** **

** **

**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON,D.C. 20549**

 

**FORM 10-Q**

 

| **(MARK ONE)**                                              |
|-------------------------------------------------------------|
|                                                        |   |
| **x**                                                       | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934** |
|                                                        |   |
| **For the  Quarterly Period ended September 30, 2009** |
|                                                        |   |
| **OR**                                                      |
|                                                        |   |
| **o**                                                       | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |

 

**For theTransition Period from                  to                  **

 

**CommissionFile 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 29601**

(Address ofprincipal executive offices)

 

**(864) 672-1776**

(Registrant’stelephone number, including area code)

 

----

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that the registrant was required to file such reports),and (2) has been subject to such filing requirements for the past 90days.  Yes x  No o

 

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

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer.  See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act).

 

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

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act). Yes o  No x

 

Indicate the number ofshares outstanding of each of the issuer’s classes of common stock, as of thelatest practicable date: 2,085,010 shares of common stock, $.01 par value pershare, were issued and outstanding as of October 30, 2009.

 

 

 

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**Independence Bancshares, Inc.**

 

**Part I - Financial Information**

 

## **Item 1. Financial Statements**

## ** **

**Consolidated Balance Sheets**

** **
| ** **                                                                                                     | ** ** | **September 30, 2009** | ** **        | **December 31, 2008** | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|-----------------------------|-------------------|----------------------------|------------|
| ** **                                                                                                     | ** ** | **(unaudited)**             | ** **        | **(audited)**              | ** ** |
| **Assets**                                                                                                     | ** ** | ** **                  | ** **        | ** **                 | ** ** |
| Cash and due from banks                                                                                        |       | $                           |  6,498,687   |                       | $          |  1,724,886 |   |
| Federal funds sold                                                                                             |       | 7,855,000                   |              | 2,393,000                  |       |
| Investment securities available for sale                                                                       |       | 8,078,514                   |              | 4,484,486                  |       |
| Non-marketable equity securities                                                                               |       | 1,546,100                   |              | 1,599,804                  |       |
| Loans, net of allowance for loan losses of $2,146,535 and  $1,611,977, respectively                            |       | 105,552,488                 |              | 121,835,777                |       |
| Accrued interest receivable                                                                                    |       | 413,997                     |              | 433,854                    |       |
| Property and equipment, net                                                                                    |       | 3,819,622                   |              | 3,348,042                  |       |
| Other real estate owned and repossessed assets                                                                 |       | 2,315,023                   |              | —                     |       |
| Other assets                                                                                                   |       | 1,622,142                   |              | 1,070,122                  |       |
| Total assets                                                                                                   |       | $                           |  137,701,573 |                       | $          |  136,889,971 |   |
|                                                                                                           |       |                        |              |                       |       |
| **Liabilities**                                                                                                |       |                        |              |                       |       |
| Deposits:                                                                                                      |       |                        |              |                       |       |
| Noninterest bearing                                                                                            |       | $                           |  5,491,284   |                       | $          |  4,708,170 |   |
| Interest bearing                                                                                               |       | 98,394,909                  |              | 94,149,548                 |       |
| Total deposits                                                                                                 |       | 103,886,193                 |              | 98,857,718                 |       |
|                                                                                                           |       |                        |              |                       |       |
| Borrowings                                                                                                     |       | 16,046,577                  |              | 19,064,093                 |       |
| Accrued interest payable                                                                                       |       | 97,268                      |              | 131,201                    |       |
| Accounts payable and accrued expenses                                                                          |       | 238,304                     |              | 128,227                    |       |
| Total liabilities                                                                                              |       | 120,268,342                 |              | 118,181,239                |       |
|                                                                                                           |       |                        |              |                       |       |
| 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                                                                                     |       | 20,959,635                  |              | 20,840,248                 |       |
| Accumulated other comprehensive income                                                                         |       | 49,908                      |              | 40,715                     |       |
| Accumulated deficit                                                                                            |       | (3,597,162                  | )                 | (2,193,081                 | )          |
| Total shareholders’ equity                                                                                |       | 17,433,231                  |              | 18,708,732                 |       |
| Total liabilities and shareholders’ equity                                                                |       | $                           |  137,701,573 |                       | $          |  136,889,971 |   |

 

**The accompanying notes are an integral part of these consolidatedfinancial statements.**

 

2

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**Independence Bancshares, Inc.**

** **

**Consolidated Statements ofOperations**

**(unaudited)**

** **
| ** **                                                               | ** ** | **Three Months Ended  September 30,** | ** **      | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------------------------------|------------|--------------------------------------------|-----------------|-------------------------------------------|------------|
| ** **                                                               | ** ** | **2009**                                   | ** **      | **2008**                                  | ** ** | **2009** | ** ** | **2008** | ** ** |
| **Interest income**                                                      |       |                                       |            |                                      |       |   |   |   |   |
| Loans                                                                    |       | $                                          |  1,425,590 |                                      | $          |  1,831,631 |   | $ |  4,187,037 |   | $ |  5,408,932 |   |
| Investment  securities                                                   |       | 59,735                                     |            | 52,861                                    |       | 151,898 |   | 165,342 |   |
| Federal  funds sold and other                                            |       | 11,490                                     |            | 22,608                                    |       | 26,758 |   | 101,021 |   |
| Total  interest income                                                   |       | 1,496,815                                  |            | 1,907,100                                 |       | 4,365,693 |   | 5,675,295 |   |
|                                                                     |       |                                       |            |                                      |       |   |   |   |   |
| **Interest expense**                                                     |       |                                       |            |                                      |       |   |   |   |   |
| Deposits                                                                 |       | 645,775                                    |            | 863,358                                   |       | 2,083,786 |   | 2,701,459 |   |
| Borrowings                                                               |       | 147,172                                    |            | 169,745                                   |       | 442,975 |   | 417,415 |   |
| Total  interest expense                                                  |       | 792,947                                    |            | 1,033,103                                 |       | 2,526,761 |   | 3,118,874 |   |
|                                                                     |       |                                       |            |                                      |       |   |   |   |   |
| Net  interest income                                                     |       | 703,868                                    |            | 873,997                                   |       | 1,838,932 |   | 2,556,421 |   |
|                                                                     |       |                                       |            |                                      |       |   |   |   |   |
| **Provision for loan losses**                                            |       | 137,000                                    |            | 57,000                                    |       | 787,000 |   | 328,000 |   |
|                                                                     |       |                                       |            |                                      |       |   |   |   |   |
| Net  interest income after  provision for  loan losses              |       | 566,868                                    |            | 816,997                                   |       | 1,051,932 |   | 2,228,421 |   |
|                                                                     |       |                                       |            | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Noninterest income**                                                   |       | 68,155                                     |            | 42,467                                    |       | 176,730 |   | 79,422 |   |
|                                                                     |       |                                       |            |                                      |       |   |   |   |   |
| **Noninterest expenses**                                                 |       |                                       |            |                                      |       |   |   |   |   |
| Compensation  and benefits                                               |       | $                                          |  526,499   |                                      | $          |  516,153 |   | $ |  1,604,321 |   | $ |  1,509,024 |   |
| Professional  fees                                                       |       | 50,384                                     |            | 46,228                                    |       | 181,685 |   | 155,620 |   |
| Marketing                                                                |       | 20,993                                     |            | 42,903                                    |       | 101,341 |   | 148,860 |   |
| Insurance                                                                |       | 110,726                                    |            | 36,314                                    |       | 373,214 |   | 103,289 |   |
| Occupancy  and equipment                                                 |       | 140,602                                    |            | 126,144                                   |       | 411,395 |   | 423,433 |   |
| Data  processing and related costs                                       |       | 71,434                                     |            | 79,176                                    |       | 245,834 |   | 236,445 |   |
| Telephone  and supplies                                                  |       | 18,717                                     |            | 14,188                                    |       | 60,008 |   | 53,648 |   |
| Other                                                                    |       | 69,827                                     |            | 36,726                                    |       | 147,495 |   | 128,588 |   |
| Total  noninterest expenses                                              |       | 1,009,182                                  |            | 897,832                                   |       | 3,125,293 |   | 2,758,907 |   |
|                                                                     |       |                                       |            |                                      |       |   |   |   |   |
| Loss  before income tax benefit                                          |       | (374,159                                   | )               | (38,368                                   | )          | (1,896,631 | ) | (451,064 | ) |
|                                                                     |       |                                       |            |                                      |       |   |   |   |   |
| **Income tax benefit**                                                   |       | —                                     |            | 13,080                                    |       | 492,550 |   | 153,380 |   |
|                                                                     |       |                                       |            |                                      |       |   |   |   |   |
| Net  loss                                                                |       | $                                          |  (374,159  | )                                         | $          |  (25,288 | ) | $ |  (1,404,081 | ) | $ |  (297,684 | ) |
|                                                                     |       |                                       |            |                                      |       |   |   |   |   |
| **Loss per common share — basic and diluted**                       |       | $                                          |  (0.18     | )                                         | $          |  (0.01 | ) | $ |  (0.67 | ) | $ |  (0.14 | ) |
| ** **                                                               |       |                                       |            |                                      |       |   |   |   |   |
| **Weighted average common shares outstanding —  basic and diluted** |       | 2,085,010                                  |            | 2,085,010                                 |       | 2,085,010 |   | 2,085,010 |   |

