** **

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 

**(MARK ONE)**

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

** **

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

 

**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 No. 000-51907**

 

**INDEPENDENCE BANCSHARES, INC.**

(Exact name of registrant asspecified in its charter)

 

| **South Carolina**            | ** ** | **20-1734180**      |
|-------------------------------|------------|---------------------|
| (State or other  jurisdiction |       | (I.R.S. Employer    |
| of incorporation)             |       | Identification No.) |

 

**500 East Washington Street**

**Greenville, South Carolina 29601**

(Address of principalexecutive offices)

 

**(864) 672-1776**

(Registrant’s telephone number,including area code)

 

----

 

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

 

Indicate by check mark whether the registrant has submittedelectronically and posted on its corporate Web site, if any, every InteractiveData File required to be submitted and posted pursuant to Rule 405 ofRegulation S-T (§232.405 of this chapter) during the preceding 12 months (orfor such shorter period that the registrant was required to submit and postsuch files). o  Yes  o No

 

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

 

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

 

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

 

Indicate the number of shares outstanding of each of the issuer’sclasses of common stock, as of the latest practicable date:

 

2,085,010 shares of commonstock, $.01 par value per share, were issued and outstanding as of August 6,2010.

 

 

 

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**IndependenceBancshares, Inc.**

 

**Part I - FinancialInformation**

 

**Item 1.Financial Statements**

 

**Consolidated Balance Sheets**

** **
| ** **                                                                                                      | ** ** | **June 30, 2010** | ** **  | **December 31, 2009** | ** ** |
|-----------------------------------------------------------------------------------------------------------------|------------|------------------------|-------------|----------------------------|------------|
| ** **                                                                                                      | ** ** | **(unaudited)**        | ** **  | **(audited)**              | ** ** |
| **Assets**                                                                                                      | ** ** | ** **             | ** **  | ** **                 | ** ** |
| Cash and due from banks                                                                                         |       | $                      | 5,387,333   |                       | $          | 4,929,360 |   |
| Federal funds sold                                                                                              |       | 10,445,000             |        | 5,295,000                  |       |
| Investment securities  available for sale                                                                       |       | 10,206,670             |        | 8,171,648                  |       |
| Non-marketable equity  securities                                                                               |       | 1,546,100              |        | 1,546,100                  |       |
| Loans, net of allowance  for loan losses of $2,122,456 and $1,847,513, respectively                             |       | 94,506,220             |        | 106,129,956                |       |
| Accrued interest  receivable                                                                                    |       | 356,242                |        | 401,386                    |       |
| Property and equipment,  net                                                                                    |       | 3,706,960              |        | 3,771,983                  |       |
| Other real estate owned  and repossessed assets                                                                 |       | 3,878,011              |        | 2,411,890                  |       |
| Other assets                                                                                                    |       | 2,536,365              |        | 2,653,876                  |       |
|                                                                                                            |       |                   |        |                       |       |
| Total assets                                                                                                    |       | $                      | 132,568,901 |                       | $          | 135,311,199 |   |
|                                                                                                            |       |                   |        |                       |       |
| **Liabilities**                                                                                                 | ** ** | ** **             |        |                       |       |
| Deposits:                                                                                                       |       |                   |        |                       |       |
| Noninterest bearing                                                                                             |       | $                      | 5,228,508   |                       | $          | 5,243,210 |   |
| Interest bearing                                                                                                |       | 102,151,272            |        | 99,032,246                 |       |
| Total deposits                                                                                                  |       | 107,379,780            |        | 104,275,456                |       |
|                                                                                                            |       |                   |        |                       |       |
| Borrowings                                                                                                      |       | 10,010,832             |        | 14,157,992                 |       |
| Accrued interest payable                                                                                        |       | 60,250                 |        | 97,269                     |       |
| Accounts payable and  accrued expenses                                                                          |       | 162,871                |        | 93,615                     |       |
|                                                                                                            |       |                   |        |                       |       |
| Total liabilities                                                                                               |       | 117,613,733            |        | 118,624,332                |       |
|                                                                                                            |       |                   |        |                       |       |
| Commitments and  contingencies                                                                                  |       |                   |        |                       |       |
|                                                                                                            |       |                   |        |                       |       |
| **Shareholders’  equity**                                                                                  | ** ** | ** **             |        |                       |       |
| Preferred stock, par value  $.01 per share; 10,000,000 shares authorized; no shares issued                      |       | —                 |        | —                     |       |
| Common stock, par value  $.01 per share; 10,000,000 shares authorized; 2,085,010 shares issued and  outstanding |       | 20,850                 |        | 20,850                     |       |
| Additional paid-in capital                                                                                      |       | 21,056,085             |        | 20,997,135                 |       |
| Accumulated other  comprehensive income                                                                         |       | 110,895                |        | 23,052                     |       |
| Accumulated deficit                                                                                             |       | (6,232,662             | )           | (4,354,170                 | )          |
|                                                                                                            |       |                   |        |                       |       |
| Total shareholders’ equity                                                                                 |       | 14,955,168             |        | 16,686,867                 |       |
|                                                                                                            |       |                   |        |                       |       |
| Total liabilities and  shareholders’ equity                                                                |       | $                      | 132,568,901 |                       | $          | 135,311,199 |   |

 

**Theaccompanying notes are an integral part of these consolidated financialstatements.**

 

2

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**IndependenceBancshares, Inc.**

 

**ConsolidatedStatements of Operations**

**(unaudited)**

** **
| ** **                                                               | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                               | ** ** | **2010**                              | ** ** | **2009**                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| **Interest income**                                                      |       |                                  |       |                                |       |   |   |   |   |
| Loans                                                                    |       | $                                     | 1,200,726  |                                | $          | 1,363,476 |   | $ | 2,474,005 |   | $ | 2,761,447 |   |
| Investment securities                                                    |       | 64,960                                |       | 44,997                              |       | 128,450 |   | 92,163 |   |
| Federal funds sold and  other                                            |       | 14,618                                |       | 7,703                               |       | 25,703 |   | 15,268 |   |
| Total interest income                                                    |       | 1,280,304                             |       | 1,416,176                           |       | 2,628,158 |   | 2,868,878 |   |
|                                                                     |       |                                  |       |                                |       |   |   |   |   |
| **Interest expense**                                                     |       |                                  |       |                                |       |   |   |   |   |
| Deposits                                                                 |       | 540,035                               |       | 688,039                             |       | 1,103,129 |   | 1,438,011 |   |
| Borrowings                                                               |       | 109,999                               |       | 147,494                             |       | 242,010 |   | 295,803 |   |
| Total interest expense                                                   |       | 650,034                               |       | 835,533                             |       | 1,345,139 |   | 1,733,814 |   |
|                                                                     |       |                                  |       |                                |       |   |   |   |   |
| Net interest income                                                      |       | 630,270                               |       | 580,643                             |       | 1,283,019 |   | 1,135,064 |   |
|                                                                     |       |                                  |       |                                |       |   |   |   |   |
| Provision for loan losses                                                |       | 735,000                               |       | 560,000                             |       | 835,000 |   | 650,000 |   |
|                                                                     |       |                                  |       |                                |       |   |   |   |   |
| Net interest income  (expense) after provision for loan losses           |       | (104,730                              | )          | 20,643                              |       | 448,019 |   | 485,064 |   |
| ** **                                                               | ** ** | ** **                            | ** ** | ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Noninterest income**                                                   |       | 40,389                                |       | 99,851                              |       | 112,414 |   | 108,575 |   |
|                                                                     |       |                                  |       |                                |       |   |   |   |   |
| **Noninterest expenses**                                                 |       |                                  |       |                                |       |   |   |   |   |
| Compensation and benefits                                                |       | $                                     | 476,646    |                                | $          | 542,141 |   | $ | 1,004,126 |   | $ | 1,077,822 |   |
| Write-downs on real estate  owned and repossessed assets                 |       | 142,104                               |       | —                              |       | 374,159 |   | — |   |
| Occupancy and equipment                                                  |       | 141,560                               |       | 142,607                             |       | 289,519 |   | 270,793 |   |
| Insurance                                                                |       | 144,694                               |       | 173,570                             |       | 258,058 |   | 262,488 |   |
| Data processing and  related costs                                       |       | 71,782                                |       | 87,167                              |       | 145,581 |   | 174,400 |   |
| Professional fees                                                        |       | 70,374                                |       | 66,233                              |       | 133,424 |   | 131,301 |   |
| Marketing                                                                |       | 35,600                                |       | 46,978                              |       | 60,731 |   | 80,348 |   |
| Telephone and supplies                                                   |       | 14,372                                |       | 19,037                              |       | 32,503 |   | 41,291 |   |
| Other                                                                    |       | 87,278                                |       | 44,738                              |       | 140,824 |   | 77,668 |   |
| Total noninterest expenses                                               |       | 1,184,410                             |       | 1,122,471                           |       | 2,438,925 |   | 2,116,111 |   |
|                                                                     |       |                                  |       |                                |       |   |   |   |   |
| Loss before income tax  benefit                                          |       | (1,248,751                            | )          | (1,001,977                          | )          | (1,878,492 | ) | (1,522,472 | ) |
|                                                                     |       |                                  |       |                                |       |   |   |   |   |
| **Income tax benefit**                                                   |       | —                                |       | 340,700                             |       | — |   | 492,550 |   |
|                                                                     |       |                                  |       |                                |       |   |   |   |   |
| Net loss                                                                 |       | $                                     | (1,248,751 | )                                   | $          | (661,277 | ) | $ | (1,878,492 | ) | $ | (1,029,922 | ) |
|                                                                     |       |                                  |       |                                |       |   |   |   |   |
| **Loss per common share — basic  and diluted**                      |       | $                                     | (0.60      | )                                   | $          | (0.32 | ) | $ | (0.90 | ) | $ | (0.49 | ) |
|                                                                     |       |                                  |       |                                |       |   |   |   |   |
| **Weighted average common shares  outstanding — basic and diluted** |       | 2,085,010                             |       | 2,085,010                           |       | 2,085,010 |   | 2,085,010 |   |

 

**Theaccompanying notes are an integral part of these consolidated financialstatements.**

 

3

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**IndependenceBancshares, Inc.**

** **

**ConsolidatedStatements of Changes**

**InShareholders’ Equity and Comprehensive Income (Loss)**

**(unaudited)**

 
| ** **                                                               |       |                  |       |           |       |                     |       | **Accumulated** |       |        |       |       |       |
|--------------------------------------------------------------------------|------------|-----------------------|------------|----------------|------------|--------------------------|------------|-----------------|------------|-------------|------------|------------|------------|
| ** **                                                               |       |                  |       |           |       |                     |       | **other**       |       |        |       |       |       |
| ** **                                                               |       | **Common stock** |       | **Additional** |       | **comprehensive**        |       | **Accumulated** |       |        |       |
| ** **                                                               | ** ** | **Shares**            | ** ** | **Amount**     | ** ** | **paid-in capital** | ** ** | **income**      | ** ** | **deficit** | ** ** | **Total**  | ** ** |
| ** **                                                               |       |                  |       |           |       |                     |       |            |       |        |       |       |       |
| **December 31,  2008**                                              |       | 2,085,010             |       | $              | 20,850     |                     | $          | 20,840,248      |       | $           | 40,715     |       | $          | (2,193,081 | ) | $ | 18,708,732 |   |
| Compensation expense  related to stock options granted                   |       | —                |       | —         |       | 81,887                   |       | —          |       | —      |       | 81,887     |       |
| Net loss                                                                 |       | —                |       | —         |       | —                   |       | —          |       | (1,029,922  | )          | (1,029,922 | )          |
| Unrealized gain on  investment securities available for sale, net of tax |       | —                |       | —         |       | —                   |       | 1,151           |       | —      |       | 1,151      |       |
| Total comprehensive loss                                                 |       | —                |       | —         |       | —                   |       | —          |       | —      |       | (1,028,771 | )          |
| **June 30,  2009**                                                  |       | 2,085,010             |       | $              | 20,850     |                     | $          | 20,922,135      |       | $           | 41,866     |       | $          | (3,223,003 | ) | $ | 17,761,848 |   |
|                                                                     |       |                  |       |           |       |                     |       |            |       |        |       |       |       |
| **December 31,  2009**                                              |       | 2,085,010             |       | $              | 20,850     |                     | $          | 20,997,135      |       | $           | 23,052     |       | $          | (4,354,170 | ) | $ | 16,686,867 |   |
| Compensation expense  related to stock options granted                   |       | —                |       | —         |       | 58,950                   |       | —          |       | —      |       | 58,950     |       |
| Net loss                                                                 |       | —                |       | —         |       | —                   |       | —          |       | (1,878,492  | )          | (1,878,492 | )          |
| Unrealized gain on  investment securities available for sale, net of tax |       | —                |       | —         |       | —                   |       | 87,843          |       | —      |       | 87,843     |       |
| Total comprehensive loss                                                 |       | —                |       | —         |       | —                   |       | —          |       | —      |       | (1,790,649 | )          |
| **June 30,  2010**                                                  |       | 2,085,010             |       | $              | 20,850     |                     | $          | 21,056,085      |       | $           | 110,895    |       | $          | (6,232,662 | ) | $ | 14,955,168 |   |

