not already included in nonaccrual status at December 31, 2009.Our analysis under generally accepted accounting principles indicates that thelevel of the allowance for loan losses is appropriate to cover estimated creditlosses on individually evaluated loans as well as estimated credit lossesinherent in the remainder of the portfolio. We do not recognize interest incomeon loans that are impaired. At December 31, 2009, the Bank had $275,000reserved for off-balance sheet credit exposure related to unfunded commitmentsincluded in other liabilities on our consolidated balance sheet.**

 

At December 31,2009, loans totaling $32.4 million were pledged as collateral at the Federal HomeLoan Bank.

 

F-18

----

 

**NOTE 7 - OTHER REAL ESTATE OWNED**

 

Transactions in otherreal estate owned for the years ended December 31, 2009 and 2008 aresummarized below:

 
| ** **                  | ** ** | **December 31,** | ** **    |
|-----------------------------|------------|-----------------------|---------------|
| ** **                  | ** ** | **2009**              | ** **    | **2008** | ** ** |
| Balance,  beginning of year |       | $                     | 1,800,604     |   | $ | — |   |
| Additions                   |       | 7,641,984             |          | 2,074,974 |   |
| Sales                       |       | (2,423,878            | )             | (274,370 | ) |
| Write  downs                |       | (153,249              | )             | — |   |
| Balance,  end of year       | ** ** | **$**                 | **6,865,461** | ** ** | **$** | **1,800,604** | ** ** |

 

**NOTE 8 - PREMISES, FURNITURE ANDEQUIPMENT**

 

Premises, furniture andequipment consist of the following:

 
| ** **                              | ** ** | **December 31,** | ** **     |
|-----------------------------------------|------------|-----------------------|----------------|
| ** **                              | ** ** | **2009**              | ** **     | **2008** | ** ** |
|                                    |       |                  |           |   |   |
| Land  and land improvements             |       | $                     | 3,265,318      |   | $ | 3,265,318 |   |
| Building  and leasehold improvements    |       | 13,291,654            |           | 13,289,774 |   |
| Furniture  and equipment                |       | 4,061,487             |           | 4,014,591 |   |
| Software                                |       | 684,421               |           | 568,953 |   |
| Construction  in progress               |       | 425,701               |           | 278,802 |   |
| Total                                   |       | 21,728,581            |           | 21,417,438 |   |
| Less,  accumulated depreciation         |       | 2,925,880             |           | 2,005,846 |   |
| Premises,  furniture and equipment, net | ** ** | **$**                 | **18,802,701** | ** ** | **$** | **19,411,592** | ** ** |

 

Depreciationexpense for the years ended December 31, 2009, 2008 and 2007 amounted to$962,146, $883,785 and $575,079, respectively. Construction in progress relates to the planned construction of anexecutive office building located at 830 Lowcountry Boulevard.  Estimated construction costs for the projectare expected to be approximately $4.5 million. For the years ended December 31, 2009, 2008 and 2007, the Bankcapitalized $6,801, $42,280 and $165,410, respectively, in interest related tothe construction of our new branch locations and the aforementioned executiveoffices.

 

### **NOTE 9 - DEPOSITS**

 

At December 31,2009, the scheduled maturities of certificates of deposit were as follows:

 
| **Maturing:** | ** ** | **Amount** | ** **      |
|---------------|------------|------------|-----------------|
| 2010          |       | $          | 294,586,797     |   |
| 2011          |       | 11,146,844 |            |
| 2012          |       | 897,017    |            |
| 2013          |       | 526,328    |            |
| 2014          |       | 35,000     |            |
| Thereafter    |       | 108,380    |            |
| Total         | ** ** | **$**      | **307,300,366** | ** ** |

 

At December 31, 2009and 2008, the Bank had customer relationships with eight deposit brokeragefirms, totaling $69.7 million and $145.7 million, respectively.

 

F-19

----

 

**NOTE 10 - SECURITIES SOLD UNDERAGREEMENTS TO REPURCHASE**

 

The Bank hasentered into sales of securities under agreements to repurchase.  These obligations to repurchase securitiessold are reflected as liabilities in the consolidated balance sheets and consistof three obligations totaling $60.0 million at December 31, 2009. On September 21,2007, the Bank borrowed $10.0 million under a five-year repurchase agreement ata fixed rate of 4.01%.  On November 14,2007, the Bank borrowed $10.0 million under a nine-year repurchase agreement ata fixed rate of 3.50%. On October 19, 2009, the Bank borrowed $40.0million under a three month repurchase agreement at a fixed rate of 0.45% whichhas been subsequently renewed. All repurchase agreements require quarterly interestonly payments with principal and interest due on maturity. The dollar amountsof securities underlying the agreements are book entry securities.  U.S. government agency securities with bookvalues of $73,349,838 and $21,851,616 and fair values of $72,884,324 and$22,266,107 at December 31, 2009 and 2008, respectively, are used ascollateral for the agreements.

 

Securities sold underrepurchase agreements are summarized as follows for the years ended December 31,2009 and 2008:

 
| ** **                                  | ** ** | **2009**   | ** ** | **2008**   | ** ** |
|---------------------------------------------|------------|------------|------------|------------|------------|
| Amount  outstanding at year end             |       | $          | 60,000,000 |       | $          | 20,000,000 |   |
| Average  amount outstanding during year     |       | 63,090,274 |       | 35,187,060 |       |
| Maximum  outstanding at any month-end       |       | 72,500,000 |       | 50,000,000 |       |
| Weighted  average rate paid at year-end     |       | 1.55       | %          | 3.76       | %          |
| Weighted  average rate paid during the year |       | 1.67       | %          | 3.58       | %          |
|                                             |            |            |            |            |            |  |  |

 

**NOTE 11 -JUNIOR SUBORDINATED DEBENTURES**

 

On February 22, 2006, Tidelands Statutory Trust (the “Trust I”), a non-consolidated subsidiary of the Company, issued and sold floating rate capital securities of the trust (the “Trust I Securities”), generating proceeds of $8.0 million.  The Trust I loaned these proceeds to the Company to use for general corporate purposes, primarily to provide capital to the Bank. The debentures qualify as Tier 1 capital under Federal Reserve Board guidelines.

 

The Trust I Securities in the transaction accrue and pay distributions quarterly at a rate per annum equal to the three-month LIBOR plus 1.38%, which was 1.63% at December 31, 2009.  The distribution rate payable on the Trust I Securities is cumulative and payable quarterly in arrears.  The Company has the right, subject to events of default, to defer payments of interest on the Trust I Securities for a period not to exceed 20 consecutive quarterly periods, provided that no extension period may extend beyond the maturity date of March 30, 2036.  The Company has no current intention to exercise its right to defer payments of interest on the Trust I Securities.

 

#### **TheTrust I Securities mature or are mandatorily redeemable upon maturity on March 30,2036 or upon earlier optional redemption as provided in the indenture.  The Company has the right to redeem the TrustI Securities in whole or in part, on or after March 30, 2011.  The Company may also redeem the Trust ISecurities prior to such dates upon occurrence of specified conditions and thepayment of a redemption premium.**

 

On June 20, 2008, Tidelands Statutory Trust II (the “Trust II”), a non-consolidated subsidiary of the Company, issued and sold floating rate capital securities of the trust (the “Trust II Securities”), generating proceeds of $6.0 million.  The Trust II loaned these proceeds to the Company to use for general corporate purposes, primarily to provide capital to the Bank. The debentures qualify as Tier 1 Capital under Federal Reserve Board guidelines.

 

The Trust II Securities accrue and pay distributions quarterly at a rate equal to (i) 9.425% fixed for the first 5 years, and (ii) the three-month LIBOR rate plus 5.075% thereafter.  The distribution rate payable on the Trust II Securities is cumulative and payable quarterly in arrears.  The Company has the right, subject to events of default, to defer payments of interest on the Trust II Securities for a period not to exceed 20 consecutive quarterly periods, provided that no extension period may extend beyond the maturity date of June 30, 2038.  The Company has no current intention to exercise its right to defer payments of interest on the Trust II Securities.

#### ** **

#### **TheTrust II Securities mature or are mandatorily redeemable upon maturity on June 30,2038 or upon earlier optional redemption as provided in the indenture.  The Company has the right to redeem the TrustII Securities in**

 

F-20

----

 

#### **wholeor in part, on or after June 30, 2013. The Company may also redeem the Trust II Securities prior to such datesupon occurrence of specified conditions and the payment of a redemptionpremium.**

 

**NOTE 12 —ADVANCES FROM FEDERAL HOME LOAN BANK**

 

At December 31,2009, advances from the Federal Home Loan Bank (“FHLB”) were comprised of threeadvances totaling $65.0 million.   On September 7,2007, the Bank borrowed $16.0 million under a five-year convertible advance ata fixed rate of 4.22%. On September 21, 2007, the Bank borrowed $9.0million under a 10-year convertible advance at a fixed rate of 3.96%.  On January 21, 2009, the Bank borrowed$40.0 million under a three-year fixed advance at a rate of 2.35%.  All advances require interest only paymentswith principal and interest due on maturity. The advances are collateralized bypledged FHLB stock and certain investment securities.  At December 31, 2009, loans totaling$32.4 million were pledged as collateral at the Federal Home Loan Bank. FHLBadvances are summarized as follows for the periods ended December 31, 2009and 2008:

 
| ** **                                  | ** ** | **2009**    | ** ** | **2008**   | ** ** |
|---------------------------------------------|------------|-------------|------------|------------|------------|
| Amount  outstanding at period end           |       | $           | 65,000,000 |       | $          | 60,800,000 |   |
| Average  amount outstanding during the year |       | 91,074,521  |       | 40,914,754 |       |
| Maximum  outstanding at any month-end       |       | 100,800,000 |       | 60,800,000 |       |
| Weighted  average rate at year-end          |       | 3.03        | %          | 2.71       | %          |
| Weighted  average rate during the year      |       | 2.55        | %          | 3.51       | %          |
|                                             |            |             |            |            |            |  |  |