 

**The accompanying notes are an integral part of these consolidatedfinancial statements.**

 

3

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**Independence Bancshares, Inc.**

 

**Consolidated Statements of Changes In**

**Shareholders’ Equity and Comprehensive Loss**

# ** (unaudited)**

 
| ** **                                                               | ** ** | ** **       | ** ** | ** **     | ** **   | ** **          | ** ** | **Accumulated**  | ** ** | ** **  | ** **   | ** ** | ** ** |
|--------------------------------------------------------------------------|------------|------------------|------------|----------------|--------------|---------------------|------------|------------------|------------|-------------|--------------|------------|------------|
| ** **                                                               | ** ** | ** **       | ** ** | ** **     | ** **   | ** **          | ** ** | **other**        | ** ** | ** **  | ** **   | ** ** | ** ** |
| ** **                                                               | ** ** | **Common stock** | ** ** | **Additional** | ** **   | **comprehensive**   | ** ** | **Accumulated**  | ** ** | ** **  | ** **   |
| ** **                                                               | ** ** | **Shares**       | ** ** | **Amount**     | ** **   | **paid-in capital** | ** ** | **income**       | ** ** | **deficit** | ** **   | **Total**  | ** ** |
| ** **                                                               |       |             |       |           |         |                |       |             |       |        |         |       |       |
| **December 31, 2007**                                               |       | 2,085,010        |       | $              | 20,850       |                | $          | 20,671,588       |       | $           | 5,570        |       | $          | (1,708,575 | ) | $ | 18,989,433 |   |
| Compensation  expense related to stock options granted                   |       | —           |       | —         |         | 127,365             |       | —           |       | —      |         | 127,365    |       |
| Net  loss                                                                |       | —           |       | —         |         | —              |       | —           |       | (297,684    | )            | (297,684   | )          |
| Unrealized  loss on investment securities available for sale, net of tax |       | —           |       | —         |         | —              |       | (2,429           | )          | —      |         | (2,429     | )          |
| Total  comprehensive loss                                                |       | —           |       | —         |         | —              |       | —           |       | —      |         | (300,113   | )          |
| **September 30, 2008**                                              |       | 2,085,010        |       | $              |  20,850 |                | $          |  20,798,953 |       | $           |  3,141  |       | $          |  (2,006,259 | ) | $ |  18,816,685 |   |
|                                                                     |       |             |       |           |         |                |       |             |       |        |         |       |       |
| **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                   |       | —           |       | —         |         | 119,387             |       | —           |       | —      |         | 119,387    |       |
| Net  loss                                                                |       | —           |       | —         |         | —              |       | —           |       | (1,404,081  | )            | (1,404,081 | )          |
| Unrealized  gain on investment securities available for sale, net of tax |       | —           |       | —         |         | —              |       | 9,193            |       | —      |         | 9,193      |       |
| Total  comprehensive loss                                                |       | —           |       | —         |         | —              |       | —           |       | —      |         | (1,394,888 | )          |
| **September 30, 2009**                                              |       | 2,085,010        |       | $              |  20,850 |                | $          |  20,959,635 |       | $           |  49,908 |       | $          |  (3,597,162 | ) | $ |  17,433,231 |   |

 

**The accompanying notes are an integral part of these consolidatedfinancial statements.**

 

4

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**Independence Bancshares, Inc.**

 

**Consolidated Statements of Cash Flows**

**(unaudited)**

 
| ** **                                                                  | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                  | ** ** | **2009**                                  | ** ** | **2008** | ** ** |
| **Operating activities**                                                    |       |                                      |       |   |   |
| Net  loss                                                                   |       | $                                         | (1,404,081 | ) | $ | (297,684 | ) |
| Adjustments  to reconcile net loss to cash provided by operating activities |       |                                      |       |   |   |
| Provision  for loan losses                                                  |       | 787,000                                   |       | 328,000 |   |
| Depreciation                                                                |       | 135,922                                   |       | 153,436 |   |
| Amortization  of investment securities premiums, net                        |       | 2,717                                     |       | 2,126 |   |
| Compensation  expense related to stock options granted                      |       | 119,387                                   |       | 127,365 |   |
| Other-than-temporary  impairment on non-marketable equity securities        |       | 60,404                                    |       | — |   |
| Loss  on sale and write downs of REO and repossessed assets                 |       | 7,832                                     |       | — |   |
| Increase  in other assets, net                                              |       | (536,898                                  | )          | (182,252 | ) |
| Increase  (decrease) in other liabilities, net                              |       | 76,144                                    |       | (77,274 | ) |
| Net  cash provided by (used in) operating activities                        |       | (751,573                                  | )          | 53,717 |   |
|                                                                        |       |                                      |       |   |   |
| **Investing activities**                                                    |       |                                      |       |   |   |
| Repayments  (originations) of loans, net                                    |       | 12,819,273                                |       | (25,132,657 | ) |
| Purchase  of investment securities available for sale                       |       | (7,102,773                                | )          | — |   |
| Maturity  of investment securities available for sale                       |       | 3,000,000                                 |       | — |   |
| Repayments  of investment securities available for sale                     |       | 519,956                                   |       | 592,588 |   |
| Purchase  of non-marketable equity securities, net                          |       | (6,700                                    | )          | (541,204 | ) |
| Purchase  of property and equipment                                         |       | (607,502                                  | )          | (235,124 | ) |
| Sale  of other real estate owned                                            |       | 354,161                                   |       | — |   |
| Net  cash provided by (used in) investing activities                        |       | 8,976,415                                 |       | (25,316,397 | ) |
|                                                                        |       |                                      |       |   |   |
| **Financing activities**                                                    |       |                                      |       |   |   |
| Increase  in deposits, net                                                  |       | 5,028,475                                 |       | 19,201,962 |   |
| Increase  (decrease) in borrowings                                          |       | (3,017,516                                | )          | 6,966,307 |   |
| Net  cash provided by financing activities                                  |       | 2,010,959                                 |       | 26,168,269 |   |
|                                                                        |       |                                      |       |   |   |
| **Net increase in cash and cash equivalents**                               |       | 10,235,801                                |       | 905,589 |   |
|                                                                        |       |                                      |       |   |   |
| **Cash and cash equivalents at beginning of the  period**                   |       | 4,117,886                                 |       | 2,617,663 |   |
|                                                                        |       |                                      |       |   |   |
| **Cash and cash equivalents at end of the period**                          |       | $                                         | 14,353,687 |   | $ | 3,523,252 |   |
|                                                                        |       |                                      |       |   |   |
| **Supplemental information:**                                               |       |                                      |       |   |   |
| **Cash paid for**                                                           |       |                                      |       |   |   |
| Interest                                                                    |       | $                                         | 2,560,964  |   | $ | 3,111,858 |   |
| Income  taxes                                                               |       | $                                         | —     |   | $ | 14,499 |   |
| **Schedule of non-cash transactions**                                       |       |                                      |       |   |   |
| Change in unrealized gain on securities, net of tax                         |       | $                                         | 9,193      |   | $ | (2,429 | ) |
| Loans  transferred to other real estate owned                               |       | $                                         | 2,677,016  |   | $ | — |   |

