FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY





Table
of Contents





PageSelected
      Financial Data
                2Management’s
      Discussion and Analysis
                3-22Management's
      Annual Report on Internal Control Over Financial Reporting
                23Report
      of Independent Registered Public Accounting Firm
                24Consolidated
      Balance Sheets
                25Consolidated
      Statements of Income
                26Consolidated
      Statements of Changes in Shareholders’ Equity and Comprehensive
      Income
                27Consolidated
      Statements of Cash Flows
                28Notes
      to Consolidated Financial Statements
                29-54Corporate
      Data
                55-57









Selected
Financial Data




The
following selected financial data is derived from the consolidated financial
statements and other data of First Reliance Bancshares, Inc. and Subsidiary (the
“Company”).  The selected financial data should be read in conjunction
with the consolidated financial statements, including the accompanying notes,
included elsewhere herein.





(Dollars in thousands,
      except per share data)
                            
                            2008
                            
                            
                            2007
                            
                            
                            2006
                            
                            
                            2005
                            
                            
                            2004Income
      Statement Data:Interest
      income
                            
                            $
                            36,243
                            
                            
                            $
                            37,540
                            
                            
                            $
                            31,717
                            
                            
                            $
                            23,131
                            
                            
                            $
                            13,291Interest
      expense
                            
                            
                            17,298
                            
                            
                            
                            18,433
                            
                            
                            
                            14,214
                            
                            
                            
                            8,979
                            
                            
                            
                            4,061Net
      interest income
                            
                            
                            18,945
                            
                            
                            
                            19,107
                            
                            
                            
                            17,503
                            
                            
                            
                            14,152
                            
                            
                            
                            9,230Provision
      for loan losses
                            
                            
                            4,935
                            
                            
                            
                            1,643
                            
                            
                            
                            1,393
                            
                            
                            
                            1,811
                            
                            
                            
                            1,362Net
      interest income after provision for loan losses
                            
                            
                            14,010
                            
                            
                            
                            17,464
                            
                            
                            
                            16,110
                            
                            
                            
                            12,341
                            
                            
                            
                            7,868Noninterest
      income
                            
                            
                            5,009
                            
                            
                            
                            5,302
                            
                            
                            
                            4,591
                            
                            
                            
                            2,871
                            
                            
                            
                            2,380Noninterest
      expense
                            
                            
                            18,852
                            
                            
                            
                            18,961
                            
                            
                            
                            16,272
                            
                            
                            
                            12,475
                            
                            
                            
                            8,338Income
      before income taxes
                            
                            
                            167
                            
                            
                            
                            3,805
                            
                            
                            
                            4,429
                            
                            
                            
                            2,737
                            
                            
                            
                            1,910Income
      tax expense (benefit)
                            
                            
                            (459
                            )
                            
                            
                            1,245
                            
                            
                            
                            1,183
                            
                            
                            
                            789
                            
                            
                            
                            571Net
      income
                            
                            $
                            626
                            
                            
                            $
                            2,560
                            
                            
                            $
                            3,246
                            
                            
                            $
                            1,948
                            
                            
                            $
                            1,339Balance
      Sheet Data:Assets
                            
                            $
                            603,434
                            
                            
                            $
                            591,704
                            
                            
                            $
                            456,211
                            
                            
                            $
                            403,038
                            
                            
                            $
                            284,971Earning
      assets
                            
                            
                            560,032
                            
                            
                            
                            550,559
                            
                            
                            
                            412,687
                            
                            
                            
                            381,158
                            
                            
                            
                            271,020Securities
      available for sale(1)
                            
                            
                            76,311
                            
                            
                            
                            58,580
                            
                            
                            
                            35,931
                            
                            
                            
                            37,121
                            
                            
                            
                            28,568Loans
      (2)
                            
                            
                            478,579
                            
                            
                            
                            487,739
                            
                            
                            
                            360,123
                            
                            
                            
                            319,539
                            
                            
                            
                            239,695Allowance
      for loan losses
                            
                            
                            8,224
                            
                            
                            
                            5,271
                            
                            
                            
                            4,002
                            
                            
                            
                            3,419
                            
                            
                            
                            2,758Deposits
                            
                            
                            461,135
                            
                            
                            
                            449,498
                            
                            
                            
                            372,938
                            
                            
                            
                            334,437
                            
                            
                            
                            225,494Shareholders’
      equity
                            
                            
                            37,426
                            
                            
                            
                            37,028
                            
                            
                            
                            34,093
                            
                            
                            
                            29,651
                            
                            
                            
                            27,359Per-Share
      Data:Basic
      earnings
                            
                            $
                            0.18
                            
                            
                            $
                            0.74
                            
                            
                            $
                            0.96
                            
                            
                            $
                            0.60
                            
                            
                            $
                            0.52Diluted
      earnings
                            
                            
                            0.18
                            
                            
                            
                            0.72
                            
                            
                            
                            0.91
                            
                            
                            
                            0.57
                            
                            
                            
                            0.48Book
      value (period end)
                            
                            
                            10.65
                            
                            
                            
                            10.63
                            
                            
                            
                            9.95
                            
                            
                            
                            8.97
                            
                            
                            
                            8.54Performance
      Ratios:Return
      on average assets
                            
                            
                            0.11
                            %
                            
                            
                            0.52
                            %
                            
                            
                            0.75
                            %
                            
                            
                            0.54
                            %
                            
                            
                            0.59
                            %Return
      on average equity
                            
                            
                            1.65
                            
                            
                            
                            7.16
                            
                            
                            
                            10.19
                            
                            
                            
                            6.82
                            
                            
                            
                            7.04Net
      interest margin (3)
                            
                            
                            3.53
                            
                            
                            
                            4.20
                            
                            
                            
                            4.42
                            
                            
                            
                            4.20
                            
                            
                            
                            4.41Efficiency
      (4)
                            
                            
                            78.80
                            
                            
                            
                            77.69
                            
                            
                            
                            73.65
                            
                            
                            
                            73.28
                            
                            
                            
                            71.82Capital
      and Liquidity Ratios:Average
      equity to average assets
                            
                            
                            6.42
                            %
                            
                            
                            7.15
                            %
                            
                            
                            7.39
                            %
                            
                            
                            7.96
                            %
                            
                            
                            8.43
                            %Leverage
      (4.00% required minimum)
                            
                            
                            9.28
                            
                            
                            
                            9.46
                            
                            
                            
                            9.90
                            
                            
                            
                            10.02
                            
                            
                            
                            10.11Risk-based
      capitalTier
      1
                            
                            
                            10.73
                            
                            
                            
                            9.26
                            
                            
                            
                            11.42
                            
                            
                            
                            12.02
                            
                            
                            
                            11.36Total
                            
                            
                            11.97
                            
                            
                            
                            10.29
                            
                            
                            
                            12.45
                            
                            
                            
                            13.05
                            
                            
                            
                            12.52Average
      loans to average deposits
                            
                            
                            106.63
                            
                            
                            
                            99.37
                            
                            
                            
                            96.86
                            
                            
                            
                            102.07
                            
                            
                            
                            101.16





(1)
            Securities
      available-for-sale are stated at fair
value.


(2)
            Loans
      are stated at gross amounts before allowance for loan losses and include
      loans held for sale.


(3)
            Tax
      equivalent net interest income divided by average earning
      assets.


(4)
            Noninterest
      expense divided by the sum of net interest income and noninterest income,
      excluding gains and losses on sales of
assets.




-2-


FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY




Management’s
Discussion and Analysis


of
Financial Condition and Results of Operations





Basis
of Presentation





The
following discussion should be read in conjunction with the preceding “Selected
Financial Data” and the Company’s Consolidated Financial Statements and the
Notes thereto and the other financial data included elsewhere
herein.  The financial information provided below has been rounded in
order to simplify its presentation.  However, the ratios and
percentages provided below are calculated using the detailed financial
information contained in the Consolidated Financial Statements, the Notes
thereto and the other financial data included elsewhere herein.





General




First
Reliance Bank (the “Bank”) is a state-chartered bank headquartered in Florence,
South Carolina.  The Bank opened for business on August 16,
1999.  The principal business activity of the Bank is to provide
banking services to domestic markets, principally in Florence County, Lexington
County, and Charleston County, South Carolina. The deposits of the Bank are
insured by the Federal Deposit Insurance Corporation (the “FDIC”).





On June
7, 2001, the shareholders of the Bank approved a plan of corporate
reorganization (the “Reorganization”) under which the Bank would become a wholly
owned subsidiary of First Reliance Bancshares, Inc. (the “Company”), a South
Carolina corporation.  The Reorganization was accomplished through a
statutory share exchange between the Bank and the Company, whereby each
outstanding share of common stock of the Bank was exchanged for one share of
common stock of the Company.  The Reorganization was completed on
April 1, 2002, and the Bank became a wholly-owned subsidiary of the
Company.





Organizing
activities for the Bank began on November 23, 1998.  Upon the
completion of the application process with the South Carolina State Board of
Financial Institutions for a state charter and with the FDIC for deposit
insurance, the Bank issued 723,518 shares of common stock at a price of $10.00
per share, resulting in capital totaling $7,173,293, net of selling expenses of
$61,887.





The Bank
began operations on August 16, 1999 at its temporary facility on West Palmetto
Street in Florence, South Carolina.  In June of 2000, the Bank moved
into its headquarters at 2170 West Palmetto Street in Florence, South
Carolina.  The Bank also opened a banking office on Second Loop Road
in Florence, South Carolina in April of 2001. On May 15, 2002, the Bank
purchased an additional facility located at 2145 Fernleaf Drive in Florence,
South Carolina.  The Fernleaf Drive site contains approximately 0.5
acres of land and includes a 7,500 square feet building.  The facility
serves as additional space for operational activities of the Bank, including
data processing and auditing.  No customer services are being
conducted in this facility.





On
November 12, 2002, the Company commenced a stock offering whereby a minimum of
125,000 shares and a maximum of 1,250,000 shares of common stock were offered to
fund continued expansion.  The offering price was $8.00 per
share.  This was a best efforts offering and was conducted without an
underwriter.  The Company had sold 1,007,430 shares resulting in
additional capital of $8,059,439 net of selling expenses of $162,965, at the
close of the offering in May 2003.  Also 10,400 stock options were
exercised in 2003 for a total amount of $52,000.





During
the second quarter of 2004, the Bank opened its third branch in Lexington, South
Carolina.  On March 15, 2005, the Bank opened its fourth branch in
Charleston, South Carolina located at 51 State Street.  The Bank also
opened its fifth branch in Mount Pleasant, South Carolina located at 800 South
Shelmore Blvd on October 3, 2005.





On June
30, 2005, First Reliance Capital Trust I (a non-consolidated affiliate) issued
$10,000,000 in trust preferred securities with a maturity of November 23,
2035 and may be redeemed by the Company after five years, and sooner in
certain specific events.  The rate is fixed at 5.93% until August 23,
2010, at which point the rate adjusts quarterly to the three-month LIBOR plus
1.83%, and can be called without penalty beginning on June 15,
2011.  In accordance with the revised FIN 46, the Trust has not been
consolidated in these financial statements.  The Company received from
the trust the $10,000,000 proceeds from the issuance of the securities and the
$310,000 initial proceeds from the capital investment in the trust, and
accordingly has shown the funds due to the trust as $10,310,000 junior
subordinated debentures.  Current regulations allow the entire amount
of junior subordinated debentures to be included in the calculation of
regulatory capital.


-3-


FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY




Management’s
Discussion and Analysis


of
Financial Condition and Results of Operations





General - continued





On
December 28, 2007, the Company injected $3,000,000 into the Bank as permanent
capital.





On March
6, 2009, as part of the capital purchase component of the U.S. Department of the
Treasury’s (the “Treasury”) Troubled Asset Relief Program, the Company
entered into a Letter Agreement and a Securities Purchase Agreement – Standard
Terms attached thereto with the Treasury, pursuant to which the Company agreed
to issue and sell, and the Treasury agreed to purchase (i) 15,349 shares of the
Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A, having a
liquidation preference of $1,000 per share (“Series A Preferred Shares”), and
(ii) a warrant (the “Warrant”) to purchase up to 767.00767 shares of the
Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series B, having a
liquidation preference of $1,000 per share (“Series B Preferred Shares”), at an
exercise price of $0.01 per share, for an aggregate purchase price of
$15,349,000 in cash.  The Warrant was exercised by the Treasury on a
net basis immediately following the closing of the transaction, resulting in the
issuance of 767 Series B Preferred Shares.  The investment amount
approved by the Treasury was increased from the previously announced $14.9
million due to an increase in the Company’s total risk-weighted assets from
September 30, 2008 to December 31, 2008.  The Series A Preferred Shares
will qualify as Tier 1 capital and pay cumulative dividends at a rate of
5% per annum for the first five years and 9% per annum
thereafter.  The Series B Preferred Shares will pay cumulative
dividends at a rate of 9% per annum.  Dividends are payable on both
the Series A Preferred Shares and the Series B Preferred Shares (collectively,
the “Preferred Shares”) quarterly and are payable on February 15, May 15, August
15, and November 15 of each year.





Like most
financial institutions, the Company’s profitability depends largely upon net
interest income, which is the difference between the interest received on
earning assets, such as loans and investment securities, and the interest paid
on interest-bearing liabilities, principally deposits and
borrowings.  The Company’s results of operations are also affected by
the provision for loan losses; non-interest expenses, such as salaries, employee
benefits, and occupancy expenses; and non-interest income, such as mortgage loan
fees and service charges on deposit accounts.





Economic
conditions, competition and federal monetary and fiscal policies also affect
financial institutions. Lending activities are also influenced by regional and
local economic factors, such as housing supply and demand, competition among
lenders, customer preferences and levels of personal income and savings in our
primary market area.