 

**NOTE 13 -OTHER OPERATING EXPENSES**

 

Other operating expensesfor the years ended December 31, 2009, 2008 and 2007 are summarized below:

 
| ** **                                 | ** ** | **2009**  | ** **    | **2008**   | ** ** | **2007**      | ** ** |
|--------------------------------------------|------------|-----------|---------------|------------|------------|---------------|------------|
| Professional  fees                         |       | $         | 1,234,219     |       | $          | 1,180,078     |       | $ | 1,107,653 |   |
| Telephone  expenses                        |       | 199,121   |          | 162,106    |       | 153,174       |       |
| Office  supplies, stationery, and printing |       | 99,512    |          | 151,136    |       | 170,697       |       |
| Insurance                                  |       | 199,996   |          | 199,643    |       | 120,770       |       |
| Postage                                    |       | 21,454    |          | 22,965     |       | 26,001        |       |
| Data  processing                           |       | 497,951   |          | 448,010    |       | 275,158       |       |
| Advertising  and marketing                 |       | 461,880   |          | 750,042    |       | 647,322       |       |
| FDIC  Insurance                            |       | 1,440,629 |          | 484,000    |       | 238,885       |       |
| Loan  related expenses                     |       | 1,211,219 |          | 109,884    |       | 81,420        |       |
| Other                                      |       | 765,701   |          | 640,091    |       | 579,803       |       |
| Total                                      | ** ** | **$**     | **6,131,682** | ** ** | **$**      | **4,147,955** | ** ** | **$** | **3,400,883** | ** ** |

### ** **

### **NOTE 14 - INCOMETAXES**

 

For the years ended December 31,2009, 2008 and 2007 income tax expense consisted of the following:

 
| ** **                    | ** ** | **2009**  | ** **    | **2008**   | ** ** | **2007**       | ** ** |
|-------------------------------|------------|-----------|---------------|------------|------------|----------------|------------|
| Current  portion:             |       |      |          |       |       |           |       |
| Federal                       |       | $         | (445,909      | )          | $          | 52,806         |       | $ | 459,977 |   |
| State                         |       | —    |          | —     |       | 26,419         |       |
| Total  current                |       | (445,909  | )             | 52,806     |       | 486,396        |       |
| Deferred  income taxes        |       | 3,825,564 |          | (2,751,806 | )          | (211,396       | )          |
| Income  tax expense (benefit) | ** ** | **$**     | **3,379,655** | ** ** | **$**      | **(2,699,000** | **)**      | **$** | **275,000** | ** ** |

 

Deferred tax assetsrepresent the future tax benefit of deductible differences and, if it is morelikely than not that a tax asset will not be realized, a valuation allowance isrequired to reduce the recorded deferred tax assets to net realizablevalue.  As of December 31, 2009, theCompany has stated net operating losses for tax purposes of $1,602,693. Thisnet operating loss begins expiring in 2025. Management has determined that ismore likely than not that the deferred tax asset related to continuingoperations at December 31, 2009 will not be realized, and accordingly, hasestablished a valuation allowance. Management determined as of December 31,2008 that a valuation allowance was only needed for the South Carolina netoperating loss deferred tax asset.

 

F-21

----

 

At December 31,2009, income tax returns from 2008, 2007 and 2006 remain subject to review bytax authorities.

The gross amountsof deferred tax assets and deferred tax liabilities are as follows:

 
| ** **                                        | ** ** | **December 31,** | ** **  |
|---------------------------------------------------|------------|-----------------------|-------------|
| ** **                                        | ** ** | **2009**              | ** **  | **2008** | ** ** | **2007** | ** ** |
| Deferred  tax assets:                             | ** ** | ** **            | ** **  | ** ** |   |   |   |
| Allowance  for loan losses                        |       | $                     | 3,225,488   |   | $ | 2,261,996 |   | $ | 984,449 |   |
| Net  operating loss carry forward                 |       | 660,365               |        | 82,714 |   | 39,734 |   |
| Organization  and start-up costs                  |       | —                |        | — |   | 86,245 |   |
| Loan  fees and costs                              |       | 44,541                |        | 71,320 |   | 118,816 |   |
| Interest  on nonaccrual loans                     |       | 140,053               |        | 75,307 |   | 6,104 |   |
| Tax  credit                                       |       | 306,799               |        | 95,753 |   | 18,038 |   |
| Stock  option expense                             |       | 45,269                |        | 34,997 |   | 21,879 |   |
| Deferred  compensation                            |       | 244,919               |        | 96,688 |   | — |   |
| Other  than temporary impairment (OTTI)           |       | 1,562,708             |        | 1,562,708 |   | — |   |
| Unrealized  loss on securities available-for-sale |       | 710,754               |        | — |   | — |   |
| Other                                             |       | 270,932               |        | 30,600 |   | 28,901 |   |
| Total  deferred tax assets                        |       | 7,211,828             |        | 4,312,083 |   | 1,304,166 |   |
| Valuation  allowance                              |       | 6,012,385             |        | 82,714 |   | — |   |
| Total  net deferred tax assets                    |       | 1,199,443             |        | 4,229,369 |   | 1,304,166 |   |
| Deferred  tax liabilities:                        | ** ** | ** **            | ** **  | ** ** | ** ** | ** ** | ** ** |
| Accumulated  depreciation                         |       | 386,711               |        | 342,381 |   | 166,891 |   |
| Prepaid  expenses                                 |       | 101,978               |        | 61,424 |   | 63,517 |   |
| Unrealized  gain on securities available-for-sale |       | —                |        | 921,424 |   | 289,757 |   |
| Total  deferred tax liabilities                   |       | 488,689               |        | 1,325,229 |   | 520,165 |   |
| Net  deferred tax asset                           | ** ** | **$**                 | **710,754** | ** ** | **$** | **2,904,140** | ** ** | **$** | **784,001** | ** ** |

 

A reconciliation betweenthe income tax expense and the amount computed by applying the federalstatutory rate of 34% for 2009, 2008 and 2007 to income before income taxesfollows:

 
| ** **                                          | ** ** | **2009**   | ** **    | **2008**   | ** ** | **2007**   | ** ** |
|-----------------------------------------------------|------------|------------|---------------|------------|------------|------------|------------|
| ** **                                          | ** ** | **Amount** | ** **    | **Rate**   | ** ** | **Amount** | ** ** | **Rate** | ** ** | **Amount** | ** ** | **Rate** | ** ** |
| Tax  expense (benefit) at statutory rate            |       | $          | (2,338,289    | )          | (34.0      | )%         | $          | (2,602,218 | ) | (34.0 | )% | $ | 234,023 |   | 34.0 | % |
| State  income tax, net of federal income tax effect |       | (33,644    | )             | (0.5       | )%         | —     |       | — | % | 17,437 |   | 2.5 | % |
| Cash  value of life insurance                       |       | (177,138   | )             | (2.6       | )%         | (164,680   | )          | (2.2 | )% | — |   | — | % |
| Stock  based compensation expense                   |       | 145,393    |          | 2.1        | %          | 226,216    |       | 3.0 | % | 210,250 |   | 30.6 | % |
| Tax  exempt interest                                |       | (45,066    | )             | (0.6       | )%         | (97,527    | )          | (1.3 | )% | (149,504 | ) | (21.7 | )% |
| Valuation  allowance                                |       | 5,929,671  |          | 86.2       | %          | —     |       | — | % | — |   | — | % |
| Other                                               |       | (101,272   | )             | (1.5       | )%         | (60,791    | )          | (0.8 | )% | (37,206 | ) | (5.4 | )% |
| Income  tax expense (benefit)                       | ** ** | **$**      | **3,379,655** | ** ** | **49.1**   | %          | **$**      | **(2,699,000** | **)** | **(35.3** | )% | **$** | **275,000** | ** ** | **40.0** | % |

 

**NOTE 15 - LEASES**

 

The lease on the Bank’smain branch was originated on March 24, 2004 and had an initial 10-yearterm.  The lease requires monthlypayments of $14,840 for the first three years, increased 9% in year four and 3%every year thereafter.  The lease isrenewable at the bank’s option for two five-year terms.  Rental expense on this facility was $204,781,$198,956 and $191,432 for the years ended December 31, 2009, 2008 and2007, respectively.

 

The Bank leases abuilding for the permanent Myrtle Beach branch location from a lessor in whicha Company director has a 50% ownership. The lease commenced on July 1, 2007 and has a 20-year term at amonthly expense of $12,500.  The leasemay be extended at the Bank’s option for two additional ten-year terms. Rentalexpense under these operating lease agreements was $150,000, $150,000 and$104,000 for the years ended December 31, 2009, 

 

F-22

----

 

2008 and 2007.

 

The Bank has entered intoa land lease for a West Ashley branch, which opened in July 2007. Thelease was originated on December 22, 2005 and has an initial 20-year term.The lease may be extended at the Bank’s option for four additional five-yearterms.  The lease requires monthlypayments of $6,067 for the first five years and increases 12% every fifth yearthereafter. Rental expense under these operating lease agreements was $72,800,$73,037 and $53,783 for the years ended December 31, 2009, 2008 and 2007.

 

The Bank also leasedoffice space for its Bluffton loan production office. The lease was originatedon September 28, 2006 and had an initial one-year term. The lease wasextended at the Bank’s option for an additional 12-month term.  The lease required minimum monthly paymentsof $3,000 and was terminated in March 2008. In addition, the Bank leasesoffice space for the permanent Bluffton branch location. The lease wasoriginated on June 13, 2007 and has a 20-year term with four five-yearrenewal options. The lease requires monthly payments of $13,189. Rental expenseunder these operating lease agreements was $157,402, $167,440 and $79,558 forthe years ended December 31, 2009, 2008 and 2007.