 

**The accompanying notes are an integral part of these consolidatedfinancial 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 and nine month periods ended September 30,2009 are not necessarily indicative of the results that may be expected for theyear ending December 31, 2009.  Forfurther information, refer to the financial statements and footnotes theretoincluded in our Annual Report on Form 10-K for 2008 as filed with theSecurities and Exchange Commission.

 

Management performed an evaluation to determinewhether or not there have been any subsequent events since the balance sheetdate.  The evaluation was performed through November 10, 2009, thedate on which the Company’s 10-Q was issued as filed with the Securities andExchange Commission.

 

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

 

A summary of thesepolicies is included in our Annual Report on Form 10-K filed with theSecurities and Exchange Commission for the year ended December 31,2008.  For further information, refer to the consolidated financialstatements and footnotes thereto included in our Annual Report on Form 10-Kfor 2008 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.

 

InJune 2009, the Financial Accounting Standards Board (“FASB”) issuedStatement of Financial Accounting Standards (“SFAS”) No. 168, “The *FASB Accounting Standards Codification*TM and the Hierarchy of Generally AcceptedAccounting Principles — a replacement of FASB Statement No. 162,” (“SFAS168”).  SFAS 168 establishes the *FASB Accounting Standards Codification*TM (“Codification”) as the source ofauthoritative generally accepted accounting principles (“GAAP”) fornongovernmental entities.  TheCodification does not change GAAP. Instead, it takes the thousands ofindividual pronouncements that currently comprise GAAP and reorganizes theminto approximately 90 accounting Topics, and displays all Topics using aconsistent structure.  Contents in eachTopic are further organized first by Subtopic, then Section and finallyParagraph. The Paragraph level is the only level that contains substantivecontent. Citing particular content in the Codification involves specifying theunique numeric path to the content through the Topic, Subtopic, Section andParagraph structure. FASB suggests that all citations begin with “FASB ASC,”where ASC stands for *Accounting StandardsCodification*. Changes to the ASC subsequent to June 30, 2009are referred to as Accounting Standards Updates (“ASU”).  In conjunction with the issuance of SFAS 168,the FASB also issued its first Accounting Standards Update No. 2009-1, “Topic105 —Generally Accepted Accounting Principles” (“ASU 2009-1”) which includesSFAS 168 in its entirety as a transition to the ASC.    ASU 2009-1 is effective for interim andannual periods ending after September 15, 2009 and will not have an impacton the Company’s financial position or results of operations but will changethe referencing system for accounting standards.

 

**Cash and Cash Equivalents**- For purposes ofreporting cash flows, cashand cash equivalents includes 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 and nine month periods ended September 30, 2009 and 2008, 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 82% 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 September 30, 2009 was $3.3 million.

 

Available-for-sale investment securities ($8,078,514 at September 30, 2009) 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 such as vehicles 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 September 30, 2009 was $2,315,023.

 

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” (“ASC Topic 825”), requires disclosures about fair value offinancial instruments for interim reporting periods of publicly tradedcompanies as well as in annual financial statements.  ASC Topic 825 defines a financial instrumentas cash, evidence of an ownership interest in an entity or contractualobligations which require the exchange of cash or other financialinstruments.  Certain items arespecifically excluded from the disclosure requirements, including the Company’scommon stock, property and equipment and other assets and liabilities.

 

Fair value 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 existsfor non-marketable equity securities, and they have no quoted marketvalue.  However, redemption of thesestocks has historically been at par value. Accordingly, the carrying amounts are deemed to be a reasonable estimateof 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.  Certificateof deposit accounts with a maturity within one year are valued at theircarrying value.  The fair value ofcertificate of deposit accounts with a maturity after one year are estimated bydiscounting cash flows from expected maturities using current interest rates onsimilar instruments.

 

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 September 30, 2009 and December 31,2008 are as follows:

 
| ** **                                      | ** ** | **September 30, 2009** | ** ** | **December 31, 2008** | ** ** |
|-------------------------------------------------|------------|-----------------------------|------------|----------------------------|------------|
| ** **                                      | ** ** | **Carrying**                | ** ** | **Fair**                   | ** ** | **Carrying** | ** ** | **Fair** | ** ** |
| ** **                                      | ** ** | **Amount**                  | ** ** | **Value**                  | ** ** | **Amount** | ** ** | **Value** | ** ** |
| **Financial Assets:**                           |       |                        |       |                       |       |   |   |   |   |
| Cash  and due from banks                        |       | $                           | 6,498,687  |                       | $          | 6,498,687 |   | $ | 1,724,886 |   | $ | 1,724,886 |   |
| Federal  funds sold                             |       | 7,855,000                   |       | 7,855,000                  |       | 2,393,000 |   | 2,393,000 |   |
| Investment  securities available for sale       |       | 8,078,514                   |       | 8,078,514                  |       | 4,484,486 |   | 4,484,486 |   |
| Non-marketable  equity securities               |       | 1,546,100                   |       | 1,546,100                  |       | 1,599,804 |   | 1,599,804 |   |
| Loans,  net                                     |       | 105,552,488                 |       | 93,815,109                 |       | 121,835,777 |   | 106,952,831 |   |
|                                            |       |                        |       |                       |       |   |   |   |   |
| **Financial Liabilities:**                      |       |                        |       |                       |       |   |   |   |   |
| Deposits                                        |       | 103,886,193                 |       | 104,539,778                |       | 98,857,718 |   | 99,340,825 |   |
| Federal  Home Loan Bank advances                |       | 16,000,000                  |       | 16,602,110                 |       | 19,000,000 |   | 19,781,569 |   |
| Securities  sold under agreements to repurchase |       | 46,577                      |       | 46,577                     |       | 64,093 |   | 64,093 |   |
|                                                 |            |                             |            |                            |            |  |  |  |  |  |  |  |  |

 

**NOTE 3 — INVESTMENT SECURITIES**

 

Investment securities classified as “Available forSale” are carried at fair value with unrealized gains and losses excluded fromearnings and reported as a separate component of shareholders’ equity (net ofestimated tax effects).  Realized gainsor losses on the sale of investments are based on the specific identificationmethod.

 

At September 30, 2009, the investment portfolioincluded an unrealized gain of approximately $76,000. At September 30,2009 the investment portfolio included three securities with a fair value of$3,015,958 and an amortized cost of $3,044,865 that had been in an unrealizedloss position for less than twelve months and no securities in a loss positionfor more than twelve months.  The Companybelieves, based on industry analyst reports and credit ratings, that thedeterioration in the fair value of these investment securities available forsale is attributed to changes in market interest rates and not in the creditquality of the issuer and therefore, these losses are not consideredother-than-temporary.  The Company hasthe ability and intent to hold these securities until such time as the valuerecovers or the securities mature.