Our
balanced growth continued during 2008, with increases in assets, loans,
investment securities, deposits and shareholders’ equity.  The
following chart shows our growth in these areas from December 31, 2007 to
December 31, 2008:





PercentDecember 31,
                  
                  
                  Increase(Dollars
      in millions)
                  
                  2008
                  
                  
                  2007
                  
                  
                  (Decrease)Total
      assets
                  
                  $
                  603.4
                  
                  
                  $
                  591.7
                  
                  
                  
                  1.98
                  %Loans,
      excluding mortgage loans held for sale
                  
                  
                  469.0
                  
                  
                  
                  468.1
                  
                  
                  
                  0.19Investment
      securities
                  
                  
                  80.9
                  
                  
                  
                  62.5
                  
                  
                  
                  29.44Deposits
                  
                  
                  461.1
                  
                  
                  
                  449.5
                  
                  
                  
                  2.58Shareholders'
      equity
                  
                  
                  37.4
                  
                  
                  
                  37.0
                  
                  
                  
                  1.08





The
additional capital received from the Treasury on March 9, 2009, increased our
legal lending limit, thereby allowing us to extend larger loans to our
customers.   Our loan portfolio increased $0.9 million from
December 31, 2007 to December 31, 2008.  Our deposit base also
increased in 2008 by $11.6 million from $449.5 million in 2007 to $461.1 million
in 2008.  The significant increase in average earning assets had a
positive impact on our results of operations for 2008.  Average
earning assets increased from $461.0 million in 2007 to $549.7 million in
2008.  Our increased volume in deposits also increased our fees from
service charges and deposit accounts by approximately $116,967 from 2007 to
2008.  Gains on sales of mortgage loans were also an important source
of noninterest income in 2008.  However, due to the decline in the
residential real estate market, gains on the sale of mortgage loans decreased by
$472,978, or 21.76% from $2.2 million in 2007 to $1.7 million in
2008.


-4-


FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY




Management’s
Discussion and Analysis


of
Financial Condition and Results of Operations





Results
of Operations





Year
ended December 31, 2008, compared with year ended December 31, 2007




Net
interest income decreased $162,932 or 0.85%, to $18,944,346 in 2008 from
$19,107,278 in 2007.  The decrease in the net interest income was
partially attributable to the numerous declines in the prime interest rate that
occurred during 2008. These declines negatively impacted interest income, since
approximately 55% of the average volume of our loan portfolio included variable
interest rate loans.  Also, the decrease in net interest income was
significantly impacted by the increase in our nonaccruing loans, which increased
$17,934,375 during 2008.  Net interest income would have been
$1,423,361 higher if interest on our nonaccruing loans had been recognized on a
fully accruing basis.  For 2008 and 2007, the primary components of
interest income were interest on loans, including fees, of $33,150,366 and
$35,325,242 and interest on investment securities of $2,818,078 and $1,672,468,
respectively.  Average earning assets increased $88,604,493 or 19.22%,
mainly due to continued growth in the loan portfolio.  The average
balance of our loans increased $66,665,000 during 2008.  Our average
interest bearings liabilities increased $89,618,000 from 2007 to
$506,359,000.  This increase was mainly due to the increase in the
average balance of other borrowings, which increased $56,926,000 during
2008.





The
Company’s net interest spread and net interest margin were 3.25% and 3.53%,
respectively, in 2008, compared to 3.78% and 4.20%, respectively, in
2007.  The decrease in the net interest spread was primarily the
result of the negative impact of the numerous declines in the prime interest
rate that occurred during 2008 and the lost interest income on our nonaccruing
loans.  Yields on loans, our largest category of earnings assets,
decreased from 8.51% in 2007 to 6.88% in 2008.  Overall, yields on
earning assets decreased from 8.20% in 2007 to 6.67% in 2008.  If the
lost interest income attributable to the nonaccruing loans was recognized then
the average yields for 2008 on our loans and earnings assets would have been
7.18% and 6.93%, respectively. Yields on interest-bearing liabilities decreased
from 4.42% in 2007 to 3.42% in 2008.





The
provision for loan losses was $4,934,912 in 2008 compared to $1,643,100 in
2007.  The allowance for loan losses was 1.75% and 1.13% of total
loans at December 31, 2008 and 2007, respectively.  The Company
continues to maintain the allowance for loan losses at a level management
believes to be sufficient to cover known and inherent losses in the loan
portfolio.





Noninterest
income decreased $292,995, or 5.53%, to $5,008,804 in 2008 from $5,301,799 in
2007.  The decrease is primarily attributable to a reduction in gains
on sales of mortgage loans, which decreased $472,978 or 21.76% to $1,700,162 for
the year ended December 31, 2008.  This decrease is attributable to
the decline in the residential real estate market, which resulted in a weak
demand for new mortgage loans and refinancings.  The increase in total
income from service charges, commissions and fees partially offset the decrease
in income from gains on sale of mortgage loans.  Total service
charges, commissions and fees increased $222,113 or 9.77% from 2007, to
$2,496,143 for the year ended December 31, 2008.  This increase is
attributable to the increase in the number of customers we served and the
increase in fees for certain services





Noninterest
expense decreased $109,629, or 0.58%, to $18,851,646 in 2008 from $18,961,275 in
2007.  Except for occupancy expense, all other major category of
noninterest expense decreased $675,881, or 3.84% in 2008, as compared to
2007.  The primarily reason for this decline is our continual emphasis
on expense management.  Occupancy expense increased $566, 252, or
41.63% in 2008 as compared to 2007.  This increase is primarily
associated with the Bank’s extended operating hours.  The Company’s
efficiency ratio was 78.80% in 2008, compared to 77.69% in 2007.





Net
income was $625,632 in 2008, compared to $2,559,520 in 2007.  The
decrease in net income can be attributed to net interest margin compression due
to declining interest rate movements, the lost income on our nonaccruing loans
and the higher than normal amount of the addition to the provision loan losses,
which is the result of the depressed economy.  In 2009, we intend to
focus on growing our no cost/low cost deposit accounts, improving operational
efficiencies with an emphasis on


expense
management, and leveraging our customer loyalty ratings.Return
on average assets during 2008 was 0.11%, compared to 0.52% in 2007, and return
on average equity was 1.65% during 2008, compared to 7.16% during
2007.


-5-


FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY




Management’s
Discussion and Analysis


of
Financial Condition and Results of Operations





Net
Interest Income




General.  The largest
component of the Company’s net income is its net interest income, which is the
difference between the income earned on assets and interest paid on deposits and
on borrowings used to support such assets.  Net interest income is
determined by the yields earned on the Company’s interest-earning assets and the
rates paid on its interest-bearing liabilities, the relative amounts of
interest-earning assets and interest-bearing liabilities, and the degree of
mismatch and the maturity and repricing characteristics of its interest-earning
assets and interest-bearing liabilities.  Total interest earning
assets yield less total interest bearing liabilities rate represents the
Company’s net interest rate spread.





Average Balances,
Income and Expenses, and Rates.  The following
table sets forth, for the years indicated, certain information related to the
Company’s average balance sheet and its average yields on assets and average
costs of liabilities.  Such yields are derived by dividing income or
expense by the average balance of the corresponding assets or
liabilities.  Average balances have been derived from the daily
balances throughout the periods indicated.





Average
Balances, Income and Expenses, and Rates




Year
      ended December 31,
                                          
                                          2008
                                          
                                          
                                          2007Average
                                          
                                          
                                          Income/
                                          
                                          
                                          Yield/
                                          
                                          
                                          Average
                                          
                                          
                                          Income/(Dollars
      in thousands)
                                          
                                          Balance
                                          
                                          
                                          Expense
                                          
                                          
                                          Rate
                                          
                                          
                                          Balance
                                          
                                          
                                          Expense
                                          
                                          
                                          RateAssets:Earning
      Assets:Loans(1)(2)
                                          
                                          $
                                          481,572
                                          
                                          
                                          $
                                          33,150
                                          
                                          
                                          
                                          6.88
                                          %
                                          
                                          $
                                          414,907
                                          
                                          
                                          $
                                          35,325
                                          
                                          
                                          
                                          8.51
                                          %Securities,
      taxable(2)
                                          
                                          
                                          30,075
                                          
                                          
                                          
                                          1,519
                                          
                                          
                                          
                                          5.05
                                          %
                                          
                                          
                                          17,967
                                          
                                          
                                          
                                          892
                                          
                                          
                                          
                                          4.96
                                          %Securities,
      tax exempt(2)
                                          
                                          
                                          30,112
                                          
                                          
                                          
                                          1,741
                                          
                                          
                                          
                                          5.78
                                          %
                                          
                                          
                                          18,204
                                          
                                          
                                          
                                          1,045
                                          
                                          
                                          
                                          5.74
                                          %Federal
      funds sold
                                          
                                          
                                          2,838
                                          
                                          
                                          
                                          56
                                          
                                          
                                          
                                          1.97
                                          %
                                          
                                          
                                          7,479
                                          
                                          
                                          
                                          391
                                          
                                          
                                          
                                          5.23
                                          %Other
                                          
                                          
                                          5,095
                                          
                                          
                                          
                                          218
                                          
                                          
                                          
                                          4.28
                                          %
                                          
                                          
                                          2,529
                                          
                                          
                                          
                                          152
                                          
                                          
                                          
                                          6.01
                                          %Total
      earning assets
                                          
                                          
                                          549,692
                                          
                                          
                                          
                                          36,684
                                          
                                          
                                          
                                          6.67
                                          %
                                          
                                          
                                          461,086
                                          
                                          
                                          
                                          37,805
                                          
                                          
                                          
                                          8.20
                                          %Cash
      and due from banks
                                          
                                          
                                          5,524
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          8,586Premises
      and equipment
                                          
                                          
                                          23,983
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          18,049Other
      assets
                                          
                                          
                                          17,882
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          16,758Allowance
      for loan losses
                                          
                                          
                                          (5,819
                                          )
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          (4,433
                                          )Total
      assets
                                          
                                          $
                                          591,262
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          $
                                          500,046Liabilities:Interest-bearing
      liabilities:Interest-bearings
      deposits:Interest-bearing
      transaction accounts
                                          
                                          $
                                          28,760
                                          
                                          
                                          $
                                          184
                                          
                                          
                                          
                                          0.64
                                          %
                                          
                                          $
                                          36,625
                                          
                                          
                                          $
                                          710
                                          
                                          
                                          
                                          1.94
                                          %Savings
      deposits
                                          
                                          
                                          98,210
                                          
                                          
                                          
                                          2,123
                                          
                                          
                                          
                                          2.16
                                          %
                                          
                                          
                                          80,943
                                          
                                          
                                          
                                          3,184
                                          
                                          
                                          
                                          3.93
                                          %Time
      deposits
                                          
                                          
                                          280,843
                                          
                                          
                                          
                                          11,313
                                          
                                          
                                          
                                          4.03
                                          %
                                          
                                          
                                          254,934
                                          
                                          
                                          
                                          12,874
                                          
                                          
                                          
                                          5.05
                                          %Other
      interest-bearing liabilities:Note
      payable
                                          
                                          
                                          3,389
                                          
                                          
                                          
                                          136
                                          
                                          
                                          
                                          4.01
                                          %
                                          
                                          
                                          8
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          6.00
                                          %Junior
      subordinated debentures
                                          
                                          
                                          10,310
                                          
                                          
                                          
                                          616
                                          
                                          
                                          
                                          5.97
                                          %
                                          
                                          
                                          10,310
                                          
                                          
                                          
                                          620
                                          
                                          
                                          
                                          6.01
                                          %Other
      borrowings
                                          
                                          
                                          84,847
                                          
                                          
                                          
                                          2,926
                                          
                                          
                                          
                                          3.45
                                          %
                                          
                                          
                                          33,923
                                          
                                          
                                          
                                          1,045
                                          
                                          
                                          
                                          3.08
                                          %Total
      interest-bearing liabilities
                                          
                                          
                                          506,359
                                          
                                          
                                          
                                          17,298
                                          
                                          
                                          
                                          3.42
                                          %
                                          
                                          
                                          416,743
                                          
                                          
                                          
                                          18,433
                                          
                                          
                                          
                                          4.42
                                          %Non-interest
      bearing deposits
                                          
                                          
                                          43,812
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          45,038Other
      liabilities
                                          
                                          
                                          3,124
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          2,513Shareholders’
      equity
                                          
                                          
                                          37,967
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          35,752Total
      liabilities and shareholders’ equity
                                          
                                          $
                                          591,262
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          $
                                          500,046Net
      interest spread
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          3.25
                                          %
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          3.78
                                          %Net
      interest income
                                          
                                          
                                          
                                          
                                          
                                          $
                                          19,386
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          $
                                          19,372Net
      interest margin
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          3.53
                                          %
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          4.20
                                          %





(1)
            Nonaccrual
      loans are included in the balances.  The effect of these loans
      is not significant to the computations.  All loans and deposits
      are domestic.


(2)
            Fully
      tax-equivalent basis at 34% tax rate for non-taxable securities and
      loans.


-6-


FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY




Management’s
Discussion and Analysis


of
Financial Condition and Results of Operations





Rate/Volume
Analysis





Analysis of
Changes in Net Interest Income.  Net interest
income can also be analyzed in terms of the impact of changing rates and
changing volume.  The following table describes the extent to which
changes in interest rates and changes in the volume of earning assets and
interest-bearing liabilities have affected the Company’s interest income and
interest expense during the periods indicated.  Information on changes
in each category attributable to (i) changes due to volume (change in volume
multiplied by prior period rate), (ii) changes due to rates (changes in rates
multiplied by prior period volume) and (iii) changes in rate/volume (change in
rate multiplied by the change in volume) is provided in the table
below.  Changes to both rate and volume (in iii above) which cannot be
segregated have been allocated proportionately.