 

The Bank has entered intoa land lease for office space located at 830 Lowcountry Boulevard, MountPleasant, SC for the building of executive offices. The lease was originated onApril 24, 2007 and has a 20-year term with four five-year renewal options.The lease requires monthly payments of $9,167 for the first five years,increased 71⁄2% every fifth year thereafter. Rental expense under this operating lease agreement was $110,000,$110,000 and $67,072 for the years ended December 31, 2009, 2008 and 2007.

 

The Bank also leasesoffice space for its Murrells Inlet branch location. The lease was originatedon March 20, 2007 and has a 20-year term. The lease may be extended at the Bank’s option for one additionalten-year term. The lease requires monthly payments of $10,000 that began on June 26,2008.  Rental expense under thisoperating lease agreement was $120,000 and $76,904 for the years ended December 31,2009 and 2008.

 

Future minimum leasepayments under these operating leases are summarized as follows:

 
| 2010       |       | $         | 822,134        |       |
|------------|------------|-----------|----------------|------------|
| 2011       |       | 828,467   |           |
| 2012       |       | 842,380   |           |
| 2013       |       | 855,557   |           |
| 2014       |       | 663,541   |           |
| Thereafter |       | 8,137,277 |           |
| ** ** | ** ** | **$**     | **12,149,356** | ** ** |

 

F-23

----

 

**NOTE 16 -RELATED PARTY TRANSACTIONS**

 

Certain parties(principally certain directors and executive officers of the Company, theirimmediate families and business interests) were loan customers of and had othertransactions in the normal course of business with the Company.  Related party loans are made on substantiallythe same terms, including interest rates and collateral, as those prevailing atthe time for comparable transactions with unrelated persons and do not involvemore than the normal risk of collectibility.

 

Related party loan transactionsfor the years ended December 31, 2009 and 2008 are summarized below:

 
| ** **                                         | ** ** | **December 31,** | ** **     |
|----------------------------------------------------|------------|-----------------------|----------------|
| ** **                                         | ** ** | **2009**              | ** **     | **2008** | ** ** |
| Balance,  beginning of year                        |       | $                     | 16,569,531     |   | $ | 15,886,034 |   |
| New  loans                                         |       | 13,256,859            |           | 4,630,505 |   |
| Less  loan repayments                              |       | (8,430,776            | )              | (3,947,008 | ) |
| Other  changes due to changes in Board composition |       | (6,848,188            | )              | — |   |
| Balance,  end of year                              | ** ** | **$**                 | **14,547,426** | ** ** | **$** | **16,569,531** | ** ** |

 

Deposits from directorsand executive officers and their related interests totaled $1,114,506 and$1,479,175, at December 31, 2009 and 2008, respectively.  As mentioned in Note 15, one of the Company’sdirectors is a 50% owner of an office building in Myrtle Beach, SC in whichTidelands Bank is a tenant.

 

### **NOTE 17 -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.

 

F-24

----

 

**NOTE 18**-**EARNINGS (LOSS) PER SHARE**

 

Basic earnings (loss) pershare are computed by dividing net income by the weighted-average number ofcommon shares outstanding.  Dilutedearnings (loss) per share is computed by dividing net income by the weighted-averagenumber of common shares outstanding and dilutive common share equivalents usingthe treasury stock method.  Potentiallydilutive common share equivalents include common shares issuable upon theexercise of outstanding stock options and warrants.

 

Basic and dilutedearnings (loss) per share are computed below:

 
| ** **                                          | ** ** | **Year Ended December 31,** | ** **  |
|-----------------------------------------------------|------------|----------------------------------|-------------|
| ** **                                          | ** ** | **2009**                         | ** **  | **2008** | ** ** | **2007** | ** ** |
| **Basic earnings (loss) per share computation:**    |       |                             |        |   |   |   |   |
| Net  income (loss) available to common shareholders |       | $                                | (11,183,316 | ) | $ | (4,954,583 | ) | $ | 413,304 |   |
| Average  common shares outstanding - basic          |       | 4,071,313                        |        | 4,050,301 |   | 4,214,910 |   |
| Basic  net income (loss) per share                  |       | $                                | (2.75       | ) | $ | (1.22 | ) | $ | 0.10 |   |
| **Diluted earnings (loss) per share computation:**  |       |                             |        |   |   |   |   |
| Net  income (loss) available to common shareholders |       | $                                | (11,183,316 | ) | $ | (4,954,583 | ) | $ | 413,304 |   |
| Average  common shares outstanding - basic          |       | 4,071,313                        |        | 4,050,301 |   | 4,214,910 |   |
| Incremental  shares from assumed conversions:       |       |                             |        |   |   |   |   |
| Stock  options and warrants                         |       | —                           |        | — |   | 55,095 |   |
| Average  common shares outstanding - diluted        |       | 4,071,313                        |        | 4,050,301 |   | 4,270,005 |   |
| Diluted  earnings (loss) per share                  |       | $                                | (2.75       | ) | $ | (1.22 | ) | $ | 0.10 |   |

 

For the years ended December 31,2009, 2008 and 2007, there were 742,060, 777,537 and 247,590 stock optionsoutstanding that were anti-dilutive. At December 31, 2009 and 2008, therewere 571,821 warrants outstanding that were anti-dilutive. These options andwarrants are considered anti-dilutive because the exercise price exceeded theaverage market price for the period.

 

### **NOTE 19 -REGULATORY MATTERS**

 

The Company and Bank aresubject to various regulatory capital requirements administered by the federalbanking agencies.  Failure to meetminimum capital requirements can initiate certain mandatory and possiblyadditional discretionary actions by regulators that, if undertaken, could havea direct adverse material effect on the Company’s or Bank’s financialstatements.  Under capital adequacyguidelines and the regulatory framework for prompt corrective action, theCompany and Bank must meet specific capital guidelines that involvequantitative measures of the Company’s and Bank’s assets, liabilities, andcertain off-balance-sheet items as calculated under regulatory accountingpractices.  The Company’s and Bank’scapital amounts and classification are also subject to qualitative judgments bythe regulators about components, risk weightings, and other factors.

 

Quantitative measuresestablished by regulation to ensure capital adequacy require the Company andBank to maintain minimum ratios of Tier 1 and total capital as a percentage ofassets and off-balance-sheet exposures, adjusted for risk weights ranging from0% to 100%.  Tier 1 capital consists ofcommon shareholders’ equity, excluding the unrealized gain or loss onsecurities available-for-sale, minus certain intangible assets.  Tier 2 capital consists of the allowance forloan losses subject to certain limitations. Total capital for purposes of computing the capital ratios consists ofthe sum of Tier 1 and Tier 2 capital. The regulatory minimum requirements are 4% for Tier 1 and 8% for totalrisk-based capital.

 

F-25

----

 

### **The Company and Bank are also required to maintain capitalat a minimum level based on total assets, which is known as the leverageratio.  Only the strongest institutionsare allowed to maintain capital at the minimum requirement of 3%.  All others are subject to maintaining ratios1% to 2% above the minimum.**

### ** **

As of December 31,2009 and 2008, management believes it is categorized as well-capitalized underthe regulatory framework for prompt corrective action.  There are no conditions or events thatmanagement believes have changed the Company’s and Bank’s category.

 

The following tablesummarizes the capital amounts and ratios of the Company and the regulatoryminimum requirements at December 31, 2009 and 2008:

 
| ** **                               | ** ** | **Actual** | ** ** | **For Capital  Adequacy Purposes** | ** ** | **To Be Well-  Capitalized Under  Prompt Corrective  Action Provisions** | ** ** |
|------------------------------------------|------------|------------|------------|------------------------------------|------------|--------------------------------------------------------------------------|------------|
| **Tidelands  Bancshares, Inc.**     | ** ** | **Amount** | ** ** | **Ratio**                          | ** ** | **Amount**                                                               | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| ** **                               | ** ** | ** ** | ** ** | ** **                         | ** ** | ** **                                                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **December 31, 2009**               | ** ** | ** ** | ** ** | ** **                         | ** ** | ** **                                                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total capital (to risk-weighted assets)  |       | $          | 61,076,000 |                               | 11.67      | %                                                                        | $          | 41,860,560 |   | 8.00 | % | N/A |   | N/A |   |
| Tier 1 capital (to risk-weighted assets) |       | 53,407,000 |       | 10.21                              | %          | 20,930,280                                                               |       | 4.00 | % | N/A |   | N/A |   |
| Tier 1 capital (to average assets)       |       | 53,407,000 |       | 6.83                               | %          | 31,257,760                                                               |       | 4.00 | % | N/A |   | N/A |   |
| **December 31, 2008**               | ** ** | ** ** | ** ** | ** **                         | ** ** | ** **                                                               | ** ** | ** ** |   |   |   |   |   |
| Total capital (to risk-weighted assets)  |       | $          | 68,338,000 |                               | 14.20      | %                                                                        | $          | 38,495,760 |   | 8.00 | % | N/A |   | N/A |   |
| Tier 1 capital (to risk-weighted assets) |       | 62,338,000 |       | 12.96                              | %          | 19,247,880                                                               |       | 4.00 | % | N/A |   | N/A |   |
| Tier 1 capital (to average assets)       |       | 62,338,000 |       | 9.03                               | %          | 27,624,560                                                               |       | 4.00 | % | N/A |   | N/A |   |

 
| ** **                               | ** ** | **Actual** | ** ** | **For Capital  Adequacy Purposes** | ** ** | **To Be Well-  Capitalized Under  Prompt Corrective  Action Provisions** | ** ** |
|------------------------------------------|------------|------------|------------|------------------------------------|------------|--------------------------------------------------------------------------|------------|
| **Tidelands  Bank**                      | ** ** | **Amount** | ** ** | **Ratio**                          | ** ** | **Amount**                                                               | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| ** **                               | ** ** | ** ** | ** ** | ** **                         | ** ** | ** **                                                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **December 31, 2009**               | ** ** | ** ** | ** ** | ** **                         | ** ** | ** **                                                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total capital (to risk-weighted assets)  |       | $          | 57,989,000 |                               | 11.10      | %                                                                        | $          | 41,793,690 |   | 8.00 | % | $ | 52,242,110 |   | 10.00 | % |
| Tier 1 capital (to risk-weighted assets) |       | 51,412,000 |       | 9.84                               | %          | 20,896,840                                                               |       | 4.00 | % | 31,345,260 |   | 6.00 | % |
| Tier 1 capital (to average assets)       |       | 51,412,000 |       | 6.59                               | %          | 31,225,960                                                               |       | 4.00 | % | 39,032,450 |   | 5.00 | % |
| **December 31, 2008**               | ** ** | ** ** | ** ** | ** **                         | ** ** | ** **                                                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total capital (to risk-weighted assets)  |       | $          | 57,495,000 |                               | 12.02      | %                                                                        | $          | 38,270,240 |   | 8.00 | % | $ | 47,837,800 |   | 10.00 | % |
| Tier 1 capital (to risk-weighted assets) |       | 51,495,000 |       | 10.77                              | %          | 19,135,120                                                               |       | 4.00 | % | 28,702,680 |   | 6.00 | % |
| Tier 1 capital (to average assets)       |       | 51,495,000 |       | 7.49                               | %          | 27,511,800                                                               |       | 4.00 | % | 34,389,750 |   | 5.00 | % |

