**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 

**(MARKONE)**

 

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

 

**For the Quarterly Period ended March 31, 2010**

 

**OR**

 

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

 

**For the Transition Period from                  to                  **

 

**Commission File No. 000-51907**

 

**INDEPENDENCEBANCSHARES, INC.**

(Exact name ofregistrant as specified 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 296****01**

(Address of principal executive offices)

 

**(864) 672-1776**

(Registrant’s telephone number, including area code)

 

----

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days. Yes  x  No  o

 

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

 

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

 

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

 

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

 

Indicatethe number of shares outstanding of each of the issuer’s classes of commonstock, as of the latest practicable date:

 

2,085,010 shares of common stock, $.01 par value per share, were issuedand outstanding as of May 7, 2010.

 

 

 

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**Independence Bancshares, Inc.**

 

**Part I - Financial Information**

 

## **Item 1. Financial Statements**

## ** **

**Consolidated Balance Sheets**

** **
| ** **                                                                                                     | ** ** | **March 31, 2010** | ** **  | **December 31, 2009** | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|-------------------------|-------------|----------------------------|------------|
| ** **                                                                                                     | ** ** | **(unaudited)**         | ** **  | **(audited)**              | ** ** |
| **Assets**                                                                                                     | ** ** | ** **              | ** **  | ** **                 | ** ** |
| Cash and due from banks                                                                                        |       | $                       | 6,549,050   |                       | $          | 4,929,360 |   |
| Federal funds sold                                                                                             |       | 10,240,000              |        | 5,295,000                  |       |
| Investment securities available for sale                                                                       |       | 7,480,458               |        | 8,171,648                  |       |
| Non-marketable equity securities                                                                               |       | 1,546,100               |        | 1,546,100                  |       |
| Loans, net of allowance for loan losses of $1,985,293 and  $1,847,513, respectively                            |       | 103,340,743             |        | 106,129,956                |       |
| Accrued interest receivable                                                                                    |       | 361,537                 |        | 401,386                    |       |
| Property and equipment, net                                                                                    |       | 3,732,824               |        | 3,771,983                  |       |
| Other real estate owned and repossessed assets                                                                 |       | 1,878,860               |        | 2,411,890                  |       |
| Other assets                                                                                                   |       | 2,595,146               |        | 2,653,876                  |       |
|                                                                                                           |       |                    |        |                       |       |
| Total assets                                                                                                   |       | $                       | 137,724,718 |                       | $          | 135,311,199 |   |
|                                                                                                           |       |                    | ** **  | ** **                 | ** ** |
| **Liabilities**                                                                                                | ** ** | ** **              |        |                       |       |
| Deposits:                                                                                                      |       |                    |        |                       |       |
| Noninterest bearing                                                                                            |       | $                       | 4,808,023   |                       | $          | 5,243,210 |   |
| Interest bearing                                                                                               |       | 104,624,730             |        | 99,032,246                 |       |
|                                                                                                           |       |                    |        |                       |       |
| Total deposits                                                                                                 |       | 109,432,753             |        | 104,275,456                |       |
|                                                                                                           |       |                    |        |                       |       |
| Borrowings                                                                                                     |       | 12,054,094              |        | 14,157,992                 |       |
| Accrued interest payable                                                                                       |       | 68,840                  |        | 97,269                     |       |
| Accounts payable and accrued expenses                                                                          |       | 92,519                  |        | 93,615                     |       |
|                                                                                                           |       |                    |        |                       |       |
| Total liabilities                                                                                              |       | 121,648,206             |        | 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                                                                                     |       | 21,034,635              |        | 20,997,135                 |       |
| Accumulated other comprehensive income                                                                         |       | 4,938                   |        | 23,052                     |       |
| Accumulated deficit                                                                                            |       | (4,983,911              | )           | (4,354,170                 | )          |
|                                                                                                           |       |                    |        |                       |       |
| Total shareholders’ equity                                                                                |       | 16,076,512              |        | 16,686,867                 |       |
|                                                                                                           |       |                    |        |                       |       |
| Total liabilities and shareholders’ equity                                                                |       | $                       | 137,724,718 |                       | $          | 135,311,199 |   |

 

**The accompanying notes arean integral part of these consolidated financial statements.**

 

2

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**Independence Bancshares, Inc.**

 

**Consolidated Statements ofOperations**

**(unaudited)**

 
| ** **                                                               | ** ** | **Three Months Ended  March 31,** | ** ** |
|--------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                               | ** ** | **2010**                               | ** ** | **2009** | ** ** |
| **Interest income**                                                      |       |                                   |       |   |   |
| Loans                                                                    |       | $                                      | 1,273,279  |   | $ | 1,397,971 |   |
| Investment  securities                                                   |       | 63,490                                 |       | 47,166 |   |
| Federal  funds sold and other                                            |       | 11,085                                 |       | 7,565 |   |
| Total  interest income                                                   |       | 1,347,854                              |       | 1,452,702 |   |
|                                                                     |       |                                   |       |   |   |
| **Interest expense**                                                     |       |                                   |       |   |   |
| Deposits                                                                 |       | 563,094                                |       | 749,972 |   |
| Borrowings                                                               |       | 132,011                                |       | 148,309 |   |
| Total  interest expense                                                  |       | 695,105                                |       | 898,281 |   |
|                                                                     |       |                                   |       |   |   |
| Net  interest income                                                     |       | 652,749                                |       | 554,421 |   |
|                                                                     |       |                                   |       |   |   |
| Provision  for loan losses                                               |       | 100,000                                |       | 90,000 |   |
|                                                                     |       |                                   |       |   |   |
| Net  interest income after provision for loan losses                     |       | 552,749                                |       | 464,421 |   |
|                                                                     |       |                                   |       |   |   |
| **Noninterest income**                                                   |       | 72,025                                 |       | 8,724 |   |
|                                                                     |       |                                   |       |   |   |
| **Noninterest expenses**                                                 |       |                                   |       |   |   |
| Compensation  and benefits                                               |       | 527,480                                |       | 535,681 |   |
| Write-downs  on real estate owned and repossessed assets                 |       | 232,055                                |       | — |   |
| Occupancy  and equipment                                                 |       | 147,959                                |       | 128,186 |   |
| Insurance                                                                |       | 113,364                                |       | 88,918 |   |
| Data  processing and related costs                                       |       | 73,799                                 |       | 87,233 |   |
| Professional  fees                                                       |       | 63,050                                 |       | 65,068 |   |
| Marketing                                                                |       | 25,131                                 |       | 33,370 |   |
| Telephone  and supplies                                                  |       | 18,131                                 |       | 22,254 |   |
| Other                                                                    |       | 53,546                                 |       | 32,930 |   |
| Total  noninterest expenses                                              |       | 1,254,515                              |       | 993,640 |   |
|                                                                     |       |                                   |       |   |   |
| Loss  before income tax benefit                                          |       | (629,741                               | )          | (520,495 | ) |
|                                                                     |       |                                   |       |   |   |
| **Income tax benefit**                                                   |       | —                                 |       | 151,850 |   |
|                                                                     |       |                                   |       |   |   |
| Net  loss                                                                |       | $                                      | (629,741   | ) | $ | (368,645 | ) |
|                                                                     |       |                                   |       |   |   |
| **Loss per common share — basic and diluted**                       |       | $                                      | (0.30      | ) | $ | (0.18 | ) |
| ** **                                                               |       |                                   |       |   |   |
| **Weighted average common shares outstanding — basic  and diluted** |       | 2,085,010                              |       | 2,085,010 |   |