2008
      Compared to 2007Due to increase (decrease)
    in(Dollars
      in thousands)
                    
                    Volume
                    
                    
                    Rate
                    
                    
                    TotalInterest
      income:Loans
                    
                    $
                    5,178
                    
                    
                    $
                    (7,353
                    )
                    
                    $
                    (2,175
                    )Securities,
      taxable
                    
                    
                    611
                    
                    
                    
                    16
                    
                    
                    
                    627Securities,
      tax exempt
                    
                    
                    689
                    
                    
                    
                    7
                    
                    
                    
                    696Federal
      funds sold and other
                    
                    
                    (167
                    )
                    
                    
                    (168
                    )
                    
                    
                    (335
                    )Other
                    
                    
                    120
                    
                    
                    
                    (54
                    )
                    
                    
                    66Total
      interest income
                    
                    
                    6,431
                    
                    
                    
                    (7,552
                    )
                    
                    
                    (1,121
                    )Interest
      expense:Interest-bearing
      deposits
                    
                    
                    (128
                    )
                    
                    
                    (398
                    )
                    
                    
                    (526
                    )Savings
      deposits
                    
                    
                    580
                    
                    
                    
                    (1,641
                    )
                    
                    
                    (1,061
                    )Time
      deposits
                    
                    
                    1,218
                    
                    
                    
                    (2,779
                    )
                    
                    
                    (1,561
                    )Note
      payable
                    
                    
                    136
                    
                    
                    
                    0
                    
                    
                    
                    136Junior
      subordinated debentures
                    
                    
                    0
                    
                    
                    
                    (4
                    )
                    
                    
                    (4
                    )Other
      borrowings
                    
                    
                    1,741
                    
                    
                    
                    140
                    
                    
                    
                    1,881Total
      interest expense
                    
                    
                    3,547
                    
                    
                    
                    (4,682
                    )
                    
                    
                    (1,135
                    )Net
      interest income
                    
                    $
                    2,884
                    
                    
                    $
                    (2,870
                    )
                    
                    $
                    14





2007
      Compared to 2006Due to increase (decrease)
    in(Dollars
      in thousands)
                
                Volume
                
                
                Rate
                
                
                TotalInterest
      income:Loans
                
                $
                5,642
                
                
                $
                461
                
                
                $
                6,103Securities,
      taxable
                
                
                (191
                )
                
                
                53
                
                
                
                (138
                )Securities,
      tax exempt
                
                
                194
                
                
                
                (6
                )
                
                
                188Federal
      funds sold and other
                
                
                (329
                )
                
                
                33
                
                
                
                (296
                )Other
                
                
                47
                
                
                
                (33
                )
                
                
                14Total
      interest income
                
                
                5,363
                
                
                
                508
                
                
                
                5,871Interest
      expense:Interest-bearing
      deposits
                
                
                84
                
                
                
                441
                
                
                
                525Savings
      deposits
                
                
                (188
                )
                
                
                129
                
                
                
                (59
                )Time
      deposits
                
                
                2,403
                
                
                
                1,403
                
                
                
                3,806Junior
      subordinated debentures
                
                
                0
                
                
                
                2
                
                
                
                2Other
      borrowings
                
                
                240
                
                
                
                (295
                )
                
                
                (55
                )Total
      interest expense
                
                
                2,539
                
                
                
                1,680
                
                
                
                4,219Net
      interest income
                
                $
                2,824
                
                
                $
                (1,172
                )
                
                $
                1,652





-7-


FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY




Management’s
Discussion and Analysis


of
Financial Condition and Results of Operations





Net
Interest Income





Interest
Sensitivity.  The Company
monitors and manages the pricing and maturity of its assets and liabilities in
order to diminish the potential adverse impact that changes in interest rates
could have on its net interest income.  The principal monitoring
technique employed by the Company is the measurement of the Company’s interest
sensitivity “gap,” which is the positive or negative dollar difference between
assets and liabilities that are subject to interest rate repricing within a
given period of time.  Interest rate sensitivity can be managed by
repricing assets or liabilities, selling securities available-for-sale,
replacing an asset or liability at maturity, or adjusting the interest rate
during the life of an asset or liability. Managing the amount of assets and
liabilities repricing in this same time interval helps to hedge interest
sensitivity and minimize the impact on net interest income of rising or falling
interest rates.





The
following table sets forth the Company’s interest rate sensitivity at December
31, 2008.





Interest
Sensitivity Analysis





GreaterAfter One
                    
                    
                    After Three
                    
                    
                    
                    
                    
                    Than OneThrough
                    
                    
                    Through
                    
                    
                    Within
                    
                    
                    Year orDecember 31, 2008
                    
                    Within One
                    
                    
                    Three
                    
                    
                    Twelve
                    
                    
                    One
                    
                    
                    Non-(Dollars
      in thousands)
                    
                    Month
                    
                    
                    Months
                    
                    
                    Months
                    
                    
                    Year
                    
                    
                    Sensitive
                    
                    
                    TotalAssetsInterest-earning
      assetsLoans,
      including held for sale
                    
                    $
                    59,236
                    
                    
                    $
                    32,006
                    
                    
                    $
                    109,241
                    
                    
                    $
                    200,483
                    
                    
                    $
                    278,096
                    
                    
                    $
                    478,579Securities,
      taxable
                    
                    
                    124
                    
                    
                    
                    63
                    
                    
                    
                    
                    
                    
                    
                    187
                    
                    
                    
                    47,599
                    
                    
                    
                    47,786Securities,
      nontaxable
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    28,525
                    
                    
                    
                    28,525Nonmarketable
      securities
                    
                    
                    4,575
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    4,575
                    
                    
                    
                    
                    
                    
                    
                    4,575Federal
      funds sold
                    
                    
                    257
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    257
                    
                    
                    
                    
                    
                    
                    
                    257Investment
      in trust
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    310
                    
                    
                    
                    310Total
      earning assets
                    
                    
                    64,192
                    
                    
                    
                    32,069
                    
                    
                    
                    109,241
                    
                    
                    
                    205,502
                    
                    
                    
                    354,530
                    
                    
                    
                    560,032LiabilitiesInterest-bearing
      liabilities:Interest-bearing
      deposits:Demand
      deposits
                    
                    
                    34,709
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    34,709
                    
                    
                    
                    
                    
                    
                    
                    34,709Savings
      deposits
                    
                    
                    110,629
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    110,629
                    
                    
                    
                    
                    
                    
                    
                    110,629Time
      deposits
                    
                    
                    33,911
                    
                    
                    
                    51,904
                    
                    
                    
                    132,288
                    
                    
                    
                    218,103
                    
                    
                    
                    58,227
                    
                    
                    
                    276,330Total
      interest-bearing deposits
                    
                    
                    179,249
                    
                    
                    
                    51,904
                    
                    
                    
                    132,288
                    
                    
                    
                    363,441
                    
                    
                    
                    58,227
                    
                    
                    
                    421,668Advances
      from FederalHome
      Loan Bank
                    
                    
                    8,500
                    
                    
                    
                    9,000
                    
                    
                    
                    35,500
                    
                    
                    
                    53,000
                    
                    
                    
                    25,000
                    
                    
                    
                    78,000Note
      payable
                    
                    
                    6,950
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    6,950
                    
                    
                    
                    
                    
                    
                    
                    6,950Junior
      subordinated debentures
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    10,310
                    
                    
                    
                    10,310Repurchase
      agreements
                    
                    
                    8,197
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    8,197
                    
                    
                    
                    
                    
                    
                    
                    8,197Total
      interest-bearing liabilities
                    
                    
                    202,896
                    
                    
                    
                    60,904
                    
                    
                    
                    167,788
                    
                    
                    
                    431,588
                    
                    
                    
                    93,537
                    
                    
                    
                    525,125Period
      gap
                    
                    $
                    (138,704
                    )
                    
                    $
                    (28,835
                    )
                    
                    $
                    (58,547
                    )
                    
                    $
                    (226,086
                    )
                    
                    $
                    260,993Cumulative
      gap
                    
                    $
                    (138,704
                    )
                    
                    $
                    (167,539
                    )
                    
                    $
                    (226,086
                    )
                    
                    $
                    (226.086
                    )
                    
                    $
                    34,907Ratio
      of cumulative gap to total earning assets
                    
                    
                    (24.77
                    )%
                    
                    
                    (29.92
                    )%
                    
                    
                    (40.37
                    )%
                    
                    
                    (40.37
                    )%
                    
                    
                    6.23
                    %


-8-


FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY




Management’s
Discussion and Analysis


of
Financial Condition and Results of Operations





Net Interest Income- continued





The above
table reflects the balances of earning assets and interest-bearing liabilities
at the earlier of their repricing or maturity dates.  Federal funds
sold are reflected at the earliest pricing interval due to the immediately
available nature of the instruments.  Securities are reflected at each
instrument’s ultimate maturity date.  Scheduled payment amounts of
fixed rate amortizing loans are reflected at each scheduled payment
date.  Scheduled payment amounts of variable rate amortizing loans are
reflected at each scheduled payment date until the loan may be repriced
contractually; the unamortized balance is reflected at that
point.  Interest-bearing liabilities with no contractual maturity,
such as demand deposits and savings deposits, are reflected in the earliest
repricing period due to contractual arrangements which give the Company the
opportunity to vary the rates paid on those deposits within one month or shorter
period.  However, the Company is not obligated to vary the rates paid
on these deposits within any given period.  Fixed rate time deposits,
principally certificates of deposit, are reflected at their contractual maturity
dates. Repurchase agreements mature on a daily basis and are reflected in the
earliest pricing period. Advances from the Federal Home Loan Bank and junior
subordinated debentures are reflected at their contractual maturity
date.





The
Company is in a liability sensitive position (or a negative gap) of $226.1
million over the 12 month time frame.  The gap is negative when
interest-bearing liabilities exceed interest sensitive earning assets, as was
the case at the end of 2008 with respect to the one-year time horizon. When
interest sensitive earning assets exceed interest-bearing liabilities for a
specific repricing "horizon,” a positive interest sensitivity gap is the
result.





A
positive gap generally has a favorable effect on net interest income during
periods of rising rates.  A positive one year gap position occurs when
the dollar amount of earning assets maturing or repricing within one year
exceeds the dollar amount of interest-bearing liabilities maturing or repricing
during that same period.  As a result, during periods of rising
interest rates, the interest received on earning assets will increase faster
than interest paid on interest-bearing liabilities, thus increasing interest
income.  The reverse is true in periods of declining interest rates
resulting generally in a decrease in net interest income.





The
Company's Board of Directors and management review the asset liability
management with information obtained from our system which measure the interest
rate sensitivity.  The Company's asset and liability policies are
focused upon maximizing long term profitability while managing acceptable
interest rate risk.





However,
the Company’s gap analysis is not a precise indicator of its interest
sensitivity position.  The analysis presents only a static view of the
timing of maturities and repricing opportunities, without taking into
consideration that changes in interest rates do not affect all assets and
liabilities equally.  For example, rates paid on a substantial portion
of core deposits may change contractually within a relatively short time frame,
but those rates are viewed by management as significantly less
interest-sensitive than market-based rates such as those paid on non-core
deposits.  Net interest income may be impacted by other significant
factors in a given interest rate environment, including changes in the volume
and mix of earning assets and interest-bearing
liabilities.  Management believes the Company has positioned itself
where there is minimal impact on interest income in a rising or falling rate
environment.


-9-





FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY




Management’s
Discussion and Analysis


of
Financial Condition and Results of Operations





Provision
and Allowance for Loan Losses





General.  The Company has
developed policies and procedures for evaluating the overall quality of its
credit portfolio and the timely identification of potential problem
credits.  On a quarterly basis, the Company’s Board of Directors
reviews and approves the appropriate level for the Company’s allowance for loan
losses based upon management’s recommendations, the results of the internal
monitoring and reporting system, and an analysis of economic conditions in its
market.  The objective of management has been to fund the allowance
for loan losses at a level greater or equal to the Company's internal risk
measurement system for loan risk. The Board maintained an allowance for loan
losses level of 1.75% and 1.13% of total loans at December 31, 2008 and 2007,
respectfully.  Management and the Board believe the allowance at
December 31, 2008, is adequate to meet potential loan losses inherent in the
loan portfolio.





Additions
to the allowance for loan losses, which are expensed as the provision for loan
losses on the Company’s income statement, are made periodically to maintain the
allowance at an appropriate level based on management’s analysis of the
potential risk in the loan portfolio.  Loan losses and recoveries are
charged or credited directly to the allowance.  The amount of the
provision is a function of the level of loans outstanding, the level of
nonperforming loans, historical loan loss experience, the amount of loan losses
actually charged against the reserve during a given period, and current and
anticipated economic conditions.





The
allowance represents an amount which management believes will be adequate to
absorb inherent losses on existing loans that may become
uncollectible.  Our judgment in determining the adequacy of the
allowance is based on evaluations of the collectibility of loans, including
consideration of factors such as the balance of impaired loans; the quality, mix
and size of our overall loan portfolio; economic conditions that may affect the
borrower's ability to repay the amount and quality of collateral securing the
loans; our limited historical loan loss experience and a review of specific
problem loans.





The
Company adjusts the amount of the allowance periodically based on changing
circumstances as a component of the provision for loan losses.  We
charge recognized losses against the allowance and add subsequent recoveries
back to the allowance.  Under the Company’s policy, it evaluates the
allowance for loan losses needs using three categories; specific reserves,
historical losses base on loan category, and environmental
factors.  Detailed calculations are documented on a monthly basis and
submitted through appropriate areas for approval to ensure adequate levels for
the allowance for loan losses. Management and the Board agree that the current
methodology meets regulatory requirements and industry
standards.


-10-





FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY




Management’s
Discussion and Analysis


of
Financial Condition and Results of Operations





Provision and Allowance for Loan
Losses -continued





Our
various regulatory agencies review the Company’s allowance for loan losses
through their periodic examinations, and they may require additions to the
allowance for loan losses based on their judgment about information available to
them at the time of their examinations. The Company’s losses will undoubtedly
vary from our estimates, and it is possible that charge-offs in future periods
will exceed the allowance for loan losses as estimated at any point in
time.





As of
December 31, 2008, the Company's allowance for loan losses was $8,223,899, an
increase of $2,953,292 from 2007.  The increase in the allowance for
loan losses was driven primarily by a higher level of required reserves for all
categories of loans due to depressed economic conditions in our market
areas.  The categories and concentrations of loans have been
consistent between the past two years.





The
following table sets forth certain information with respect to the Company’s
allowance for loan losses and the composition of chargeoffs and recoveries for
the five years ended December 31, 2008.