 

**NOTE 4 — OTHER-THAN-TEMPORARYIMPAIRMENT**

 

On May 1, 2009,Silverton Bank, N.A. the Bank’s primary correspondent bank, was closed by theOffice of the Comptroller of the Currency and the FDIC was named Receiver.  The FDIC created a bridge bank, SilvertonBridge Bank, N.A., to take over the operations of Silverton Bank,N.A.  The creation of the bridge bank allowed its client banks totransition their correspondent banking needs to other providers with the leastamount of disruptions until it ceased operations, as previously announced, on July 29,2009.  As a result of the closure, itbecame highly unlikely that we will recover any portion of our investment inthe stock of Silverton Bank, N.A.’s holding company, Silverton FinancialServices, Inc.  Accordingly, theBank recorded an other-than-temporary impairment charge of $60,404 which isincluded in noninterest income in the consolidated statements ofoperations.  The Bank’s original costbasis in the stock was $154,404, and the Bank recorded an other-than-temporaryimpairment charge of $94,000 as of December 31, 2008.  These two impairment charges have brought thecarrying value of our investment to zero as of September 30, 2009.  In July 2009, the Bank moved allservices once performed by Silverton Bank, N.A. to other correspondent banks,primarily Pacific Coast Bankers’ Bank.

 

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 financialstatements.  The commentary should beread in conjunction with the discussion of forward-looking statements, thefinancial statements, and the related notes and the other statisticalinformation included in this report.*

 

**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. These statements are based on many assumptions and estimates and are notguarantees of future performance.  Ouractual results may differ materially from those anticipated in anyforward-looking statements, as they will depend on many factors about which weare unsure, including many factors which are beyond our control.  The words “may,” “would,” “could,” “will,” “expect,”“anticipate,” “believe,” “intend,” “plan,” and “estimate,” as well as similarexpressions, are meant to identify such forward-looking statements.  Potential risks and uncertainties that couldcause our actual results to differ from those anticipated in ourforward-looking statements include, but are not limited, to the following:

 

·                  reduced earnings due to higher credit losses generallyand specifically because losses in the sectors of our loan portfolio secured byreal estate are greater than expected due to economic factors, includingdeclining real estate values, increasing interest rates, increasingunemployment, or changes in payment behavior or other factors;

·                  reduced earnings due to higher credit losses becauseour loans are concentrated by loan type, industry segment, borrower type, orlocation of the borrower or collateral;

·                  the amount of our real estate-based loan portfoliocollateralized by real estates, and the weakness in the commercial real estatemarket;

·                  significant increases in competitive pressure in thebanking and financial services industries;

·                  changes in the interest rate environment which couldreduce anticipated margins;

·                  changes in political conditions or the legislative orregulatory environment;

·                  general economic conditions, either nationally orregionally and especially in our primary service area, becoming less favorablethan expected, resulting in, among other things, a deterioration in creditquality;

·                  changes occurring in business conditions andinflation;

·                  changes in deposit flows;

·                  changes in technology;

·                  changes in monetary and tax policies;

·                  adequacy of the level of our allowance for loanlosses;

·                  the rate of delinquencies and amount of loanscharged-off;

·                  the rate of loan growth;

·                  adverse changes in asset quality and resulting creditrisk-related losses and expenses;

·                  loss of consumer confidence and economic disruptionsresulting from terrorist activities;

·                  changes in the securities markets; and

·                  other risks and uncertainties detailed from time totime in our filings with the Securities and Exchange Commission.

 

These risks are exacerbated by the recent developmentsin national and international financial markets, and we are unable to predictwhat effect these uncertain market conditions will have on our Company.  During 2008 and continuing through the thirdquarter of 2009, the capital and credit markets experienced unprecedentedlevels of extended volatility and disruption. There can be no assurance thatthese unprecedented recent developments will not materially and adverselyaffect our business, financial condition and results of operations.

 

All forward-looking statements in this report arebased on information available to us as of the date of this report.  Although we believe that the expectationsreflected in our forward-looking statements are reasonable, we cannot guaranteeyou that these expectations will be achieved. We undertake no obligation to publicly update or otherwise revise anyforward-looking statements, whether as a result of new information, futureevents, or otherwise.

 

9

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**Critical Accounting Policies**

 

We have adopted various accounting policies thatgovern the application of accounting principles generally accepted in theUnited States of America and with general practices within the banking industryin the preparation of our financial statements. Our significant accounting policies are described in the footnotes toour audited consolidated financial statements as of December 31, 2008, asfiled on 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 and estimatesthat could have a material impact on the carrying values of our assets andliabilities 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 incometaxes payable or refundable for the current year, deferred income taxliabilities and assets for events recognized differently in our financialstatements and income 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 factors change.  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 potential adverseadjustments, 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 and ninemonth periods ended September 30, 2009 and 2008 and also analyzes ourfinancial condition as of September 30, 2009.

 

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

 

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

 

10

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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 this noninterestincome, as well as our noninterest expenses, in the following discussion.

 

Marketsin the United States and elsewhere have experienced extreme volatility anddisruption for more than 12 months. These circumstances have exerted significant downward pressure on pricesof equity securities and virtually all other asset classes, and have resultedin substantially increased market volatility, severely constrained credit andcapital markets, particularly for financial institutions, and an overall lossof investor confidence.  Loan portfolioperformances have deteriorated at many institutions resulting from, among otherfactors, a weak economy and a decline in the value of the collateral supportingtheir loans.  Dramatic slowdowns in thehousing industry, due in part to falling home prices and increasingforeclosures and unemployment, have created strains on financialinstitutions.  Many borrowers are nowunable to repay their loans, and the collateral securing these loans has, insome cases, declined below the loan balance.  In response to the challenges facing thefinancial services sector, several regulatory and governmental actions havebeen announced including:

 

·                  The Emergency Economic Stabilization Act, approved byCongress and signed by President Bush on October 3, 2008, which, amongother provisions, allowed the U.S. Treasury to purchase troubled assets frombanks, authorized the Securities and Exchange Commission to suspend theapplication of marked-to-market accounting, and raised the basic limit of FDICdeposit insurance from $100,000 to $250,000 through  December 31, 2013;

 

·                  On October 7, 2008, the FDIC approved a plan toincrease the rates banks pay for deposit insurance;

 

·                  On October 14, 2008, the U.S. Treasury announcedthe creation of a new program, the Capital Purchase Program, that encouragesand allows financial institutions to build capital through the sale of seniorpreferred shares to the U.S. Treasury on terms that are non-negotiable;

 

·                  On October 14, 2008, the FDIC announced thecreation of the Temporary Liquidity Guarantee Program (“TLGP”), which seeks tostrengthen confidence and encourage liquidity in the banking system.  The TLGP has two primary components that areavailable on a voluntary basis to financial institutions:

 

·                  Guarantee of newly-issued seniorunsecured debt; the guarantee would apply to new debt issued on or before June 30,2009 and would provide protection until June 30, 2012; issuers electing toparticipate would pay a 75 basis point fee for the guarantee;

 

·                  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 17, 2009, the American Recovery andReinvestment Act (the “Recovery Act”) was signed into law in an effort to,among other things, create jobs and stimulate growth in the United Stateseconomy.  The Recovery Act specifiesappropriations 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 imposes certainlimitations on compensation paid by participants in the U.S. Treasury’sTroubled Asset Relief Program (“TARP”).