 

**The accompanying notes arean integral part of these consolidated financial statements.**

 

3

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**Independence Bancshares, Inc.**

 

**Consolidated Statements of Changes**

**In Shareholders’ Equity and Comprehensive Income(Loss)**

# **(unaudited)**

 
| ** **                                                               | ** ** | **Common stock** | ** ** | **Additional** | ** ** | **Accumulated  other  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                   |       | —           |       | —         |       | 43,487                                |       | —          |       | —      |       | 43,487 |   |
| Net  loss                                                                |       | —           |       | —         |       | —                                |       | —          |       | (368,645    | )          | (368,645 | ) |
| Unrealized  gain on investment securities available for sale, net of tax |       | —           |       | —         |       | —                                |       | 5,859           |       | —      |       | 5,859 |   |
| Total  comprehensive loss                                                |       | —           |       | —         |       | —                                |       | —          |       | —      |       | (362,786 | ) |
| **March 31, 2009**                                                  |       | 2,085,010        |       | $              | 20,850     |                                  | $          | 20,883,735      |       | $           | 46,574     |   | $ | (2,561,726 | ) | $ | 18,389,433 |   |
|                                                                     |       |             |       |           |       |                                  |       |            |       |        |       |   |   |
| **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                   |       | —           |       | —         |       | 37,500                                |       | —          |       | —      |       | 37,500 |   |
| Net  loss                                                                |       | —           |       | —         |       | —                                |       | —          |       | (629,741    | )          | (629,741 | ) |
| Unrealized  gain on investment securities available for sale, net of tax |       | —           |       | —         |       | —                                |       | (18,114         | )          | —      |       | (18,114 | ) |
| Total  comprehensive loss                                                |       | —           |       | —         |       | —                                |       | —          |       | —      |       | (647,855 | ) |
| **March 31, 2010**                                                  |       | 2,085,010        |       | $              | 20,850     |                                  | $          | 21,034,635      |       | $           | 4,938      |   | $ | (4,983,911 | ) | $ | 16,076,512 |   |

 

**The accompanying notes arean integral part of these consolidated financial statements.**

 

4

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**Independence Bancshares, Inc.**

 

**Consolidated Statements of Cash Flows**

**(unaudited)**

 
| ** **                                                              | ** ** | **Three Months Ended  March 31,** | ** ** |
|-------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                              | ** ** | **2010**                               | ** ** | **2009** | ** ** |
| **Operating activities**                                                |       |                                   |       |   |   |
| Net  loss                                                               |       | $                                      | (629,741   | ) | $ | (368,645 | ) |
| Adjustments  to reconcile net loss to cash used in operating activities |       |                                   |       |   |   |
| Provision  for loan losses                                              |       | 100,000                                |       | 90,000 |   |
| Depreciation                                                            |       | 50,148                                 |       | 36,180 |   |
| Amortization  of investment securities discounts, net                   |       | 15,555                                 |       | 538 |   |
| Compensation  expense related to stock options granted                  |       | 37,500                                 |       | 43,487 |   |
| Other-than-temporary  impairment on non-marketable equity securities    |       | —                                 |       | 60,404 |   |
| Write  downs of real estate owned and repossessed assets                |       | 232,055                                |       | — |   |
| (Increase)  decrease in other assets, net                               |       | 90,941                                 |       | (223,145 | ) |
| Increase  (decrease) in other liabilities, net                          |       | (29,525                                | )          | 193 |   |
| Net  cash used in operating activities                                  |       | (133,067                               | )          | (360,988 | ) |
|                                                                    |       |                                   |       |   |   |
| **Investing activities**                                                |       |                                   |       |   |   |
| Repayments  of loans, net                                               |       | 2,689,213                              |       | 4,529,188 |   |
| Purchase  of investment securities available for sale                   |       | —                                 |       | (1,000,000 | ) |
| Maturity  of investment securities available for sale                   |       | —                                 |       | 1,000,000 |   |
| Repayments  of investment securities available for sale                 |       | 648,189                                |       | 156,172 |   |
| Purchase  of non-marketable equity securities, net                      |       | —                                 |       | (47,500 | ) |
| Purchase  of property and equipment, net                                |       | (10,989                                | )          | (453,322 | ) |
| Sale  of repossessed assets                                             |       | 317,945                                |       | — |   |
| Net  cash provided by investing activities                              |       | 3,644,358                              |       | 4,184,538 |   |
|                                                                    |       |                                   |       |   |   |
| **Financing activities**                                                |       |                                   |       |   |   |
| Increase  in deposits, net                                              |       | 5,157,297                              |       | 3,658,092 |   |
| Increase  (decrease) in borrowings                                      |       | (2,103,898                             | )          | 117,518 |   |
| Net  cash provided by financing activities                              |       | 3,053,399                              |       | 3,775,610 |   |
|                                                                    |       |                                   |       |   |   |
| **Net increase in cash and cash equivalents**                           |       | 6,564,690                              |       | 7,599,160 |   |
|                                                                    |       |                                   |       |   |   |
| **Cash and cash equivalents at beginning of the  period**               |       | 10,224,360                             |       | 4,117,886 |   |
|                                                                    |       |                                   |       |   |   |
| **Cash and cash equivalents at end of the period**                      |       | $                                      | 16,789,050 |   | $ | 11,717,046 |   |
|                                                                    |       |                                   |       |   |   |
| **Supplemental information:**                                           |       |                                   |       |   |   |
| **Cash paid for**                                                       |       |                                   |       |   |   |
| Interest                                                                |       | $                                      | 723,534    |   | $ | 903,276 |   |
| **Schedule of non-cash transactions**                                   |       |                                   |       |   |   |
| Change in unrealized gain on securities, net of tax                     |       | $                                      | (18,114    | ) | $ | 5,859 |   |

 

**The accompanying notes arean integral part of these consolidated financial statements.**

 

5

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**Notes to Unaudited Consolidated FinancialStatements**

 

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

###### ** **

***IndependenceBancshares, Inc.*** (the “Company”) is a South Carolina corporation organized to operateas a bank holding company pursuant to the Federal Bank Holding Company Act of1956 and the South Carolina Bank Holding Company Act, and to own and controlall of the capital stock of Independence National Bank (the “Bank”).  The Bank is a national association organizedunder the laws of the United States to conduct general banking business inGreenville, South Carolina.

 

**Basis of Presentation**

 

The accompanying unaudited consolidated financialstatements have been prepared in accordance with accounting principlesgenerally accepted in the United States of America for interim financialinformation 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 month period ended March 31, 2010are not necessarily indicative of the results that may be expected for the yearending 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 theSecurities and Exchange Commission.