 

The following tablesummarizes the capital amounts and ratios of the Bank and the regulatoryminimum requirements at December 31, 2009 and 2008:

 

### **NOTE 20 - UNUSEDLINES OF CREDIT**

 

As of December 31,2009, the Bank had unused lines of credit to purchase federal funds fromunrelated banks totaling $27.0 million. There were no balances outstandingrelated to any of these lines of credit as of December 31, 2009. Theselines of credit are available on a one to 14 day basis for general corporatepurposes.  In addition to these creditlines, unused credit availability at the Federal Home Loan Bank amounted to$128.5 million at December 31, 2009. As of December 31, 2009, theCompany had an unused line of credit available from an unrelated bank totaling$2.0 million.  In addition, we maintain aline of credit with the Federal Reserve Bank of $16.3 million secured bycurrent loans in our loan portfolio.

 

**NOTE 21 -SHAREHOLDERS’ EQUITY**

 

**PreferredStock** - In December 2008,in connection with the TARP Capital Purchase Program, established as part ofthe Emergency Economic Stabilization Act of 2008, the Company issued to theU.S. Treasury 14,448 shares of the Company’s Fixed Rate Cumulative PerpetualPreferred Stock, Series T (the “Preferred Stock”), having a liquidationpreference of $1,000 per share. The Preferred Stock has a dividend rate of 5%for the first five years and 9% thereafter. The Preferred Stock has a callfeature after three years.

 

F-26

----

 

In connection with thesale of the Preferred Stock, the Company also issued to the U.S. Treasuryten-year warrants to purchase up to 571,821 shares of the Company’s commonstock (the “Warrants”), par value $0.01 per share at an initial exercise priceof $3.79 per share.

 

As required under theTARP Capital Purchase Program, dividend payments on and repurchase of theCompany’s common stock are subject to certain restrictions. For as long as thePreferred Stock is outstanding, no dividends may be declared or paid on theCompany’s common stock until all accrued and unpaid dividends on the PreferredStock are fully paid. In addition, the U.S. Treasury’s consent is required forany increase in dividends on common stock before the third anniversary ofissuance of the Preferred Stock and for any repurchase of any common stockexcept for repurchases of common shares in connection with benefit plans.

 

The Preferred Stock andWarrants were sold to the U.S. Treasury for an aggregate purchase price of$14,448,000 in cash. The purchase price was allocated between the PreferredStock and the Warrants based upon the relative fair values of each to arrive atthe amounts recorded by the Company. This resulted in the Preferred Stock beingissued at a discount which is being amortized on a level yield basis as acharge to retained earnings over an assumed life of five years.

 

**Restrictionson Dividends**- South Carolina banking regulations restrict the amount of dividends that canbe paid to shareholders.  All of the Bank’sdividends to Tidelands Bancshares, Inc. are payable only from theundivided profits of the Bank.  The Bankis authorized to pay cash dividends up to 100% of net income in any calendaryear without obtaining the prior approval of the Commissioner of Bankingprovided that the Bank received a composite rating of one or two at the lastFederal or State regulatory examination. Under Federal Reserve Board regulations, the amounts of loans oradvances from the Bank to the parent company are also restricted.

 

**NOTE 22 - FINANCIAL INSTRUMENTSWITH OFF-BALANCE-SHEET RISK**

 

The Company is a party tofinancial instruments with off-balance-sheet risk in the normal course ofbusiness to meet the financing needs of its customers.  These financial instruments consist ofcommitments to extend credit and standby letters of credit.  Commitments to extend credit are agreementsto lend to a customer as long as there is no violation of any conditionestablished in the contract.  Commitmentsgenerally have fixed expiration dates or other termination clauses and mayrequire payment of a fee.  A commitmentinvolves, to varying degrees, elements of credit and interest rate risk inexcess of the amount recognized in the balance sheet.  The Company’s exposure to credit loss in theevent of nonperformance by the other party to the instrument is represented bythe contractual notional amount of the instrument.  Since certain commitments are expected toexpire without being drawn upon, the total commitment amounts do notnecessarily represent future cash requirements. The Company uses the same credit policies in making commitments toextend credit as it does for on-balance-sheet instruments.  Standby letters of credit are conditionalcommitments issued to guarantee a customer’s performance to a third party andhave essentially the same credit risk as other lending facilities.

 

Collateral held forcommitments to extend credit and letters of credit varies but may includeaccounts receivable, inventory, property, plant, equipment and income-producingcommercial properties.

 

The followingtable sets forth unused commitments to extend credit and standby letters ofcredit at December 31, 2009 and 2008:

 
| ** **                    | ** ** | **2009** | ** **     | **2008**   | ** ** |
|-------------------------------|------------|----------|----------------|------------|------------|
| Commitments to  extend credit |       | $        | 28,429,383     |       | $          | 31,750,422 |   |
| Standby letters  of credit    |       | 466,739  |           | 761,765    |       |
| Total                         | ** ** | **$**    | **28,896,122** | ** ** | **$**      | **32,512,187** | ** ** |

 

F-27

----

 

**NOTE 23 - STOCK COMPENSATIONPLANS**

 

On May 10, 2004, theCompany established the 2004 Tidelands Bancshares, Inc. Stock IncentivePlan (“Stock Plan”) that provides for the granting of options to purchase 20%of the outstanding shares of the Company’s common stock to directors, officers,or employees of the Company.  The planwas amended during 2005 to provide for the designation of an additional 348,997shares as incentive stock options. The per-share exercise price of incentivestock options granted under the Stock Plan may not be less than the fair marketvalue of a share on the date of grant and vest based on continued service withthe Company for a specified period, generally two to five years following thedate of grant.  The per-share exerciseprice of stock options granted is determined by a committee appointed by theBoard of Directors.  The expiration dateof any option may not be greater than 10 years from the date of grant.  Options that expire unexercised or areforfeited become available for reissuance.

 

The fair value of optionsgranted is estimated as of the date granted using the Binomial option valuationmodel with the following weighted-average assumptions used for grants:

 
| ** **                | ** ** | **2009** | ** ** | **2008**  | ** ** | **2007**  | ** ** |
|---------------------------|------------|----------|------------|-----------|------------|-----------|------------|
| Dividend  yield           |       | N/A      |       | 0.00      | %          | 0.00      | %          |
| Expected  volatility      |       | N/A      |       | 22.0-73.8 | %          | 19.5-24.6 | %          |
| Risk-free  interest rate  |       | N/A      |       | 1.79      | %          | 4.07      | %          |
| Expected  life (in years) |       | N/A      |       | 3.0 - 8.0 |       | 3.0 - 8.0 |       |

 

The Company did not grantoptions during the year ended December 31, 2009. The weighted-average fairvalue of options granted during the years 2008 and 2007 is $2.11 and $3.49,respectively. There were no options exercised during the years ended December 31,2009 and 2008. The total intrinsic value of options exercised during the yearended December 31, 2007 was $24,724.

 

A summary of the statusof the Company’s Stock Plan as of December 31, 2009 and 2008 is presentedbelow:

 
| ** **                        | ** ** | **2009**    | ** ** | **2008**                                                 | ** ** |
|-----------------------------------|------------|-------------|------------|----------------------------------------------------------|------------|
| ** **                        | ** ** | **Options** | ** ** | **Weighted********Average********Exercise********Price** | ** ** | **Aggregate********Intrinsic********Value** | ** ** | **Options** | ** ** | **Weighted********Average********Exercise********Price** | ** ** | **Aggregate********Intrinsic********Value** | ** ** |
| Outstanding  at beginning of year |       | 777,537     |       | $                                                        | 10.31      |   |   |   | 708,320 |   | $ | 11.44 |   |   |   |
| Granted                           |       | —      |       | —                                                   |       |   |   | 122,452 |   | 4.36 |   |   |   |
| Exercised                         |       | —      |       | —                                                   |       |   |   | — |   | — |   |   |   |
| Forfeited                         |       | (35,477     | )          | 11.05                                                    |       |   |   | (53,235 | ) | 11.57 |   |   |   |
| Outstanding  at end of year       | ** ** | **742,060** | ** ** | **$**                                                    | **10.28**  | ** ** | **$** | **—** | ** ** | **777,537** | ** ** | **$** | **10.31** | ** ** | **$** | **20,387** | ** ** |
| Options  exercisable at year-end  | ** ** | **460,103** |       |                                                     | ** ** | **$** | **—** | ** ** | **360,408** |   |   | ** ** | **$** | **285** | ** ** |
| Shares  available for grant (1)   | ** ** | **41,446**  |       |                                                     | ** ** | ** ** | ** ** | **4,470** |   |   |   |   |   |

 

----

(1) 20% of outstanding shares

 

The aggregate intrinsicvalue in the table above represents the total pre-tax intrinsic value (thedifference between the Company’s closing stock price on the last trading day of2009 and the exercise price, multiplied by the number of in-the-money options)that would be received by the option holders had all options holders exercisedtheir options on December 31, 2009. This amount changes based on the fairvalue of the Company’s stock. For the years ended December 31, 2009, 2008and 2007, there was $455,165, $700,509 and $699,964 of total recognizedcompensation cost related to the share-based compensation arrangements grantedunder the Stock Plan.