 

**Theaccompanying notes are an integral part of these consolidated financialstatements.**

 

4

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**IndependenceBancshares, Inc.**

 

**ConsolidatedStatements of Cash Flows**

**(unaudited)**

 
| ** **                                                              | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                              | ** ** | **2010**                            | ** ** | **2009** | ** ** |
| **Operating activities**                                                |       |                                |       |   |   |
| Net loss                                                                |       | $                                   | (1,878,492 | ) | $ | (1,029,922 | ) |
| Adjustments to reconcile  net loss to cash used in operating activities |       |                                |       |   |   |
| Provision for loan losses                                               |       | 835,000                             |       | 650,000 |   |
| Depreciation                                                            |       | 97,470                              |       | 86,314 |   |
| Amortization of investment  securities premiums, net                    |       | 31,725                              |       | 1,143 |   |
| Compensation expense  related to stock options granted                  |       | 58,950                              |       | 81,887 |   |
| Other-than-temporary  impairment on non-marketable equity securities    |       | —                              |       | 60,404 |   |
| Write downs of real estate  owned and repossessed assets                |       | 374,159                             |       | — |   |
| (Increase) decrease in  other assets, net                               |       | 117,402                             |       | (467,805 | ) |
| Increase  in other liabilities, net                                     |       | 32,237                              |       | 106,686 |   |
| Net cash used in operating  activities                                  |       | (331,549                            | )          | (511,293 | ) |
|                                                                    |       |                                |       |   |   |
| **Investing  activities**                                               |       |                                |       |   |   |
| Repayments of loans, net                                                |       | 8,615,548                           |       | 6,695,615 |   |
| Purchase of investment  securities available for sale                   |       | (3,000,000                          | )          | (1,000,000 | ) |
| Maturity of investment  securities available for sale                   |       | —                              |       | 1,000,000 |   |
| Repayments of investment  securities available for sale                 |       | 1,066,349                           |       | 327,011 |   |
| Purchase of non-marketable  equity securities, net                      |       | —                              |       | (37,550 | ) |
| Purchase of property and  equipment, net                                |       | (32,447                             | )          | (607,502 | ) |
| Sale of repossessed assets                                              |       | 332,908                             |       | — |   |
| Net cash provided by  investing activities                              |       | 6,982,358                           |       | 6,377,574 |   |
|                                                                    |       |                                |       |   |   |
| **Financing  activities**                                               |       |                                |       |   |   |
| Increase in deposits, net                                               |       | 3,104,324                           |       | 2,617,675 |   |
| Decrease in borrowings                                                  |       | (4,147,160                          | )          | (2,922,376 | ) |
| Net cash used in financing  activities                                  |       | (1,042,836                          | )          | (304,701 | ) |
|                                                                    |       |                                |       |   |   |
| **Net  increase in cash and cash equivalents**                          |       | 5,607,973                           |       | 5,561,580 |   |
|                                                                    |       |                                |       |   |   |
| **Cash and  cash equivalents at beginning of the period**               |       | 10,224,360                          |       | 4,117,886 |   |
|                                                                    |       |                                |       |   |   |
| **Cash and  cash equivalents at end of the period**                     |       | $                                   | 15,832,333 |   | $ | 9,679,466 |   |
|                                                                    |       |                                |       |   |   |
| **Supplemental  information:**                                          |       |                                |       |   |   |
| **Cash paid for**                                                       |       |                                |       |   |   |
| Interest                                                                |       | $                                   | 1,382,158  |   | $ | 1,748,666 |   |
| **Schedule  of non-cash transactions**                                  |       |                                |       |   |   |
| Change  in unrealized gain on securities, net of tax                    |       | $                                   | 87,843     |   | $ | 1,151 |   |
| Loans  transferred to other real estate owned                           |       | $                                   | 2,173,188  |   | $ | 643,113 |   |

 

**Theaccompanying notes are an integral part of these consolidated financialstatements.**

 

5

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**Notesto Unaudited Consolidated Financial Statements**

 

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

 

***Independence Bancshares, Inc.*** (the “Company”)is a South Carolina corporation organized to operate as a bank holding companypursuant to the Federal Bank Holding Company Act of 1956 and the South CarolinaBank Holding Company Act, and to own and control all of the capital stock ofIndependence National Bank (the “Bank”). The Bank is a national association organized under the laws of theUnited States to conduct general banking business in Greenville, SouthCarolina.

 

**Basis of Presentation**

 

Theaccompanying unaudited consolidated financial statements have been prepared inaccordance with accounting principles generally accepted in the United States ofAmerica for interim financial information and with the instructions to Form 10-Q.  Accordingly, they do not include allinformation and footnotes required by accounting principles generally acceptedin the United States of America for complete financial statements.  However, in the opinion of management, alladjustments (consisting of normal recurring adjustments) considered necessaryfor a fair presentation have been included. Operating results for the three and six month periods ended June 30,2010 are not necessarily indicative of the results that may be expected for theyear ending December 31, 2010.  Forfurther information, refer to the financial statements and footnotes theretoincluded in our Annual Report on Form 10-K for 2009 as filed with the Securitiesand Exchange Commission.

 

**Subsequent Events**

 

Subsequent events are events or transactions thatoccur after the balance sheet date but before financial statements are issued.Recognized subsequent events are events or transactions that provide additionalevidence about conditions that existed at the date of the balance sheet,including the estimates inherent in the process of preparing financialstatements.  Non-recognized subsequentevents are events that provide evidence about conditions that did not exist atthe date of the balance sheet but arose after that date. Management performedan evaluation to determine whether or not there have been any subsequent eventssince the balance sheet date, and concluded that no subsequent events occurredrequiring accrual or disclosure.

 

**Recent Regulatory Developments**

 

On January 20, 2010, the Bank entered into aFormal Agreement (the “Formal Agreement”) with its primary regulator, theOffice of the Comptroller of the Currency (the “OCC”).  The Formal Agreement seeks to enhance theBank’s existing practices and procedures in the areas of management oversight,strategic and capital planning, credit risk management, credit underwriting,liquidity, and funds management.  Inaddition, the OCC has established Individual Minimum Capital Ratio levels ofTier 1 and total capital for the Bank that are higher than the minimum andwell capitalized ratios applicable to all banks.  The Bank must maintain total risk-basedcapital of at least 12%, Tier 1 capital of at least 10%, and a leverage ratioof at least 9%.  The Board of Directorsand management of the Bank have been aggressively working to address thefindings of the exam and will continue to work to comply with all therequirements of the Formal Agreement. For additional information on the Formal Agreement, including actionsthe Bank has taken in response to the Formal Agreement, see “Management’sDiscussion and Analysis — Recent Regulatory Developments” and “Management’sDiscussion and Analysis — Results of Operations — Capital Resources.”

 

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

 

A summary of significant accounting policies is included in our AnnualReport on Form 10-K filed with the Securities and Exchange Commission forthe year ended December 31, 2009.  For further information, refer tothe consolidated financial statements and footnotes thereto included in ourAnnual Report on Form 10-K for 2009 as filed with the Securities andExchange Commission.  Accounting standards that have been issued orproposed by the Financial Accounting Standards Board that do not requireadoption until a future date are not expected to have a material impact on theconsolidated financial statements upon adoption.

 

**Cash and Cash Equivalents**- For purposes of reportingcash flows, cash and cash equivalents include cash, amounts due from banks andfederal funds sold.  Generally, federalfunds are sold for one-day periods.

 

6

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**Loss per Share** - Basic loss per share represents net lossdivided by the weighted-average number of common shares outstanding during theperiod.  Dilutive loss per share reflectsadditional common shares that would have been outstanding if dilutive potentialcommon shares had been issued.  Potentialcommon shares that may be issued by the Company relate to outstanding stockoptions and warrants, and are determined using the treasury stock method.  For the three and six month periods ended June 30,2010 and 2009, as a result of the Company’s net loss, all of the potentialcommon shares were considered anti-dilutive.

 

**Fair Value Measurements -**The Companyapplies the provisions of FASB ASC Topic 820, “Fair Value Measurements andDisclosures” (“ASC Topic 820”), which provides a framework for measuring anddisclosing fair value under generally accepted accounting principles.  ASCTopic 820 requires disclosures about the fair value of assets and liabilitiesrecognized in the balance sheet in periods subsequent to initial recognition,whether the measurements are made on a recurring basis (for example,available-for-sale investment securities) or on a nonrecurring basis (forexample, impaired loans).

 

ASC Topic 820 defines fair value as the exchange price that would bereceived for an asset or paid to transfer a liability (an exit price) in theprincipal or most advantageous market for the asset or liability in an orderlytransaction between market participants on the measurement date.  ASCTopic 820 also establishes a fair value hierarchy which requires an entity tomaximize the use of observable inputs and minimize the use of unobservableinputs when measuring fair value.  The standard describes three levels ofinputs that may be used to measure fair value:  Level 1 - quoted prices inactive markets for identical assets or liabilities; Level 2 - observable inputsother than Level 1 prices such as quoted prices for similar assets orliabilities, quoted prices in markets that are not active, or other inputs thatare observable or can be corroborated by observable market data forsubstantially the full term of the assets or liabilities; and Level 3 -unobservable inputs that are supported by little or no market activity and thatare significant to the fair value of the assets or liabilities.

 

The Company is predominantly an asset-based lender with real estateserving as collateral on approximately 84% of loans.  Loans which are deemed to be impaired arevalued on a nonrecurring basis at the lower of cost or market value of theunderlying collateral.  Such marketvalues are generally obtained using independent appraisals or other marketdata, which the Company considers to be Level 2 inputs (other observableinputs).  The aggregate carrying amount,net of specific reserves, of impaired loans at June 30, 2010 was $9.6million.

 

Available-for-sale investment securities which were $10,206,670 at June 30,2010 are the only assets whose fair values are measured on a recurring basisusing Level 2 inputs (other observable inputs).

 

Other real estate owned and repossessed assets, consisting ofproperties or other collateral obtained through foreclosure or in satisfactionof loans, are carried at fair value. Market values are generally obtained using independent appraisals orother current market information, including but not limited to offers receivedon the property, which the Company considers to be Level 2 inputs (otherobservable inputs).  The carrying amountof other real estate owned and repossessed assets at June 30, 2010 was$3,878,011.

 

The Company has no liabilities carried at fair value or measured atfair value on a recurring or nonrecurring basis.  The Company also has noassets or liabilities whose fair values are measured using Level 1 or Level 3inputs.

 

FASB ASC Topic 825, “Financial Instruments” requires disclosure of fairvalue information, whether or not recognized in the consolidated balancesheets, when it is practical to estimate the fair value.  FASB ASC Topic 825 defines a financialinstrument as cash, evidence of an ownership interest in an entity orcontractual obligations which require the exchange of cash or other financialinstruments.  Certain items arespecifically excluded from the disclosure requirements, including the Company’scommon stock, property and equipment and other assets and liabilities.

 

Fair value approximates carrying value for the following financialinstruments due to the short-term nature of the instrument:  cash and due from banks, federal funds sold,and securities sold under agreements to repurchase.

 

Investment securities arevalued using quoted market prices.

 

Noready market exists for non-marketable equity securities, and they have noquoted market value.  However, redemptionof these stocks has historically been at par value.  Accordingly, the carrying amounts are deemedto be a reasonable estimate of fair value.

 

Fair value of loans is based on the discounted present value of theestimated future cash flows.  Discountrates used in these computations approximate the rates currently offered forsimilar loans of comparable terms and credit quality.