 

·                  On March 23, 2009, the U.S. Treasury, inconjunction with the FDIC and the Federal Reserve, announced the Public-PrivatePartnership Investment Program for Legacy Assets which consists of two separateplans, addressing two distinct asset groups:

 

·                  The Legacy Loan Program, which theprimary purpose will be to facilitate the sale of troubled mortgage loans byeligible institutions, which include FDIC-insured federal or state banks andsavings associations. Eligible assets may not be strictly limited to loans;however, what constitutes an eligible asset will be determined by participatingBanks, their primary regulators, the FDIC and the U.S. Treasury. Additionally,the Loan Program’s requirements and structure will be subject to notice andcomment rulemaking, which may take some time to complete.

 

11

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·                  The Securities Program, which will beadministered by the U.S. Treasury, involves the creation of public-privateinvestment funds to target investments in eligible residential mortgage-backedsecurities and commercial mortgage-backed securities issued before 2009 thatoriginally were rated AAA or the equivalent by two or more nationallyrecognized statistical rating organizations, without regard to ratingenhancements (collectively, “Legacy Securities”). Legacy Securities must bedirectly secured by actual mortgage loans, leases or other assets, and may bepurchased only from financial institutions that meet TARP eligibilityrequirements.

 

We are participating inthe unlimited deposit insurance component of the TLGP; however, we do notexpect to issue unsecured debt before the termination of that component of theTLGP.  As a result of the enhancements todeposit insurance protection and the expectation that there will be demands onthe FDIC’s deposit insurance fund, our deposit insurance costs have increasedand will continue to increase significantly throughout 2009.  We have elected not to participate in theTARP Capital Purchase Program, but will consider participating in similarprograms, if any, announced in the future. Regardless of our lack of participation, governmental intervention andnew regulations under these programs could materially and adversely affect ourbusiness, financial condition and results of operations.  The followingdiscussion and analysis describes our performance in this challenging economicenvironment.

 

**Resultsof Operations**

 

*Three months ended September 30,2009 and 2008*

 

We incurred a net loss of$374,159, or $0.18 per diluted share, for the quarter ended September 30,2009 compared to a net loss of $25,288, or $0.01 per diluted share, for thequarter ended September 30, 2008, a difference of $348,871.  The increase in net loss is primarily due toa decrease in net interest income, in addition to increases in provision forloan losses, FDIC insurance premiums and noninterest expenses due to theopening of a new branch in February 2009, each of which is furtherdiscussed 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 September 30, 2009 and 2008.  We derived these yields by dividingannualized income or expense by the average balance of the corresponding assetsor liabilities.  We derived averagebalances from the daily balances throughout the periods indicated.  The net amount of capitalized loan fees areamortized into interest income on loans.

 
| ** **                                        | ** ** | **For the Three  Months Ended September 30,** | ** **  |
|---------------------------------------------------|------------|----------------------------------------------------|-------------|
| ** **                                        | ** ** | **2009**                                           | ** **  | **2008** | ** ** |
| ** **                                        | ** ** | **Average**                                        | ** **  | **Income/** | ** ** | **Yield/** | ** ** | **Average** | ** ** | **Income/** | ** ** | **Yield/** | ** ** |
| ** **                                        | ** ** | **Balance**                                        | ** **  | **Expense** | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Expense** | ** ** | **Rate** | ** ** |
|                                              |       |                                               |        |   |   |   |   |   |   |   |   |   |   |
| Federal funds  sold and other                     |       | $                                                  | 6,084,384   |   | $ | 11,490 |   | 0.75 | % | $ | 2,271,095 |   | $ | 22,608 |   | 3.96 | % |
| Investment  securities (1)                        |       | 5,558,605                                          |        | 59,735 |   | 4.26 |   | 4,634,049 |   | 52,861 |   | 4.54 |   |
| Loans (2)                                         |       | 113,170,781                                        |        | 1,425,590 |   | 5.00 |   | 122,335,330 |   | 1,831,631 |   | 5.96 |   |
| Total  interest-earning assets                    |       | $                                                  | 124,813,770 |   | $ | 1,496,815 |   | 4.76 | % | $ | 129,240,474 |   | $ | 1,907,100 |   | 5.87 | % |
|                                              |       |                                               |        |   |   |   |   |   |   |   |   |   |   |
| NOW accounts                                      |       | $                                                  | 5,844,955   |   | $ | 8,949 |   | 0.61 | % | $ | 3,513,834 |   | $ | 13,875 |   | 1.57 | % |
| Savings &  money market                  |       | 15,765,694                                         |        | 74,678 |   | 1.88 |   | 13,495,438 |   | 93,874 |   | 2.77 |   |
| Time deposits  (excluding brokered time deposits) |       | 32,728,882                                         |        | 241,045 |   | 2.92 |   | 30,160,886 |   | 300,440 |   | 3.96 |   |
| Brokered time  deposits                           |       | 41,788,842                                         |        | 321,103 |   | 3.05 |   | 44,415,043 |   | 455,169 |   | 4.08 |   |
| Total  interest-bearing deposits                  |       | 96,128,373                                         |        | 645,775 |   | 2.67 |   | 91,585,201 |   | 863,358 |   | 3.75 |   |
| Borrowings                                        |       | 16,168,165                                         |        | 147,172 |   | 3.61 |   | 17,037,351 |   | 169,745 |   | 3.96 |   |
| Total  interest-bearing liabilities               |       | $                                                  | 112,296,538 |   | $ | 792,947 |   | 2.80 | % | $ | 108,622,552 |   | $ | 1,033,103 |   | 3.78 | % |
|                                              |       |                                               |        |   |   |   |   |   |   |   |   |   |   |
| Net interest  spread                              |       |                                               |        |   |   | 1.96 | % |   |   |   |   | 2.09 | % |
| Net interest  income/ margin                      |       |                                               |        | $ | 703,868 |   | 2.24 | % |   |   | $ | 873,997 |   | 2.69 | % |

 

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(1)                                  The average balances forinvestment securities exclude the unrealized gain recorded for available forsale securities.

(2)                                  Nonaccrual loans are included in average balances for yieldcomputations.

 

12

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For the three monthsended September 30, 2009, we recognized $1.5 million in interest incomeand $792,947 in interest expense, resulting in net interest income of $703,868,a decrease of $170,129, or 19%, over the same period in 2008.   Average earning assets decreased to $124.8million for the three months ended September 30, 2009 from $129.2 millionfor the three months ended September 30, 2008, a decrease of $4.4 million,or 3%.  Average interest bearingliabilities increased to $112.3 million for the three months ended September 30,2009 from $108.6 million for the three months ended September 30, 2008, anincrease of $3.7 million, or 3%.  Netinterest margin, calculated as net interest income divided by average earningassets, decreased from 2.69% for the quarter ended September 30, 2008 to2.24% for the quarter ended September 30, 2009, primarily due to adecrease in yield on earning assets from 5.87% to 4.76% between periods due tosignificant rate decreases initiated by the Federal Reserve Board during2008.  This decrease was slightly offsetby a lesser decrease in cost of funds from 3.78% to 2.80% between periods dueto the mix of liabilities and the timing of their repricing.

 

Provision for loan losseswas $137,000 for the quarter ended September 30, 2009, an increase of$80,000, or 140%, compared to the expense of $57,000 for the quarter ended September 30,2008.  This increase in provision expenseis due to an increase in classified and impaired loans between comparablequarters.  The provision for loan lossesis discussed further below under “Provision and Allowance for Loan Losses”.