 

**Subsequent Events**

 

### **Subsequentevents are events or transactions that occur after the balance sheet date butbefore financial statements are issued. Recognized subsequent events are eventsor transactions that provide additional evidence about conditions that existedat the date of the balance sheet, including the estimates inherent in theprocess of preparing financial statements. Non-recognized subsequent events are events that provide evidence aboutconditions that did not exist at the date of the balance sheet but arose afterthat date. Management performed an evaluation to determine whether or not therehave been any subsequent events since the balance sheet date, and concludedthat no subsequent events occurred requiring accrual or disclosure.**

### ** **

**Recent Regulatory Developments**

 

### **On January 20,2010, the Bank entered into a Formal Agreement with its primary regulator, theOCC (the “Formal Agreement”). The Formal Agreement seeks to enhance the Bank’sexisting 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.  We must maintain total risk-based capital ofat least 12%, Tier 1 capital of at least 10%, and a leverage ratio of at least9%.  The Board of Directors andmanagement of the Bank have been aggressively working to address the findingsof the exam and will continue to work to comply with all the requirements ofthe Formal Agreement.  See “Management’sDiscussion and Analysis — Results of Operations — Capital Resources” for morediscussion.**

### ** **

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

 

A summary of significantaccounting policies is included in our Annual Report on Form 10-K filedwith the Securities and Exchange Commission for the year ended December 31,2009.  For further information, refer to the consolidated financialstatements and footnotes thereto included in our Annual Report on Form 10-Kfor 2009 as filed with the Securities and Exchange Commission.  Accountingstandards that have been issued or proposed by the Financial AccountingStandards Board that do not require adoption until a future date are notexpected to have a material impact on the consolidated financial statementsupon adoption.

 

**Cash and Cash Equivalents**- For purposes ofreporting cash flows, cashand cash equivalents include cash, amounts due from banks and federal fundssold.  Generally, federal funds are soldfor one-day periods.

 

6

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**Loss per Share** - Basic loss per share represents net loss divided by the weighted-average number of common shares outstanding during the period.  Dilutive loss per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued.  Potential common shares that may be issued by the Company relate to outstanding stock options and warrants, and are determined using the treasury stock method.  For the three month periods ended March 31, 2010 and 2009, as a result of the Company’s net loss, all of the potential common shares were considered anti-dilutive.

 

**Fair Value Measurements -**The Company applies the provisions of FASB ASC Topic 820, “Fair Value Measurements and Disclosures” (“ASC Topic 820”), which provides a framework for measuring and disclosing fair value under generally accepted accounting principles.  ASC Topic 820 requires disclosures about the fair value of assets and liabilities recognized 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 (for example, impaired loans).

 

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

 

The Company is predominantly an asset-based lender with real estate serving as collateral on approximately 84% of loans.  Loans which are deemed to be impaired are valued on a nonrecurring basis at the lower of cost or market value of the underlying collateral.  Such market values are generally obtained using independent appraisals or other market data, which the Company considers to be level 2 inputs (other observable inputs).  The aggregate carrying amount, net of specific reserves, of impaired loans at March 31, 2010 was $10.4 million.

 

Available-for-sale investment securities ($7,480,458 at March 31, 2010) are the only assets whose fair values are measured on a recurring basis using Level 2 inputs (other observable inputs).

 

Other real estate owned and repossessed assets, consisting of properties or other collateral obtained through foreclosure or in satisfaction of loans, are carried at fair value.  Market values are generally obtained using independent appraisals or other current market information, including but not limited to offers received on the property, which the Company considers to be level 2 inputs (other observable inputs).  The carrying amount of other real estate owned and repossessed assets at March 31, 2010 was $1,878,860.

 

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

 

FASB ASC Topic 825, “FinancialInstruments” requires disclosure of fair value information, whether or notrecognized in the consolidated balance sheets, when it is practical to estimatethe fair value.  FASB ASC Topic 825defines a financial instrument as cash, evidence of an ownership interest in anentity or contractual obligations which require the exchange of cash or otherfinancial instruments.  Certain items arespecifically excluded from the disclosure requirements, including the Company’scommon stock, property and equipment and other assets and liabilities.

 

Fair value approximatescarrying value for the following financial instruments due to the short-termnature of the instrument:  cash and duefrom banks, federal funds sold, and securities sold under agreements torepurchase.

 

Investmentsecurities are valued using quoted market prices.

 

No ready market exists for non-marketable equity securities, and theyhave no quoted market value.  However,redemption of 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 isbased on the discounted present value of the estimated future cash flows.  Discount rates used in these computationsapproximate the rates currently offered for similar loans of comparable termsand credit quality.

 

7

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Fair value for demanddeposit accounts and interest bearing accounts with no fixed maturity date isequal to the carrying value.  The fairvalue of certificate of deposit accounts are estimated by discounting cashflows from expected maturities using current interest rates on similarinstruments.

 

Fair value for FHLBAdvances is based on discounted cash flows using the Company’s currentincremental borrowing rate.

 

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

 

The estimated fair valuesof the Company’s financial instruments at March 31, 2010 and December 31,2009 are as follows:

 
| ** **                                      | ** ** | **March 31, 2010** | ** ** | **December 31, 2009** | ** ** |
|-------------------------------------------------|------------|-------------------------|------------|----------------------------|------------|
| ** **                                      | ** ** | **Carrying**            | ** ** | **Fair**                   | ** ** | **Carrying** | ** ** | **Fair** | ** ** |
| ** **                                      | ** ** | **Amount**              | ** ** | **Value**                  | ** ** | **Amount** | ** ** | **Value** | ** ** |
| **Financial Assets:**                           | ** ** | ** **              |       |                       |       |   |   |   |   |
| Cash  and due from banks                        |       | $                       | 6,549,050  |                       | $          | 6,549,050 |   | $ | 4,929,360 |   | $ | 4,929,360 |   |
| Federal  funds sold                             |       | 10,240,000              |       | 10,240,000                 |       | 5,295,000 |   | 5,295,000 |   |
| Investment  securities available for sale       |       | 7,480,458               |       | 7,480,458                  |       | 8,171,648 |   | 8,171,648 |   |
| Non-marketable  equity securities               |       | 1,546,100               |       | 1,546,100                  |       | 1,546,100 |   | 1,546,100 |   |
| Loans,  net                                     |       | 103,340,743             |       | 91,323,340                 |       | 106,129,956 |   | 94,600,335 |   |
|                                            |       |                    |       |                       |       |   |   |   |   |
| **Financial Liabilities:**                      | ** ** | ** **              |       |                       |       |   |   |   |   |
| Deposits                                        |       | 109,432,753             |       | 110,065,230                |       | 104,275,456 |   | 105,094,907 |   |
| Federal  Home Loan Bank advances                |       | 12,000,000              |       | 12,445,453                 |       | 14,000,000 |   | 14,506,533 |   |
| Securities  sold under agreements to repurchase |       | 54,094                  |       | 54,094                     |       | 157,992 |   | 157,992 |   |
|                                                 |            |                         |            |                            |            |  |  |  |  |  |  |  |  |

 

**NOTE 3 — INVESTMENT SECURITIES**

 

Investment securitiesclassified as “Available for Sale” are carried at fair value with unrealizedgains and losses excluded from earnings and reported as a separate component ofshareholders’ equity (net of estimated tax effects).  Realized gains or losses on the sale ofinvestments are based on the specific identification method.