 

7

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Fair value for demand deposit accounts and interest bearing accountswith no fixed maturity date is equal to the carrying value.  The fair value of certificate of depositaccounts are estimated by discounting cash flows from expected maturities usingcurrent interest rates on similar instruments.

 

Fair value for Federal Home Loan Bank (“FHLB”) advances is based ondiscounted cash flows using the Company’s current incremental borrowing rate.

 

The Company has used management’s best estimate of fair value based onthe above assumptions.  Thus, the fairvalues presented may not be the amounts that could be realized in an immediatesale or settlement of the instrument.  Inaddition, any income taxes or other expenses, which would be incurred in anactual sale or settlement, are not taken into consideration in the fair valuepresented.

 

The estimated fair values of the Company’s financial instruments at June 30,2010 and December 31, 2009 are as follows:

 
| ** **                                      | ** ** | **June 30,  2010** | ** ** | **December 31,  2009** | ** ** |
|-------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                      | ** ** | **Carrying**            | ** ** | **Fair**                    | ** ** | **Carrying** | ** ** | **Fair** | ** ** |
| ** **                                      | ** ** | **Amount**              | ** ** | **Value**                   | ** ** | **Amount** | ** ** | **Value** | ** ** |
| **Financial  Assets:**                          | ** ** | ** **              |       |                        |       |   |   |   |   |
| Cash and due from banks                         |       | $                       | 5,387,333  |                        | $          | 5,387,333 |   | $ | 4,929,360 |   | $ | 4,929,360 |   |
| Federal funds sold                              |       | 10,445,000              |       | 10,445,000                  |       | 5,295,000 |   | 5,295,000 |   |
| Investment securities  available for sale       |       | 10,206,670              |       | 10,206,670                  |       | 8,171,648 |   | 8,171,648 |   |
| Non-marketable equity  securities               |       | 1,546,100               |       | 1,546,100                   |       | 1,546,100 |   | 1,546,100 |   |
| Loans, net                                      |       | 94,506,220              |       | 83,796,663                  |       | 106,129,956 |   | 94,600,335 |   |
|                                            |       |                    |       |                        |       |   |   |   |   |
| **Financial  Liabilities:**                     | ** ** | ** **              |       |                        |       |   |   |   |   |
| Deposits                                        |       | 107,379,780             |       | 107,879,139                 |       | 104,275,456 |   | 105,094,907 |   |
| Federal Home Loan Bank  advances                |       | 10,000,000              |       | 10,440,086                  |       | 14,000,000 |   | 14,506,533 |   |
| Securities sold under  agreements to repurchase |       | 10,832                  |       | 10,832                      |       | 157,992 |   | 157,992 |   |
|                                                 |            |                         |            |                             |            |  |  |  |  |  |  |  |  |

 

**NOTE 3 — INVESTMENT SECURITIES**

 

Investment securities classified as “Available for Sale” are carried atfair value with unrealized gains and losses excluded from earnings and reportedas a separate component of shareholders’ equity (net of estimated taxeffects).  Realized gains or losses onthe sale of investments are based on the specific identification method.

 

The amortized costs and fairvalues of investment securities available for sale are as follows:

 
| ** **                        | ** ** | **June 30,  2010** | ** **     |
|-----------------------------------|------------|-------------------------|----------------|
| ** **                        | ** ** | **Amortized**           | ** **     | **Gross  Unrealized** | ** ** | **Fair** | ** ** |
| ** **                        | ** ** | **Cost**                | ** **     | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
|                              |       |                    |           |   |   |   |   |   |   |
| Government-sponsored  enterprises |       | $                       | 6,005,486      |   | $ | 31,654 |   | $ | — |   | $ | 6,037,140 |   |
| Mortgage-backed securities        |       | 3,659,667               |           | 135,179 |   | — |   | 3,794,846 |   |
| Municipals, taxable               |       | 373,494                 |           | 1,190 |   | — |   | 374,684 |   |
|                              |       |                    |           |   |   |   |   |   |   |
| Total investment  securities      | ** ** | **$**                   | **10,038,647** | ** ** | **$** | **168,023** | ** ** | **$** | **—** | ** ** | **$** | **10,206,670** | ** ** |

 
| ** **                        | ** ** | **December 31,  2009** | ** **    |
|-----------------------------------|------------|-----------------------------|---------------|
| ** **                        | ** ** | **Amortized**               | ** **    | **Gross  Unrealized** | ** ** | **Fair** | ** ** |
| ** **                        | ** ** | **Cost**                    | ** **    | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
|                              |       |                        |          |   |   |   |   |   |   |
| Government-sponsored  enterprises |       | $                           | 3,031,796     |   | $ | — |   | $ | (8,139 | ) | $ | 3,023,657 |   |
| Mortgage-backed securities        |       | 4,731,232                   |          | 53,868 |   | (9,795 | ) | 4,775,305 |   |
| Municipals, taxable               |       | 373,693                     |          | — |   | (1,007 | ) | 372,686 |   |
|                              |       |                        |          |   |   |   |   |   |   |
| Total investment  securities      | ** ** | **$**                       | **8,136,721** | ** ** | **$** | **53,868** | ** ** | **$** | **(18,941** | **)** | **$** | **8,171,648** | ** ** |

 

AtJune 30, 2010, the investment portfolio included an unrealized gain ofapproximately $168,000. At June 30, 2010, the investment portfolioincluded no securities in a loss position.

 

8

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**Item 2.Management’s Discussion and Analysis of Financial Condition and Results ofOperations**

 

*Thefollowing discussion reviews our results of operations and assesses ourfinancial condition.  You should read thefollowing discussion and analysis in conjunction with the accompanyingconsolidated financial statements.  Thecommentary should be read in conjunction with the discussion of forward-lookingstatements, the financial statements, and the related notes and the otherstatistical information included in this report.*

** **

**DISCUSSIONOF FORWARD-LOOKING STATEMENTS**

 

Thisreport contains statements which constitute forward-looking statements withinthe meaning of Section 27A of the Securities Act of 1933 and Section 21Eof 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 manyassumptions and estimates and are not guarantees of future performance.  Our actual results may differ materially fromthose anticipated in any forward-looking statements, as they will depend onmany factors about which we are unsure, including many factors which are beyondour control.  The words “may,” “would,” “could,”“should,” “will,” “expect,” “anticipate,” “predict,” “project,” “potential,” “believe,”“continue,” “assume,” “intend,” “plan,” and “estimate,” as well as similarexpressions, are meant to identify such forward-looking statements.  Potential risks and uncertainties that couldcause our actual results to differ from those anticipated in ourforward-looking statements include, but are not limited, to the following:

 

·                  reduced earnings due tohigher credit losses generally and specifically because losses in the sectorsof our loan portfolio secured by real estate are greater than expected due toeconomic factors, including, but not limited to,  declining real estate values, increasinginterest rates, increasing unemployment, or changes in payment behavior orother factors;

·                  reduced earnings due tohigher credit losses because our loans are concentrated by loan type, industrysegment, borrower type, or location of the borrower or collateral;

·                  high concentration of realestate-based loans collateralized by real estate in a weak commercial realestate market;

·                  restrictions or conditionsimposed by our regulators on our operations may make it more difficult for usto achieve our goals;

·                  significant increases incompetitive pressure in the banking and financial services industries;

·                  changes in the interest rateenvironment which could reduce anticipated margins;

·                  changes in politicalconditions or the legislative or regulatory environment, including the effectof recent financial reform legislation on the banking industry;

·                  the effect of final rules amendingRegulation E that prohibit financial institutions from charging consumerfees for paying overdrafts on ATM and one-time debit card transactions, unlessthe consumer consents or opts-in to the overdraft service for those types oftransactions;

·                  general economic conditions,either nationally or regionally and especially in our primary service area,being less favorable than expected, resulting in, among other things, adeterioration in credit quality;

·                  changes occurring inbusiness conditions and inflation;

·                  changes in deposit flows;

·                  changes in technology;

·                  changes in monetary and taxpolicies;

·                  adequacy of the level of ourallowance for loan losses;

·                  the rate of delinquenciesand amount of loans charged-off;

·                  the rate of loan growth;

·                  adverse changes in assetquality and resulting credit risk-related losses and expenses;

·                  loss of consumer confidenceand economic disruptions resulting from terrorist activities;

·                  changes in the securitiesmarkets; and

·                  other risks anduncertainties detailed from time to time in our filings with the Securities andExchange Commission.

 

These risks are exacerbatedby the developments over the last 30 months in national and internationalfinancial markets, and we are unable to predict what effect these uncertainmarket conditions will continue to have on our Company.  Beginning in 2008 and continuing through thefirst half of 2010, the capital and credit markets experienced unprecedentedlevels of extended volatility and disruption. There can be no assurance that these unprecedented developments will notcontinue to materially and adversely affect our business, financial condition andresults of operations.

 

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All forward-lookingstatements in this report are based on information available to us as of thedate of this report.  Although we believethat the expectations reflected in our forward-looking statements arereasonable, we cannot guarantee you that these expectations will beachieved.  We undertake no obligation topublicly update or otherwise revise any forward-looking statements, whether asa result of new information, future events, or otherwise.

 

**Critical Accounting Policies**

 

We have adopted various accounting policies that govern the applicationof accounting principles generally accepted in the United States of America andwith general practices within the banking industry in the preparation of ourfinancial statements.  Our significantaccounting policies are described in the footnotes to our audited consolidatedfinancial statements as of December 31, 2009, as filed in our AnnualReport on Form 10-K.

 

Certain accounting policies involve significant judgments andassumptions by us that have a material impact on the carrying value of certainassets and liabilities.  We considerthese accounting 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 thecarrying values of our assets and liabilities and our results of operations.

 

**Allowance for Loan Losses**

 

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

 

**Real Estate Acquired in Settlement of Loans**

 

Real estate acquired through foreclosure is initially recorded at thelower of cost or estimated fair value.  Subsequent to the date ofacquisition, it is carried at the lower of cost or fair value, adjusted for netselling costs.  Fair values of real estate owned are reviewed regularlyand write-downs are recorded when it is determined that the carrying value ofreal estate exceeds the fair value less estimated costs to sell.  Costsrelating to the development and improvement of such property are capitalized,whereas those costs relating to holding the property are expensed.

 

**Income Taxes**

 

Weuse assumptions and estimates in determining income taxes payable or refundablefor the current year, deferred income tax liabilities and assets for eventsrecognized differently in our consolidated financial statements and income taxreturns, and income tax benefit or expense. Determining these amounts requires analysis of certain transactions andinterpretation of tax laws and regulations. Management exercises judgment in evaluating the amount and timing ofrecognition of resulting tax liabilities and assets.  These judgments and estimates are reevaluatedon a continual basis as regulatory and business factors change.  Valuation allowances are established toreduce deferred tax assets if it is determined to be “more likely than not”that all or some portion of the potential deferred tax asset will not berealized.  No assurance can be given thateither the tax returns submitted by us or the income tax reported on thefinancial statements will not be adjusted by either adverse rulings by theUnited States Tax Court, changes in the tax code, or assessments made by theInternal Revenue Service.  We are subjectto potential adverse adjustments, including, but not limited to, an increase inthe statutory federal or state income tax rates, the permanentnon-deductibility of amounts currently considered deductible either now or infuture periods, and the dependency on the generation of future taxable income,including capital gains, in order to ultimately realize deferred income taxassets.

 

10

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**Overview**

 

Thefollowing discussion describes our results of operations for the three and sixmonth periods ended June 30, 2010 and 2009 and also analyzes our financialcondition as of June 30, 2010.

 

Likemost community banks, we derive the majority of our income from interest wereceive on our loans and investments. Our primary source of funds for making these loans and investments isour deposits, on which we pay interest. Consequently, one of the key measures of our success is our amount ofnet 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 borrowings.  Another key measure is the spread between theyield we earn on these interest-earning assets and the rate we pay on ourinterest-bearing liabilities.

 

Thereare risks inherent in all loans, so we maintain an allowance for loan losses toabsorb probable losses on existing loans that may become uncollectible.  We establish and maintain this allowance bycharging a provision for loan losses against our operating earnings.  In the following section we have included adetailed discussion of this process.