Allowance
      for Loan Losses(Dollars
      in thousands)
                        
                        2008
                        
                        
                        2007
                        
                        
                        2006
                        
                        
                        2005
                        
                        
                        2004Total
      loans outstanding at end of year
                        
                        $
                        468,990
                        
                        
                        $
                        468,138
                        
                        
                        $
                        353,491
                        
                        
                        $
                        311,544
                        
                        
                        $
                        238,362Average
      loans outstanding
                        
                        $
                        481,572
                        
                        
                        $
                        414,907
                        
                        
                        $
                        348,709
                        
                        
                        $
                        294,740
                        
                        
                        $
                        182,996Balance
      of allowance for loan losses at beginning of year
                        
                        $
                        5,271
                        
                        
                        $
                        4,002
                        
                        
                        $
                        3,419
                        
                        
                        $
                        2,758
                        
                        
                        $
                        1,752Loans
      charged off:Real
      estate - construction
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        17
                        
                        
                        
                        142
                        
                        
                        
                        -Real
      estate - mortgage
                        
                        
                        1,136
                        
                        
                        
                        205
                        
                        
                        
                        718
                        
                        
                        
                        472
                        
                        
                        
                        166Commercial
      and industrial
                        
                        
                        997
                        
                        
                        
                        58
                        
                        
                        
                        170
                        
                        
                        
                        317
                        
                        
                        
                        44Consumer
      and other
                        
                        
                        235
                        
                        
                        
                        193
                        
                        
                        
                        151
                        
                        
                        
                        300
                        
                        
                        
                        181Total
      loan losses
                        
                        
                        2,368
                        
                        
                        
                        456
                        
                        
                        
                        1,056
                        
                        
                        
                        1,231
                        
                        
                        
                        391Recoveries
      of previous loan losses:Real
      estate - construction
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -Real
      estate – mortgage
                        
                        
                        322
                        
                        
                        
                        36
                        
                        
                        
                        105
                        
                        
                        
                        38
                        
                        
                        
                        -Commercial
      and industrial
                        
                        
                        10
                        
                        
                        
                        24
                        
                        
                        
                        111
                        
                        
                        
                        12
                        
                        
                        
                        -Consumer
      and other
                        
                        
                        54
                        
                        
                        
                        22
                        
                        
                        
                        31
                        
                        
                        
                        31
                        
                        
                        
                        35Total
      recoveries
                        
                        
                        386
                        
                        
                        
                        82
                        
                        
                        
                        247
                        
                        
                        
                        81
                        
                        
                        
                        35Net
      charge-offs
                        
                        
                        1,982
                        
                        
                        
                        374
                        
                        
                        
                        809
                        
                        
                        
                        1,150
                        
                        
                        
                        356Provision
      for loan losses
                        
                        
                        4,935
                        
                        
                        
                        1,643
                        
                        
                        
                        1,392
                        
                        
                        
                        1,811
                        
                        
                        
                        1,362Balance
      of allowance for loan losses at end of year
                        
                        $
                        8,224
                        
                        
                        $
                        5,271
                        
                        
                        $
                        4,002
                        
                        
                        $
                        3,419
                        
                        
                        $
                        2,758Ratios:Net
      charge-offs to average loans outstanding
                        
                        
                        0.41
                        %
                        
                        
                        0.09
                        %
                        
                        
                        0.23
                        %
                        
                        
                        0.39
                        %
                        
                        
                        0.20
                        %Net
      charge-offs to loans at end of year
                        
                        
                        0.42
                        
                        
                        
                        0.08
                        
                        
                        
                        0.23
                        
                        
                        
                        0.37
                        
                        
                        
                        0.15Allowance
      for loan losses to average loans
                        
                        
                        1.71
                        
                        
                        
                        1.27
                        
                        
                        
                        1.15
                        
                        
                        
                        1.16
                        
                        
                        
                        1.51Allowance
      for loan losses to loans at end of year
                        
                        
                        1.75
                        
                        
                        
                        1.13
                        
                        
                        
                        1.13
                        
                        
                        
                        1.10
                        
                        
                        
                        1.16Net
      charge-offs to allowance for loan losses
                        
                        
                        24.10
                        
                        
                        
                        7.10
                        
                        
                        
                        20.21
                        
                        
                        
                        33.64
                        
                        
                        
                        12.90Net
      charge-offs to provisions for loan losses
                        
                        
                        40.16
                        
                        
                        
                        22.76
                        
                        
                        
                        58.11
                        
                        
                        
                        63.50
                        
                        
                        
                        26.13


-11-


FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY




Management’s
Discussion and Analysis


of
Financial Condition and Results of Operations





Nonperforming
Assets





Nonperforming
Assets. There
were $19,591,982 and $1,657,607 loans in nonaccrual status at December 31, 2008
and 2007, respectively.  There were $2,097,426 and $1,780,505 in loans
ninety days or more overdue and still accruing interest at December 31, 2008 and
2007, respectively.  There were $566,161 and $218,616 in restructured
loans at December 31, 2008 and 2007, respectively.





The
following table shows the nonperforming assets, percentages of net charge-offs,
and the related percentage of allowance for loan losses for the five years ended
December 31, 2008.





(Dollars
      in thousands)
                  
                  2008
                  
                  
                  2007
                  
                  
                  2006
                  
                  
                  2005
                  
                  
                  2004Loans
      over 90 days past due and still accruing
                  
                  $
                  2,097
                  
                  
                  $
                  1,781
                  
                  
                  $
                  464
                  
                  
                  $
                  705
                  
                  
                  $
                  59Loans
      on nonaccrual:Real
      Estate Construction
                  
                  
                  6,250
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Real
      Estate Mortgage
                  
                  
                  12,573
                  
                  
                  
                  1,465
                  
                  
                  
                  637
                  
                  
                  
                  1,619
                  
                  
                  
                  1,078Commercial
                  
                  
                  563
                  
                  
                  
                  114
                  
                  
                  
                  -
                  
                  
                  
                  95
                  
                  
                  
                  17Consumer
                  
                  
                  206
                  
                  
                  
                  79
                  
                  
                  
                  34
                  
                  
                  
                  78
                  
                  
                  
                  91Total
      nonaccrual loans
                  
                  
                  19,592
                  
                  
                  
                  1,658
                  
                  
                  
                  671
                  
                  
                  
                  1,792
                  
                  
                  
                  1,186Total
      of nonperforming loans
                  
                  
                  21,689
                  
                  
                  
                  3,439
                  
                  
                  
                  1,135
                  
                  
                  
                  2,497
                  
                  
                  
                  1,245Other
      nonperforming assets
                  
                  
                  380
                  
                  
                  
                  197
                  
                  
                  
                  1,386
                  
                  
                  
                  346
                  
                  
                  
                  321Total
      nonperforming assets
                  
                  $
                  22,069
                  
                  
                  $
                  3,636
                  
                  
                  $
                  2,521
                  
                  
                  $
                  2,843
                  
                  
                  $
                  1,566Percentage
      of nonperforming assets to total assets
                  
                  
                  3.66
                  %
                  
                  
                  0.61
                  %
                  
                  
                  0.55
                  %
                  
                  
                  0.71
                  %
                  
                  
                  0.55
                  %Percentage
      of nonperforming loans to total loans
                  
                  
                  4.62
                  %
                  
                  
                  0.73
                  %
                  
                  
                  0.32
                  %
                  
                  
                  0.80
                  %
                  
                  
                  0.52
                  %Allowance
      for loan losses as a percentage of non-performing loans
                  
                  
                  37.92
                  %
                  
                  
                  153.27
                  %
                  
                  
                  352.60
                  %
                  
                  
                  136.92
                  %
                  
                  
                  221.53
                  %





Generally,
loans are placed on nonaccrual status if principal or interest payments become
90 days past due and/or we deems the collectibility of the principal and/or
interest to be doubtful.  Once a loan is placed in nonaccrual status,
all previously accrued and uncollected interest is reversed against interest
income.  Interest income on nonaccrual loans is recognized on a cash
basis when the ultimate collectability is no longer considered
doubtful.  Loans are returned to accrual status when the principal and
interest amounts contractually due are brought current and future payments are
reasonably assured.  If interest on our loans classified as nonaccrual
at December 31, 2008 had been recognized on a fully accruing basis, we would
have recorded an additional $1,423,361 of interest income for the year ended
December 31, 2008.  All nonaccruing loans at December 31, 2008, were
included in our impaired loans.





Impaired
loans.  At December 31,
2008, we had impaired loans totaling $26,183,601 as compared to $1,876,221 at
December 31, 2007.  Included in the impaired loans at December 31,
2008, were 22 borrowers that accounted for approximately 80% of the total amount
of the impaired loans at that date.  These borrowers were isolated to
the coastal area of South Carolina and their loans were mostly commercial real
estate loans.  Impaired loans, as a percentage of total loans, were
5.58% at December 31, 2008 as compared to 0.40% at December 31,
2007.  The loan portfolio increased 0.18% during the same
period.





The
recent downturn in the real estate market has resulted in an increase in loan
delinquencies, defaults and foreclosures, and management believes these trends
are likely to continue. In some cases, this downturn has resulted in a
significant impairment to the value of the Company’s collateral and ability to
sell the collateral upon foreclosure at its appraised value, and there is a risk
that this trend will continue.  If real estate values continue to
decline, it is also more likely that the Company would be required to increase
its allowance for loan losses.


-12-


FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY




Management’s
Discussion and Analysis


of
Financial Condition and Results of Operations





Impaired
loans. -(continued)





In early
2008, the Company refined its system to track impaired loans and reserves
related to these loans.  At December 31, 2008, nonaccrual loans were
$19,591,982 and total recorded investments in impaired loans were $26,183,601
versus $1,876,221 for 2007.  For 2008, the average investments in
impaired loans were $8,509,024 as compared to $903,980 for
2007.  Impaired loans with a specific allocation of the allowance for
loan losses totaled $20,235,727 at December 31, 2008. The amount of the specific
allocation was $3,658,653.  There was no specific allocation of the
allowance for loan losses at December 31, 2007.





Monthly,
management analyzes each loan that is classified as impaired to determine the
potential for possible loan losses.  This analysis is focused upon
determining the then current estimated value of the collateral, local market
condition and estimated costs to foreclose, repair and resell the
property.  The net realizable value of the property is then computed
and compared to the loan balance to determine the appropriate amount of specific
reserve for each loan.





Interest
income recognized on impaired loans for 2008 was $568,735.





Noninterest
Income and Expense




Noninterest
Income.Noninterest income
decreased $292,995, or 5.53%, to $5,008,804 in 2008 from $5,301,799 in
2007.  The decrease is primarily attributable to a reduction in gains
on sales of mortgage loans, which decreased $472,978 or 21.76% to $1,700,162 for
the year ended December 31, 2008.  This decrease is attributable to
the decline in the residential real estate market, which resulted in a weak
demand for new mortgage loans and refinancings.  The increase in total
income from service charges, commissions and fees partially offset the decrease
in income from gains on sale of mortgage loans.  Total service
charges, commissions and fees increased $222,113 or 9.77% from 2007, to
$2,496,143 for the year ended December 31, 2008.  This increase is
attributable to the increase in the number of customers we served and the
increase in fees for certain services.





The
following table sets forth the principal components of noninterest income for
the years ended December 31, 2008 and 2007.





(Dollars
      in thousands)
                        
                        2008
                        
                        
                        2007Service
      charges on deposit accounts
                        
                        $
                        2,019
                        
                        
                        $
                        1,902Other
      service charges, commissions, and fees
                        
                        
                        478
                        
                        
                        
                        372Gain
      on sale of mortgage loans
                        
                        
                        1,700
                        
                        
                        
                        2,173Brokerage
      fees
                        
                        
                        146
                        
                        
                        
                        150Income
      from bank owned life insurance
                        
                        
                        446
                        
                        
                        
                        406Other
                        
                        
                        220
                        
                        
                        
                        299Total
      noninterest income
                        
                        $
                        5,009
                        
                        
                        $
                        5,302





Noninterest
Expense.Noninterest
expense decreased $109,629, or 0.58%, to $18,851,646 in 2008 from $18,961,275 in
2007.  Except for occupancy expense, all other major category of
noninterest expense decreased $675,881, or 3.84% in 2008, as compared to
2007.  The primarily reason for this decline is management’s continual
emphasis on expense management.  Occupancy expense increased $566,
252, or 41.63% in 2008 as compared to 2007.  This increase is
primarily associated with the Bank’s extended operating hours.  The
Company’s efficiency ratio was 78.80% in 2008, compared to 77.69% in
2007.


-13-


FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY




Management’s
Discussion and Analysis


of
Financial Condition and Results of Operations





Noninterest Income and Expense
- continued





The
following table sets forth the primary components of noninterest expense for the
years ended December 31, 2008 and 2007.





(Dollars
      in thousands)
                
                2008
                
                
                2007Salaries
      and employee benefits
                
                $
                10,266
                
                
                $
                10,661Net
      occupancy
                
                
                1,927
                
                
                
                1,360Furniture
      and equipment
                
                
                1,068
                
                
                
                1,062Advertising
                
                
                345
                
                
                
                526Office
      supplies and printing
                
                
                237
                
                
                
                328Computer
      supplies and software amortization
                
                
                482
                
                
                
                267Telephone
                
                
                262
                
                
                
                315Professional
      fees and services
                
                
                820
                
                
                
                634Meetings
      and travel expenses
                
                
                372
                
                
                
                504Supervisory
      fees and assessments
                
                
                379
                
                
                
                263Debit
      and credit card expenses
                
                
                353
                
                
                
                291Other
                
                
                2,341
                
                
                
                2,750Total
      noninterest expense
                
                $
                18,852
                
                
                $
                18,961Efficiency
      ratio
                
                
                78.80
                %
                
                
                77.69
                %





Earning
Assets





Loans.Loans, including loans held
for sale, are the largest category of earning assets and typically provide
higher yields than the other types of earning assets.  Associated with
the higher loan yields are the inherent credit and liquidity risks which
management attempts to control and counterbalance.  Loans averaged
$481,572,108 in 2008 compared to $414,907,406 in 2007, an increase of
$66,664,702 or 16.07%.  At December 31, 2008, total loans were
$478,579,283 compared to $487,738,540 at December 31, 2007, a decrease of
$9,159,257 or 1.88%.  Excluding loans held for sale, loans were
$468,990,202, compared to $468,137,690, an increase of $852,512 or
0.18%





The
following table sets forth the composition of the loan portfolio, excluding
loans held for sale, by category at the dates indicated and highlights the
Company’s general emphasis on all types of lending.