 

For the three monthsended September 30, 2009, noninterest income was $68,155 compared to$42,467 for the three months ended September 30, 2008, an increase of$25,688, or 60%, between comparable periods primarily due to an increase inmortgage origination income of approximately $18,000.  Noninterest income for the three months endedSeptember 30, 2009 and 2008 was derived from service charges on deposits,customer service fees, rental income, and mortgage origination income.

 

During the currentquarter, we incurred noninterest expenses of $1,009,182, compared tononinterest expenses of $897,832 for the quarter ended September 30, 2008,an increase of $111,350, or 12%.  Thisincrease of noninterest expenses for the three month period ended September 30,2009 primarily resulted from an increase of $74,412 in insurance expense comparedto the quarter ended September 30, 2008, primarily due to increased FDICinsurance premium assessments. Compensation and benefits expense increased $10,346 and occupancy andequipment increased $14,458 due to the addition of the Simpsonville branch in February 2009.  Data processing and related costs decreased$7,742 due to savings realized as a result of the renewal of our coreprocessing contract. Marketing expenses decreased $21,910 in the current periodcompared to the prior year comparable period as a result of more focusedmarketing efforts.  Other expensesincreased $33,102 primarily as a result of approximately $32,000 of expensesand losses related to REO and repossessed assets.

 

Income tax benefit forthe quarter ended September 30, 2009 was zero compared to $13,080 for thequarter ended September 30, 2008. We analyzed the existing deferred tax assets of $1,356,882, included inother assets, and determined it is more likely than not that they will berecognized in future years based on projections in the near term and ourforecasted projected income.  However,due to the unprecedented economic conditions specifically affecting the bankingindustry and the uncertainty as to the expected recovery period of the industryas a whole, we recorded a valuation allowance of 100% on all deferred taxassets generated during the quarter ended September 30, 2009.   The income tax benefit for the quarter endedSeptember 30, 2008 is based on our estimated effective tax rate.

 

*Nine months ended September 30,2009 and 2008*

 

We incurred a net loss of$1,404,081, or $0.67 per diluted share, for the nine month period ended September 30,2009 compared to a net loss of $297,684, or $0.14 per diluted share, for thenine month period ended September 30, 2008, a difference of$1,106,397.  As discussed in greaterdetail below, the increase in net loss is primarily due to a decrease in netinterest income, in addition to increases in provision for loan losses, FDICinsurance premiums, and noninterest expenses due to the opening of a new branchin February 2009.

 

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The following table sets forth information related to ouraverage balance sheet, average yields on assets, and average costs ofliabilities for the nine months ended September 30, 2009 and 2008.  We derived these yields by dividingannualized income or expense by the average balance of the corresponding assetsor liabilities.  We derived averagebalances from the daily balances throughout the periods indicated.  The net amount of capitalized loan fees areamortized into interest income on loans.

 
| ** **                                        | ** ** | **For the Nine Months Ended  September 30,** | ** **  |
|---------------------------------------------------|------------|---------------------------------------------------|-------------|
| ** **                                        | ** ** | **2009**                                          | ** **  | **2008** | ** ** |
| ** **                                        | ** ** | **Average   Balance**                             | ** **  | **Income/  Expense** | ** ** | **Yield/  Rate** | ** ** | **Average   Balance** | ** ** | **Income/  Expense** | ** ** | **Yield/  Rate** | ** ** |
| Federal funds  sold and other                     |       | $                                                 | 4,593,833   |   | $ | 26,758 |   | 0.78 | % | $ | 3,832,066 |   | $ | 101,021 |   | 3.52 | % |
| Investment securities  (1)                        |       | 4,651,833                                         |        | 151,898 |   | 4.37 |   | 4,847,866 |   | 165,342 |   | 4.56 |   |
| Loans (2)                                         |       | 117,639,350                                       |        | 4,187,037 |   | 4.76 |   | 112,685,522 |   | 5,408,932 |   | 6.41 |   |
| Total  interest-earning assets                    |       | $                                                 | 126,885,016 |   | $ | 4,365,693 |   | 4.60 | % | $ | 121,365,454 |   | $ | 5,675,295 |   | 6.25 | % |
|                                              |       |                                              |        |   |   |   |   |   |   |   |   |   |   |
| NOW accounts                                      |       | $                                                 | 5,576,853   |   | $ | 24,882 |   | 0.60 | % | $ | 3,629,194 |   | $ | 48,745 |   | 1.79 | % |
| Savings &  money market                  |       | 14,225,464                                        |        | 201,268 |   | 1.89 |   | 12,667,287 |   | 275,024 |   | 2.90 |   |
| Time deposits  (excluding brokered time deposits) |       | 31,264,728                                        |        | 750,273 |   | 3.21 |   | 30,891,508 |   | 1,029,398 |   | 4.45 |   |
| Brokered time  deposits                           |       | 45,557,637                                        |        | 1,107,363 |   | 3.25 |   | 40,962,613 |   | 1,348,292 |   | 4.40 |   |
| Total  interest-bearing deposits                  |       | 96,624,682                                        |        | 2,083,786 |   | 2.88 |   | 88,150,602 |   | 2,701,459 |   | 4.09 |   |
| Borrowings                                        |       | 17,741,760                                        |        | 442,975 |   | 3.34 |   | 13,287,275 |   | 417,415 |   | 4.20 |   |
| Total interest-bearing  liabilities               |       | $                                                 | 114,366,442 |   | $ | 2,526,761 |   | 2.95 | % | $ | 101,437,877 |   | $ | 3,118,874 |   | 4.11 | % |
|                                              |       |                                              |        |   |   |   |   |   |   |   |   |   |   |
| Net interest  spread                              |       |                                              |        |   |   | 1.65 | % |   |   |   |   | 2.14 | % |
| Net interest  income/ margin                      |       |                                              |        | $ | 1,838,932 |   | 1.94 | % |   |   | $ | 2,556,421 |   | 2.81 | % |

 

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(1)                                  The average balances forinvestment securities exclude the unrealized gain recorded for available forsale securities.

(2)                                  Nonaccrual loans are included inaverage balances for yield computations.

 

For the nine months endedSeptember 30, 2009, we recognized $4.4 million in interest income and $2.5million in interest expense, resulting in net interest income of $1.8 million,a decrease of $717,489, or 28%, over the same period in 2008.  Because of compression in our net interestmargin, net interest income declined even though our average earning assetsincreased.  Average earning assetsincreased to $126.9 million for the nine months ended September 30, 2009from $121.4 million for the nine months ended September 30, 2008, anincrease of $5.5 million, or 5%.  Averageinterest bearing liabilities increased to $114.4 million for the nine monthsended September 30, 2009 from $101.4 million for the nine months ended September 30,2008, an increase of $12.9 million, or 13%. Net interest margin, calculated as net interest income divided byaverage earning assets, decreased from 2.81% for the nine month period ended September 30,2008 to 1.94% for the nine month period ended September 30, 2009 primarilydue to a decrease in yield on earning assets from 6.25% to 4.60% betweenperiods due to significant rate decreases initiated by the Federal ReserveBoard during 2008.  This decrease wasslightly offset by a lesser decrease in cost of funds from 4.11% to 2.95%between periods due to the mix of liabilities and the timing of their repricing.

 

Provision for loan losseswas $787,000 for the nine month period ended September 30, 2009, anincrease of $459,000, or 140%, compared to the expense of $328,000 for the ninemonth period ended September 30, 2008. This increase in provision expense is due to an increase in classifiedand impaired loans between comparable quarters offset somewhat by netrepayments of loans during the first nine months of 2009 compared to net loanoriginations for the comparable period in 2008. The provision for loan losses is discussed further below under “Provisionand Allowance for Loan Losses”.