 

Inaddition to earning interest on our loans and investments, we earn incomethrough fees and other expenses we charge to our customers.  We describe the various components of thisnoninterest income, as well as our noninterest expenses, in the followingdiscussion.

 

Markets in the United States and elsewhere have experienced extremevolatility and disruption over the past two years.  These circumstances have exerted significantdownward pressure on prices of equity securities and virtually all other assetclasses, and have resulted in substantially increased market volatility,severely constrained credit and capital markets, particularly for financialinstitutions, and an overall loss of investor confidence.  Loan portfolio performances have deterioratedat many institutions resulting from, among other factors, a weak economy and adecline in the value of the collateral supporting their loans.  Dramatic slowdowns in the housing industry,due in part to falling home prices and increasing foreclosures and unemployment,have created strains on financial institutions. Many borrowers are now unable to repay their loans, and the collateralsecuring these loans has, in some cases, declined below the loan balance.  In response to the challenges facing thefinancial services sector, several regulatory and governmental actions havebeen announced including:

 

·                  The Emergency EconomicStabilization Act, approved by Congress and signed by President Bush on October 3,2008, which, among other provisions, allowed the U.S. Treasury to purchasetroubled assets from banks, authorized the Securities and Exchange Commissionto suspend the application of marked-to-market accounting, and raised the basiclimit of FDIC deposit insurance from $100,000 to $250,000 through  December 31, 2013;

 

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

 

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

 

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

 

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

 

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

 

11

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

 

·                                    A capital assistance programthat will invest in mandatory convertible preferred stock of certain qualifyinginstitutions determined on a basis and through a process similar to the CapitalPurchase Program;

 

·                                    A consumer and businesslending initiative to fund new consumer loans, small business loans andcommercial mortgage asset-backed securities issuances;

 

·                                    A new public-privateinvestment fund that will leverage public and private capital with publicfinancing to purchase up to $500 billion to $1 trillion of legacy “toxic assets”from financial institutions; and

 

·                                    Assistance for homeowners byproviding up to $75 billion to reduce mortgage payments and interest rates andestablishing loan modification guidelines for government and private programs.

 

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

 

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

 

·                                       The first planis the Legacy Loan Program, which has a primary purpose to facilitate the saleof troubled mortgage loans by eligible institutions, including FDIC-insuredfederal or state banks and savings associations. Eligible assets are notstrictly limited to loans; however, what constitutes an eligible asset will bedetermined by participating banks, their primary regulators, the FDIC and theTreasury. Under the Legacy Loan Program, the FDIC has sold certain troubledassets out of an FDIC receivership in two separate transactions relating to thefailed Illinois bank, Corus Bank, NA, and the failed 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”). LegacySecurities must be directly secured by actual mortgage loans, leases or otherassets, and may be purchased only from financial institutions that meet TARPeligibility requirements. Treasury received over 100 unique applications toparticipate in the Legacy Securities PPIP and in July 2009 selected ninepublic-private investment fund managers. As of December 31, 2009, public-private investment funds havecompleted initial and subsequent closings on approximately $6.2 billion ofprivate sector equity capital, which was matched 100% by Treasury, representing$12.4 billion of total equity capital. Treasury has also provided $12.4 billionof debt capital, representing $24.8 billion of total purchasing power. As of December 31,2009, public-private investment funds have drawn-down approximately $4.3billion of total capital which has been invested in certain non-agencyresidential mortgage backed securities and commercial mortgage backedsecurities and cash equivalents pending investment.

 

12

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

 

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

 

·                  On July 21, 2010, the U.S. Presidentsigned into law the Dodd-Frank Wall Street Reform and Consumer Protection Actof 2010, a comprehensive regulatory framework that will affect every financialinstitution in the U.S.  U.S. financial regulators will begin therulemaking process over the next 6 to 18 months which will set the parametersof the new regulatory framework and provide a clearer understanding of thelegislation’s effect on banks.

 

We are participating in the unlimited deposit insurance component ofthe TLGP; however, we did not issue unsecured debt before the termination ofthat component of the TLGP.  On April 13,2010, the FDIC approved an interim rule that extends the TransactionAccount Guarantee Program to December 31, 2010.  We have elected to continue our voluntaryparticipation in the program. Coverage under the program is in addition to andseparate from the basic coverage available under the FDIC’s general depositinsurance rules.   We believeparticipation in the program is enhancing our ability to retain customerdeposits.  As a result of theenhancements to deposit insurance protection and the expectation that therewill be demands on the FDIC’s deposit insurance fund, our deposit insurancecosts increased significantly.   We haveelected not to participate in the TARP Capital Purchase Program, but willconsider participating in similar programs, if any, announced in the future.   Regardless of our lack of participation,governmental intervention and new regulations under these programs couldmaterially and adversely affect our business, financial condition and resultsof operations.

 

Although it is likely that further regulatory actions will arise as theFederal government attempts to address the economic situation, we cannotpredict the continuing effect that fiscal or monetary policies, economiccontrol, or new federal or state legislation may have on our business and earningsin the future.

 

**Recent Regulatory Developments**

 

On January 20, 2010, the Bank entered into a Formal Agreement (the“Formal Agreement”) with its primary regulator, the Office of the Comptrollerof the Currency (the “OCC”).  The FormalAgreement seeks to enhance the Bank’s existing practices and procedures in theareas of management oversight, strategic and capital planning, credit riskmanagement, credit underwriting, liquidity, and funds management.  In response, the Bank has formed a ComplianceCommittee of its Board of Directors (the “Compliance Committee”) to overseemanagement’s response to all sections of the Formal Agreement.  The Compliance Committee also monitorsadherence to deadlines for submission to the OCC of information required underthe Formal Agreement.  The Board ofDirectors and management of the Bank have been aggressively working to addressthe findings of the exam and will continue to work to comply with all therequirements of the Formal Agreement.  Asummary of the requirements of the Formal Agreement and the Bank’s status oncomplying with the Formal Agreement is as follows:

 
| **Requirements of the Formal  Agreement**                                                                                                                                                                                                                                                                                                                                                                                                                                                     | ** ** | **Bank’s Compliance Status**                                                                                                                                                                                                       |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Establish, within 30 days from the effective  date of the Formal Agreement, a Compliance Committee of at least five  directors to be responsible for monitoring and coordinating the Bank’s  adherence to the provisions of the Formal Agreement. The Compliance Committee  is required to meet at least monthly to receive written progress reports from  management on the results and status of actions needed to achieve full  compliance with each article of the Formal Agreement. |       | The Compliance Committee was formed in  January 2010 and has met monthly to review written progress reports  provided by management.                                                                                               |
| Complete, within 60 days of the effective date  of the Formal Agreement, a thorough review and assessment of the Bank’s Board  of Directors and management supervision, management structure and staffing  requirements.                                                                                                                                                                                                                                                                 |       | The Compliance Committee completed this review and  assessment, including obtaining Board approval of the findings and  recommendations, in April and June 2010, and submitted its report  to the OCC immediately thereafter. |

 

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| Adopt and implement, within 45 days of the  effective date of the Formal Agreement, an updated written strategic plan for  the Bank covering at least a three-year period including an updated three  year capital program to strengthen the Bank’s capital structure.                                                                                       |   | The Board adopted the Bank’s strategic plan,  including the required capital program, on March 3, 2010 which was  submitted to the OCC on March 8, 2010. The Bank has also taken steps to  implement this strategic plan and capital program.                                                                                            |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Develop and implement, within 45 days of the  effective date of the Formal Agreement, an updated written profit plan to  improve and sustain the earnings of the Bank.                                                                                                                                                                                            |   | The Board adopted the Bank’s profit plan in  December 2009 which was submitted to the OCC on March 8, 2010. The  Bank is currently in the process of updating this profit plan based on actual  results for the first six months of 2010 compared to the original profit  plan.                                                          |
| Adopt and implement, within 45 days of the  effective date of the Formal Agreement, an updated written liquidity, asset/liability  management policy addressing liquidity, contingency funding and  asset/liability management.                                                                                                                                   |   | The Bank’s Liquidity and Funding Policy,  Contingency Funding Policy and Asset Liability Management Policy were  reviewed and approved by the Bank’s Board of Directors on March 3, 2010  and were submitted to the OCC on March 8, 2010.                                                                                           |
| Review the Bank’s liquidity on a monthly basis  and provide the full Board of Directors with a written report of the results  of this review to ensure adequate sources of liquidity in relation to the  Bank’s needs.                                                                                                                                  |   | Through June 30, 2010, we believe the Bank  has complied with this provision of the Formal Agreement.                                                                                                                                                                                                                                              |
| Adopt and implement, within 60 days of the  effective date of the Formal Agreement, an updated written interest rate risk  policy addressing management reports used for decision-making, interest rate  risk tolerance, tools used to measure and monitor the Bank’s overall interest  rate risk profile, and model validation and back-testing procedures. |   | The Bank’s Interest Rate Risk Policy, which  addresses management reports, interest rate risk tolerance, measuring and  monitoring the Bank’s risk profile and model validation and back-testing, was  reviewed and approved by the Bank’s Board of Directors on March 3, 2010  and was submitted to the OCC on March 8, 2010. |
| Improve, within 90 days of the effective date  of the Formal Agreement, the Bank’s liquidity position and maintain adequate  sources of stable funding given the Bank’s anticipated liquidity and funding  needs by reducing wholesale or credit sensitive liabilities and/or increasing  liquid assets.                                                |   | As of June 30, 2010, the Bank has  increased its liquidity position to 19.64% from 13.60% as of  December 31, 2009. In addition, the Bank has decreased wholesale funding  reliance by $11.6 million in the first six months of 2010.                                                                                                         |
| Accept, renew or rollover brokered deposits for  deposit at the Bank only after obtaining a prior written determination of no  supervisory objection from the OCC.                                                                                                                                                                                                |   | The Bank has obtained required written  approvals from the OCC for all new and renewed brokered deposit requests  since the effective date of the Formal Agreement.                                                                                                                                                                                     |

 

14

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| Take immediate and continuing action to protect  the Bank’s interest in certain assets identified by the OCC or any other bank  examiner. Adopt and implement, within 60 days of the effective date of the  Formal Agreement, a written program designed to eliminate the basis of  criticism of assets criticized by the OCC or any other bank examiner, or in  any list provided to management by the OCC during any examination as  “doubtful,” “substandard,” or “special mention.” In addition, provide to the  OCC a copy of the program for all criticized assets equal to or exceeding  $300,000. Conduct a monthly review to determine the status of each criticized  asset that equals or exceeds $300,000 and management’s adherence to and the  status and effectiveness of the criticized asset program adopted. |   | The Bank is utilizing a criticized assets  report covering the entire credit relationship with respect to such assets.  Initial reports were submitted to the OCC on March 30, 2010, and ongoing  monthly monitoring is being performed in accordance with the Formal  Agreement.                                                          |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Extend credit, including renewals or  extensions, to a borrower whose loans or other extensions of credit exceed  $300,000 and are criticized by the OCC or any other bank examiner, only after  the Board or designated committee finds that the extension of additional  credit is necessary to promote the best interests of the Bank.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |   | Through June 30, 2010, we believe the Bank  has complied with this provision of the Formal Agreement.                                                                                                                                                                                                                                      |
| Adopt and implement, within 60 days of the  effective date of the Formal Agreement, an updated and comprehensive policy  for determining the adequacy of the Bank’s allowance for loan losses, which  must provide for a review of the Bank’s allowance for loan losses by the  Board at least once each calendar quarter.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |   | The Bank’s Allowance for Loan Losses  Methodology and Model was reviewed and approved by the Bank’s Board of  Directors on April 28, 2010 and was submitted to the OCC on May 3,  2010.                                                                                                                                     |
| Develop and implement, within 60 days of the  effective date of the Formal Agreement, an updated written program to improve  the Bank’s loan portfolio management including a pricing policy, guidelines  for loans to insiders, guidelines on concentrations of credit, lending  procedures, underwriting, documentation, exception tracking, re-appraisal  guidelines and a comprehensive loan review process.                                                                                                                                                                                                                                                                                                                                                                                                                                                 |   | The Bank’s General Loan Policy, which addresses  loans to insiders, guidelines on concentrations of credit, lending  procedures, underwriting, documentation, exception tracking, re-appraisal,  was reviewed and approved by the Bank’s Board of Directors on April 28,  2010 and was submitted to the OCC on May 3, 2010. |
| Develop and implement, within 60 days of the  effective date of the Formal Agreement, updated systems which provide for  effective monitoring of early problem loan identification and sources of  problem loans by various factors, previously charged-off assets and their  recovery potential, compliance with the Bank’s lending policies and laws,  rules, and regulations pertaining to the Bank’s lending function, adequacy of  credit and collateral documentation, and concentrations of credit.                                                                                                                                                                                                                                                                                                                                                  |   | Since the effective date of the Formal  Agreement, the Bank has developed new loan tracking reports, has engaged a  third party to perform loan portfolio stress testing, and has increased the  scope of external quarterly loan review procedures.                                                                                            |
| Provide to the Board of Directors, within 60  days of the effective date of the Formal Agreement, written reports on a  monthly basis, including problem loans, delinquent loans, documentation  exceptions, regulatory violations, concentrations of credit, significant  economic factors, and general conditions and their impact on the credit  quality of the Bank’s loan and lease portfolios, loans to insiders, and  policy exceptions.                                                                                                                                                                                                                                                                                                                                                                                                                  |   | Through June 30, 2010, we believe the Bank  has complied with this provision of the Formal Agreement.                                                                                                                                                                                                                                      |