Composition
of Loan Portfolio





December
      31,
                        
                        2008
                        
                        
                        2007
                        
                        
                        2006(Dollars
      in thousands)
                        
                        
                        
                        
                        Percent
                        
                        
                        
                        
                        
                        Percent
                        
                        
                        
                        
                        
                        PercentAmount
                        
                        
                        of Total
                        
                        
                        Amount
                        
                        
                        of Total
                        
                        
                        Amount
                        
                        
                        of TotalCommercial
      and industrial
                        
                        $
                        70,878
                        
                        
                        
                        15.11
                        %
                        
                        $
                        67,772
                        
                        
                        
                        14.48
                        %
                        
                        $
                        51,710
                        
                        
                        
                        14.63
                        %Real
      estateConstruction
                        
                        
                        60,744
                        
                        
                        
                        12.95
                        
                        
                        
                        65,432
                        
                        
                        
                        13.98
                        
                        
                        
                        64,118
                        
                        
                        
                        18.14Mortgage-residential
                        
                        
                        122,133
                        
                        
                        
                        26.04
                        
                        
                        
                        120,198
                        
                        
                        
                        25.67
                        
                        
                        
                        91,039
                        
                        
                        
                        25.75Mortgage-nonresidential
                        
                        
                        201,318
                        
                        
                        
                        42.94
                        
                        
                        
                        195,992
                        
                        
                        
                        41.87
                        
                        
                        
                        127,214
                        
                        
                        
                        35.99Consumer
                        
                        
                        8,974
                        
                        
                        
                        1.91
                        
                        
                        
                        11,342
                        
                        
                        
                        2.42
                        
                        
                        
                        12,729
                        
                        
                        
                        3.60Other
                        
                        
                        4,943
                        
                        
                        
                        1.05
                        
                        
                        
                        7,402
                        
                        
                        
                        1.58
                        
                        
                        
                        6,681
                        
                        
                        
                        1.89Total
      loans
                        
                        
                        468,990
                        
                        
                        
                        100.00
                        %
                        
                        
                        468,138
                        
                        
                        
                        100.00
                        %
                        
                        
                        353,491
                        
                        
                        
                        100.00
                        %Allowance
      for loan losses
                        
                        
                        (8,224
                        )
                        
                        
                        
                        
                        
                        
                        (5,271
                        )
                        
                        
                        
                        
                        
                        
                        (4,002
                        )Net
      loans
                        
                        $
                        460,766
                        
                        
                        
                        
                        
                        
                        $
                        462,867
                        
                        
                        
                        
                        
                        
                        $
                        349,489


-14-


FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY




Management’s
Discussion and Analysis


of
Financial Condition and Results of Operations





Earning Assets- continued





Composition of Loan Portfolio
- continued





December
      31,
                    
                    2005
                    
                    
                    2004(Dollars
      in thousands)
                    
                    
                    
                    
                    Percent
                    
                    
                    
                    
                    
                    PercentAmount
                    
                    
                    of
      Total
                    
                    
                    Amount
                    
                    
                    of
      TotalCommercial
      and industrial
                    
                    $
                    50,320
                    
                    
                    
                    16.15
                    %
                    
                    $
                    47,890
                    
                    
                    
                    20.09
                    %Real
      estateConstruction
                    
                    
                    52,268
                    
                    
                    
                    16.78
                    
                    
                    
                    39,023
                    
                    
                    
                    16.37Mortgage-residential
                    
                    
                    86,716
                    
                    
                    
                    27.83
                    
                    
                    
                    69,921
                    
                    
                    
                    29.33Mortgage-nonresidential
                    
                    
                    106,125
                    
                    
                    
                    34.06
                    
                    
                    
                    63,189
                    
                    
                    
                    26.51Consumer
                    
                    
                    13,953
                    
                    
                    
                    4.48
                    
                    
                    
                    13,931
                    
                    
                    
                    5.84Other
                    
                    
                    2,162
                    
                    
                    
                    0.70
                    
                    
                    
                    4,408
                    
                    
                    
                    1.86Total
      loans
                    
                    
                    311,544
                    
                    
                    
                    100.00
                    %
                    
                    
                    238,362
                    
                    
                    
                    100.00
                    %Allowance
      for loan losses
                    
                    
                    (3,419
                    )
                    
                    
                    
                    
                    
                    
                    (2,758
                    )Net
      loans
                    
                    $
                    308,125
                    
                    
                    
                    
                    
                    
                    $
                    235,604





In the
context of this discussion, a “real estate mortgage loan” is defined as any
loan, other than a loan for construction purposes, secured by real estate,
regardless of the purpose of the loan.  It is common practice for
financial institutions in the Company’s market area to obtain a mortgage on real
estate whenever possible, in addition to any other available
collateral.  This collateral is taken to reinforce the likelihood of
the ultimate repayment of the loan and tends to increase management’s
willingness to make real estate loans and, to that extent, also tends to
increase the magnitude of the real estate loan portfolio component.





The
largest component of the Company’s loan portfolio is real estate mortgage
loans.  At December 31, 2008, real estate mortgage loans totaled
$323,450,913 and represented 68.97% of the total loan portfolio, compared to
$316,189,973 or 67.54%, at December 31, 2007.





Residential
mortgage loans totaled $122,132,568 at December 31, 2008, and represented 26.04%
of the total loan portfolio, compared to $120,197,668 at December 31, 2007 or
25.67%.  Residential real estate loans consist of first and second
mortgages on single or multi-family residential
dwellings.  Nonresidential mortgage loans, which include commercial
loans and other loans secured by multi-family properties and farmland, totaled
$201,318,345 at December 31, 2008, compared to $195,992,305 at December 31,
2007.  This represents an increase of $5,326,040 or 2.72%, from the
December 31, 2007 balance.  Construction loans decreased $4,686,870,
or 7.16%, from $65,431,302 at December 31, 2007 to $60,744,432 at December 31,
2008.  The demand for residential and commercial real estate loans in
the Bank's market area remained strong.





Commercial
and industrial loans increased $3,106,225 or 4.58%, to $70,877,890 at December
31, 2008, from $67,771,665 at December 31, 2007.





The
Company’s loan portfolio is also comprised of consumer
loans.  Consumer loans decreased $2,367,987, or 20.88%, to $8,974,448
at December 31, 2008, from $11,342,435 at December 31, 2007.





The
Company’s loan portfolio reflects the diversity of its markets.  The
economies of the Company’s markets contain elements of medium and light
manufacturing, higher education, regional health care, and distribution
facilities. Management expects the area to remain stable with continued growth
in the near future.  The diversity of the economy creates
opportunities for all types of lending.  The Company does not engage
in foreign lending.


-15-


FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY




Management’s
Discussion and Analysis


of
Financial Condition and Results of Operations





Earning Assets- continued





The
repayment of loans in the loan portfolio as they mature is also a source of
liquidity for the Company.  The following table sets forth the
Company's loans maturing within specified intervals at December 31,
2008.





Loan
Maturity Schedule and Sensitivity to Changes in Interest Rates





Over One YearDecember 31, 2008
                          
                          One Year or
                          
                          
                          Through
                          
                          
                          Over Five(Dollars in thousands)
                          
                          Less
                          
                          
                          Five Years
                          
                          
                          Years
                          
                          
                          TotalCommercial
      and industrial
                          
                          $
                          43,700
                          
                          
                          $
                          26,536
                          
                          
                          $
                          642
                          
                          
                          $
                          70,878Real
      estate
                          
                          
                          153,110
                          
                          
                          
                          182,215
                          
                          
                          
                          48,870
                          
                          
                          
                          384,195Consumer
      and other
                          
                          
                          5,445
                          
                          
                          
                          8,251
                          
                          
                          
                          221
                          
                          
                          
                          13,917$
                          202,255
                          
                          
                          $
                          217,002
                          
                          
                          $
                          49,733
                          
                          
                          $
                          468,990Loans
      maturing after one year with:Fixed
      interest rates
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          $
                          148,464Floating
      interest rates
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          118,271$
                          266,735





The
information presented in the above table is based on the contractual maturities
of the individual loans, including loans which may be subject to renewal at
their contractual maturity.  Renewal of such loans is subject to
review and credit approval as well as modification of terms upon
maturity.  Consequently, management believes this treatment presents
fairly the maturity and repricing structure of the loan portfolio shown in the
above table.





Investment
Securities. The
investment securities portfolio is also a component of the Company’s total
earning assets.  Investment securities consist of securities
available-for-sale and nonmarketable equity securities. Total securities
available-for-sale averaged $60,386,067 in 2008, compared to $36,170,565 in
2007.  At December 31, 2008 and 2007, nonmarketable equity securities
consists of Federal Home Loan Bank stock, which is recorded at its original cost
of $4,574,700 and $3,930,400 at December 31, 2008 and 2007,
respectively.





The
following table sets forth the fair market value of the securities
available-for-sale held by the Company at December 31, 2008 and
2007.





Fair
Value of Securities available-for-sale




December
      31,
                  
                  2008
                  
                  
                  2007(Dollars
      in thousands)U.S.
      government agencies and corporations
                  
                  $
                  88
                  
                  
                  $
                  193Municipals
                  
                  
                  28,525
                  
                  
                  
                  31,069Mortgage-backed
      securities
                  
                  
                  47,574
                  
                  
                  
                  27,066Other
      Securities
                  
                  
                  124
                  
                  
                  
                  252Total
      securities available-for-sale
                  
                  $
                  76,311
                  
                  
                  $
                  58,580


-16-


FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY




Management’s
Discussion and Analysis


of
Financial Condition and Results of Operations





Earning Assets- continued





The
following table sets forth the scheduled maturities and average yields of
securities held at December 31, 2008.





Investment
Securities Maturity Distribution and Yields





After
      One But
                                      
                                      
                                      After
      Five ButDecember
      31, 2008
                                      
                                      Within
      One Year
                                      
                                      
                                      Within
      Five Years
                                      
                                      
                                      Within
      Ten Years
                                      
                                      
                                      After
      Ten Years
                                      
                                      
                                      Total(Dollars
      in thousands)
                                      
                                      Amount
                                      
                                      
                                      Yield
                                      
                                      
                                      Amount
                                      
                                      
                                      Yield
                                      
                                      
                                      Amount
                                      
                                      
                                      Yield
                                      
                                      
                                      Amount
                                      
                                      
                                      Yield
                                      
                                      
                                      Amount
                                      
                                      
                                      YieldU.S.
      government agencies and corporations
                                      
                                      $
                                      63
                                      
                                      
                                      
                                      6.09
                                      %
                                      
                                      $
                                      25
                                      
                                      
                                      
                                      6.32
                                      %
                                      
                                      $
                                      -
                                      
                                      
                                      %
                                      
                                      
                                      $
                                      -
                                      
                                      
                                      
                                      -
                                      %
                                      
                                      $
                                      88
                                      
                                      
                                      
                                      6.16
                                      %Municipals(2)
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      1,098
                                      
                                      
                                      
                                      5.50
                                      
                                      
                                      
                                      1,753
                                      
                                      
                                      
                                      6.60
                                      
                                      
                                      
                                      25,673
                                      
                                      
                                      
                                      6.22
                                      
                                      
                                      
                                      28,524
                                      
                                      
                                      
                                      6.19Total
      securities(1)
                                      
                                      $
                                      63
                                      
                                      
                                      
                                      6.09
                                      %
                                      
                                      $
                                      1,123
                                      
                                      
                                      
                                      5.51
                                      %
                                      
                                      $
                                      1,753
                                      
                                      
                                      
                                      6.60
                                      %
                                      
                                      $
                                      25,673
                                      
                                      
                                      
                                      6.22
                                      %
                                      
                                      $
                                      28,612
                                      
                                      
                                      
                                      6.19
                                      %





(1)
            Excludes
      mortgage-backed securities totaling $47,574,021 with a yield of 4.69 % and
      other securities totaling $124,300.


(2)
            Yields
      are based on a tax equivalent basis of
34%.





Other
attributes of the securities portfolio, including yields and maturities, are
discussed above in “Net Interest Income-Interest Sensitivity
Analysis.”





Federal Funds
Sold.  Federal funds sold averaged $2,837,541 in 2008 compared
to $7,479,356 in 2007.  At December 31, 2008 and 2007, federal funds
sold totaled $257,000 and $0, respectively.





Deposits
and Other Interest-Bearing Liabilities





Average
interest-bearing liabilities increased $89,616,706 or 21.50%, to $506,359,426 in
2008, from $416,742,720 in 2007.  The increase is primarily a result
of the continued growth of the Company.





Deposits.  Average total
deposits increased $34,083,921, or 8.16%, to $451,624,870 in 2008, from
$417,540,949 in 2007.  At December 31, 2008, total deposits were
$461,135,384 compared to $449,497,715 a year earlier, an increase of
2.59%.





Average
interest-bearing deposits increased $35,310,354, or 9.48%, to $407,813,353 in
2008, from $372,502,999 in 2007.


The
average balance of non-interest bearing deposits decreased $1,226,433, or 2.72%,
to $43,811,517 in 2008, from $45,037,950 in 2007.


-17-


FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY




Management’s
Discussion and Analysis


of
Financial Condition and Results of Operations





Deposits and Other Interest-Bearing
Liabilities-
continued





The
following table sets forth the average balance amounts and the average rates
paid on deposits of the Company by category at December 31, 2008 and
2007.





Deposits





2008
                  
                  
                  2007Average
                  
                  
                  
                  
                  
                  AverageAverage
                  
                  
                  Rate
                  
                  
                  Average
                  
                  
                  Rate(Dollars
      in thousands)
                  
                  Amount
                  
                  
                  Paid
                  
                  
                  Amount
                  
                  
                  PaidDemand
      deposit accounts
                  
                  $
                  43,812
                  
                  
                  
                  -
                  %
                  
                  $
                  45,038
                  
                  
                  
                  -
                  %NOW
      accounts
                  
                  
                  28,760
                  
                  
                  
                  0.64
                  
                  
                  
                  36,625
                  
                  
                  
                  1.94Savings
      accounts
                  
                  
                  98,210
                  
                  
                  
                  2.16
                  
                  
                  
                  80,943
                  
                  
                  
                  3.93Time
      deposits $100,000 and over
                  
                  
                  164,409
                  
                  
                  
                  4.08
                  
                  
                  
                  140,926
                  
                  
                  
                  4.97Other
      time deposits
                  
                  
                  116,434
                  
                  
                  
                  3.95
                  
                  
                  
                  114,008
                  
                  
                  
                  5.15Total
      deposits
                  
                  $
                  451,625
                  
                  
                  
                  3.02
                  %
                  
                  $
                  417,540
                  
                  
                  
                  4.02
                  %





Core
deposits, which exclude time deposits of $100,000 or more, provide a relatively
stable funding source for the Company’s loan portfolio and other earning
assets.  The Company’s core deposits were $323,690,517 and
$279,672,463 at December 31, 2008 and 2007, respectively.  Included in
time deposits $100,000 and over, at December 31, 2008 and 2007 are brokered time
deposits of $96,652,000 and $85,330,473, respectively.