 

At March 31, 2010, the investment portfolio included an unrealizedgain of approximately $7,000. At March 31, 2010, the investment portfolioincluded six securities with a fair value of $5,891,045 and an amortized costof $5,930,480 that had been in an unrealized loss position for less than twelvemonths and no securities in a loss position for more than twelve months.  The Company believes, based on industryanalyst reports and credit ratings, that the deterioration in the fair value ofthese investment securities available for sale is attributed to changes inmarket interest rates and not in the credit quality of the issuer andtherefore, these losses are not considered other-than-temporary.  The Company has the ability and intent tohold these securities until such time as the value recovers or the securitiesmature.

 

8

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**Item 2. Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**

 

*The following discussion reviewsour results of operations and assesses our financial condition.  You should read the following discussion andanalysis in conjunction with the accompanying consolidated financial statements.  The commentary should be read in conjunctionwith the discussion of forward-looking statements, the financial statements,and the related notes and the other statistical information included in thisreport.*

 

**DISCUSSION OF 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:

 

·      reducedearnings due to higher credit losses generally and specifically because lossesin the sectors of our loan portfolio secured by real estate are greater thanexpected due to economic factors, including, but not limited to,  declining real estate values, increasinginterest rates, increasing unemployment, or changes in payment behavior orother factors;

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

·      highconcentration of real estate-based loans collateralized by real estate in aweak commercial real estate market;

·      restrictionsor conditions imposed by our regulators on our operations may make it moredifficult for us to achieve our goals;

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

·      changesin the interest rate environment which could reduce anticipated margins;

·      changesin political conditions or the legislative or regulatory environment;

·      theeffect of final rules amending Regulation E that prohibit financialinstitutions from charging consumer fees for paying overdrafts on ATM and one-timedebit card transactions, unless the consumer consents or opts-in to theoverdraft service for those types of transactions;

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

·      changesoccurring in business conditions and inflation;

·      changesin deposit flows;

·      changesin technology;

·      changesin monetary and tax policies;

·      adequacyof the level of our allowance for loan losses;

·      therate of delinquencies and amount of loans charged-off;

·      therate of loan growth;

·      adversechanges in asset quality and resulting credit risk-related losses and expenses;

·      lossof consumer confidence and economic disruptions resulting from terroristactivities;

·      changesin the securities markets; and

·      otherrisks and uncertainties detailed from time to time in our filings with theSecurities and Exchange Commission.

 

These risks areexacerbated by the developments over the last 24 months in national andinternational financial markets, and we are unable to predict what effect theseuncertain market conditions will have on our Company.  During 2008 and 2009, the capital and creditmarkets experienced unprecedented levels of extended volatility anddisruption.  There can be no assurancethat these unprecedented developments will not materially and adversely affectour business, financial condition and results of operations.

 

9

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Allforward-looking statements in this report are based on information available tous as of the date of this report. Although we believe that the expectations reflected in ourforward-looking statements are reasonable, we cannot guarantee you that theseexpectations will be achieved.  Weundertake no obligation to publicly update or otherwise revise anyforward-looking statements, whether as a result of new information, futureevents, or otherwise.

 

**CriticalAccounting Policies**

 

We have adopted variousaccounting policies that govern the application of accounting principlesgenerally accepted in the United States of America and with general practiceswithin the banking industry in the preparation of our financial statements.  Our significant accounting policies aredescribed in the footnotes to our audited consolidated financial statements asof December 31, 2009, as filed in our Annual Report on Form 10-K.

 

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

 

**Allowance for Loan Losses**

 

We believe the allowancefor loan losses is the critical accounting policy that requires the mostsignificant judgment and estimates used in preparation of our consolidatedfinancial statements.  Some of the morecritical judgments supporting the amount of our allowance for loan lossesinclude judgments about the credit worthiness of borrowers, the estimated valueof the underlying collateral, the assumptions about cash flow, determination ofloss factors for estimating credit losses, the impact of current events andconditions, and other factors impacting the level of probable inherentlosses.  Under different conditions orusing different assumptions, the actual amount of credit losses incurred by usmay be different from management’s estimates provided in our consolidatedfinancial statements.  Refer to theportion of this discussion that addresses our allowance for loan losses for amore complete discussion of our processes and methodology for determining ourallowance for loan losses.

 

**Income Taxes**

 

We use assumptions and estimates in determining income taxes payable orrefundable for the current year, deferred income tax liabilities and assets forevents recognized differently in our consolidated financial statements andincome tax returns, and income tax benefit or expense.  Determining these amounts requires analysisof certain transactions and interpretation of tax laws and regulations.  Management exercises judgment in evaluatingthe amount and timing of recognition of resulting tax liabilities andassets.  These judgments and estimatesare reevaluated on a continual basis as regulatory and business factorschange.  Valuation allowances areestablished to reduce deferred tax assets if it is determined to be “morelikely than not” that all or some portion of the potential deferred tax assetwill not be realized.  No assurance can be given that either thetax returns submitted by us or the income tax reported on the financialstatements will not be adjusted by either adverse rulings by the United StatesTax Court, changes in the tax code, or assessments made by the Internal RevenueService.  We are subject to potentialadverse adjustments, including, but not limited to, an increase in the statutoryfederal or state income tax rates, the permanent non-deductibility of amountscurrently considered deductible either now or in future periods, and thedependency on the generation of future taxable income, including capital gains,in order to ultimately realize deferred income tax assets.

 

**Overview**

 

Thefollowing discussion describes our results of operations for the three monthperiods ended March 31, 2010 and 2009 and also analyzes our financialcondition as of March 31, 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.

 

10

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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 UnitedStates and elsewhere have experienced extreme volatility and disruption overthe past two years.  These circumstanceshave exerted significant downward pressure on prices of equity securities andvirtually all other asset classes, and have resulted in substantially increasedmarket volatility, severely constrained credit and capital markets,particularly for financial institutions, and an overall loss of investorconfidence.  Loan portfolio performanceshave deteriorated at many institutions resulting from, among other factors, aweak economy and a decline in the value of the collateral supporting theirloans.  Dramatic slowdowns in the housingindustry, due in part to falling home prices and increasing foreclosures andunemployment, have created strains on financial institutions.  Many borrowers are now unable to repay theirloans, and the collateral securing these loans has, in some cases, declinedbelow the loan balance.  In response tothe challenges facing the financial services sector, several regulatory andgovernmental actions have been announced including:

 

·      TheEmergency Economic Stabilization Act, approved by Congress and signed byPresident Bush on October 3, 2008, which, among other provisions, allowedthe U.S. Treasury to purchase troubled assets from banks, authorized theSecurities and Exchange Commission to suspend the application ofmarked-to-market accounting, and raised the basic limit of FDIC depositinsurance from $100,000 to $250,000 through December 31, 2013;

 

·      On October 7,2008, the FDIC approved a plan to increase the rates banks pay for depositinsurance;

 

·      On October 14,2008, the U.S. Treasury announced the creation of a new program, the CapitalPurchase Program, that encourages and allows financial institutions to buildcapital through the sale of senior preferred shares to the U.S. Treasury onterms that are non-negotiable;

 