 

15

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| Adopt and implement, within 60 days of the  effective date of the Formal Agreement, a written asset diversification  program including policies and procedures to control and monitor concentrations  of credit and an action plan to reduce the risk of current concentrations of  credit.                                                                                                                                                                                                                                                                                                                                                                                                                  |   | The Board of Directors has approved the updated  General Loan Policy and has adopted a Commercial Real Estate Action Plan to  ensure a reduction in the Bank’s commercial real estate portfolio. The  General Loan Policy and Commercial Real Estate Action Plan were reviewed and  approved by the Bank’s Board of Directors on April 28, 2010 and were  submitted to the OCC on May 3, 2010. |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Obtain, within 90 days of the effective date of  the Formal Agreement, current and satisfactory credit information on all  loans lacking such information, including those criticized by the OCC or any  other bank examiner.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |   | As of June 30, 2010, we believe the Bank  has complied with this provision of the Formal Agreement.                                                                                                                                                                                                                                                                                                           |
| Ensure, within 60 days of the effective date of  the Formal Agreement, proper collateral documentation is maintained on all  loans and correct each collateral exception listed by the OCC or any other  bank examiner.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |   | As of June 30, 2010, we believe the Bank  has complied with this provision of the Formal Agreement.                                                                                                                                                                                                                                                                                                           |
| Effective immediately, the Bank may grant,  extend, renew, alter or restructure any loan or other extension of credit  only after: (1) documenting the specific reason or purpose for the  extension of credit; (2) identifying the expected source of repayment in  writing; (3) structuring the repayment terms to coincide with the  expected source of repayment; (4) obtaining and analyzing current and  satisfactory credit information, including cash flow analysis, where loans  are to be repaid from operations; and (5) documenting, with adequate  supporting material, the value of collateral and properly perfecting the  Bank’s lien on it where applicable. |   | Through June 30, 2010, we believe the Bank  has complied with this provision of the Formal Agreement.                                                                                                                                                                                                                                                                                                         |
| Adopt and implement, within 90 days of the  effective date of the Formal Agreement, an updated written, comprehensive  conflict of interest policy applicable to the Bank’s and the Bank holding  company’s directors, principal shareholders, executive officers, affiliates,  and employees (“Insiders”) and related interests of such Insiders.                                                                                                                                                                                                                                                                                                                                       |   | The Bank’s Conflict of Interest and Code of  Ethics Policy was reviewed and approved by the Bank’s Board of Directors on  December 9, 2009 and was submitted to the OCC on March 8, 2010.                                                                                                                                                                                                      |
| Within 30 days of the effective date of the  Formal Agreement, the Board of Directors must reduce to conforming amounts  all loans or other extensions of credit which exceed the Bank’s legal lending  limit. The Board is also required to establish, implement, and thereafter  ensure Bank adherence to written procedures to prevent future violations.                                                                                                                                                                                                                                                                                                                                            |   | The Bank is in the process of reducing  non-conforming loan relationships at the time of each renewal through the  requirement of principal reductions or payoff. The Bank is regularly  reporting to the OCC the status of its progress related to this provision of  the Formal Agreement.                                                                                                                       |

 

We intend to take all actions necessary to enable the Bank to complywith the requirements of the Formal Agreement, and as of the date hereof wehave submitted all documentation required as of this date to the OCC.  There can be no assurance that the Bank willbe able to comply fully with the provisions of the Formal Agreement, and thedetermination of our compliance will be made by the OCC.  However, we believe we are currently incompliance with all provisions of the Formal Agreement except for therequirement related to non-conforming loans. Failure to meet the requirements of the Formal Agreement could result inadditional regulatory requirements, which could result in regulators takingadditional enforcement actions against the Bank.

 

16

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In addition, the OCC has established Individual Minimum Capital Ratiolevels of Tier 1 and total capital for the Bank that are higher than theminimum and well capitalized ratios applicable to all banks.  Specifically, the Bank must maintain totalrisk-based capital of at least 12%, Tier 1 capital of at least 10%, and aleverage ratio of at least 9%.  As of June 30,2010, the Bank is in compliance with the established Individual Minimum CapitalRatios.  See “Management’s Discussion andAnalysis — Results of Operations — Capital Resources” for more discussion.

 

Currently, the Company alsohas to obtain the prior written approval of the Federal Reserve Bank ofRichmond before (1) declaring or paying any dividends, (2) directlyor indirectly accepting dividends or any other form of payment representing areduction in capital from the Bank, (3) making any distributions ofinterest, principal or other sums on subordinated debentures or trust preferredsecurities, (4) directly or indirectly, incurring, increasing orguaranteeing any debt, and (5) directly or indirectly, purchasing orredeeming any shares of its stock.  Pursuant to our plans to preservecapital, the Company has no plans to undertake any of the foregoing activities.

 

**Resultsof Operations**

 

*Three months ended June 30, 2010 and 2009*

 

We incurred a net loss of $1,248,751, or $0.60 per diluted share, forthe quarter ended June 30, 2010 compared to a net loss of $661,277, or$0.32 per diluted share, for the quarter ended June 30, 2009, a differenceof $587,474.  As described below, theincrease in net loss is primarily due to a decrease in income tax benefit inaddition to an increase in provision for loan losses.  Our noninterest expenses increased due towrite downs on other real estate owned and repossessed assets which more than offsetan increase in net interest income, discussed in greater detail below.  In addition, our noninterest income decreaseddue to a decrease in mortgage origination income as discussed below.

 

The following table sets forth information related to ouraverage balance sheet, average yields on assets, and average costs ofliabilities for the three months ended June 30, 2010 and 2009.  We derived these yields by dividingannualized income or expense by the average balance of the corresponding assetsor liabilities.  We derived averagebalances from the daily balances throughout the periods indicated.  The net amount of capitalized loan fees areamortized into interest income on loans.

 
| ** **                                        | ** ** | **For the Three Months Ended June 30,** | ** **  |
|---------------------------------------------------|------------|----------------------------------------------|-------------|
| ** **                                        | ** ** | **2010**                                     | ** **  | **2009** | ** ** |
| ** **                                        | ** ** | **Average  Balance**                         | ** **  | **Income/  Expense** | ** ** | **Yield/  Rate** | ** ** | **Average  Balance** | ** ** | **Income/  Expense** | ** ** | **Yield/  Rate** | ** ** |
|                                              |       |                                         |        |   |   |   |   |   |   |   |   |   |   |
| Federal  funds sold and other                     |       | $                                            | 14,088,280  |   | $ | 14,618 |   | 0.42 | % | $ | 5,152,252 |   | $ | 7,703 |   | 0.60 | % |
| Investment  securities (1)                        |       | 8,394,957                                    |        | 64,960 |   | 3.10 |   | 4,182,428 |   | 44,997 |   | 4.32 |   |
| Loans (2)                                         |       | 101,549,090                                  |        | 1,200,726 |   | 4.74 |   | 118,274,131 |   | 1,363,476 |   | 4.62 |   |
| Total  interest-earning assets                    |       | $                                            | 124,032,327 |   | $ | 1,280,304 |   | 4.14 | % | $ | 127,608,811 |   | $ | 1,416,176 |   | 4.45 | % |
|                                              |       |                                         |        |   |   |   |   |   |   |   |   |   |   |
| NOW  accounts                                     |       | $                                            | 5,716,856   |   | $ | 8,621 |   | 0.60 | % | $ | 5,589,040 |   | $ | 7,691 |   | 0.55 | % |
| Savings &  money market                  |       | 33,562,976                                   |        | 146,658 |   | 1.75 |   | 14,497,843 |   | 67,606 |   | 1.87 |   |
| Time  deposits (excluding brokered time deposits) |       | 29,360,257                                   |        | 152,276 |   | 2.08 |   | 31,462,473 |   | 254,935 |   | 3.25 |   |
| Brokered  time deposits                           |       | 35,026,402                                   |        | 232,480 |   | 2.66 |   | 45,622,924 |   | 357,807 |   | 3.15 |   |
| Total  interest-bearing deposits                  |       | 103,666,491                                  |        | 540,035 |   | 2.09 |   | 97,172,280 |   | 688,039 |   | 2.84 |   |
| Borrowings                                        |       | 11,248,125                                   |        | 109,999 |   | 3.92 |   | 17,868,361 |   | 147,494 |   | 3.31 |   |
| Total  interest-bearing liabilities               |       | $                                            | 114,914,616 |   | $ | 650,034 |   | 2.27 | % | $ | 115,040,641 |   | $ | 835,533 |   | 2.91 | % |
|                                              |       |                                         |        |   |   |   |   |   |   |   |   |   |   |
| Net  interest spread                              |       |                                         |        |   |   | 1.87 | % |   |   |   |   | 1.54 | % |
| Net  interest income/ margin                      |       |                                         |        | $ | 630,270 |   | 2.04 | % |   |   | $ | 580,643 |   | 1.83 | % |

 

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(1)                                  The averagebalances for investment securities exclude the unrealized gain recorded foravailable for sale securities.

(2)                                  Nonaccrualloans are included in average balances for yield computations.

 

17

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For the three months ended June 30, 2010, we recognized $1.3million in interest income and $650,034 in interest expense, resulting in netinterest income of $630,270, an increase of $49,627, or 9%, over the sameperiod in 2009.  Average earning assetsdecreased to $124.0 million for the three months ended June 30, 2010 from$127.6 million for the three months ended June 30, 2009, a decrease of$3.6 million, or 3%.  Average interestbearing liabilities decreased to $114.9 million for the three months ended June 30,2010 from $115.0 million for the three months ended June 30, 2009, adecrease of $126,025, or less than 1%. Net interest margin, calculated as annualized net interest incomedivided by average earning assets, increased from 1.83% for the quarter ended June 30,2009 to 2.04% for the quarter ended June 30, 2010, primarily due to adecrease in cost of interest-bearing liabilities from 2.91 % to 2.27% betweenperiods due to the mix of liabilities and the timing of their repricing.  This decrease was offset somewhat by adecrease in yield on earning assets from 4.45% to 4.14% between periods.

 

Provision for loan losses was $735,000 for the quarter ended June 30,2010 representing an increase of $175,000, or 31%, compared to the expense of$560,000 for the quarter ended June 30, 2009.  The increase in provision for loan losses isdue to the increase in impaired and non-accrual loans and their relatedspecific reserves in addition to an increase in the general allowanceallocation due to declining economic conditions and the resulting decline inour borrowers’ ability to repay their loans as well as increased charge offlevels.  The total allowance as apercentage of gross loans increased to 2.20% at June 30, 2010 from 1.71%at December 31, 2009.  Specificreserves were approximately $713,000 on impaired loans of approximately $10.3million as of June 30, 2010.  As of June 30,2010, the general reserve allocation was 1.63% of gross loans not impairedcompared to 1.62% as of December 31, 2009. The provision for loan lossesis discussed further below under “Provision and Allowance for Loan Losses.”

 

For the three months ended June 30, 2010, noninterest income was$40,389 compared to $99,851 for the three months ended June 30, 2009, adecrease of $59,462 between comparable periods. This decrease is primarily due to a decrease of more than $73,000 inmortgage origination income offset by increases in services charges on depositsand customer service fees.  Mortgageorigination income decreased significantly due to the loss of an originator whowas not replaced until later in the second quarter.   Noninterest income for the three monthsended June 30, 2010 and 2009 was derived from service charges on deposits,customer service fees, rental income, and mortgage origination income.