 

F-28

----

 

A summary of the statusof the Company’s nonvested shares as of December 31, 2009 is presentedbelow:

 
| **Nonvested  Shares**           | ** ** | **Shares**  | ** ** | **Weighted  Average  Grant-Date  Fair Value** | ** ** |
|---------------------------------|------------|-------------|------------|-----------------------------------------------|------------|
| Nonvested  at beginning of year |       | 417,129     |       | $                                             | 3.56       |   |
| Granted                         |       | —      |       | —                                        |       |
| Vested                          |       | (111,568    | )          | 3.61                                          |       |
| Forfeited                       |       | (23,604     | )          | 3.88                                          |       |
| Nonvested  at end of year       | ** ** | **281,957** | ** ** | **$**                                         | **3.52**   | ** ** |

 

As of December 31,2009, there was $453,603 of total unrecognized compensation cost related tononvested share-based compensation arrangements granted under the Stock Plan.That cost is expected to be recognized over a weighted-average period of 1.81years. The weighted average remaining term for exercisable options at December 31,2009 is 6.42 years. The total fair value of shares vested during the yearsended December 31, 2009, 2008 and 2007, was $402,507, $436,949 and$361,194, respectively.

 

The following tablesummarizes information about the stock options outstanding under the Company’sstock compensation plan at December 31, 2009:

 
| ** **                     | ** ** | **Options Outstanding**              | ** ** | **Options Exercisable**                            | ** ** |
|--------------------------------|------------|--------------------------------------|------------|----------------------------------------------------|------------|
| **Range  of Exercise  Prices** | ** ** | **Number  Outstanding  at 12/31/09** | ** ** | **Weighted  Average  Remaining  Contractual Life** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number  Exercisable  at 12/31/09** | ** ** | **Weighted Average  Exercise  Price** | ** ** |
| $3.75  to $8.79                |       | 106,314                              |       | 8.98 years                                         |       | $ | 3.85 |   | 28,810 |   | $ | 4.11 |   |
| $8.80  to $9.00                |       | 150,870                              |       | 4.60 years                                         |       | $ | 8.80 |   | 148,866 |   | $ | 8.80 |   |
| $9.01  to $10.00               |       | 227,963                              |       | 7.62 years                                         |       | $ | 9.57 |   | 116,493 |   | $ | 9.62 |   |
| $10.01  to $15.00              |       | 251,899                              |       | 7.01 years                                         |       | $ | 14.38 |   | 161,559 |   | $ | 14.43 |   |
| $15.01  to $17.65              |       | 5,014                                |       | 6.57 years                                         |       | $ | 17.08 |   | 4,375 |   | $ | 17.18 |   |
|                           |       | 742,060                              |       | 6.98 years                                         |       | $ | 10.28 |   | 460,103 |   | $ | 10.77 |   |

 

**NOTE 24 - EMPLOYEE STOCKOWNERSHIP PLAN**

 

On May 17,2007, the Company announced the formation of the Tidelands Bancshares, Inc.Employee Stock Ownership Plan (“ESOP”), a non-contributory plan, for itsemployees. The ESOP will purchase shares of the Company’s common stock on theopen market from time to time with funds borrowed from a loan from a thirdparty lender. All employees of the Company meeting certain tenure requirementsare entitled to participate in the ESOP. Compensation expense related to theESOP was $209,325 for the year ended December 31, 2009.  At December 31, 2009, the ESOP hasoutstanding loans amounting to $2,300,000.

 

A summary of theunallocated share activity of the Company’s ESOP is presented below:

 
| ** **                        | ** ** | **December 31,** | ** ** |
|-----------------------------------|------------|-----------------------|------------|
| ** **                        | ** ** | **2009**              | ** ** | **2008** | ** ** | **2007** | ** ** |
| Balance,  beginning of year       |       | 203,308               |       | 189,107 |   | — |   |
| New  share purchases              |       | 18,701                |       | 43,883 |   | 198,033 |   |
| Shares  released to participants  |       | (330                  | )          | — |   | — |   |
| Shares  allocated to participants |       | (43,610               | )          | (29,682 | ) | (8,926 | ) |
| Balance,  end of year             | ** ** | **178,069**           | ** ** | **203,308** | ** ** | **189,107** | ** ** |

 

F-29

----

 

The aggregate fair valueof the 177,740 unallocated shares was $657,638 based on the $3.70 closing priceof our common stock on December 31, 2009. The aggregate fair value of the 203,308 unallocated shares was $801,035based on the $3.94 closing price of our common stock on December 31,2008.  The aggregate fair value of the189,107 unallocated shares was $2,032,900 based on the $10.75 closing price ofour common stock on December 31, 2007.

 

**NOTE 25 — RETIREMENT PLAN**

 

The Company has a 401(k) profitsharing plan, which provides retirement benefits to a majority of officers andemployees who meet certain age and service requirements.  The plan includes a “salary reduction”feature pursuant to Section 401(k) of the Internal Revenue Code.  At its discretion, the Bank may make matchingcontributions of $.50 for every dollar contributed up to 6% of the participants’annual compensation.  Expenses charged toearnings for the 401(k) profit sharing plan were approximately $119,077,$60,075 and $48,980 in 2009, 2008 and 2007, respectively.

 

The Bank has aSupplemental Executive Retirement Plan (Supplemental Plan).  This plan provides an annual post-retirementcash payment beginning after a chosen retirement date for certain officers ofthe Bank.  The officer will receive anannual payment from the Bank equal to the promised benefits.  In connection with this plan, life insurancecontracts were purchased on the officers. There was $435,976 expense related to the plan in 2009.

 

As of December 31,2009, total benefits expected to be paid in future periods equal $12,118,050,such payments commence in the year 2013 totaling $100,000.  Total benefits expected to be paid betweenthe years 2014 and 2018 equal $939,010 with $11,179,040 remaining in the yearsthereafter.

 

F-30

----

 

**NOTE 26 -TIDELANDS BANCSHARES, INC. (PARENT COMPANY ONLY)**

 

Presented below are thecondensed financial statements for Tidelands Bancshares, Inc. (ParentCompany Only).

 

**CondensedBalance Sheets**

** **
| ** **                                       | ** ** | **December 31,** | ** **     |
|--------------------------------------------------|------------|-----------------------|----------------|
| ** **                                       | ** ** | **2009**              | ** **     | **2008** | ** ** |
| **Assets:**                                      |       |                  |           |   |   |
| Cash                                             |       | $                     | 4,452,222      |   | $ | 14,118,702 |   |
| Other  equity securities                         |       | 28,750                |           | 151,640 |   |
| Investment  in banking subsidiary                |       | 50,281,637            |           | 53,027,410 |   |
| Other  assets                                    |       | 907,136               |           | 2,317,112 |   |
| Total  assets                                    | ** ** | **$**                 | **55,669,745** | ** ** | **$** | **69,614,864** | ** ** |
| ** **                                       |       |                  |           |   |   |
| **Liabilities and shareholders’ equity:**   |       |                  |           |   |   |
| Junior  subordinated debentures                  |       | $                     | 14,434,000     |   | $ | 14,434,000 |   |
| ESOP  borrowings                                 |       | 2,300,000             |           | 2,600,000 |   |
| Other  borrowings                                |       | —                |           | 615,837 |   |
| Other  liabilities                               |       | 11,001                |           | 5,595 |   |
| Shareholders’  equity                       |       | 38,924,744            |           | 51,959,432 |   |
| Total  liabilities and shareholders’ equity | ** ** | **$**                 | **55,669,745** | ** ** | **$** | **69,614,864** | ** ** |

 

**CondensedStatements of Operations**

 
| ** **                                                                                            | ** ** | **For the Years Ended December 31,** | ** **      |
|-------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|-----------------|
| ** **                                                                                            | ** ** | **2009**                                  | ** **      | **2008** | ** ** | **2007** | ** ** |
| **Income:**                                                                                           |       |                                      |            |   |   |   |   |
| Income  on trust preferred securities                                                                 |       | $                                         | 23,247          |   | $ | 21,602 |   | $ | 16,862 |   |
| Income  on securities available-for-sale                                                              |       | 167,599                                   |            | — |   | — |   |
| Gain  on sale of available-for-sale securities                                                        |       | 105,677                                   |            | — |   | — |   |
| Impairment  on nonmarketable equity securities                                                        |       | (122,890                                  | )               | — |   | — |   |
| Dividend  paid from subsidiary                                                                        |       | —                                    |            | 396,575 |   | — |   |
| Total  income                                                                                         |       | 173,633                                   |            | 418,177 |   | 16,862 |   |
| ** **                                                                                            |       |                                      |            |   |   |   |   |
| **Expense:**                                                                                          |       |                                      |            |   |   |   |   |
| Stock  based compensation                                                                             |       | 455,165                                   |            | 700,509 |   | 699,964 |   |
| Junior  subordinated debentures                                                                       |       | 773,550                                   |            | 724,023 |   | 560,806 |   |
| ESOP  compensation                                                                                    |       | 209,324                                   |            | 252,220 |   | — |   |
| Other  borrowings                                                                                     |       | 58,508                                    |            | 127,831 |   | — |   |
| Other                                                                                                 |       | 124,226                                   |            | 89,990 |   | 24,000 |   |
| Total  expense                                                                                        |       | 1,620,773                                 |            | 1,894,573 |   | 1,284,770 |   |
|                                                                                                  |       |                                      |            |   |   |   |   |
| **Loss before income taxes and equity in****undistributed earnings  (loss) of banking****subsidiary** |       | (1,447,140                                | )               | (1,476,396 | ) | (1,267,908 | ) |
| Income  tax benefit                                                                                   |       | (347,813                                  | )               | (466,000 | ) | (507,000 | ) |
| Equity  in undistributed earnings (loss) of banking subsidiary                                        |       | (9,157,648                                | )               | (3,944,187 | ) | 1,174,212 |   |
| **Net income (loss)**                                                                                 | ** ** | **$**                                     | **(10,256,975** | **)** | **$** | **(4,954,583** | **)** | **$** | **413,304** | ** ** |