 

For the nine months endedSeptember 30, 2009, noninterest income was $176,730 compared to $79,422for the nine months ended September 30, 2008, an increase of $97,308, or123%, between comparable periods. Mortgage origination income increased approximately $139,000 betweenperiods; however, this increase was offset by the other-than-temporaryimpairment on non-marketable equity securities of $60,404 discussed in Note 4to our Unaudited Consolidated Financial Statements included in this QuarterlyReport.  Noninterest income for the ninemonths ended September 30, 2009 and 2008 was primarily derived fromservice charges on deposits, customer service fees, rental income, and mortgageorigination income.

 

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During the nine monthsended September 30, 2009, we incurred noninterest expenses of $3,125,293,compared to noninterest expenses of $2,758,907 for the nine month period ended September 30,2008, an increase of $366,385, or 13%. This increase of noninterest expenses for the nine month period ended September 30,2009 primarily resulted from an increase of $269,925 in insurance expensecompared to the nine months ended September 30, 2008, primarily due toincreased FDIC insurance premium assessments including a special assessment ofapproximately $60,000 paid in September 2009.  Compensation and benefits expense increased$95,297 due to the addition of the Simpsonville branch employees in February 2009and increased mortgage origination income which resulted in higher commissionspaid.  There were also small increases indata processing and related costs, and telephone and supplies due to theopening of the new branch.  Professionalfees increased $26,065 due to consulting fees related to the renewal of ourcore processing contract as well as increased audit fees. Marketing expensesdecreased $47,519 in the current period compared to the prior year comparableperiod as a result of more focused marketing efforts.  Occupancy and equipment decreased $12,038compared to the prior year comparable period because a portion of the originalfixed assets purchased at the Bank’s organization became fully depreciated in2008.  This was offset somewhat bydepreciation on the new fixed assets related to the Wade Hampton andSimpsonville branches.

 

Income tax benefit forthe nine month period ended September 30, 2009 was $492,550 compared to$153,380 for the nine month period ended September 30, 2008.  The income tax benefit for the nine monthsended September 30, 2009 and 2008 is based on our estimated effective taxrate and necessary valuation allowances. The increase in income tax benefit is a result of the increase in netloss between periods. We analyzed the existing deferred tax assets of$1,356,882, included in other assets, and determined it is more likely than notthat they will be recognized in future years based on projections in the nearterm and our forecasted projected income. However, due to the unprecedented economic conditions specificallyaffecting the banking industry and the uncertainty as to the expected recoveryperiod of the industry as a whole, we recorded a valuation allowance of 100% onall deferred tax assets generated during the quarter ended September 30,2009.   We also recorded a valuationallowance of $20,537 against our deferred tax assets related to theother-than-temporary impairment as this is a capital loss which can only beoffset against capital gains.

 

**Assets and Liabilities**

 

*General*

 

Total assets as of September 30,2009 were $137.7 million, representing a slight increase of $811,602, or 0.6%,compared to December 31, 2008.  Thesmall change in assets is due to an increase in cash and cash equivalents of$10.2 million which was the result of net loan repayments of $12.8 million andan increase in deposits of $5.0 million offset by an increase in investmentsecurities of $3.6 million and a decrease in total borrowings of $3.0 million.  At September 30, 2009, our total assetsconsisted principally of $6.5 million in cash and due from banks, $7.9 millionin federal funds sold, $8.1 million in investment securities, $105.6 million innet loans, and $3.8 million in property and equipment.  Our management closely monitors and seeks tomaintain appropriate levels of interest-earning assets and interest-bearingliabilities so that maturities of assets are such that adequate funds areprovided to meet customer withdrawals and demand.

 

Liabilities at September 30,2009 totaled $120.3 million, representing an increase of $2.1 million, or 2%,compared to December 31, 2008, and consisted principally of $103.9 millionin deposits and $16.0 million in borrowings consisting of Federal Home LoanBank (“FHLB”) Advances and customer repurchase agreements.  At September 30, 2009, shareholders’equity was $17.4 million compared to $18.7 million at December 31, 2008.

 

*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 September 30, 2009, our loan portfolio consisted primarily of $68.9 million of commercial real estate loans, $16.6 million of commercial business loans, and $22.3 million of consumer and home equity loans.

 

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 $2.6 million and $394,950 in non-accrual loans at September 30, 2009 and December 31, 2008, respectively.  This increase between periods is due to several new loans which 

 

15

 

were changed to non-accrual status as a result of a review of these relationships, their payment history and the current economic environment.  Non-accrual loans represented 2.44% of gross loans at September 30, 2009.  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 September 30, 2009, we had ten loans totaling $4.0 million that were considered impaired with specific reserves of approximately $671,000 allocated in the allowance for loan losses.  Impaired loans consisted of $3.4 million of loans secured by real estate and approximately $622,000 of commercial loans with other forms of collateral.  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 such as recent offers to the borrower.  At September 30, 2009, we were not aware of any potential problem loans that were not already considered for impairment or categorized as impaired or non-accrual.

 

*Provision and Allowance for Loan Losses*

 

We have established anallowance for loan losses through a provision for loan losses charged toexpense on our consolidated statement of operations.  The allowance for loan losses for the threeand nine months ended September 30, 2009 and 2008 is presented below:

 
| ** **                                  | ** ** | **Three Months Ended********September 30,** | ** **    | **Nine Months Ended********September 30,** | ** ** |
|---------------------------------------------|------------|--------------------------------------------------|---------------|-------------------------------------------------|------------|
| ** **                                  | ** ** | **2009**                                         | ** **    | **2008**                                        | ** ** | **2009** | ** ** | **2008** | ** ** |
| Balance  at beginning of the period         |       | $                                                | 2,261,977     |                                            | $          | 1,554,491 |   | $ | 1,611,977 |   | $ | 1,283,491 |   |
| Provision  for loan losses                  |       | 137,000                                          |          | 57,000                                          |       | 787,000 |   | 328,000 |   |
| Loans  charged-off                          |       | (252,442                                         | )             | —                                          |       | (252,442 | ) | — |   |
| Recoveries  of loans previously charged-off |       | —                                           |          | —                                          |       | — |   | — |   |
| Balance  at end of the period               | ** ** | **$**                                            | **2,146,535** | ** **                                      | **$**      | **1,611,491** | ** ** | **$** | **2,146,535** | ** ** | **$** | **1,611,491** | ** **

** ** |

 

As of September 30,2009, the allowance for loan losses was $2.1 million, or 1.99% of gross loans,compared to $1.6 million, or 1.31% of gross loans as of December 31,2008.  Provision for loan losses was$137,000 for the quarter ended September 30, 2009, an increase of $80,000,or 140%, compared to the expense of $57,000 for the quarter ended September 30,2008.  For the nine months ended September 30,2009, provision for loan losses was $787,000, an increase of $459,000, or 140%,over the nine months ended September 30, 2008.  This increase in provision expense is due toan increase in classified and impaired loans between comparable periods.

 

The allowance for loanlosses represents an amount which we believe will be adequate to absorbprobable losses on existing loans that may become uncollectible.  We strive to follow a comprehensive,well-documented, and consistently applied analysis of our loan portfolio indetermining an appropriate level for the allowance for loan losses.  Our judgment as to the adequacy of theallowance for loan losses is based on a number of assumptions about futureevents, which we believe to be reasonable, but which may or may not prove to beaccurate.  Our determination of theallowance for loan losses is based on what we believe are all significantfactors that impact the collectability of loans, including consideration offactors 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.   If delinquenciesand defaults increase, we may be required to increase our provision for loanlosses, which would adversely affect our results of operations and financialcondition.  Periodically, we will adjustthe amount of the allowance based on changing circumstances.  We will charge recognized losses to theallowance and add subsequent recoveries back to the allowance for loanlosses.  There can be no assurance thatcharge-offs of loans in future periods will not exceed the allowance for loanlosses as estimated at any point in time or that provisions for loan losseswill not be significant to a particular accounting period.