 

During the three months ended June 30, 2010, we incurrednoninterest expenses of $1.2 million, compared to noninterest expenses of $1.1million for the three months ended June 30, 2009, an increase of $61,939,or 6%.  This increase of noninterestexpenses for the three month period ended June 30, 2010 primarily resultedfrom write downs of $142,104 on other real estate owned and repossessed assetsdiscussed in greater detail below.  Otherexpense also increased $42,540 compared to the three month period ended June 30,2009, primarily due to increased expenses related to other real estate owned, suchas taxes and maintenance. These increases were offset by decreases in otherexpense categories.  Compensation andbenefits decreased $65,495 due to a decrease in commissions on mortgageorigination fees as well as the discontinuation of our 401k match beginning April 1,2010. Insurance expense for the three months ended June 30, 2010 decreased$28,876 compared to the three months ended June 30, 2009 primarily due tothe FDIC special assessment in 2009.  Wehave focused on expense control over the past year which has resulted in smalldecreases in marketing and telephone and supplies.  We also renegotiated and renewed our dataprocessing contract in May 2009 resulting in decreased data processingexpenses.

 

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Income tax benefit for the three months ended June 30, 2010 waszero compared to $340,700 for the three months ended June 30, 2009.  We analyzed whether a valuation allowanceshould be recorded against our deferred tax assets.  Accounting literature states that a deferredtax asset should be reduced by a valuation allowance if, based on the weight ofall available evidence, it is more likely than not (a likelihood of more than50%) that some portion or the entire deferred tax asset will not be realized.  The determination of whether a deferred taxasset is realizable is based on weighting all available evidence, includingboth positive and negative evidence. In making such judgments, significantweight is given to evidence that can be objectively verified.  During third quarter 2009, it became evidentthat the unprecedented economic conditions specifically affecting the bankingindustry had increased the uncertainty as to the timing of the expectedrecovery period of the industry as a whole. Although later than many areas of the United States, it also became moreevident that our local market and our Bank were affected by these deterioratingeconomic conditions.  These events led usto record a valuation allowance of 100% on all deferred tax assets generatedbeginning July 1, 2009 through June 30, 2010.  We have analyzed the existing deferred taxassets of $1.3 million, net of the valuation allowance, included in otherassets, and determined it is more likely than not that they will be recognizedin future years based on forecasted projected income in the near term, the factthat we had reached profitable operations prior to the economic decline, ourstrong capital position, and our month-to-month improvement in net interestmargin during 2009 and the first half of 2010. Our projections include moderate balance sheet growth, maintenance ofliquidity levels, no branch expansion, the sale of our land in downtownGreenville, interest rate projections based on leading economic analyses, andthe maintenance of higher than historical charge-off and allowance for loanlosses levels.  We will continue toanalyze our deferred tax assets and related valuation allowance each quartertaking into account performance compared to forecast and current economic orinternal information that would impact forecasted earnings.

 

*Six months ended June 30, 2010 and 2009*

 

We incurred a net loss of $1,878,492, or $0.90 per diluted share, forthe six months ended June 30, 2010 compared to a net loss of $1,029,922,or $0.49 per diluted share, for the six months ended June 30, 2009, adifference of $848,570.  As describedbelow, the increase in net loss is primarily due to a decrease in income taxbenefit in addition to an increase in provision for loan losses.  Our noninterest expenses increased due towrite downs on other real estate owned and repossessed assets which more thanoffset an increase in net interest income, discussed in greater detail below.

 

The following table sets forth information related to ouraverage balance sheet, average yields on assets, and average costs ofliabilities for the six months ended June 30, 2010 and 2009.  We derived these yields by dividingannualized income or expense by the average balance of the corresponding assetsor liabilities.  We derived averagebalances from the daily balances throughout the periods indicated.  The net amount of capitalized loan fees areamortized into interest income on loans.

 
| ** **                                        | ** ** | **For the Six Months Ended June 30,** | ** **  |
|---------------------------------------------------|------------|--------------------------------------------|-------------|
| ** **                                        | ** ** | **2010**                                   | ** **  | **2009** | ** ** |
| ** **                                        | ** ** | **Average  Balance**                       | ** **  | **Income/  Expense** | ** ** | **Yield/  Rate** | ** ** | **Average  Balance** | ** ** | **Income/  Expense** | ** ** | **Yield/  Rate** | ** ** |
|                                              |       |                                       |        |   |   |   |   |   |   |   |   |   |   |
| Federal  funds sold and other                     |       | $                                          | 11,133,677  |   | $ | 25,703 |   | 0.47 | % | $ | 3,837,867 |   | $ | 15,268 |   | 0.80 | % |
| Investment  securities (1)                        |       | 8,079,066                                  |        | 128,450 |   | 3.21 |   | 4,190,933 |   | 92,163 |   | 4.43 |   |
| Loans (2)                                         |       | 104,060,141                                |        | 2,474,005 |   | 4.79 |   | 119,910,667 |   | 2,761,447 |   | 4.64 |   |
| Total  interest-earning assets                    |       | $                                          | 123,272,884 |   | $ | 2,628,158 |   | 4.30 | % | $ | 127,939,467 |   | $ | 2,868,878 |   | 4.52 | % |
|                                              |       |                                       |        |   |   |   |   |   |   |   |   |   |   |
| NOW  accounts                                     |       | $                                          | 5,312,321   |   | $ | 16,791 |   | 0.64 | % | $ | 5,440,580 |   | $ | 15,933 |   | 0.59 | % |
| Savings &  money market                  |       | 30,209,960                                 |        | 273,543 |   | 1.83 |   | 13,442,585 |   | 126,590 |   | 1.90 |   |
| Time  deposits (excluding brokered time deposits) |       | 29,702,446                                 |        | 316,770 |   | 2.15 |   | 30,520,516 |   | 509,228 |   | 3.36 |   |
| Brokered  time deposits                           |       | 36,480,478                                 |        | 496,025 |   | 2.74 |   | 47,473,266 |   | 786,260 |   | 3.34 |   |
| Total  interest-bearing deposits                  |       | 101,705,205                                |        | 1,103,129 |   | 2.19 |   | 96,876,947 |   | 1,438,011 |   | 2.99 |   |
| Borrowings                                        |       | 12,692,646                                 |        | 242,010 |   | 3.84 |   | 18,541,598 |   | 295,803 |   | 3.22 |   |
| Total  interest-bearing liabilities               |       | $                                          | 114,397,851 |   | $ | 1,345,139 |   | 2.37 | % | $ | 115,418,545 |   | $ | 1,733,814 |   | 3.03 | % |
|                                              |       |                                       |        |   |   |   |   |   |   |   |   |   |   |
| Net  interest spread                              |       |                                       |        |   |   | 1.93 | % |   |   |   |   | 1.49 | % |
| Net  interest income/ margin                      |       |                                       |        | $ | 1,283,019 |   | 2.10 | % |   |   | $ | 1,135,064 |   | 1.79 | % |

 

----

(1)                                  The averagebalances for investment securities exclude the unrealized gain recorded foravailable for sale securities.

(2)                                  Nonaccrualloans are included in average balances for yield computations.

 

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For the six months ended June 30, 2010, we recognized $2.6 millionin interest income and $1.3 million in interest expense, resulting in netinterest income of $1.3 million, an increase of $147,955, or 13%, over the sameperiod in 2009.  Average earning assetsdecreased to $123.3 million for the six months ended June 30, 2010 from$127.9 million for the six months ended June 30, 2009, a decrease of $4.7million, or 4%.  Average interest bearingliabilities decreased to $114.4 million for the six months ended June 30,2010 from $115.4 million for the six months ended June 30, 2009, adecrease of $1.0 million, or 1%.  Netinterest margin, calculated as annualized net interest income divided byaverage earning assets, increased from 1.79% for the six months ended June 30,2009 to 2.10% for the six months ended June 30, 2010, primarily due to adecrease in cost of interest-bearing liabilities from 3.03 % to 2.37% betweenperiods due to the mix of liabilities and the timing of their repricing.  This decrease was offset somewhat by adecrease in yield on earning assets from 4.52% to 4.30% between periods.

 

Provision for loan losses was $835,000 for the six months ended June 30,2010 representing an increase of $185,000, or 28%, compared to the expense of$650,000 for the six months ended June 30, 2009.  The increase in provision for loan losses isdue to the increase in impaired and non-accrual loans and their relatedspecific reserves in addition to an increase in the general allowanceallocation due to declining economic conditions and increased charge offlevels.  The provision for loan losses isdiscussed further below under “Provision and Allowance for Loan Losses.”

 

For the six months ended June 30, 2010, noninterest income was$112,414 compared to $108,575 for the six months ended June 30, 2009, anincrease of $3,839 between comparable periods. This small increase is mainly due to the fact that we recognized another than temporary impairment charge of $60,404 during the six months ended June 30,2009 which drove noninterest income down in 2009 compared to the six monthsended June 30, 2010.   This smallincrease also reflects increases in services charges on deposits and customerservice fees offset by a decrease of more than $80,000 in mortgage originationincome. Mortgage origination income decreased significantly during the currentyear due to the loss of an originator who was not replaced until later in thesecond quarter.   Noninterest income forthe six months ended June 30, 2010 and 2009 was derived from servicecharges on deposits, customer service fees, rental income, and mortgageorigination income.

 

During the current six months, we incurred noninterest expenses of $2.4million, compared to noninterest expenses of $2.1 million for the six monthsended June 30, 2009, an increase of $322,814, or 15%.  This increase of noninterest expenses for thesix month period ended June 30, 2010 primarily resulted from write downsof $374,159 on other real estate owned and repossessed assets discussed ingreater detail below.  Other expense alsoincreased $63,156 compared to the six months ended June 30, 2009,primarily due to increased expenses related to other real estate owned, such astaxes and maintenance. Occupancy and equipment expenses increased $18,726 forthe six months ended June 30, 2010 compared to the six months ended June 30,2009 due to the opening of the Simpsonville branch in February 2009, whichresulted in fewer number of months expense in 2009 compared to 2010.  These increases were offset by decreases inother expense categories.  Compensationand benefits decreased $73,696 due to a decrease in commissions on mortgageorigination fees as well as the discontinuation of our 401k match beginning April 1,2010. We have been focusing on expense control over the past year which hasresulted in small decreases in marketing and telephone and supplies.  We also renegotiated and renewed our dataprocessing contract in May 2009 resulting in decreased data processingexpenses.

 

20

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Income tax benefit for the six months ended June 30, 2010 was zerocompared to $492,550 for the six months ended June 30, 2009.  We analyzed whether a valuation allowanceshould be recorded against our deferred tax assets.  Accounting literature states that a deferredtax asset should be reduced by a valuation allowance if, based on the weight ofall available evidence, it is more likely than not (a likelihood of more than50%) that some portion or the entire deferred tax asset will not be realized.  The determination of whether a deferred taxasset is realizable is based on weighting all available evidence, includingboth positive and negative evidence. In making such judgments, significantweight is given to evidence that can be objectively verified.  During third quarter 2009, it became evidentthat the unprecedented economic conditions specifically affecting the bankingindustry had increased the uncertainty as to the timing of the expectedrecovery period of the industry as a whole. Although later than many areas of the United States, it also became moreevident that our local market and our Bank were affected by these deterioratingeconomic conditions.  These events led usto record a valuation allowance of 100% on all deferred tax assets generatedbeginning July 1, 2009 through June 30, 2010.  We have analyzed the existing deferred taxassets of $1.3 million, net of the valuation allowance, included in otherassets, and determined it is more likely than not that they will be recognizedin future years based on forecasted projected income in the near term, the factthat we had reached profitable operations prior to the economic decline, ourstrong capital position, and our month-to-month improvement in net interestmargin during 2009 and the first half of 2010. Our projections include moderate balance sheet growth, maintenance ofliquidity levels, no branch expansion, the sale of our land in downtownGreenville, interest rate projections based on leading economic analyses, andthe maintenance of higher than historical charge-off and allowance for loanlosses levels.  We will continue toanalyze our deferred tax assets and related valuation allowance each quartertaking into account performance compared to forecast and current economic orinternal information that would impact forecasted earnings.