·      On October 14,2008, the FDIC announced the creation of the Temporary Liquidity GuaranteeProgram (“TLGP”), which seeks to strengthen confidence and encourage liquidityin the banking system.  The TLGP has twoprimary components that are available on a voluntary basis to financialinstitutions:

 

·              Guarantee of newly-issued seniorunsecured debt; the guarantee would apply to new debt issued on or before October 31,2009 and would provide protection until December 31, 2012; issuerselecting to participate would pay a 75 basis point fee for the guarantee; and

 

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

 

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

 

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

 

·      A consumer and business lendinginitiative to fund new consumer loans, small business loans and commercialmortgage asset-backed securities issuances;

 

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

 

11

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

 

·      On February 17, 2009, the AmericanRecovery and Reinvestment Act (the “Recovery Act”) was signed into law in aneffort to, among other things, create jobs and stimulate growth in the UnitedStates economy.  The Recovery Actspecifies appropriations of approximately $787 billion for a wide range of Federalprograms 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 firstplan is the Legacy Loan Program, which has a primary purpose to facilitate thesale of troubled mortgage loans by eligible institutions, includingFDIC-insured federal or state banks and savings associations. Eligible assetsare not strictly limited to loans; however, what constitutes an eligible assetwill be determined by participating banks, their primary regulators, the FDICand the Treasury. Under the Legacy Loan Program, the FDIC has sold certaintroubled assets out of an FDIC receivership in two separate transactionsrelating to the failed Illinois bank, Corus Bank, NA, and the failed Texasbank, Franklin Bank, S.S.B. These transactions were completed in September 2009and October 2009, respectively.

 

·      The secondplan is the Securities Program, which is administered by the Treasury andinvolves the creation of public-private investment funds to target investmentsin eligible residential mortgage-backed securities and commercialmortgage-backed securities issued before 2009 that originally were rated AAA orthe equivalent by two or more nationally recognized statistical rating organizations,without regard to rating enhancements (collectively, “Legacy Securities”).Legacy Securities must be directly secured by actual mortgage loans, leases orother assets, and may be purchased only from financial institutions that meetTARP eligibility requirements. Treasury received over 100 unique applicationsto participate in the Legacy Securities PPIP and in July 2009 selectednine public-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.

 

·      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 FDICissued a final rule to require banks to prepay their estimated quarterlyrisk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011and 2012 and to increase assessment rates effective on January 1, 2011.

 

We are participating inthe unlimited deposit insurance component of the TLGP; however, we did notissue unsecured debt before the termination of that component of the TLGP.  On April 13, 2010, the FDIC approved aninterim rule that extends the Transaction Account Guarantee Program to December 31,2010.  We have elected to continue ourvoluntary participation in the program. Coverage under the program is inaddition to and separate from the basic coverage available under the FDIC’s generaldeposit insurance 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 insurance costsincreased significantly.  We have electednot to participate in the TARP Capital Purchase Program, but will considerparticipating in similar programs, if any, announced in the future.  Regardless of our lack of participation,governmental intervention and new regulations under these programs could materiallyand adversely affect our business, financial condition and results ofoperations.

 

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Although it is likelythat further regulatory actions will arise as the Federal government attemptsto address the economic situation, we cannot predict the effect that fiscal ormonetary policies, economic control, or new federal or state legislation mayhave on our business and earnings in the future.

 

**Resultsof Operations**

 

*Three months ended March 31,2010 and 2009*

 

We incurred a net loss of$629,741, or $0.30 per diluted share, for the quarter ended March 31, 2010compared to a net loss of $368,645, or $0.18 per diluted share, for the quarterended March 31, 2009, a difference of $261,096.  As described below, the increase in net lossis primarily due to a decrease in income tax benefit.  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 three months ended March 31, 2010 and 2009.  We derived these yields by dividing annualizedincome or expense by the average balance of the corresponding assets orliabilities.  We derived average balancesfrom 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  March 31,** | ** **  |
|---------------------------------------------------|------------|------------------------------------------------|-------------|
| ** **                                        | ** ** | **2010**                                       | ** **  | **2009** | ** ** |
| ** **                                        | ** ** | **Average   Balance**                          | ** **  | **Income/  Expense** | ** ** | **Yield/  Rate** | ** ** | **Average   Balance** | ** ** | **Income/  Expense** | ** ** | **Yield/  Rate** | ** ** |
| ** **                                        |       |                                           |        |   |   |   |   |   |   |   |   |   |   |
| Federal funds  sold and other                     |       | $                                              | 8,146,244   |   | $ | 11,085 |   | 0.55 | % | $ | 2,508,876 |   | $ | 7,565 |   | 1.22 | % |
| Investment  securities (1)                        |       | 7,759,665                                      |        | 63,490 |   | 3.32 |   | 4,199,532 |   | 47,166 |   | 4.55 |   |
| Loans (2)                                         |       | 106,599,093                                    |        | 1,273,279 |   | 4.84 |   | 121,565,386 |   | 1,397,971 |   | 4.66 |   |
| Total  interest-earning assets                    |       | $                                              | 122,505,002 |   | $ | 1,347,854 |   | 4.46 | % | $ | 128,273,794 |   | $ | 1,452,702 |   | 4.59 | % |
|                                              |       |                                           |        |   |   |   |   |   |   |   |   |   |   |
| NOW accounts                                      |       | $                                              | 4,903,290   |   | $ | 8,170 |   | 0.68 | % | $ | 5,290,470 |   | $ | 8,242 |   | 0.63 | % |
| Savings &  money market                  |       | 26,819,689                                     |        | 126,885 |   | 1.92 |   | 12,375,603 |   | 58,984 |   | 1.93 |   |
| Time deposits  (excluding brokered time deposits) |       | 30,048,435                                     |        | 164,493 |   | 2.22 |   | 29,568,094 |   | 254,293 |   | 3.49 |   |
| Brokered time  deposits                           |       | 37,950,711                                     |        | 263,546 |   | 2.82 |   | 49,344,168 |   | 428,453 |   | 3.52 |   |
| Total  interest-bearing deposits                  |       | 99,722,125                                     |        | 563,094 |   | 2.29 |   | 96,578,335 |   | 749,972 |   | 3.15 |   |
| Borrowings                                        |       | 14,153,216                                     |        | 132,011 |   | 3.78 |   | 19,222,314 |   | 148,309 |   | 3.13 |   |
| Total  interest-bearing liabilities               |       | $                                              | 113,875,341 |   | $ | 695,105 |   | 2.48 | % | $ | 115,800,649 |   | $ | 898,281 |   | 3.15 | % |
|                                              |       |                                           |        |   |   |   |   |   |   |   |   |   |   |
| Net interest  spread                              |       |                                           |        |   |   | 1.98 | % |   |   |   |   | 1.44 | % |
| Net interest  income/ margin                      |       |                                           |        | $ | 652,749 |   | 2.16 | % |   |   | $ | 554,421 |   | 1.75 | % |

 

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(1)           The average balances for investment securities exclude theunrealized gain recorded for available for sale securities.