Deposits,
and particularly core deposits, have been the Company’s primary source of
funding and have enabled the Company to meet successfully both its short-term
and long-term liquidity needs.  Management anticipates that such
deposits will continue to be the Company’s primary source of funding in the
future.  However, advances from the Federal Home Loan Bank are being
used as an alternative source of funds.  The Company’s loan-to-deposit
ratio was 101.70% at December 31, 2008, and 104.15% at December 31,
2007.  The maturity distribution of the Company’s time deposits over
$100,000 and over at December 31, 2008, is set forth in the following
table:





Maturities
of Time Deposits of $100,000 or over





After SixAfter Three
                  
                  
                  ThroughWithin Three
                  
                  
                  Through Six
                  
                  
                  Twelve
                  
                  
                  After Twelve(Dollars
      in thousands)
                  
                  Months
                  
                  
                  Months
                  
                  
                  Months
                  
                  
                  Months
                  
                  
                  TotalCertificates
      of deposit of $100,000 or over
                  
                  $
                  41,992
                  
                  
                  $
                  74,905
                  
                  
                  $
                  20,072
                  
                  
                  $
                  476
                  
                  
                  $
                  137,445





Approximately
30.55% of the Company’s time deposits of $100,000 or more had scheduled
maturities within three months, and 54.50% had maturities within three to six
months.  Large certificate of deposit customers tend to be extremely
sensitive to interest rate levels, making these deposits less reliable sources
of funding for liquidity planning purposes than core deposits.  The
current interest rate environment has led depositors to invest in short term
deposit accounts.  The Company expects most certificates of deposits
with maturities less than twelve months to be renewed upon maturity. However,
there is the possibility that some certificates may not be
renewed.  Management believes that, should that occur, the impact
would be minimal on the Company’s operations and liquidity due to the
availability of other funding sources.  The Company has an available
line to borrow funds from the Federal Home Loan Bank up to 30% of the its total
assets which provided additional available funds of $37,661,261 at December 31,
2008 and available lines to purchase federal funds with various financial
institutions up to $44,500,000 at December 31, 2008.  Management
believes that these funds would be sufficient to meet future liquidity
needs.


-18-


FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY




Management’s
Discussion and Analysis


of
Financial Condition and Results of Operations





Deposits and Other Interest-Bearing
Liabilities-
continued




Other
Borrowings.  The following table summarizes the Company's
borrowings for the years ended December 31, 2008 and 2007.  These
borrowings consist of securities sold under agreements to repurchase, advances
from the Federal Home Loan Bank, federal funds purchased, a note payable and
junior subordinated debentures.  Securities sold under agreements to
repurchase mature on a one to seven day basis.  These agreements are
secured by U.S. government agencies.  Advances from Federal Home Loan
Bank mature at different periods as discussed in the footnotes to the financial
statements and are secured by the Company's one to four family residential
mortgage loans and the Company's investment in Federal Home Loan Bank
stock.  Federal funds purchased are short-term borrowings from other
financial institutions that mature daily.





MaximumOutstanding
                
                
                Weighted
                
                
                
                
                
                
                
                
                Interest(Dollars in thousands)
                
                at any
                
                
                Average
                
                
                Average
                
                
                Balance
                
                
                Rate atMonth End
                
                
                Balance
                
                
                Interest Rate
                
                
                December 31,
                
                
                December 31,December
      31, 2008Securities
      sold under agreement to repurchase
                
                $
                9,291
                
                
                $
                7,845
                
                
                
                1.54
                %
                
                $
                8,198
                
                
                
                0.25
                %Advances
      from Federal Home Loan Bank
                
                
                83,500
                
                
                
                72,617
                
                
                
                3.77
                
                
                
                78,000
                
                
                
                3.43Federal
      funds purchased
                
                
                11,482
                
                
                
                4,359
                
                
                
                2.99
                
                
                
                -
                
                
                
                -Note
      payable
                
                
                6,950
                
                
                
                3,389
                
                
                
                4.01
                
                
                
                6,950
                
                
                
                2.00Junior
      subordinated debentures
                
                
                10,310
                
                
                
                10,310
                
                
                
                5.97
                
                
                
                10,310
                
                
                
                5.93December
      31, 2007Securities
      sold under agreement to repurchase
                
                $
                11,651
                
                
                $
                9,128
                
                
                
                4.38
                %
                
                $
                7,928
                
                
                
                4.43
                %Advances
      from Federal Home Loan Bank
                
                
                69,000
                
                
                
                22,985
                
                
                
                3.61
                
                
                
                69,000
                
                
                
                4.40Federal
      funds purchased
                
                
                13,359
                
                
                
                1,809
                
                
                
                5.11
                
                
                
                13,359
                
                
                
                4.50Note
      payable
                
                
                3,000
                
                
                
                8
                
                
                
                6.00
                
                
                
                3,000
                
                
                
                6.00Junior
      subordinated debentures
                
                
                10,310
                
                
                
                10,310
                
                
                
                6.01
                
                
                
                10,310
                
                
                
                5.93





Capital




The
Company and the Bank are subject to various regulatory capital requirements
administered by the federal banking agencies.  Failure to meet minimum
capital requirements can initiate certain mandatory and possible additional
discretionary actions by regulators that, if undertaken, could have a material
effect on the Company’s consolidated 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 Company’s assets, liabilities, and certain off-balance-sheet
items as calculated under regulatory accounting practices.  The
Company’s capital amounts and classifications are also subject to qualitative
judgments by the regulators about components, risk weightings, and other
factors.




-19-


FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY




Management’s
Discussion and Analysis


of
Financial Condition and Results of Operations





Capital - continued




Quantitative
measures established by regulation to ensure capital adequacy require the
Company 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 Company consists of common
shareholders’ equity, excluding the unrealized gain or loss on securities
available-for-sale, minus certain intangible assets.  The Company’s
Tier 2 capital consists of the allowance for loan losses subject to certain
limitations.  Total capital for purposes of computing the capital
ratios consists of the sum of Tier 1 and Tier 2 capital.  The
regulatory minimum requirements are 4% for Tier 1 capital and 8% for total
risk-based capital.





The
Company and the Bank are 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
Company and the Bank exceeded the regulatory minimum capital requirements at
December 31, 2008.  The following table shows the Company's and the
Bank's ratios at December 31, 2008.





Analysis
of Capital and Capital Ratios





Company
                  
                  
                  Bank(Dollars
      in thousands)Tier
      1 capital
                  
                  $
                  54,888
                  
                  
                  $
                  48,678Tier
      2 capital
                  
                  
                  6,359
                  
                  
                  
                  6,359Total
      qualifying capital
                  
                  $
                  61,247
                  
                  
                  $
                  55,037Risk-adjusted
      total assets (including off-balance-sheet exposures)
                  
                  $
                  511,661
                  
                  
                  $
                  506,827Risk-based
      capital ratios:Total
      risk-based capital ratio
                  
                  
                  11.97
                  %
                  
                  
                  10.86
                  %Tier
      1 risk-based capital ratio
                  
                  
                  10.73
                  
                  
                  
                  9.60Tier
      1 leverage ratio
                  
                  
                  9.28
                  
                  
                  
                  8.18





Impact
of Off-Balance Sheet Instruments




The
Company is a party to financial instruments with off-balance-sheet risk in the
normal course of business to meet the financing needs of the Company’s
customers.  These financial instruments consist of commitments to
extend credit and standby letters of credit.  Commitments to extend
credit are legally binding agreements to lend to a customer at predetermined
interest rates as long as there is no violation of any condition established in
the contract.  Commitments generally have fixed expiration dates or
other termination clauses and may require payment of a fee.  A
commitment involves, to varying degrees, elements of credit and interest rate
risk in excess of the amount recognized in the balance sheets.  The
exposure to credit loss in the event of nonperformance by the other party to the
instrument is represented by the contractual notional amount of the
instrument.  Since certain commitments are expected to expire without
being drawn upon, the total commitment amounts do not necessarily represent
future cash requirements.  Letters of credit are conditional
commitments issued to guarantee a customer’s performance to a third party and
have essentially the same credit risk as other lending
facilities.  Standby letters of credit often expire without being
used.





The
Company uses the same credit underwriting procedures for commitments to extend
credit and standby letters of credit as it does for its on-balance sheet
instruments.  The credit worthiness of each borrower is evaluated and
the amount of collateral, if deemed necessary, is based on the credit
evaluation.  Collateral held for commitments to extend credit and
standby letters of credit varies but may include accounts receivable, inventory,
property, plant, equipment, and income-producing commercial
properties.





The
Company is not involved in off-balance sheet contractual relationships, other
than those disclosed in this report, that could result in liquidity needs or
other commitments or that could significantly impact earnings.





As of
December 31, 2008, commitments to extend credit totaled $53,812,183 and its
standby letters of credit totaled $3,006,214. These Commitments include
$46,105,448 of credits with variable interest rates.


-20-


FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY




Management’s
Discussion and Analysis


of
Financial Condition and Results of Operations





Impact of Off-Balance Sheet
Instruments -
continued




The
following table sets forth the length of time until maturity for unused
commitments to extend credit and standby letters of credit at December 31,
2008.





After One
                
                
                After ThreeThrough
                
                
                Through
                
                
                
                
                
                GreaterWithin
      One
                
                
                Three
                
                
                Twelve
                
                
                Within
      One
                
                
                Than(Dollars
      in thousands)
                
                Month
                
                
                Months
                
                
                Months
                
                
                Year
                
                
                One Year
                
                
                TotalUnused
      commitments to extend credit
                
                $
                9,650
                
                
                $
                2,854
                
                
                $
                16,898
                
                
                $
                29,402
                
                
                $
                24,410
                
                
                $
                53,812Standby
      letters of credit
                
                
                188
                
                
                
                25
                
                
                
                1,195
                
                
                
                1,408
                
                
                
                1,598
                
                
                
                3,006Totals
                
                $
                9,838
                
                
                $
                2,879
                
                
                $
                18,093
                
                
                $
                30,810
                
                
                $
                26,008
                
                
                $
                56,818





The
Company evaluates each customer’s credit worthiness on a case-by-case
basis.  The amount of collateral obtained, if deemed necessary by the
Company upon extension of credit, is based on its credit evaluation of the
borrower.  Collateral varies but may include accounts receivable,
inventory, premises, furniture and equipment, and commercial and residential
real estate.





Liquidity
Management and Capital Resources




Liquidity
is the ability to meet current and future obligations through liquidation or
maturity of existing assets or the acquisition of additional
liabilities.  Adequate liquidity is necessary to meet the requirements
of customers for loans and deposit withdrawals in the most timely and economical
manner.  Some liquidity is ensured by maintaining assets that may be
immediately converted into cash at minimal cost (amounts due from banks and
federal funds sold).  However, the most manageable sources of
liquidity are composed of liabilities, with the primary focus on liquidity
management being on the ability to obtain deposits within the Company's service
area.  Core deposits (total deposits less time deposits greater than
$100,000) provide a relatively stable funding base, and were equal to 53.64% of
total assets at December 31, 2008.  Asset liquidity is provided from
several sources, including amounts due from banks, federal funds sold,
securities available for sale, and funds from maturing loans.  The
Company had $5,708,607 in cash and cash equivalents and $76,310,816 in
securities available for sale at December 31, 2008.  The Company has
$44,500,000 available through a line of credit with other banks as an additional
source of liquidity funding.  The Company also has a line of credit to
borrow funds from the Federal Home Loan Bank up to $115,661,261 of which
$37,661,261 is available at December 31, 2008.





Contractual
Obligations




The
following table provides payments due by period for various contractual
obligations as of December 31, 2008:




Over One
                  
                  
                  Over Two
                  
                  
                  Over Three
                  
                  
                  AfterWithin One
                  
                  
                  to Two
                  
                  
                  to Three
                  
                  
                  to Five
                  
                  
                  Five(Dollars in thousands)
                  
                  Year
                  
                  
                  Years
                  
                  
                  Years
                  
                  
                  Years
                  
                  
                  Years
                  
                  
                  TotalCertificate
      accounts (1)
                  
                  $
                  218,103
                  
                  
                  $
                  51,206
                  
                  
                  $
                  6,295
                  
                  
                  $
                  726
                  
                  
                  $
                  -
                  
                  
                  $
                  276,330Short-term
      borrowings (2)
                  
                  
                  15,147
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  15,147Long-term
      debt (3)
                  
                  
                  53,000
                  
                  
                  
                  14,000
                  
                  
                  
                  10,000
                  
                  
                  
                  1,000
                  
                  
                  
                  10,310
                  
                  
                  
                  88,310Purchases
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Operating lease obligations (4)
                  
                  
                  397
                  
                  
                  
                  347
                  
                  
                  
                  328
                  
                  
                  
                  597
                  
                  
                  
                  6,047
                  
                  
                  
                  7,716Totals
                  
                  $
                  286,647
                  
                  
                  $
                  65,553
                  
                  
                  $
                  16,623
                  
                  
                  $
                  2,323
                  
                  
                  $
                  16,357
                  
                  
                  $
                  388,503





(1)
            Certificates
      of deposit give customers rights to early withdrawal.  Early
      withdrawals may be subject to penalties. The penalty amount depends on the
      remaining time to maturity at the time of early
  withdrawal.


(2)
            Short-term
      borrowings consist of securities sold under agreements to repurchase and a
      note payable.  We expect securities repurchase agreements to be
      re-issued and, as such, do not necessarily represent an immediate need for
      cash.


(3)
            Long
      term debt consists of Federal Home Loan Bank borrowings and junior
      subordinated debentures.


(4)
            Operating
      lease obligations include existing and future property and equipment
      non-cancelable lease
commitments.


-21-


FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY




Management’s
Discussion and Analysis


of
Financial Condition and Results of Operations





Liquidity Management and Capital
Resources - continued




During
2008, the Company’s primary sources of cash were generated from operating
activities of $16,174,259 and $11,637,669 from deposits.  The
Company’s primary uses of cash resources were to fund loans of $3,389,932,
purchases of premises, furniture and equipment of $7,179,668 and to fund the net
acquisition of securities available-for sale of $18,086,628. These trends are
consistent with those of a growing bank operation and consistent with past cash
uses and sources. Management believes that the Company's overall liquidity
sources are adequate to meet its operating needs in the ordinary course of its
business.




Impact
of Inflation





Unlike
most industrial companies, the assets and liabilities of financial institutions
such as the Company are primarily monetary in nature.  Therefore,
interest rates have a more significant effect on the Company’s performance than
do the general rate of inflation and of goods and services.  In
addition, interest rates do not necessarily move in the same direction or in the
same magnitude as the prices of goods and services.  As discussed
previously, management seeks to manage the relationships between interest
sensitive assets and liabilities in order to protect against wide interest rate
fluctuations, including those resulting from inflation.