 

**Assets and Liabilities**

 

*General*

 

Total assets as of June 30, 2010 were $132.6 million, representinga decrease of $2.7 million, or 2%, compared to December 31, 2009.  The decrease in assets is the result of $8.6 millionof net loan payoffs offset by increases in cash and cash equivalents of $5.6million and a $2.0 million increase in investment securities.  At June 30, 2010, our total assetsconsisted principally of $15.8 million in cash and due from banks, $10.2 millionin investment securities, $94.5 million in net loans, $3.7 million in propertyand equipment, and $3.9 million in other real estate owned and repossessedassets.  Our management closely monitorsand seeks to maintain appropriate levels of interest-earning assets andinterest-bearing liabilities so that maturities of assets are such thatadequate funds are provided to meet customer withdrawals and demand.

 

Liabilities at June 30, 2010 totaled $117.6 million, representinga decrease of $1.0 million, or 1%, compared to December 31, 2009, andconsisted principally of $107.4 million in deposits and $10.0 million inborrowings.  Our borrowings consisted ofFHLB advances and customer repurchase agreements.  At June 30, 2010, shareholders’ equitywas $15.0 million compared to $16.7 million at December 31, 2009. Thedecrease in shareholders’ equity was primarily due to the net loss of$1,878,492 for the six months ended June 30, 2010.

 

*Loans*

 

Since loans typically provide higher interest yields than other typesof interest-earning assets, we invest a substantial percentage of our earningassets in our loan portfolio.  At June 30,2010, our gross loan portfolio consisted primarily of $63.2 million ofcommercial real estate loans, $14.1 million of commercial business loans, and$19.5 million of consumer and home equity loans.  Our current loan portfolio composition is notmaterially different than the loan portfolio composition disclosed in thefootnotes to the consolidated financial statements included in our AnnualReport on Form 10-K for 2009 as filed with the SEC.  We experienced net payoffs of $8.6 millionduring the three months ended June 30, 2010 due to low market demand,careful consideration of liquidity needs and credit risk management.

 

21

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We discontinue accrual of interest on a loan when we conclude it isdoubtful that we will be able to collect interest from the borrower.  We reach this conclusion by taking intoaccount factors such as the borrower’s financial condition, economic andbusiness conditions, and the results of our previous collection efforts.  Generally, we place a delinquent loan innon-accrual status when the loan becomes 90 days or more past due.  When we place a loan in non-accrual status,we reverse all interest which has been accrued on the loan but remains unpaidand deduct this interest from earnings as a reduction of reported interestincome.  We do not accrue any additionalinterest on the loan balance until we conclude the collection of both principaland interest is reasonably certain. We had approximately $10.8 million and $6.7million in non-accrual loans at June 30, 2010 and December 31, 2009,respectively.  This increase betweenperiods is due to six new loans which were changed to non-accrual status duringthe six month period as a result of a review of these relationships, theirpayment history and the current economic environment.  However, we also successfully took possessionof the collateral of three loans that were non-accrual as of December 31,2009 as discussed below.  Non-accrualloans represented 11.1% of gross loans at June 30, 2010.  We continue to carefully monitor each ofthese loans and have established specific reserves as warranted based on areview of the underlying collateral of each loan as well as the financialcondition of each borrower.

 

At June 30, 2010, we had 9 loans totaling $10.3 million that wereconsidered impaired with specific reserves of approximately $713,000 allocatedin the allowance for loan losses.  TheCompany identifies impaired loans through its normal internal loan reviewprocess.  Impairment is measured on aloan-by-loan basis for commercial and construction loans by either the presentvalue of expected future cash flows discounted at the loan’s effective interestrate, the loan’s obtainable market price, or the fair value of the collateralif the loan is collateral dependent.  Theresultant shortfall is charged to provision for loan losses and is classifiedas specific reserves.  When an impairedloan is ultimately charged-off, the charge-off is taken against the specificreserve.  Impaired loans consisted of$10.3 million of loans secured by real estate and approximately $15,000 ofcommercial loans with other forms of collateral.  Loans which are deemed to be impaired arevalued on a nonrecurring basis at the lower of cost or market value of theunderlying collateral.  Such marketvalues are generally obtained using independent appraisals, updated inaccordance with our reappraisal policy, or other market data such as recentoffers to the borrower.  As of June 30,2010, we had loans totaling $2.5 million that were classified in accordancewith our loan rating policies but were not considered impaired.  Classified asset levels are considered indetermining management’s assessment of the adequacy of the allowance for loanlosses.

 

As of June 30 2010, we had loans totaling $4.3 million on thewatch list.  The watch list is the classification utilized by us when wehave an initial concern about the financial health of a borrower.  Theseloans are designated as such in order to be monitored more closely than othercredits in our portfolio.  We then gathercurrent financial information about the borrower and evaluate our current riskin the credit.  We will then either reclassify the loan as “substandard”or back to its original risk rating after a review of the information. There are times when we may leave the loan on the watch list, if, in management’sopinion, there are risks that cannot be fully evaluated without the passage oftime, and we determine to review the loan on a more regular basis.  Loanson the watch list are not considered “potential problem loans” until they aredetermined by management to be classified as substandard.

 

Loans past due 30-89 days amounted to $1.5 million at June 30,2010, compared to approximately $497,000 at December 31, 2009.  At June 30,2010, we did not have any loans past due greater than 90 days that were notalready placed in non-accrual status.

 

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*Provision and Allowance for Loan Losses*

 

We have established anallowance for loan losses through a provision for loan losses charged toexpense on our consolidated statement of operations.  The allowance for loan losses for the threeand six months ended June 30, 2010 and 2009 is presented below:

 
| ** **                                  | ** ** | **Three  Months Ended********June 30,** | ** ** | **Six Months  Ended********June 30,** | ** ** |
|---------------------------------------------|------------|----------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                  | ** ** | **2010**                                     | ** ** | **2009**                                   | ** ** | **2010** | ** ** | **2009** | ** ** |
| Balance at beginning of  the period         |       | $                                            | 1,985,293  |                                       | $          | 1,701,977 |   | $ | 1,847,513 |   | $ | 1,611,977 |   |
| Provision for loan losses                   |       | 735,000                                      |       | 560,000                                    |       | 835,000 |   | 650,000 |   |
| Loans charged-off                           |       | (597,837                                     | )          | —                                     |       | (600,057 | ) | — |   |
| Recoveries of loans  previously charged-off |       | —                                       |       | —                                     |       | 40,000 |   | — |   |
| Balance at end of the  period               |       | $                                            | 2,122,456  |                                       | $          | 2,261,977 |   | $ | 2,122,456 |   | $ | 2,261,977 |   |
| Net charge-offs to average  loans           |       | 2.36                                         | %          | —                                     | %          | 1.09 | % | — | % |

 

As of June 30, 2010, the allowance for loan losses was $2.1million, or 2.20% of gross loans, compared to $1.8 million, or 1.71% of grossloans, as of December 31, 2009 and $2.3 million, or 1.95% of gross loans,as of June 30, 2009.  Provision forloan losses was $735,000 for the three months ended June 30, 2010, anincrease of $175,000, or 31%, compared to the expense of $560,000 for the threemonths ended June 30, 2009.  For thesix months ended June 30, 2010, provision for loan losses was $835,000, anincrease of $185,000, or 28%, over the six months ended June 30,2009.  During the three months ended June 30,2010, we charged off $597,837 related to two relationships.  Of these charge-offs, $350,000 was anunsecured commercial loan which had no prior signs of deterioration.  The remaining $247,837 was due to a recentappraisal and evaluation on a commercial real estate loan in the process offoreclosure.

 

The increase in the allowance for loan losses is a result, inlarge part, of the general conditions of the current economic climate,including, among other things, a rise in unemployment, which affects borrowers’ability to repay, and the decrease in values in the real estate market, which affectsthe value of collateral securing certain loans with the Bank.  The allowance for loan losses represents anamount which we believe will be adequate to absorb probable losses on existingloans that may become uncollectible.  Westrive to follow a comprehensive, well-documented, and consistently appliedanalysis of our loan portfolio in determining an appropriate level for theallowance for loan losses.  Our judgmentas to the adequacy of the allowance for loan losses is based on a number ofassumptions about future events, which we believe to be reasonable, but whichmay or may not prove to be accurate.  Ourdetermination of the allowance for loan losses is based on what we believe areall significant factors that impact the collectability of loans, includingconsideration of factors such as the balance of impaired loans, the quality,mix, and size of our overall loan portfolio, economic conditions that mayaffect the borrower’s ability to repay, the amount and quality of collateralsecuring the loans, our historical loan loss experience, and a review ofspecific problem loans.  We also considersubjective issues such as changes in lending policies and procedures, changesin the local/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.  Due to our limited operating history, to datethe provision for loan losses has been made primarily as a result of ourassessment of general loan loss risk compared to banks of similar size andmaturity.  Due to our short operatinghistory, the loans in our loan portfolio and our lending relationships are ofrecent origin.  In general, loans do notbegin to show signs of credit deterioration or default until they have beenoutstanding for some period of time, a process known as seasoning.  As a result, a portfolio of older loans willusually behave more predictably than a newer portfolio.  Because our loan portfolio is new, thecurrent level of delinquencies and defaults may not be representative of thelevel that will prevail when the portfolio becomes more seasoned, which may behigher than current levels.   Ifdelinquencies and defaults increase, we may be required to increase ourprovision for loan losses, which would adversely affect our results ofoperations and financial condition. Periodically, we will adjust the amount of the allowance based onchanging circumstances.  We will chargerecognized losses to the allowance and add subsequent recoveries back to theallowance for loan losses.  There can beno assurance that charge-offs of loans in future periods will not exceed theallowance for loan losses as estimated at any point in time or that provisionsfor loan losses will not be significant to a particular accounting period.

 

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The downturn in the real estate market over the past 30months has resulted in increased loan delinquencies, defaults and foreclosures,primarily in our commercial real estate portfolio.  In some cases, thisdownturn has resulted in a significant impairment to the value of ourcollateral and our ability to sell the collateral upon foreclosure, and thereis a risk that this trend will continue.  The real estate collateral ineach case provides an alternate source of repayment in the event of default bythe borrower and may deteriorate in value during the time the credit isextended.  If real estate values continue to decline, it is also morelikely that we would be required to increase our allowance for loanlosses.  This downturn in the real estate market has resulted in anincrease in our nonperforming loans, and there is a risk that this trend willcontinue, which could result in additional losses of earnings and increases inour provision for loan losses and loans charged-offs.

 

*Other Real Estate Owned and Repossessed Assets*

 

As of June 30, 2010 we had $3.8 million in other real estate ownedand $63,458 in repossessed assets.  Otherreal estate owned consists of approximately $717,000 of residential properties,$3.0 million of land and $124,000 of commercial office space.  Repossessed assets consists ofequipment.  Charge-offs of $205,297 weretaken on these relationships at the time of transfer to other real estate ownedand repossessed assets as a result of a decline in the approximate fair valuesof the collateral based on current market information.   During the three and six months ended June 30,2010, based on new market information, $142,104 and $374,159, respectively, wascharged to expense to write down the value of other real estate owned andrepossessed assets.  Repossessed assetsof $332,908 were sold during the six months ended June 30, 2010 at zerogain or loss as these assets had been written down to market value earlier inthe period based on new market information.

 

*Deposits*

 

Our primary source of funds for loans and investments is ourdeposits.  At June 30, 2010, we had$107.4 million in deposits, representing an increase of $3.1million, or 3%,compared to December 31, 2009. Deposits at June 30, 2010 consisted primarily of $12.2 million indemand deposit accounts, $34.5 million in money market accounts and $60.5million in time deposits.  During thefourth quarter of 2006, we began obtaining deposits outside of our local marketarea in the form of brokered time deposits. Due to the interest rate environment in our market, as well as strongcompetition from other banking and financial services companies in gatheringdeposits, brokered time deposits allow us to obtain funding in order to supportloan growth.  At June 30, 2010, wehad $31.4 million in brokered time deposits, a decrease of approximately $7.6million, or 19%, compared to December 31, 2009.  Our strong customer deposit growth during2010 has enabled us to maintain a strong liquidity position while decreasingour reliance on brokered deposits, thereby lowering our cost of interest-bearing liabilities. We will continue to reduce our reliance on brokered timedeposits and other noncore funding sources, while focusing our efforts togather core deposits in our local market.