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

 

For the three monthsended March 31, 2010, we recognized $1.3 million in interest income and$695,105 in interest expense, resulting in net interest income of $652,749, anincrease of $98,328, or 18%, over the same period in 2009.  Average earning assets decreased to $122.5million for the three months ended March 31, 2010 from $128.3 million forthe three months ended March 31, 2009, a decrease of $5.8 million, or4%.  Average interest bearing liabilitiesdecreased to $113.9 million for the three months ended March 31, 2010 from$115.8 million for the three months ended March 31, 2009, a decrease of$1.9 million, or 2%.  Net interestmargin, calculated as annualized net interest income divided by average earningassets, increased from 1.75% for the quarter ended March 31, 2009 to 2.16%for the quarter ended March 31, 2010, primarily due to a decrease in costof funds from 3.15% to 2.48% between periods due to the mix of liabilities andthe timing of their repricing.  Thisdecrease was offset by a slight decrease in yield on earning assets from 4.59%to 4.46% between periods.

 

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Provision for loan losseswas $100,000 for the quarter ended March 31, 2010 representing an increaseof $10,000, or 11%, compared to the expense of $90,000 for the quarter ended March 31,2009.  The increase in provision for loanlosses is due to the increase in impaired and non-accrual loans and theirrelated specific reserves in addition to an increase in the general allowanceallocation due to declining economic conditions and increased charge offlevels.  The total allowance as apercentage of gross loans increased to 1.88% at March 31, 2010 from 1.71%at December 31, 2009.  Specificreserves were approximately $300,000 on impaired loans of approximately $10.7million as of March 31, 2010.  As ofMarch 31, 2010, the general reserve allocation was 1.77% of gross loansnot impaired compared to 1.62% as of December 31, 2009. The provision forloan losses is discussed further below under “Provision and Allowance for LoanLosses.”

 

For the three months endedMarch 31, 2010, noninterest income was $72,025 compared to $8,724 for thethree months ended March 31, 2009, an increase of $63,301 betweencomparable periods.  For the quarterended March 31, 2009, we recognized an other-than-temporary impairment onnon-marketable equity securities of $60,404 which is the primary reason for theincrease in noninterest income between quarters.  Noninterest income for the three months endedMarch 31, 2010 and 2009 was derived from service charges on deposits,customer service fees, rental income, and mortgage origination income.

 

During the currentquarter, we incurred noninterest expenses of $1.3 million, compared tononinterest expenses of $993,640 for the quarter ended March 31, 2009, anincrease of $260,875, or 26%.  Thisincrease of noninterest expenses for the three month period ended March 31,2010 primarily resulted from write downs of $232,055 on other real estate ownedand repossessed assets discussed in greater detail below.  Insurance expense also increased $24,446compared to the quarter ended March 31, 2009, primarily due to increasedFDIC insurance premium assessment rates coupled with an increase in our depositbalances, or our assessment base. Occupancy and equipment expenses for the quarter ended March 31,2010 increased $19,773 compared to the quarter ended March 31, 2009primarily due to the opening of the Simpsonville branch in February 2009,which resulted in only half a quarter of expenses during the 2009 quartercompared to a full quarter of expenses in the current quarter.  We have been focusing on expense control overthe past year which has resulted in small decreases in marketing and telephoneand supplies.  We also renegotiated andrenewed our data processing contract in May 2009 resulting in decreaseddata processing expenses. Other expenses increased $20,616 primarily due to anincrease in expenses related to loan collections and repossessions.

 

Income tax benefit forthe quarter ended March 31, 2010 was zero compared to $151,850 for thequarter ended March 31, 2009.  Wecompleted an analysis of whether a valuation allowance should be recordedagainst our deferred tax assets. Accounting literature states that a deferred tax asset should be reducedby a valuation allowance if, based on the weight of all available evidence, itis more likely than not (a likelihood of more than 50%) that some portion orthe 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 March 31, 2010.  We have analyzed the existing deferred tax assetsof $1.4 million, net of the valuation allowance, included in other assets, anddetermined it is more likely than not that they will be recognized in futureyears based on forecasted projected income in the near term, the fact that wehad reached profitable operations prior to the economic decline, our strongcapital position, and our month-to-month improvement in net interest marginduring 2009 and first quarter 2010.  Ourprojections include moderate balance sheet growth, maintenance of liquidity levels,no branch expansion, the sale of our land in downtown Greenville, interest rateprojections based on leading economic analyses, and the maintenance of higherthan historical charge-off and allowance for loan losses levels.  We will continue to analyze our deferred taxassets and related valuation allowance each quarter taking into accountperformance compared to forecast and current economic or internal informationthat would impact forecasted earnings.

 

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**Assets and Liabilities**

 

*General*

 

Total assets as of March 31,2010 were $137.7 million, representing an increase of $2.4 million, or 2%,compared to December 31, 2009.  Theincrease in assets is due to an increase in cash and cash equivalents of $6.6million, which was the result of $2.7 million of net loan payoffs and anincrease in deposits of $5.2 million during the quarter.  At March 31, 2010, our total assetsconsisted principally of $16.8 million in cash and due from banks, $7.5 millionin investment securities, $103.3 million in net loans, and $3.7 million inproperty and equipment.  Our managementclosely monitors and seeks to maintain appropriate levels of interest-earningassets and interest-bearing liabilities so that maturities of assets are suchthat adequate funds are provided to meet customer withdrawals and demand.

 

Liabilities at March 31,2010 totaled $121.6 million, representing an increase of $3.0 million, or 3%,compared to December 31, 2009, and consisted principally of $109.4 millionin deposits and $12.1 million in borrowings. Our borrowings consisted of Federal Home Loan Bank (“FHLB”) Advances andcustomer repurchase agreements.  At March 31,2010, shareholders’ equity was $16.1 million compared to $16.7 million at December 31,2009. The decrease in shareholders’ equity was primarily due to the net loss of$629,741 for the quarter ended March 31, 2010.

 

*Loans*

 

Since loans typically provide higher interest yields than other types of interest-earning assets, we invest a substantial percentage of our earning assets in our loan portfolio.  At March 31, 2010, our gross loan portfolio consisted primarily of $68.8 million of commercial real estate loans, $15.2 million of commercial business loans, and $21.5 million of consumer and home equity loans.  Our current loan portfolio composition is not materially different than the loan portfolio composition disclosed in the footnotes to the consolidated financial statements included in our Annual Report on Form 10-K for 2009 as filed with the SEC.  We experienced net payoffs of $2.7 million during the quarter ended March 31, 2010 due to low market demand, careful consideration of liquidity needs and credit risk management.

 

We discontinue accrual of interest on a loan when we conclude it is doubtful that we will be able to collect interest from the borrower.  We reach this conclusion by taking into account factors such as the borrower’s financial condition, economic and business conditions, and the results of our previous collection efforts.  Generally, we place a delinquent loan in non-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 unpaid and deduct this interest from earnings as a reduction of reported interest income.  We do not accrue any additional interest on the loan balance until we conclude the collection of both principal and interest is reasonably certain. We had approximately $11.2 million and $6.7 million in non-accrual loans at March 31, 2010 and December 31, 2009, respectively.  This increase between periods is due to four new loans which were changed to non-accrual status during the quarter as a result of a review of these relationships, their payment history and the current economic environment.  Non-accrual loans represented 10.7% of gross loans at March 31, 2010.  We continue to carefully monitor each of these loans and have established specific reserves as warranted based on a review of the underlying collateral of each loan as well as the financial condition of each borrower.