 

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The recent downturn inthe real estate market has resulted in increased loan delinquencies, defaultsand foreclosures, primarily in our commercial real estate portfolio.  In some cases, this downturn has resulted ina significant impairment to the value of our collateral and our ability to sellthe collateral upon foreclosure, and there is a risk that this trend willcontinue.  The real estate collateral ineach case provides an alternate source of repayment in the event of default bythe borrower and may deteriorate in value during the time the credit isextended.  If real estate values continueto decline, it is also more likely that we would be required to increase ourallowance for loan losses.  This downturnin the real estate market has resulted in an increase in our nonperformingloans, and there is a risk that this trend will continue, which could result inadditional losses of earnings and increases in our provision for loan lossesand loans charged-offs.

 

*Other Real Estate Owned andRepossessed Assets*

 

As of September 30,2009 we have $2,278,523 in other real estate owned and $36,500 in repossessedassets.  Other real estate owned consistsof $1.2 million of residential properties, $1.0 million of land andapproximately $124,000 of commercial office space.  Charge offs of $193,654 were taken on theserelationships at the time of transfer to other real estate owned andrepossessed assets as a result of a decline in the approximate fair values ofthe collateral based on current market information.   One property was sold during the quarterended September 30, 2009 resulting in a loss of $3,682.  Subsequent to repossession, based on newmarket information, $4,150 was charged to expense to write down the value ofrepossessed assets.  In October 2009,the repossessed assets were sold, and no material gain or loss was recognized.

 

*Deposits*

 

Our primary source offunds for loans and investments is our deposits.  At September 30, 2009, we had $103.9million in deposits, representing an increase of $5.0 million, or 5%, comparedto December 31, 2008.  Deposits at September 30,2009 consisted primarily of $13.8 million in demand deposit accounts, $19.0million in money market accounts and $70.9 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 September 30, 2009, we had $40.2million in brokered time deposits, a decrease of $9.3 million compared to December 31,2008.  We are seeking to reduce ourreliance on brokered time deposits and other noncore funding sources, whilefocusing our efforts to gather core deposits in our local market.

 

*Borrowings*

 

We use borrowings to fundgrowth of earning assets in excess of deposit growth.  Borrowings totaled $16.0 million at September 30,2009, compared to $19.1 million at December 31, 2008.  This decrease is due to the repayment of aFHLB advance in the amount of $3.0 million in May 2009 which was funded bynet loan repayments.  FHLB Advancesaccounted for $16.0 million of total borrowings.  These advances are secured with approximately$33.0 million of first and second mortgage loans, $1.4 million in cash and $1.1million of stock in the FHLB.    The remaining balance inborrowings represents customer repurchase agreements.

 

**Liquidity**

 

Liquidity  isthe  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 toachieve appropriate levels of liquidity. Cash and short-term investments are our primary sources of assetliquidity.  These funds provide a cushionagainst short-term fluctuations in cash flow from both deposits and loans.  The investment portfolio is our principalsource of secondary asset liquidity. However, the availability of this source of funds is influenced bymarket conditions and pledging agreements. Individual and commercial deposits, brokered deposits and borrowings areour primary source of funds for credit activities.  As brokered deposits or advances mature in2009, we intend to replace these funds with new brokered deposits or advancesto the extent necessary after considering core deposit growth, although overallwe will seek to reduce our reliance on brokered time deposits and other noncorefunding sources.

 

We are a member of the Federal Home Loan Bank ofAtlanta, from which applications for borrowings can be made for leveragepurposes, if so desired, in an amount up to 20% of the total assets of theBank.  We also pledge collateral to theFederal Reserve Bank’s Borrower-in-Custody ofCollateral program, and our available credit under this program wasapproximately $9.0 million as of September 30, 2009.  We have federal funds purchased lines ofcredit through two correspondent banks totaling $5.0 million.

 

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We believe our liquidity sources are adequate to meetour operating needs. The level of liquidity is measured by the cash, cashequivalents, and investment securities available for sale to total assetsratio, which was at 16.29% at September 30, 2009.  Our liquidity ratio has increased during theyear from 6.28% as of December 31, 2008 as a result of net loan payoffsand an increase in retail deposits offset by a decrease in brokered timedeposits and FHLB advances.  We carefullyfocused on liquidity management during the first nine months of 2009.  We will continue to reduce brokered timedeposits as cash balances, retail deposit growth and operating needs allow.

 

**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 September 30,2009, we had issued commitments to extend credit of $13.6 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 September 30,2009, there were no significant firm commitments outstanding for capitalexpenditures.

 

**Capital Resources**

 

Total shareholders’ equity decreased to $17.4 million at September 30, 2009 from $18.7 million at December 31, 2008, due to our net loss of $1,404,081 for the nine months ended September 30, 2009, partially offset by the increase of $9,193 in unrealized gain on securities available for sale and the capital impact of $119,387 in compensation expense related to stock option grants. We believe that our capital is sufficient to fund the activities of the 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.

 

18

 

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 September 30, 2009, as well as the ratios to be considered “well capitalized.”

 

The following table summarizes the capital amounts and ratios of the Bank and the regulatory minimum requirements at September 30, 2009.

 

(Dollars in thousands)

 
| ** **                             | ** ** | **Actual** | ** ** | **Well Capitalized   Requirement** | ** ** | **Adequately Capitalized   Requirement** | ** ** |
|----------------------------------------|------------|------------|------------|------------------------------------|------------|------------------------------------------|------------|
| ** **                             | ** ** | **Amount** | ** ** | **Ratio**                          | ** ** | **Amount**                               | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| Total capital to risk weighted assets  |       | $          | 14,462     |                               | 12.62      | %                                        | $          | 11,461 |   | 10.0 | % | $ | 9,169 |   | 8.0 | % |
| Tier 1 capital to risk weighted assets |       | $          | 13,020     |                               | 11.36      | %                                        | $          | 6,877 |   | 6.0 | % | $ | 4,585 |   | 4.0 | % |
| Tier 1 capital to average assets       |       | $          | 13,020     |                               | 9.74       | %                                        | $          | 6,685 |   | 5.0 | % | $ | 5,348 |   | 4.0 | % |

 

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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 September 30,2009.  There have been no significantchanges in our internal controls over financial reporting during the fiscalquarter ended September 30, 2009 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 goalsunder all potential future conditions, regardless of how remote.

 

20

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**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.

 

**Item2.  Unregistered Sales of EquitySecurities and Use of Proceeds**

 

None.

 

**Item 3.Default Upon Senior Securities**

 

None.

 

**Item 4.Submission of Matters to a Vote of Security Holders**

 

None.

 

**Item 5.Other Information**

 

None.

 

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**Item 6.Exhibits**

 

31.1         Rule 13a-14(a) Certificationof the Principal Executive Officer.

 

31.2                           Rule 13a-14(a) Certification ofthe Principal Financial Officer.

 

32            Section 1350 Certifications.

 

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# **SIGNATURES**

# ** **

In accordance withthe requirements of the Exchange Act, the registrant caused this report to besigned on its behalf by the undersigned thereunto duly authorized.

 

 
| Date: November 10,  2009 | By:                                                                   | /s/ Lawrence R. Miller |
|-------------------------------|-----------------------------------------------------------------------|------------------------|
|                          | Lawrence R. Miller                                                    |
|                          | Chief Executive Officer  (Principal Executive Officer)                |
|                          |                                                                  |                   |
| Date: November 10,  2009 | 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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