 

F-31

----

 

**NOTE 26 -TIDELANDS BANCSHARES, INC. (PARENT COMPANY ONLY)*******- continued*

 

**Condensed Statements of Cash Flows**

** **
| ** **                                                                            | ** ** | **For the Years Ended December 31,** | ** **    |
|---------------------------------------------------------------------------------------|------------|-------------------------------------------|---------------|
| ** **                                                                            | ** ** | **2009**                                  | ** **    | **2008** | ** ** | **2007** | ** ** |
| **Cash flows from operating activities:**                                             |       |                                      |          |   |   |   |   |
| Net  income (loss)                                                                    |       | $                                         | (10,256,975   | ) | $ | (4,954,583 | ) | $ | 413,304 |   |
| Adjustments  to reconcile net income (loss) to net cash used by operating activities: |       |                                      |          |   |   |   |   |
| Discount  accretion and premium amortization                                          |       | 80,144                                    |          | — |   | — |   |
| Gain  from sale of securities available-for-sale                                      |       | (105,677                                  | )             | — |   | — |   |
| Impairment  on securities                                                             |       | 122,890                                   |          | — |   | — |   |
| Increase  in other assets                                                             |       | (97,476                                   | )             | (516,392 | ) | — |   |
| Increase  in other liabilities                                                        |       | 5,406                                     |          | 5,595 |   | — |   |
| Equity  in undistributed income (loss) of subsidiary                                  |       | 9,157,648                                 |          | 3,944,187 |   | (1,174,212 | ) |
| Intercompany  tax sharing payment                                                     |       | (1,074,889                                | )             | — |   | — |   |
| (Increase)  decrease in deferred income taxes                                         |       | 1,507,451                                 |          | (466,000 | ) | (507,000 | ) |
| Stock  based compensation expense                                                     |       | 455,165                                   |          | 700,509 |   | 699,964 |   |
|                                                                                  |       |                                      |          |   |   |   |   |
| Net  cash used by operating activities                                                |       | (206,313                                  | )             | (1,286,684 | ) | (567,944 | ) |
|                                                                                  |       |                                      |          |   |   |   |   |
| **Cash flows from investing activities:**                                             |       |                                      |          |   |   |   |   |
| Purchases  of securities available-for-sale                                           |       | (10,293,963                               | )             | — |   | — |   |
| Proceeds  from sales of securities available-for-sale                                 |       | 8,484,061                                 |          | — |   | — |   |
| Proceeds  from calls and maturities of securities available-for-sale                  |       | 1,835,435                                 |          | — |   | — |   |
| Purchase  of Tidelands Bank stock                                                     |       | (8,000,014                                | )             | (6,000,005 | ) | — |   |
| Purchase  of equity securities                                                        |       | —                                    |          | — |   | (101,640 | ) |
|                                                                                  |       |                                      |          |   |   |   |   |
| Net  cash used by investing activities                                                |       | (7,974,481                                | )             | (6,000,005 | ) | (101,640 | ) |
|                                                                                  |       |                                      |          |   |   |   |   |
| **Cash flows from financing activities:**                                             |       |                                      |          |   |   |   |   |
| Proceeds  (repayments) from other borrowings                                          |       | (615,837                                  | )             | 615,837 |   | — |   |
| Proceeds  from junior subordinated debentures                                         |       | —                                    |          | 6,186,000 |   | — |   |
| Proceeds  from preferred stock, net                                                   |       | —                                    |          | 13,335,752 |   | — |   |
| Proceeds  from issuance of common stock-warrants                                      |       | —                                    |          | 1,112,248 |   | — |   |
| Preferred  stock-dividends paid                                                       |       | (654,174                                  | )             | — |   | — |   |
| Proceeds  from ESOP borrowings                                                        |       | —                                    |          | 472,500 |   | 2,527,500 |   |
| Repayment  of ESOP borrowings                                                         |       | (300,000                                  | )             | (300,000 | ) | (100,000 | ) |
| (Increase)  decrease in unearned ESOP shares                                          |       | 84,325                                    |          | (220,280 | ) | (2,427,500 | ) |
| Proceeds  from exercise of stock options                                              |       | —                                    |          | — |   | 43,199 |   |
| Net  cash (used) provided by financing activities                                     |       | (1,485,686                                | )             | 21,202,057 |   | 43,199 |   |
|                                                                                  |       |                                      |          |   |   |   |   |
| **Net increase (decrease) in cash**                                                   |       | (9,666,480                                | )             | 13,915,368 |   | (626,385 | ) |
|                                                                                  |       |                                      |          |   |   |   |   |
| **Cash, beginning of period**                                                         |       | 14,118,702                                |          | 203,334 |   | 829,719 |   |
|                                                                                  |       |                                      |          |   |   |   |   |
| **Cash, end of period**                                                               | ** ** | **$**                                     | **4,452,222** | ** ** | **$** | **14,118,702** | ** ** | **$** | **203,334** | ** ** |

 

F-32

----

 

#### **NOTE 27 —QUARTERLY DATA (UNAUDITED)**

 
| ** **                                                  | ** ** | **For the Year Ended December 31, 2008** | ** ** | **For the Year Ended December 31, 2009** | ** ** |
|-------------------------------------------------------------|------------|-----------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                  | ** ** | **(dollars in thousands)**                    | ** ** |
| ** **                                                  | ** ** | **First  Quarter**                            | ** ** | **Second  Quarter**                           | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter** | ** ** | **First  Quarter** | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter** | ** ** |
| Interest  Income                                            |       | $                                             | 8,415      |                                          | $          | 8,189 |   | $ | 9,106 |   | $ | 9,047 |   | $ | 9,169 |   | $ | 8,321 |   | $ | 9,077 |   | $ | 9,045 |   |
| Interest  Expense                                           |       | 5,179                                         |       | 4,804                                         |       | 5,184 |   | 5,176 |   | 4,783 |   | 4,663 |   | 4,182 |   | 3,931 |   |
| Net  interest income                                        |       | 3,236                                         |       | 3,385                                         |       | 3,922 |   | 3,871 |   | 4,386 |   | 3,658 |   | 4,895 |   | 5,114 |   |
| Provision  for loan losses                                  |       | 463                                           |       | 314                                           |       | 696 |   | 3,192 |   | 2,135 |   | 5,470 |   | 705 |   | 6,435 |   |
| Net  interest income (loss) after provision for loan losses |       | 2,773                                         |       | 3,071                                         |       | 3,226 |   | 679 |   | 2,251 |   | (1,812 | ) | 4,190 |   | (1,321 | ) |
| Gain  on sale of securities                                 |       | 32                                            |       | —                                        |       | 473 |   | 4 |   | 307 |   | 284 |   | 690 |   | 3,577 |   |
| Noninterest  income (loss)                                  |       | 336                                           |       | 377                                           |       | (4,254 | ) | 256 |   | 237 |   | 513 |   | 338 |   | 236 |   |
| Noninterest  expense                                        |       | 3,529                                         |       | 3,875                                         |       | 3,336 |   | 3,886 |   | 3,759 |   | 4,253 |   | 4,521 |   | 3,834 |   |
| Income  (loss) before taxes                                 |       | (388                                          | )          | (427                                          | )          | (3,891 | ) | (2,947 | ) | (964 | ) | (5,268 | ) | 697 |   | (1,342 | ) |
| Income  tax expense (benefit)                               |       | (155                                          | )          | (196                                          | )          | (1,453 | ) | (895 | ) | (334 | ) | (1,792 | ) | 200 |   | 5,306 |   |
| **Net Income (loss)**                                       | ** ** | **$**                                         | **(233**   | **)**                                         | **$**      | **(231** | **)** | **$** | **(2,438** | **)** | **$** | **(2,052** | **)** | **$** | **(630** | **)** | **$** | **(3,476** | **)** | **$** | **497** | ** ** | **$** | **(6,648** | **)** |
|                                                        |       |                                          |       |                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Earnings  (loss) per share:                                 |       |                                          |       |                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                                                       |       | $                                             | (0.06      | )                                             | $          | (0.06 | ) | $ | (0.60 | ) | $ | (0.50 | ) | $ | (0.21 | ) | $ | (0.91 | ) | $ | 0.07 |   | $ | (1.70 | ) |
| Diluted                                                     |       | $                                             | (0.06      | )                                             | $          | (0.06 | ) | $ | (0.60 | ) | $ | (0.50 | ) | $ | (0.21 | ) | $ | (0.91 | ) | $ | 0.07 |   | $ | (1.70 | ) |

 

F-33

----

 

**Item 9.  Changes in and Disagreements with Accountantson Accounting and Financial Disclosure.**

 

None

 

**Item 9A.  Controls and Procedures.**

 

**Evaluation of Disclosure Controlsand Procedures**

 

As of the end of the period covered by this report, wecarried out an evaluation, under the supervision and with the participation ofour management, including our Chief Executive Officer and Chief FinancialOfficer, of the effectiveness of our disclosure controls and procedures asdefined 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 December 31,2009.  There have been no significantchanges in our internal control over financial reporting during the fourthfiscal quarter ended December 31, 2009 that have materially affected, orare reasonably likely to materially affect, our internal control over financialreporting.