Accounting
and Financial Reporting Issues





The
Company has adopted various accounting policies, which govern the application of
accounting principles generally accepted in the United States in the preparation
of its consolidated financial statements.  The significant accounting
policies are described in the footnotes to the financial statements at December
31, 2008 as filed in the Annual Report on Form 10-K. Certain accounting policies
involve significant judgments and assumptions by management which have a
material impact on the carrying value of certain assets and
liabilities.  The Company considers these accounting policies to be
critical accounting policies.  The judgments and assumptions used are
based on historical experience and other factors, which management believes to
be reasonable under the circumstances.  Because of the nature of the
judgments and assumptions made, actual results could differ from these judgments
and estimates which could have a material impact on the carrying values of
assets and liabilities and the results of operations.





Of these
significant accounting policies, the Company considers its policies regarding
the allowance for loan losses (the “Allowance”) to be its most critical
accounting policy due to the significant degree of management judgment
involved  in determining the amount of Allowance.  The
Company has developed policies and procedures for assessing the adequacy of the
Allowance, recognizing that this process requires a number of assumptions and
estimates with respect to its loan portfolio.  The Company's
assessments may be impacted in future periods by changes in economic conditions,
the impact of regulatory examinations, and the discovery of information with
respect to borrowers, which is not known to management at the time of the
issuance of the consolidated financial statements.  Refer to the
discussion under Provision and Allowance for Loan Losses for a detailed
description of the Company's estimation process and methodology related to the
allowance for loan losses.





Industry
Developments





From time
to time, various bills are introduced in the United States Congress with respect
to the regulation of financial institutions.  Certain legislation, if
adopted, could significantly change the regulation of banks and the financial
services industry.  The Company cannot predict whether any such
legislation will be adopted or, if adopted, how it would affect the
Company.


-22-


MANAGEMENT'S ANNUAL REPORT
ON INTERNAL CONTROL OVER FINANCIAL REPORTING





Our
Management is responsible for establishing and maintaining adequate internal
control over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) under
the Securities Exchange Act of 1934.  Our internal control over
financial reporting is a process designed to provide reasonable assurance that
assets are safeguarded against loss from unauthorized use or disposition,
transactions are executed in accordance with appropriate management
authorization and accounting records are reliable for the preparation of
financial statements in accordance with generally accepted accounting
principles.





Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements.  Also, projections of any evaluation
of effectiveness to future periods are subject to the risk that controls may
become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.





Management
assessed the effectiveness of our internal control over financial reporting as
of December 31, 2008.  Management based this assessment on criteria
for effective internal control over financial reporting described
in  "Internal
Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission.”Management’s
assessment included an evaluation of the design of our internal control over
financial reporting and testing of the operational effectiveness of its internal
control over financial reporting.  Management reviewed the results of
its assessment with the Audit Committee of the Board of
Directors.  Based on this assessment, management believes that First
Reliance Bancshares, Inc. maintained effective internal control over financial
reporting as of December 31, 2008.





This
annual report does not include an attestation report of the Company's
independent registered public accounting firm regarding internal control over
financial reporting.  Management’s report was not subject to
attestation by the Company’s independent registered public accounting firm
pursuant to temporary rules of the Securities and Exchange Commission that
permit the Company to provide only management’s report in this annual
report.





-23-





REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM





The Board
of Directors


First
Reliance Bancshares, Inc. and Subsidiary


Florence,
South Carolina





We have
audited the accompanying consolidated balance sheets of First Reliance
Bancshares, Inc. and subsidiary (the "Company") as of December 31, 2008 and
2007, and the related consolidated statements of income, changes in
shareholders’ equity and comprehensive income, and cash flows for the years
then ended.  These consolidated financial statements are the
responsibility of the Company’s management.  Our responsibility is to
express an opinion on these consolidated financial statements based on our
audits.





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





In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of First Reliance Bancshares,
Inc. and subsidiary as of December 31, 2008 and 2007, and the results of their
operations and their cash flows for the years then ended in conformity with U.S.
generally accepted accounting principles.





We were
not engaged to examine management's assessment of the effectiveness of First
Reliance Bancshares, Inc.'s internal control over financial reporting as of
December 31, 2008 included in the accompanying Management's Annual Report on
Internal Control Over Financial Reporting and, accordingly, we do not express an
opinion thereon.





/s/
Elliott Davis, LLC


Columbia,
South Carolina


March 24,
2009





-24-





FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY


Consolidated
Balance Sheets





December 31,2008
                
                
                2007Assets:Cash
      and cash equivalents:Cash
      and due from banks
                
                $
                5,451,607
                
                
                $
                7,164,650Federal
      funds sold
                
                
                257,000
                
                
                
                -Total
      cash and cash equivalents
                
                
                5,708,607
                
                
                
                7,164,650Investment
      securities:Securities
      available-for-sale
                
                
                76,310,816
                
                
                
                58,580,313Nonmarketable
      equity securities
                
                
                4,574,700
                
                
                
                3,930,400Total
      investment securities
                
                
                80,885,516
                
                
                
                62,510,713Mortgage
      loans held for sale
                
                
                9,589,081
                
                
                
                19,600,850Loans
      receivable
                
                
                468,990,202
                
                
                
                468,137,690Less
      allowance for loan losses
                
                
                (8,223,899
                )
                
                
                (5,270,607
                )Loans,
      net
                
                
                460,766,303
                
                
                
                462,867,083Premises,
      furniture and equipment, net
                
                
                28,612,022
                
                
                
                22,233,746Accrued
      interest receivable
                
                
                2,653,260
                
                
                
                3,092,767Other
      real estate owned
                
                
                379,950
                
                
                
                196,950Cash
      surrender value of life insurance
                
                
                10,986,484
                
                
                
                10,540,273Other
      assets
                
                
                3,852,660
                
                
                
                3,497,180Total
      assets
                
                $
                603,433,883
                
                
                $
                591,704,212Liabilities:Deposits:Noninterest-bearing
      transaction accounts
                
                $
                39,467,609
                
                
                $
                43,542,528Interest-bearing
      transaction accounts
                
                
                34,708,951
                
                
                
                39,450,393Savings
                
                
                110,629,005
                
                
                
                85,819,481Time
      deposits $100,000 and over
                
                
                137,444,867
                
                
                
                169,825,252Other
      time deposits
                
                
                138,884,952
                
                
                
                110,860,061Total
      deposits
                
                
                461,135,384
                
                
                
                449,497,715Securities
      sold under agreements to repurchase
                
                
                8,197,451
                
                
                
                7,927,754Federal
      Funds Purchased
                
                
                -
                
                
                
                13,359,000Advances
      from Federal Home Loan Bank
                
                
                78,000,000
                
                
                
                69,000,000Note
      payable
                
                
                6,950,000
                
                
                
                3,000,000Junior
      subordinated debentures
                
                
                10,310,000
                
                
                
                10,310,000Accrued
      interest payable
                
                
                623,330
                
                
                
                767,577Other
      liabilities
                
                
                791,960
                
                
                
                814,262Total
      liabilities
                
                
                566,008,125
                
                
                
                554,676,308Commitments
      and contingencies (Notes 4, and 15)Shareholders'
      Equity:Common
      stock, $0.01 par value, 20,000,000 shares authorized; 3,525,004 and
      3,494,646 shares issued and outstanding at December 31, 2008 and 2007,
      respectively
                
                
                35,250
                
                
                
                34,946Nonvested
      restricted stock
                
                
                (207,653
                )
                
                
                (152,762
                )Capital
      surplus
                
                
                26,120,460
                
                
                
                25,875,012Treasury
      stock at cost; 10,829 and 9,667 shares at December 31, 2008 and 2007,
      respectively
                
                
                (159,777
                )
                
                
                (145,198
                )Retained
      earnings
                
                
                11,839,005
                
                
                
                11,417,275Accumulated
      other comprehensive loss
                
                
                (201,527
                )
                
                
                (1,369
                )Total shareholders' equity
                
                
                37,425,758
                
                
                
                37,027,904Total
      liabilities and shareholders' equity
                
                $
                603,433,883
                
                
                $
                591,704,212




The
accompanying notes are an integral part of the consolidated financial
statements.


-25-





FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY


Consolidated
Statements of Income





For
      the years endedDecember 31,2008
                        
                        
                        2007Interest
      income:Loans,
      including fees
                        
                        $
                        33,150,366
                        
                        
                        $
                        35,325,242Investment
      securities:Taxable
                        
                        
                        1,519,466
                        
                        
                        
                        892,277Tax
      exempt
                        
                        
                        1,298,612
                        
                        
                        
                        780,191Federal
      funds sold
                        
                        
                        56,343
                        
                        
                        
                        390,944Other
      interest income
                        
                        
                        217,931
                        
                        
                        
                        151,833Total
                        
                        
                        36,242,718
                        
                        
                        
                        37,540,487Interest
      expense:Time
      deposits $100,000 and over
                        
                        
                        6,714,460
                        
                        
                        
                        7,002,414Other
      deposits
                        
                        
                        6,905,884
                        
                        
                        
                        9,765,871Other
      interest expense
                        
                        
                        3,678,028
                        
                        
                        
                        1,664,924Total
                        
                        
                        17,298,372
                        
                        
                        
                        18,433,209Net
      interest income
                        
                        
                        18,944,346
                        
                        
                        
                        19,107,278Provision
      for loan losses
                        
                        
                        4,934,912
                        
                        
                        
                        1,643,100Net
      interest income after provision for loan losses
                        
                        
                        14,009,434
                        
                        
                        
                        17,464,178Noninterest
      income:Service
      charges on deposit accounts
                        
                        
                        2,018,725
                        
                        
                        
                        1,901,758Gain
      on sale of mortgage loans
                        
                        
                        1,700,162
                        
                        
                        
                        2,173,140Brokerage
      fees
                        
                        
                        146,343
                        
                        
                        
                        149,268Income
      from bank owned life insurance
                        
                        
                        446,211
                        
                        
                        
                        406,237Other
      service charges, commissions, and fees
                        
                        
                        477,418
                        
                        
                        
                        372,272Gain
      on sale of investment securities
                        
                        
                        -
                        
                        
                        
                        5,996Gain
      on sale of other real estate
                        
                        
                        22,000
                        
                        
                        
                        29,186Gain
      on sale of fixed assets
                        
                        
                        7,091
                        
                        
                        
                        59,318Other
                        
                        
                        190,854
                        
                        
                        
                        204,624Total
                        
                        
                        5,008,804
                        
                        
                        
                        5,301,799Noninterest
      expenses:Salaries
      and benefits
                        
                        
                        10,265,635
                        
                        
                        
                        10,661,153Occupancy
                        
                        
                        1,926,547
                        
                        
                        
                        1,360,295Furniture
      and equipment related expenses
                        
                        
                        1,067,845
                        
                        
                        
                        1,061,919Other
      operating
                        
                        
                        5,591,619
                        
                        
                        
                        5,877,908Total
                        
                        
                        18,851,646
                        
                        
                        
                        18,961,275Income
      before income taxes
                        
                        
                        166,592
                        
                        
                        
                        3,804,702Income
      tax expense (benefit)
                        
                        
                        (459,040
                        )
                        
                        
                        1,245,182Net
      income
                        
                        $
                        625,632
                        
                        
                        $
                        2,559,520Earnings
      per share:Basic
                        
                        $
                        0.18
                        
                        
                        $
                        0.74Diluted
                        
                        $
                        0.18
                        
                        
                        $
                        0.72


The
accompanying notes are an integral part of the consolidated financial
statements.





-26-





FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY


Consolidated
Statements of Changes in Shareholders’ Equity and Comprehensive
Income


For
the years ended December 31, 2008 and 2007





AccumulatedOtherCompre-Nonvested
                              
                              
                              
                              
                              
                              hensiveCommon
      Stock
                              
                              
                              Capital
                              
                              
                              Treasury
                              
                              
                              Restricted
                              
                              
                              Retained
                              
                              
                              IncomeShares
                              
                              
                              Amount
                              
                              
                              Surplus
                              
                              
                              Stock
                              
                              
                              Stock
                              
                              
                              Earnings
                              
                              
                              (Loss)
                              
                              
                              TotalBalance,
      December 31, 2006
                              
                              
                              3,424,878
                              
                              
                              $
                              34,249
                              
                              
                              $
                              25,257,814
                              
                              
                              $
                              -
                              
                              
                              $
                              (66,131
                              )
                              
                              $
                              8,857,755
                              
                              
                              $
                              9,576
                              
                              
                              $
                              34,093,263Net
      income
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              2,559,520
                              
                              
                              
                              
                              
                              
                              
                              2,559,520Other
      comprehensive loss,net
      of tax benefit of $5,639
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              (10,945
                              )
                              
                              
                              (10,945
                              )Comprehensive
      income
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              2,548,575Purchase
      of treasury stock
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              (145,198
                              )
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              (145,198
                              )Issuance
      of shares to advisory board
                              
                              
                              1,559
                              
                              
                              
                              15
                              
                              
                              
                              16,744
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              16,759Restricted
      stock issuance
                              
                              
                              11,681
                              
                              
                              
                              117
                              
                              
                              
                              162,893
                              
                              
                              
                              
                              
                              
                              
                              (86,631
                              )
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              76,379Issuance
      of shares to 404(c) plan
                              
                              
                              13,383
                              
                              
                              
                              134
                              
                              
                              
                              198,246
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              198,380Exercise
      of stock options
                              
                              
                              43,145
                              
                              
                              
                              431
                              
                              
                              
                              239,315
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              239,746Balance,
      December 31, 2007
                              
                              
                              3,494,646
                              
                              
                              
                              34,946
                              
                              
                              
                              25,875,012
                              
                              
                              
                              (145,198
                              )
                              
                              
                              (152,762
                              )
                              
                              
                              11,417,275
                              
                              
                              
                              (1,369
                              )
                              
                              
                              37,027,904Adjustment
      to reflect thecumulative-effect
      of change inaccounting
      for Life insurancearrangements
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              (203,902
                              )
                              
                              
                              
                              
                              
                              
                              (203,902
                              )Net
      income
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              625,632
                              
                              
                              
                              
                              
                              
                              
                              625,632Other
      comprehensive loss,net
      of tax benefit of $103,112
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              (200,158
                              )
                              
                              
                              (200,158
                              )Comprehensive
      income
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              425,474Purchase
      of treasury stock
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              (14,579
                              )
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              (14,579
                              )Issuance
      of shares to advisory board
                              
                              
                              1,083
                              
                              
                              
                              11
                              
                              
                              
                              5,675
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              5,686Issuance
      of shares to employees
                              
                              
                              100
                              
                              
                              
                              1
                              
                              
                              
                              1,009
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              1,010Restricted
      stock issuance
                              
                              
                              22,275
                              
                              
                              
                              223
                              
                              
                              
                              201,163
                              
                              
                              
                              
                              
                              
                              
                              (54,891
                              )
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              146,495Exercise
      of stock options
                              
                              
                              6,900
                              
                              
                              
                              69
                              
                              
                              
                              37,601
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              37,670Balance,
      December 31, 2008
                              
                              
                              3,525,004
                              
                              
                              $
                              35,250
                              
                              
                              $
                              26,120,460
                              
                              
                              $
                              (159,777
                              )
                              
                              $
                              (207,653
                              )
                              
                              $
                              11,839,005
                              
                              
                              $
                              (201,527
                              )
                              
                              $
                              37,425,758




The
accompanying notes are an integral part of the consolidated financial
statements.