 

*Borrowings*

 

We use borrowings to fund growth of earning assets in excess of depositgrowth.  Borrowings totaled $10.0 millionat June 30, 2010, compared to $14.2 million at December 31,2009.  FHLB advances accounted for $10.0million of total borrowings, a decrease of $4.0 million, or 29%, compared to December 31,2009.  These advances are secured withapproximately $32.9 million of first and second mortgage loans and $1.1 millionof stock in the FHLB.  The remaining balance in borrowings representscustomer repurchase agreements.

 

**Liquidity**

 

Liquidity  is the ability  to  meet current  and  future obligations  through liquidationor maturity of existing  assets or theacquisition of  liabilities.  We manage both assets and liabilities toachieve appropriate levels of liquidity. Cash and short-term investments are our primary sources of assetliquidity.  These funds provide a cushionagainst short-term fluctuations in cash flow from both deposits and loans.  The investment portfolio is our principalsource of secondary asset liquidity. However, the availability of this source of funds is influenced bymarket conditions and pledging agreements. Individual and commercial deposits, brokered deposits and borrowings areour primary source of funds for credit activities.  As brokered deposits or advances mature in2010, we intend to replace these funds with new brokered deposits or advancesto the extent necessary after considering core deposit growth, although overallwe will seek to reduce our reliance on brokered time deposits and other noncorefunding sources.

 

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Weare a member of the Federal Home Loan Bank of Atlanta, from which applicationsfor borrowings can be made for leverage purposes, if so desired, in an amountup to 20% of the total assets of the Bank, assuming that the Bank’s investmentin FHLB stock, as well as qualifying mortgages or investment securities, wouldbe available to secure any future borrowings. We also pledge collateral to the Federal Reserve Bank’sBorrower-in-Custody of Collateral program, and our available credit under thisprogram was approximately $8.9 million as of June 30, 2010.  We have federal funds purchased lines ofcredit through two correspondent banks totaling $5.0 million.

 

Webelieve our liquidity sources are adequate to meet our operating needs. Thelevel of liquidity is measured by the cash, cash equivalents, and investmentsecurities available for sale to total assets ratio, which was at 19.64% at June 30,2010 compared to 13.60% as of December 31, 2009.  The increase in liquidity is due to anincrease in deposits of $3.1 million as well as net loan payoffs of $8.6million during the six months ended June 30, 2010.  These cash increases were offset by thepayoff of $4.0 million in FHLB advances and purchases of $3.0 million ininvestment securities. We continue to carefully focus on liquidity managementduring 2010.  We plan to continuereducing brokered time deposits as cash balances, retail deposit growth andoperating needs allow.

 

**Impact of Off-Balance Sheet Instruments**

 

Through the operations of our Bank, we have made contractualcommitments to extend credit in the ordinary course of our businessactivities.  These commitments arelegally binding agreements to lend money to our customers at predeterminedinterest rates for a specified period of time. At June 30, 2010, we hadissued commitments to extend credit of $11.4 million through various types oflending arrangements.  We evaluate eachcustomer’s credit worthiness on a case-by-case basis. The amount of collateralobtained, if deemed necessary by us upon extension of credit, is based on ourcredit evaluation of the borrower. Collateral varies but may include accounts receivable, inventory,property, plant and equipment, and commercial and residential real estate.  We manage the credit risk on thesecommitments by subjecting them to normal underwriting and risk managementprocesses.

 

**Commitments and Contingencies**

 

As of June 30, 2010, there were no significant firm commitmentsoutstanding for capital expenditures.

 

**Capital Resources**

 

Total shareholders’ equity decreased to $15.0 million at June 30,2010 from $16.7 million at December 31, 2009, primarily due to our netloss for the six months of $1,878,492. Webelieve that our capital is sufficient to fund the activities of our Bank’soperations and that the rate of net losses will not deteriorate our capital basebelow required regulatory levels. Nevertheless, we are not immune to theunprecedented levels of extended volatility and disruption in thecapital and credit markets and can give no assurances with respect to ourcapital levels.

 

Our Bank and Company are subject to various regulatory capitalrequirements administered by the federal banking agencies.  However, the Federal Reserve guidelinescontain an exemption from the capital requirements for “small bank holdingcompanies,” which in 2006 were amended to cover most bank holding companieswith less than $500 million in total assets that do not have a material amountof debt or equity securities outstanding registered with the SEC.  Although our class of common stock isregistered under Section 12 of the Securities Exchange Act, we believethat because our stock is not listed on any exchange or otherwise activelytraded, the Federal Reserve Board will interpret its new guidelines to meanthat we qualify as a small bank holding company.  Nevertheless, our Bank remains subject tothese capital requirements.  Failure tomeet minimum capital requirements can initiate certain mandatory and possiblyadditional discretionary actions by regulators that, if undertaken, could havea direct material effect on the Bank’s financial statements.  Under capital adequacy guidelines and theregulatory framework for prompt corrective action, the Bank must meet specificcapital guidelines that involve quantitative measures of the Bank’s assets,liabilities, and certain off-balance-sheet items as calculated under regulatoryaccounting practices.  The Bank’s capitalamounts and classifications are also subject to qualitative judgments by theregulators about components, risk weightings, and other factors.

 

Quantitative  measures  established by  regulation to ensure  capital adequacy require the Bank to maintain minimum  ratios of Tier 1 andtotal  capital as a percentage of assetsand off-balance-sheet exposures, adjusted for risk weights ranging from  0% to  100%. Tier 1  capital  of the Bank  consists  of common shareholders’  equity,  excluding the  unrealized  gain or loss on  securities available forsale,  less certain intangibleassets.  The Bank’s Tier 2 capitalconsists of the allowance for loan losses subject to certain limitations.  Total capital for purposes of computing thecapital ratios consists of the sum of Tier 1 and Tier 2 capital.  The regulatory minimum requirements are 4% forTier 1 capital and 8% for total risk-based capital.

 

25

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The Bank is also  required  to maintain  capital  at a minimum level  based on quarterly  average assets,  which  is known as the leverage ratio.  Onlythe strongest banks are allowed to maintain capital at the minimum requirementof 3%.  All others are subject tomaintaining ratios 1% to 2% above the minimum. The Bank exceeded its minimum regulatory capital ratios as of June 30,2010, as well as the ratios to be considered “well capitalized.”

 

On January 20, 2010, the Bank entered into the Formal Agreementwith its primary regulator, the OCC.  TheFormal Agreement seeks to enhance the Bank’s existing practices and proceduresin the areas of management oversight, strategic and capital planning, creditrisk management, credit underwriting, liquidity, and funds management.

 

In response, the Bank has formed a Compliance Committee of its Board ofDirectors to oversee management’s response to all sections of the FormalAgreement.  The Compliance Committee alsomonitors adherence to deadlines for submission to the OCC of informationrequired under the Formal Agreement.  TheBoard of Directors and management of the Bank have been aggressively working toaddress the findings of the exam and will continue to work to comply with allthe requirements of the Formal Agreement. For additional information on the Formal Agreement, including actionsthe Bank has taken in response to the Formal Agreement, see “Management’sDiscussion and Analysis — Recent Regulatory Developments.”

 

In addition, the OCC has established Individual Minimum Capital Ratiolevels of Tier 1 and total capital for the Bank that are higher than theminimum and “well capitalized” ratios applicable to all banks.  The Bank must maintain total risk-basedcapital of at least 12%, Tier 1 capital of at least 10%, and a leverage ratioof at least 9%.  If we fail to maintainthese required capital levels, the OCC may deem noncompliance to be an unsafeand unsound banking practice which may make the Bank subject to a capitaldirective, a consent order, or such other administrative actions or sanctionsas the OCC considers necessary.  It isuncertain what actions, if any, the OCC would take with respect tononcompliance with these ratios, what action steps the OCC might require the Bankto take to remedy this situation, and whether such actions would be successful.

 

The following table summarizes the capital amounts and ratios of theBank and the regulatory minimum requirements at June 30, 2010 and December 31,2009. 

 
|                                     |       | ** ** |       | ** **  |   | ** **             |   | ** **            |   | ** **                  |   | ** ** |      | **To be well capitalized** |   |
|------------------------------------------|------------|------------|------------|-------------|--------|------------------------|--------|-----------------------|--------|-----------------------------|--------|------------|-----------|----------------------------|--------|
|                                     |       | ** ** |       | ** **  |   | **Individual Minimum** |   | **For capital**       |   | **under prompt corrective** |   |
|                                     |       | ** ** |       | ** **  |   | **Capital Ratio**      |   | **adequacy purposes** |   | **action provisions**       |   |
|                                     |       | **Actual** |       | **Minimum** |   | **Minimum**            |   | **Minimum**           |   |
|                                     |       | **Amount** |       | **Ratio**   |   | **Amount**             |   | **Ratio**             |   | **Amount**                  |   | **Ratio**  |      | **Amount**                 |   | **Ratio** |   |
|                                     |       |       |       |        |   |                   |   |                  |   |                        |   |       |      |                       |   |   |   |
| **As of June 30, 2010**             |       |       |       |        |   |                   |   |                  |   |                        |   |       |      |                       |   |   |   |
| Total Capital (to risk weighted assets)  |       | $          | 13,745,000 |        | 12.8   | %                      | $      | 12,895,000            |   | 12.0                        | %      | $          | 8,597,000 |                       | 8.0    | % | $ | 10,746,000 |   | 10.0 | % |
| Tier 1 Capital (to risk weighted assets) |       | 12,392,000 |       | 11.5        |   | 10,746,000             |   | 10.0                  |   | 4,298,000                   |   | 4.0        |      | 6,448,000                  |   | 6.0 |   |
| Tier 1 Capital (to average assets)       |       | 12,392,000 |       | 9.2         |   | 12,128,000             |   | 9.0                   |   | 5,390,000                   |   | 4.0        |      | 6,738,000                  |   | 5.0 |   |
|                                     |       |       |       |        |   |                   |   |                  |   |                        |   |       |      |                       |   |   |   |
| **As of December 31, 2009**         | ** ** | ** ** |       |        |   |                   |   |                  |   |                        |   |       |      |                       |   |   |   |
| Total Capital (to risk weighted assets)  |       | $          | 14,712,000 |        | 12.7   | %                      | $      | 13,864,000            |   | 12.0                        | %      | $          | 9,243,000 |                       | 8.0    | % | $ | 11,553,000 |   | 10.0 | % |
| Tier 1 Capital (to risk weighted assets) |       | 13,263,000 |       | 11.5        |   | 11,553,000             |   | 10.0                  |   | 4,621,000                   |   | 4.0        |      | 6,932,000                  |   | 6.0 |   |
| Tier 1 Capital (to average assets)       |       | 13,263,000 |       | 9.9         |   | 12,013,000             |   | 9.0                   |   | 5,339,000                   |   | 4.0        |      | 6,674,000                  |   | 5.0 |   |

 

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

 

Not applicable

 

**Item 4. Controls and Procedures**

 

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

 

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

 

**Part II - Other Information**

 

**Item 1. Legal Proceedings**

 

Thereare no material pending legal proceedings to which we are a party or of whichany of our properties are the subject.

 

**Item 1A. Risk Factors**

 

Not applicable

 

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

 

Not applicable

 

**Item 3. Default UponSenior Securities**

 

Not applicable

 

**Item 4.****  [Removed and Reserved.]**

 

**Item 5. Other Information**

 

Not applicable

 

**Item 6. Exhibits**

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

 

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**SIGNATURES**

 

Pursuant to the requirementsof the Securities Exchange Act of 1934, the registrant caused this report to besigned on its behalf by the undersigned thereunto duly authorized.

 

 
| Date: August 9, 2010 | By:                                                                  | /s/ Lawrence R. Miller |
|---------------------------|----------------------------------------------------------------------|------------------------|
|                      | Lawrence R. Miller                                                   |
|                      | Chief Executive Officer (Principal Executive Officer)                |
|                      |                                                                 |                   |
| Date: August 9, 2010 | By:                                                                  | /s/ Katie N. Tuttle    |
|                      | Katie N. Tuttle                                                      |
|                      | Chief Financial Officer (Principal Accounting and Financial Officer) |

 

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**EXHIBIT INDEX**

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

 

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