 

The design of any systemof controls 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.

 

**Management’s Report on InternalControl Over Financial Reporting**

 

Management is responsiblefor establishing and maintaining adequate internal control over financialreporting, as such term is defined in the Exchange Act Rules 13a-15(f).  A system of internal control over financialreporting is a process designed to provide reasonable assurance regarding thereliability of financial reporting and the preparation of financial statementsfor external purposes in accordance with generally accepted accountingprinciples.

 

Under the supervision andwith the participation of management, including the principal executive officerand the principal financial officer, our management has evaluated theeffectiveness of our internal control over financial reporting as of December 31,2009 based on the criteria established in a report entitled “Internal Control —Integrated Framework issued by the Committee of Sponsoring Organizations of theTreadway Commission” and the interpretive guidance issued by the Commission inRelease No. 34-55929.  Based on thisevaluation, our management has evaluated and concluded that our internalcontrol over financial reporting was effective as of December 31, 2009.

 

We are continuouslyseeking to improve the efficiency and effectiveness of our operations and ofour internal controls.  This results inmodifications to our processes throughout the company.  However, there has been no change in ourinternal control over financial reporting that occurred during our most recentfiscal quarter that has materially affected, or is reasonably likely tomaterially affect, our internal control over financial reporting.

 

This annual report doesnot include an attestation report of the company’s registered public accountingfirm regarding internal control over financial reporting.  Management’s report was not subject toattestation by the company’s registered public accounting firm pursuant totemporary rules of the Securities and Exchange Commission that permit thecompany to provide only management’s report in this annual report.

 

**Item9B.  Other Information.**

 

None

 

60

----

 

**PART III**

 

**Item 10.  Directors, Executive Officers and CorporateGovernance.**

 

Information required by Item 10 is hereby incorporatedby reference from our proxy statement for our 2010 annual meeting ofshareholders to be held on April 12, 2010.

 

**Item 11.  Executive Compensation.**

 

Information required byItem 11 is hereby incorporated by reference from our proxy statement for our2010 annual meeting of shareholders to be held on April 12, 2010.

 

**Item12.  Security Ownership of CertainBeneficial Owners and Management and Related Stockholder Matters.**

 

Information required byItem 12 is hereby incorporated by reference from our proxy statement for our2010 annual meeting of shareholders to be held on April 12, 2010.

 

**Item 13.  Certain Relationships and RelatedTransactions and Director Independence.**

 

Informationrequired by Item 13 is hereby incorporated by reference from our proxystatement for our 2010 annual meeting of shareholders to be held on April 12,2010.

 

**Item 14.  Principal Accounting Fees and Services.**

 

The information required by Item 14 is hereby incorporated by reference from our proxy statement for our 2010 annual meeting of shareholders to be held on April 12, 2010.

 

61

 

**PART IV**

 

**Item15.  Exhibits.**

 
| 3.1.   |   | Amended and Restated  Articles of Incorporation of Tidelands Bancshares, Inc. (incorporated by  reference to Exhibit 3.1 of the Company’s Current Report on  Form 8-K filed on June 16, 2008).                                                                            |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                               |
| 3.2    |   | Articles of Amendment to the Company’s Restated Articles of  Incorporation establishing the terms of the Series T Preferred Stock  (incorporated by reference as Exhibit 3.1 to the Company’s Form 8-K  filed on December 19, 2008).                                 |
|   |   |                                                                                                                                                                                                                                                                                               |
| 3.3.   |   | Amended and Restated  Bylaws of Tidelands Bancshares, Inc. (incorporated by reference to  Exhibit 3.2 of the Company’s Current Report on Form 8-K filed on  June 16, 2008).                                                                                               |
|   |   |                                                                                                                                                                                                                                                                                               |
| 4.1.   |   | See Exhibits 3.1 and  3.2 for provisions in Tidelands Bancshares, Inc.’s Articles of  Incorporation and Bylaws defining the rights of holders of the common stock.                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                               |
| 4.2.   |   | Form of  certificate of common stock (incorporated by reference as Exhibit 4.2 to  the Company’s Form SB-2 filed with the SEC, File No. 333-97035).                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                               |
| 4.3    |   | Warrant to Purchase up to 571,821  shares of Common Stock (incorporated by reference as Exhibit 4.1 to the  Company’s Form 8-K filed on December 19, 2008).                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                               |
| 4.4    |   | Form of certificate of Series T Preferred Stock Certificate  (incorporated by reference as Exhibit 4.2 to the Company’s Form 8-K  filed on December 19, 2008).                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                               |
| 4.5    |   | Indenture between  Tidelands Bancshares, Inc. and Wilmington Trust Company, as Trustee  dated as of June 20, 2008 (incorporated by reference to Exhibit 4.1  of the Company’s Current Report on Form 8-K filed on June 26,  2008).                                   |
|   |   |                                                                                                                                                                                                                                                                                               |
| 4.6    |   | Junior Subordinated  Indenture between Tidelands Bancshares, Inc. and Wilmington Trust  Company, as Trustee dated as of February 22, 2006 (incorporated by  reference to Exhibit 4.1 to the Company’s Current Report on  Form 8-K filed on dated February 28, 2006). |
|   |   |                                                                                                                                                                                                                                                                                               |
| 10.1   |   | Lease Agreement between  Savings Associates and Tidelands Bank (incorporated by reference as  Exhibit 10.1 to the Company’s Form 10-KSB filed with the SEC for  the period ended December 31, 2004).                                                                           |
|   |   |                                                                                                                                                                                                                                                                                               |
| 10.2   |   | Employment Agreement of  Robert H. Mathewes Jr. (incorporated by reference to Exhibit 10.2 of the  Company’s Current Report on Form 8-K filed on May 7, 2008).                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                               |
| 10.3   |   | Employment Agreement of  Robert E. Coffee Jr. (incorporated by reference to Exhibit 10.3 of the  Company’s Current Report on Form 8-K filed on May 7, 2008).                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                               |
| 10.4   |   | Employment Agreement of  Alan W. Jackson (incorporated by reference to Exhibit 10.4 of the  Company’s Current Report on Form 8-K filed on May 7, 2008).                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                               |
| 10.5   |   | Employment Agreement of  Thomas H. Lyles (incorporated by reference to Exhibit 10.12 of the  Company’s Current Report on Form 8-K filed on May 7, 2008).                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                               |
| 10.6   |   | Employment Agreement of  Milon C. Smith (incorporated by reference to Exhibit 10.13 of the  Company’s Current Report on Form 8-K filed on May 7, 2008).                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                               |
| 10.7   |   | Employment Agreement of  James M. Bedsole.                                                                                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                               |
| 10.8   |   | Salary Continuation  Agreement of Robert E. Coffee Jr. (incorporated by reference to  Exhibit 10.14 of the Company’s Current Report on Form 8-K filed on  May 7, 2008).                                                                                                        |

 

62

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| 10.9   |   | Salary Continuation  Agreement of Robert H. Mathewes Jr. (incorporated by reference to  Exhibit 10.15 of the Company’s Current Report on Form 8-K filed on  May 7, 2008).                                                                                                                                                                                                                                                                                                                                 |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.10  |   | Salary Continuation  Agreement of Alan W. Jackson (incorporated by reference to Exhibit 10.16  of the Company’s Current Report on Form 8-K filed on May 7, 2008).                                                                                                                                                                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.11  |   | Salary Continuation  Agreement of Thomas H. Lyles (incorporated by reference to Exhibit 10.17  of the Company’s Current Report on Form 8-K filed on May 7, 2008).                                                                                                                                                                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.12  |   | Salary Continuation  Agreement of Milon C. Smith (incorporated by reference to Exhibit 10.18  of the Company’s Current Report on Form 8-K filed on May 7, 2008).                                                                                                                                                                                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.13  |   | Salary Continuation  Agreement of James M. Bedsole.                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.14  |   | Endorsement Split  Dollar Agreement of Robert E. Coffee Jr. (incorporated by reference to  Exhibit 10.19 of the Company’s Current Report on Form 8-K filed on  May 7, 2008).                                                                                                                                                                                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.15  |   | Endorsement Split  Dollar Agreement of Robert H. Mathewes Jr. (incorporated by reference to  Exhibit 10.20 of the Company’s Current Report on Form 8-K filed on  May 7, 2008).                                                                                                                                                                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.16  |   | Endorsement Split  Dollar Agreement of Alan W. Jackson (incorporated by reference to  Exhibit 10.21 of the Company’s Current Report on Form 8-K filed on  May 7, 2008).                                                                                                                                                                                                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.17  |   | Endorsement Split  Dollar Agreement of Thomas H. Lyles (incorporated by reference to  Exhibit 10.22 of the Company’s Current Report on Form 8-K filed on  May 7, 2008).                                                                                                                                                                                                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.18  |   | Endorsement Split  Dollar Agreement of Milon C. Smith (incorporated by reference to  Exhibit 10.23 of the Company’s Current Report on Form 8-K filed on  May 7, 2008).                                                                                                                                                                                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.19  |   | Endorsement Split  Dollar Agreement of James M. Bedsole.                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.20  |   | Amended and Restated  Declaration of Trust among Tidelands Bancshares, Inc., as sponsor,  Wilmington Trust Company, as institutional trustee, Wilmington Trust Company,  as Delaware trustee, and the Administrators named therein (incorporated by  reference to Exhibit 10.1 of the Company’s Current Report on  Form 8-K filed on June 26, 2008).                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.21  |   | Guarantee Agreement  between Tidelands Bancshares, Inc., as guarantor, and Wilmington Trust  Company, as guarantee trustee (incorporated by reference to Exhibit 10.2  of the Company’s Current Report on Form 8-K filed on June 26,  2008).                                                                                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.22  |   | Amended and Restated  Trust Agreement among Tidelands Bancshares, Inc., as depositor,  Wilmington Trust Company, as property trustee, Wilmington Trust Company, as  Delaware trustee, and the administrative trustees named therein, including  exhibits containing the related forms of the Tidelands Statutory Trust I  Common Securities Certificate and the Preferred Securities Certificate  (incorporated by reference to Exhibit 10.1 to the Company’s  Form 8-K filed on February 28, 2006). |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.23  |   | Guarantee Agreement  between Tidelands Bancshares, Inc., as guarantor, and Wilmington Trust  Company, as guarantee trustee (incorporated by reference to Exhibit 10.2  to the Company’s Form 8-K filed on February 28, 2006).                                                                                                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.24  |   | Letter Agreement, dated  December 19, 2008, including Securities Purchase Agreement — Standard  Terms incorporated by reference therein, between the Company and the United  States Department of the Treasury (incorporated by reference to  Exhibit 10.1 to the Company’s Form 8-K filed on December 19,  2008).                                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.25  |   | Form of Waiver, executed by each of Messrs. Robert E.  Coffee, Jr., Alan W. Jackson, Thomas H. Lyles, Milon C. Smith, and Robert  H. Mathewes, Jr. (incorporated by reference to Exhibit 10.2                                                                                                                                                                                                                                                                                                        |