 

At March 31, 2010,we had 11 loans totaling $10.7 million that were considered impaired withspecific reserves of approximately $300,000 allocated in the allowance for loanlosses.  The Company identifies impairedloans through its normal internal loan review process.  Impairment is measured on a loan-by-loanbasis for commercial and construction loans by either the present value ofexpected future cash flows discounted at the loan’s effective interest rate,the loan’s obtainable market price, or the fair value of the collateral if theloan 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$10.7 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 or other market datasuch as recent offers to the borrower. At March 31, 2010, we were not aware of any potential problem loansthat were not already considered for impairment or categorized as impaired ornon-accrual.

 

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*Provision and Allowance for Loan Losses*

 

We haveestablished an allowance for loan losses through a provision for loan lossescharged to expense on our consolidated statement of operations.  The allowance for loan losses for the threemonths ended March 31, 2010 and 2009 is presented below:

 
| ** **                                  | ** ** | **Three Months Ended********March 31,** | ** ** |
|---------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                  | ** ** | **2010**                                     | ** ** | **2009** | ** ** |
| Balance  at beginning of the period         |       | $                                            | 1,847,513  |   | $ | 1,611,977 |   |
| Provision  for loan losses                  |       | 100,000                                      |       | 90,000 |   |
| Loans  charged-off                          |       | (2,220                                       | )          | — |   |
| Recoveries  of loans previously charged-off |       | 40,000                                       |       | — |   |
| Balance  at end of the period               |       | $                                            | 1,985,293  |   | $ | 1,701,977 |   |

 

As of March 31,2010, the allowance for loan losses was $2.0 million, or 1.88% of gross loans,compared to $1.8 million, or 1.71% of gross loans, as of December 31, 2009and $1.7 million, or 1.31% of gross loans, as of March 31, 2009.  Provision for loan losses was $100,000 forthe quarter ended March 31, 2010, an increase of $10,000, or 11%, comparedto the expense of $90,000 for the quarter ended March 31, 2009.

 

The increase in the allowance for loan losses is a result,in large 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, whichaffects the 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, including considerationof factors such as the balance of impaired loans, the quality, mix, and size ofour overall loan portfolio, economic conditions that may affect the borrower’sability to repay, the amount and quality of collateral securing the loans, ourhistorical loan loss experience, and a review of specific problem loans.  We also consider subjective issues such aschanges in lending policies and procedures, changes in the local/nationaleconomy, changes in volume or type of credits, changes in volume/severity ofproblem loans, quality of loan review and board of director oversight,concentrations of credit, and peer group comparisons.  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 ofvery recent origin.  In general, loans donot begin 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.

 

The recent downturn in the real estate market has resultedin increased loan delinquencies, defaults and foreclosures, primarily in ourcommercial real estate portfolio.  In some cases, this downturn hasresulted in a significant impairment to the value of our collateral and ourability to sell the collateral upon foreclosure, and there is a risk that thistrend will continue.  The real estate collateral in each case provides analternate source of repayment in the event of default by the borrower and maydeteriorate in value during the time the credit is extended.  If realestate values continue to decline, it is also more likely that we would berequired to increase our allowance for loan losses.  This downturn in thereal estate market has resulted in an increase in our nonperforming loans, andthere is a risk that this trend will continue, which could result in additionallosses of earnings and increases in our provision for loan losses and loans charged-offs.

 

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*Other Real Estate Owned andRepossessed Assets*

 

As of March 31, 2010we had $1.8 million in other real estate owned and $95,391 in repossessedassets.  Other real estate owned consistsof approximately $860,000 of residential properties, $800,000 of land and  $124,000 of commercial office space.  Repossessed assets consists of equipment.  Charge-offs of $205,297 were taken on theserelationships at the time of transfer to other real estate owned andrepossessed assets in 2009 as a result of a decline in the approximate fairvalues of the collateral based on current market information.  During the quarter ended March 31, 2010,based on new market information, $232,055 was charged to expense to write downthe value of other real estate owned and repossessed assets.  Repossessed assets of $317,945 were soldduring the quarter ended March 31, 2010 at zero gain or loss as theseassets had been written down to market value earlier in the quarter based onnew market information.

 

*Deposits*

 

Our primary source offunds for loans and investments is our deposits.  At March 31, 2010, we had $109.4 millionin deposits, representing an increase of $5.2 million, or 5%, compared to December 31,2009.  Deposits at March 31, 2010consisted primarily of $10.1 million in demand deposit accounts, $32.2 millionin money market accounts and $67.1 million in time deposits.  During the fourth quarter of 2006, we beganobtaining deposits outside of our local market area in the form of brokeredtime deposits.  Due to the interest rateenvironment in our market, as well as strong competition from other banking andfinancial services companies in gathering deposits, brokered time depositsallow us to obtain funding in order to support loan growth.  At March 31, 2010, we had $38.0 millionin brokered time deposits, a decrease of approximately $1.0 million compared toDecember 31, 2009.  We will continueto reduce our reliance on brokered time deposits and other noncore fundingsources, while focusing our efforts to gather core deposits in our localmarket.

 

*Borrowings*

 

We use borrowings to fundgrowth of earning assets in excess of deposit growth.  Borrowings totaled $12.1 million at March 31,2010, compared to $14.2 million at December 31, 2009.  FHLB Advances accounted for $12.0 million oftotal borrowings, a decrease of $2.0 million, or 14%, compared to December 31,2009.  These advances are secured withapproximately $36.2 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 liquidation or maturity of existing  assets or the acquisition of  liabilities. We manage both assets and liabilities to achieve appropriate levels ofliquidity.  Cash and short-term investmentsare our primary sources of asset liquidity. These funds provide a cushion against short-term fluctuations in cashflow from both deposits and loans.  Theinvestment portfolio is our principal source of secondary asset liquidity.  However, the availability of this source offunds is influenced by market conditions and pledging agreements.  Individual and commercial deposits, brokereddeposits and borrowings are our primary source of funds for creditactivities.  As brokered deposits oradvances mature in 2010, we intend to replace these funds with new brokereddeposits or advances to the extent necessary after considering core depositgrowth, although overall we will seek to reduce our reliance on brokered timedeposits and other noncore funding sources.

 

We are a member of the Federal Home Loan Bank of Atlanta, from whichapplications for borrowings can be made for leverage purposes, if so desired,in an amount up to 20% of the total assets of the Bank, assuming that the Bank’s investment in FHLB stock, as well as qualifyingmortgages or investment securities, would be available to secure any futureborrowings.  We also pledgecollateral to the Federal Reserve Bank’s Borrower-in-Custody of Collateral program, and our available creditunder this program was approximately $9.5 million as of March 31, 2010.  We have federal funds purchased lines ofcredit through two correspondent banks totaling $5.0 million.

 

We believe our liquidity sources are adequate to meet our operatingneeds. The level of liquidity is measured by the cash, cash equivalents, andinvestment securities available for sale to total assets ratio, which was at17.62% at March 31, 2010 compared to 13.60% as of December 31,2009.  The increase in liquidity is dueto an increase in deposits of $5.2 million as well as net loan payoffs of $2.7million during the quarter ended March 31, 2010.  These cash increases were offset by thepayoff of $2.0 million in FHLB advances. We continue to carefully focus onliquidity management during 2010.  Weplan to continue reducing brokered time deposits as cash balances, retaildeposit growth and operating needs allow.

 

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**Impact of Off-Balance SheetInstruments**

 

Through the operations ofour Bank, we have made contractual commitments to extend credit in the ordinarycourse of our business activities.  Thesecommitments are legally binding agreements to lend money to our customers atpredetermined interest rates for a specified period of time. At March 31,2010, we had issued commitments to extend credit of $10.5 million throughvarious types of lending arrangements. We evaluate each customer’s credit worthiness on a case-by-case basis.The amount of collateral obtained, if deemed necessary by us upon extension ofcredit, is based on our credit evaluation of the borrower.  Collateral varies but may include accountsreceivable, inventory, property, plant and equipment, and commercial andresidential real estate.  We manage thecredit risk on these commitments by subjecting them to normal underwriting andrisk management processes.

 

**Commitments and Contingencies**

 

As of March 31, 2010,there were no significant firm commitments outstanding for capitalexpenditures.

 

**Capital Resources**

 

Total shareholders’ equity decreased to $16.1 million at March 31, 2010 from $16.7 million at December 31, 2009, primarily due to our net loss for the three months of $629,741. We believe that our capital is sufficient to fund the activities of our Bank’s operations and that the rate of net losses will not deteriorate our capital base below required regulatory levels. Nevertheless, we are not immune to the unprecedented levels of extended volatility and disruption in the capital and credit markets and can give no assurances with respect to our capital levels.

 

Our Bank and Company are subject to various regulatory capital requirements administered by the federal banking agencies.  However, the Federal Reserve guidelines contain an exemption from the capital requirements for “small bank holding companies,” which in 2006 were amended to cover most bank holding companies with less than $500 million in total assets that do not have a material amount of debt or equity securities outstanding registered with the SEC.  Although our class of common stock is registered under Section 12 of the Securities Exchange Act, we believe that because our stock is not listed on any exchange or otherwise actively traded, the Federal Reserve Board will interpret its new guidelines to mean that we qualify as a small bank holding company.  Nevertheless, our Bank remains subject to these capital requirements.  Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank’s financial statements.  Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices.  The Bank’s capital amounts and classifications are also subject to qualitative judgments by the regulators 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 and total  capital as a percentage of assets and 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 for sale,  less certain intangible assets.  The Bank’s Tier 2 capital consists of the allowance for loan losses subject to certain limitations.  Total capital for purposes of computing the capital ratios consists of the sum of Tier 1 and Tier 2 capital.  The regulatory minimum requirements are 4% for Tier 1 capital and 8% for total risk-based capital.

 

The Bank is also  required  to  maintain  capital  at a minimum  level  based on quarterly  average  assets,  which  is  known as the leverage ratio.  Only the strongest banks are allowed to maintain capital at the minimum requirement of 3%.  All others are subject to maintaining ratios 1% to 2% above the minimum.  The Bank exceeded its minimum regulatory capital ratios as of March 31, 2010, as well as the ratios to be considered “well capitalized.”

 

As of January 20,2010, the Bank entered into a Formal Agreement with its primary regulator, theOCC (the “Formal Agreement”). The Formal Agreement seeks to enhance the Bank’sexisting practices and procedures in the areas of management oversight,strategic and capital planning, credit risk management, credit underwriting,liquidity, and funds management.

 

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In response, the Bank hasset up a compliance committee of its Board of Directors to oversee management’sresponse 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.

 

In addition, the OCC hasestablished Individual Minimum Capital Ratio levels of Tier 1 and totalcapital for the Bank that are higher than the minimum and “well capitalized”ratios applicable to all banks.  We mustmaintain total risk-based capital of at least 12%, Tier 1 capital of at least10%, and a leverage ratio of at least 9%. If we fail to maintain these required capital levels, the OCC may deemnoncompliance to be an unsafe and unsound banking practice which may make theBank subject to a capital directive, a consent order, or such otheradministrative actions or sanctions as the OCC considers necessary.  It is uncertain what actions, if any, the OCCwould take with respect to noncompliance with these ratios, what action stepsthe OCC might require the Bank to take to remedy this situation, and whethersuch actions would be successful.

 

The following table summarizes the capital amounts and ratios of the Bank and the regulatory minimum requirements at March 31, 2010.

 

(Dollars in thousands)

 
| ** **                                |   |       |       |        |       | ** **              |       |                   |       | ** **                     |       |      |       | **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 March 31, 2010**             |   |       |       |        |       |                    |       |                   |       |                           |       |      |       |                        |       |   |   |
| Total  Capital (to risk weighted assets)  |   | $          | 14,058,000 |        | 12.5       | %                       | $          | 13,531,000             |       | 12.0                           | %          | $         | 9,020,000  |                        | 8.0        | % | $ | 11,275,000 |   | 10.0 | % |
| Tier  1 Capital (to risk weighted assets) |   | 12,641,000 |       | 11.2        |       | 11,275,000              |       | 10.0                   |       | 4,510,000                      |       | 4.0       |       | 6,765,000                   |       | 6.0 |   |
| Tier  1 Capital (to average assets)       |   | 12,641,000 |       | 9.5         |       | 12,035,000              |       | 9.0                    |       | 5,349,000                      |       | 4.0       |       | 6,686,000                   |       | 5.0 |   |
|                                           |        |            |            |             |            |                         |            |                        |            |                                |            |           |            |                             |            |  |  |  |  |  |  |

 

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**Item 3. Quantitative andQualitative Disclosures About Market Risk.**

 

Not applicable

 

**Item 4. Controls and Procedures**

 

As of the end of theperiod covered by this report, we carried out an evaluation, under thesupervision and with the participation of our management, including our ChiefExecutive Officer and Chief Financial Officer, of the effectiveness of ourdisclosure controls and 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 March 31,2010.  There have been no significantchanges in our internal controls over financial reporting during the fiscalquarter ended March 31, 2010 that have materially affected, or arereasonably likely to materially affect, our internal controls over financialreporting.

 

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

 

**Part II- Other Information**

 

**Item 1.Legal Proceedings**

 

There are no materialpending legal proceedings to which we are a party or of which any of ourproperties are the subject.

 

**Item 1A.Risk Factors**

 

Not applicable

 

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

 

Not applicable

 

**Item 3.Default Upon Senior Securities**

 

Not applicable

 

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

 

**Item 5.Other Information**

 

Not applicable

 

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**Item 6.Exhibits**

 

31.1         Rule 13a-14(a) Certification of thePrincipal Executive Officer.

 

31.2         Rule 13a-14(a) Certification of thePrincipal Financial Officer.

 

32            Section 1350 Certifications.

 

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# **SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant caused thisreport to be signed on its behalf by the undersigned thereunto duly authorized.

 

 
| Date: May 7, 2010 | By:                                                                   | /s/ Lawrence R. Miller |
|------------------------|-----------------------------------------------------------------------|------------------------|
|                   | Lawrence R. Miller                                                    |
|                   | Chief Executive Officer  (Principal Executive Officer)                |
|                   |                                                                  |                   |
| Date: May 7, 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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