 

63

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|   |   | to the Company’s Form 8-K filed on December 19, 2008).                                                                                                                                                                                                                                                     |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                      |
| 10.26  |   | Form of Letter Agreement, executed by each of Messrs. Robert  E. Coffee, Jr., Alan W. Jackson, Thomas H. Lyles, Milon C. Smith, and  Robert H. Mathewes, Jr. with the Company (incorporated by reference to  Exhibit 10.3 to the Company’s Form 8-K filed on December 19,  2008). |
|   |   |                                                                                                                                                                                                                                                                                                                      |
| 10.27  |   | Tidelands  Bancshares, Inc. 2004 Stock Incentive Plan and Form of Stock Option  Agreement (Amendment No. 1) as adopted by the Board of Directors  November 20, 2006 (incorporated by reference to Exhibit 10.1 of the  Company’s Form 10-Q for the period ended September 30, 2007)    |
|   |   |                                                                                                                                                                                                                                                                                                                      |
| 10.28  |   | Amendment No. 2 to  the 2004 Stock Incentive Plan for Tidelands Bancshares, Inc. as adopted  by the Board of Directors October 20, 2008 (incorporated by reference to  Exhibit 10.16 of the Company’s Form 10-K filed on March 30,  2009).                                             |
|   |   |                                                                                                                                                                                                                                                                                                                      |
| 10.29  |   | Standard Form of  Agreement between Tidelands Bank and Hill Construction dated  November 17, 2009                                                                                                                                                                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                      |
| 21.1   |   | Subsidiaries of the  Company.                                                                                                                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                      |
| 23     |   | Consent of Independent  Public Accounting Firm.                                                                                                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                      |
| 24     |   | Power of Attorney  (contained on the signature page hereof).                                                                                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                      |
| 31.1   |   | Rule 13a-14(a) Certification  of the Chief Executive Officer.                                                                                                                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                      |
| 31.2   |   | Rule 13a-14(a) Certification  of the Chief Financial Officer.                                                                                                                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                      |
| 32     |   | Section 1350  Certifications.                                                                                                                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                      |
| 99.1   |   | Certification of the  Chief Executive Officer Pursuant to Section 111(b)(4) of the Emergency  Economic Stabilization Act of 2008.                                                                                                                                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                      |
| 99.2   |   | Certification of the  Chief Financial Officer Pursuant to Section 111(b)(4) of the  Emergency Economic Stabilization Act of 2008.                                                                                                                                                                               |

 

*      Copies of exhibits are available upon written request toCorporate Secretary, Tidelands Bancshares, Inc., 875 Lowcountry Blvd.,Mount Pleasant, South Carolina 29464.

 

64

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**SIGNATURES**

 

In accordance withSection 13 or 15(d) of the Securities Exchange Act of 1934, theregistrant has caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 
|   |                   | **TIDELANDS BANCSHARES, INC**. |
|--------|------------------------|--------------------------------|
|   |                   |                           |   |
|   |                   |                           |   |
| Date:  | February 22, 2010 |                           | By: | /s/ Robert E.  Coffee, Jr. |
|   |                   |                           | Robert E.  Coffee, Jr. |
|   |                   |                           | President and Chief  Executive Officer |
|        |                        |                                |  |  |

 

 

KNOW ALL MEN BY THESEPRESENTS, that each person whose signature appears below constitutes andappoints Robert E. Coffee, Jr., his true and lawful attorney-in-fact andagent, with full power of substitution and resubstitution, for him and in hisname, place and stead, in any and all capacities, to sign any and allamendments to this Form 10-K, and to file the same, with all exhibitsthereto, and other documents in connection therewith, with the Securities andExchange Commission, granting unto attorney-in-fact and agent full power andauthority to do and perform each and every act and thing requisite or necessaryto be done in and about the premises, as fully to all intents and purposes ashe might or could do in person, hereby ratifying and confirming all thatattorney-in-fact and agent, or his substitute or substitutes, may lawfully door cause to be done by virtue hereof.

 

In accordance with theExchange Act, this report has been signed below by the following persons onbehalf of the registrant and in the capacities and on the dates indicated.

 
| **Signature**                     | ** ** | **Title**                      | ** ** | **Date**               |
|-----------------------------------|------------|--------------------------------|------------|------------------------|
|                              |       |                           |       |                   |
|                              |       |                           |       |                   |
| /s/ Michael W. Burrell            |       | Director                       |       | February 22, 2010 |
| Michael W. Burrell                |       |                           |       |                   |
|                              |       |                           |       |                   |
|                              |       |                           |       |                   |
| /s/ John N.  Cagle, III, DMD |       | Director                       |       | February 22, 2010 |
| John N.  Cagle, III, DMD     |       |                           |       |                   |
|                              |       |                           |       |                   |
|                              |       |                           |       |                   |
| /s/ Alan D. Clemmons              |       | Director                       |       | February 22, 2010 |
| Alan D. Clemmons                  |       |                           |       |                   |
|                              |       |                           |       |                   |
|                              |       |                           |       |                   |
| /s/ Robert E.  Coffee, Jr.   |       | Director, President,           |       | February 22, 2010 |
| Robert E.  Coffee, Jr.       |       | and Chief Executive  Officer   |       |                   |
|                              |       | (Principal Executive  Officer) |       |                   |
|                              |       |                           |       |                   |
|                              |       |                           |       |                   |
| /s/ John W. Gandy                 |       | Director                       |       | February 22, 2010 |
| John W. Gandy                     |       |                           |       |                   |
|                              |       |                           |       |                   |
|                              |       |                           |       |                   |
| /s/ J. Louis Grant                |       | Director                       |       | February 22, 2010 |
| J. Louis Grant                    |       |                           |       |                   |
|                              |       |                           |       |                   |
|                              |       |                           |       |                   |
| /s/ Alan W. Jackson               |       | Principal Accounting  and      |       | February 22, 2010 |
| Alan W. Jackson                   |       | Chief Financial Officer        |       |                   |

 

65

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| /s/ John T.  Parker, Jr. |   | Director |   | February 22, 2010 |
|-------------------------------|--------|----------|--------|------------------------|
| John T.  Parker, Jr.     |   |     |   |                   |
|                          |   |     |   |                   |
|                          |   |     |   |                   |
| /s/ Mary V. Propes            |   | Director |   | February 22, 2010 |
| Mary V. Propes                |   |     |   |                   |
|                          |   |     |   |                   |
|                          |   |     |   |                   |
| /s/ Tanya D. Robinson         |   | Director |   | February 22, 2010 |
| Tanya D. Robinson             |   |     |   |                   |
|                          |   |     |   |                   |
|                          |   |     |   |                   |
| /s/ Larry W. Tarleton         |   | Director |   | February 22, 2010 |
| Larry W. Tarleton             |   |     |   |                   |

 

66

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**Exhibit List**

 
| 10.7   |   | Employment Agreement of  James M. Bedsole.                                                                                                  |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                        |
| 10.13  |   | Salary Continuation  Agreement of James M. Bedsole.                                                                                         |
|   |   |                                                                                                                                        |
| 10.19  |   | Endorsement Split  Dollar Agreement of James M. Bedsole.                                                                                    |
|   |   |                                                                                                                                        |
| 10.28  |   | Standard Form of  Agreement between Tidelands Bank and Hill Construction dated  November 17, 2009                                 |
|   |   |                                                                                                                                        |
| 21.1   |   | Subsidiaries of the  Company.                                                                                                               |
|   |   |                                                                                                                                        |
| 23     |   | Consent of Independent  Public Accounting Firm.                                                                                             |
|   |   |                                                                                                                                        |
| 24     |   | Power of Attorney  (contained on the signature page hereof).                                                                           |
|   |   |                                                                                                                                        |
| 31.1   |   | Rule 13a-14(a) Certification  of the Chief Executive Officer.                                                                     |
|   |   |                                                                                                                                        |
| 31.2   |   | Rule 13a-14(a) Certification  of the Chief Financial Officer.                                                                     |
|   |   |                                                                                                                                        |
| 32     |   | Section 1350  Certifications.                                                                                                          |
|   |   |                                                                                                                                        |
| 99.1   |   | Certification of the  Chief Executive Officer Pursuant to Section 111(b)(4) of the  Emergency Economic Stabilization Act of 2008. |
|   |   |                                                                                                                                        |
| 99.2   |   | Certification of the  Chief Financial Officer Pursuant to Section 111(b)(4) of the  Emergency Economic Stabilization Act of 2008. |

 

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