-27-





FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY


Consolidated
Statements of Cash Flows





For
      the years endedDecember 31,2008
                
                
                2007Cash
      flows from operating activities:Net
      income
                
                $
                625,632
                
                
                $
                2,559,520Adjustments
      to reconcile net income to net cash provided (used) by operating
      activities:Provision
      for loan losses
                
                
                4,934,912
                
                
                
                1,643,100Depreciation
      and amortization expense
                
                
                1,033,696
                
                
                
                812,762Gain
      on sales of securities available-for sale
                
                
                -
                
                
                
                (3,496
                )Gain
      on nonmarketable securities
                
                
                -
                
                
                
                (2,500
                )Gain
      on sale of fixed assets
                
                
                (7,091
                )
                
                
                (59,318
                )Gain
      on sale of other real estate owned
                
                
                (22,000
                )
                
                
                (29,186
                )Discount
      accretion and premium amortization
                
                
                52,856
                
                
                
                49,316Disbursements
      for mortgages held for sale
                
                
                (115,615,922
                )
                
                
                (146,067,873
                )Proceeds
      from sales of mortgages held for sale
                
                
                125,627,691
                
                
                
                133,099,033Writedown
      of other real estate owned
                
                
                277,000
                
                
                
                -Deferred
      income tax benefit
                
                
                (1,613,849
                )
                
                
                (413,004
                )(Increase)
      decrease in interest receivable
                
                
                439,507
                
                
                
                (628,236
                )Increase
      (decrease) in interest payable
                
                
                (144,247
                )
                
                
                1,301Increase
      for cash surrender value of life insurance
                
                
                (446,211
                )
                
                
                (406,237
                )Amortization
      of deferred compensation on restricted stock
                
                
                146,495
                
                
                
                76,379(Increase)
      decrease in other assets
                
                
                1,008,883
                
                
                
                (588,945
                )Decrease
      in other liabilities
                
                
                (123,093
                )
                
                
                (663,890
                )Net
      cash provided (used) by operating activities
                
                
                16,174,259
                
                
                
                (10,621,274
                )Cash
      flows from investing activities:Purchases
      of securities available-for-sale
                
                
                (24,151,692
                )
                
                
                (34,969,570
                )Maturities
      of securities available-for-sale
                
                
                6,065,064
                
                
                
                2,472,556Proceeds
      from sales of nonmarketable equity securities
                
                
                -
                
                
                
                2,186,000Proceeds
      on sale of securities available-for-sale
                
                
                -
                
                
                
                9,785,569Purchases
      of nonmarketable equity securities
                
                
                (644,300
                )
                
                
                (3,926,300
                )Net
      increase in loans receivable
                
                
                (3,389,932
                )
                
                
                (115,426,100
                )Purchases
      of premises, furniture and equipment
                
                
                (7,179,668
                )
                
                
                (9,043,619
                )Proceeds
      from disposal of premises, furniture and equipment
                
                
                24,273
                
                
                
                84,566Proceeds
      from sale of other real estate owned
                
                
                117,800
                
                
                
                1,623,689Net
      cash used by investing activities
                
                
                (29,158,455
                )
                
                
                (147,213,209
                )Cash
      flows from financing activities:Net
      increase in demand deposits, interest-bearing transaction accounts and
      savings accounts
                
                
                15,993,163
                
                
                
                14,630,138Net
      increase (decrease) in certificates of deposit and other time
      deposits
                
                
                (4,355,494
                )
                
                
                61,929,493Increase
      in advances from Federal Home Loan Bank
                
                
                9,000,000
                
                
                
                40,500,000Increase
      (decrease) in federal funds purchased
                
                
                (13,359,000
                )
                
                
                13,359,000Net
      increase (decrease) in securities sold under agreements to
      repurchase
                
                
                269,697
                
                
                
                (192,260
                )Proceeds
      from note payable
                
                
                3,950,000
                
                
                
                3,000,000Exercise
      of stock options
                
                
                37,670
                
                
                
                239,746Issuance
      of shares to employees
                
                
                1,010
                
                
                
                -Issuance
      of shares to advisory board
                
                
                5,686
                
                
                
                16,759Issuance
      of shares to 404(c) plan
                
                
                -
                
                
                
                198,380Purchase
      of treasury stock
                
                
                (14,579
                )
                
                
                (145,198
                )Net
      cash provided by financing activities
                
                
                11,528,153
                
                
                
                133,536,058Net
      decrease in cash and cash equivalents
                
                
                (1,456,043
                )
                
                
                (24,298,425
                )Cash
      and cash equivalents, beginning of year
                
                
                7,164,650
                
                
                
                31,463,075Cash
      and cash equivalents, end of year
                
                $
                5,708,607
                
                
                $
                7,164,650Cash
      paid during the year for:Income
      taxes
                
                $
                1,404,499
                
                
                $
                1,431,042Interest
                
                $
                17,442,619
                
                
                $
                18,431,908Supplemental
      noncash investing and financing activities:Foreclosures
      on loans
                
                $
                555,800
                
                
                $
                405,072




The
accompanying notes are an integral part of the consolidated financial
statements.


-28-




FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY
 Notes
to Consolidated Financial Statements


NOTE 1 - SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES





Organization
- First Reliance Bancshares, Inc. (the Company) was incorporated to serve as a
bank holding company for its subsidiary, First Reliance Bank (the
Bank).  First Reliance Bank was incorporated on August 9, 1999 and
commenced business on August 16, 1999.  The principal business
activity of the Bank is to provide banking services to domestic markets,
principally in Florence, Lexington, and Charleston Counties in South
Carolina.  The Bank is a state-chartered commercial Bank, and its
deposits are insured by the Federal Deposit Insurance
Corporation.  The consolidated financial statements include the
accounts of the parent company and its wholly-owned subsidiary after elimination
of all significant intercompany balances and transactions.  In 2005,
the Company formed First Reliance Capital Trust I (the "Trust") for the purpose
of issuing trust preferred securities.  In accordance with current
accounting guidance, the Trust is not consolidated in these financial
statements.




Management’s
Estimates - The preparation of consolidated financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the consolidated financial statements and the reported amounts of revenues and
expenses during the reporting period.  Actual results could differ
from those estimates.




Material
estimates that are particularly susceptible to significant change relate to the
determination of the allowance for losses on loans, including valuation
allowances for impaired loans, and the valuation of real estate acquired in
connection with foreclosures or in satisfaction of loans.  In
connection with the determination of the allowances for losses on loans and
foreclosed real estate, management obtains independent appraisals for
significant properties.  Management must also make estimates in
determining the estimated useful lives and methods for depreciating premises and
equipment.





While
management uses available information to recognize losses on loans and
foreclosed real estate, future additions to the allowances may be necessary
based on changes in local economic conditions.  In addition,
regulatory agencies, as an integral part of their examination process,
periodically review the Company’s allowances for losses on loans and foreclosed
real estate.  Such agencies may require the Company to recognize
additions to the allowances based on their judgments about information available
to them at the time of their examinations.  Because of these factors,
it is reasonably possible that the allowances for losses on loans and foreclosed
real estate may change materially in the near term.





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




The
Company makes loans to individuals and small businesses for various personal and
commercial purposes primarily in Florence, Lexington, Charleston and Mount
Pleasant, South Carolina.  At December 31, 2008, the majority of the
total loan portfolio was to borrowers from within these areas.




The
Company’s loan portfolio is not concentrated in loans to any single borrower or
a relatively small number of borrowers.  Additionally, management is
not aware of any concentrations of loans to groups of borrowers or industries
that would be similarly affected by sector specific economic
conditions.




In
addition to monitoring potential concentrations of loans to particular borrowers
or groups of borrowers, industries and geographic regions, management monitors
exposure to credit risk from concentrations of lending products and practices
such as loans that subject borrowers to substantial payment increases (e.g.
principal deferral periods, loans with initial interest-only periods, etc), and
loans with high loan-to-value ratios.  Management has determined that
there is minimal concentration of credit risk associated with its lending
policies or practices.




Additionally,
there are industry practices that could subject the Company to increased credit
risk should economic conditions change over the course of a loan’s
life.  For example, the Company makes variable rate loans and fixed
rate principal-amortizing loans with maturities prior to the loan being fully
paid (i.e. balloon payment loans).  These loans are underwritten and
monitored to manage the associated risks.  Therefore, management
believes that these particular practices do not subject the Company to unusual
credit risk.




The
Company’s investment portfolio consists principally of obligations of the United
States and its agencies or its corporations.  In the opinion of
management, there is no concentration of credit risk in its investment
portfolio.  The Company places its deposits and correspondent accounts
with and sells its federal funds to high quality institutions. Management
believes credit risk associated with correspondent accounts is not
significant.





-29-


FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY
 Notes
to Consolidated Financial Statements




NOTE 1 -
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - continued





Securities
Available-for-Sale - Securities available-for-sale are carried at
amortized cost and adjusted to estimated market value by recognizing the
aggregate unrealized gains or losses in a valuation
account.  Aggregate market valuation adjustments are recorded as part
of the comprehensive income in shareholders’ equity net of deferred income
taxes. Reductions in market value considered by management to be other than
temporary are reported as a realized loss and a reduction in the cost basis of
the security. The adjusted cost basis of investments available-for-sale is
determined by specific identification and is used in computing the gain or loss
upon sale.





Nonmarketable
Equity Securities - Nonmarketable equity securities include the cost of
the Company’s investment in the stock of Federal Home Loan Bank.  The
stock has no quoted market value and no ready market
exists.  Investment in the Federal Home Loan Bank is a condition of
borrowing from the Federal Home Loan Bank, and the stock is pledged to
collateralize such borrowings.  At December 31, 2008 and 2007, the
Company’s investment in Federal Home Loan Bank stock was $4,574,700 and
$3,930,400, respectfully. Dividends received on this stock are included as a
separate component of interest income.





Loans
receivable - Loans receivable are stated at their unpaid principal
balance.  Interest income is computed using the simple interest method
and is recorded in the period earned.





When
serious doubt exists as to the collectibility of a loan or when a loan becomes
contractually ninety days past due as to principal or interest, interest income
is generally discontinued unless the estimated net realizable value of
collateral exceeds the principal balance and accrued interest.  When
interest accruals are discontinued, income earned but not collected is
reversed.





Loan
origination and commitment fees and certain direct loan origination costs
(principally salaries and employee benefits) are deferred and amortized to
income over the contractual life of the related loans or commitments, adjusted
for prepayments, using the straight-line method.





Allowance
for Loan Losses - The allowance for loan losses is established as losses
are estimated to have occurred through a provision for loan losses charged to
earnings.  Loan losses are charged against the allowance when
management believes the uncollectibility of a loan balance is
confirmed.  Subsequent recoveries, if any, are credited to the
allowance.





The
allowance for loan losses is evaluated on a regular basis by management and is
based upon management's periodic review of the collectibility of the loans in
light of historical experience, the nature and volume of the loan portfolio,
adverse situations that may affect the borrower's ability to repay, estimated
value of any underlying collateral and prevailing economic
conditions.  This evaluation is inherently subjective as it requires
estimates that are susceptible to significant revision as more information
becomes available.





The
allowance consists of specific, general and unallocated
components.  The specific component relates to loans that are
classified as either doubtful, substandard or special mention.  For
such loans that are also classified as impaired, an allowance is established
when the discounted cash flows (or collateral value or observable market price)
of the impaired loan is lower than the carrying value of that
loan.  The general component covers non-classified loans and is based
on historical loss experience adjusted for qualitative factors.  An
unallocated component is maintained to cover uncertainties that could affect
management's estimate of probable losses.  The unallocated component
of the allowance reflects the margin of imprecision inherent in the underlying
assumptions used in the methodologies for estimating specific and general losses
in the portfolio.





-30-




FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY
 Notes
to Consolidated Financial Statements


NOTE 1 -
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – continued





Allowance
for Loan Losses (continued) - A loan is
considered impaired when, based on current information and events, it is
probable that the Company will be unable to collect the scheduled payments of
principal or interest when due according to the contractual terms of the loan
agreement.  Factors considered by management in determining impairment
include payment status, collateral value, and the probability of collecting
scheduled principal and interest payments when due.  Loans that
experience insignificant payment delays and payment shortfalls generally are not
classified as impaired. Management determines the significance of payment delays
and payment shortfalls on a case-by-case basis, taking into consideration all of
the circumstances surrounding the loan and the borrower, including the length of
the delay, the reasons for the delay, the borrower's prior payment record, and
the amount of the shortfall in relation to the principal and interest
owed.  Impairment is measured on a loan by loan basis for commercial
and construction loans by either the present value of expected future cash flows
discounted at the loan's effective interest rate, the loan's obtainable market
price, or the fair value of the collateral if the loan is collateral
dependent.





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





Mortgage
Loans Held For Sale - The Company’s mortgage activities are comprised of
accepting residential mortgage loan applications, qualifying borrowers to
standards established by investors, funding residential mortgages and selling
mortgages to investors under pre-existing commitments.  Funded
residential mortgages held temporarily for sale to investors are recorded at the
lower of cost or market value.  Gains or losses are recognized when
control over these assets has been surrendered in accordance with SFAS No. 140
"Accounting for Transfer and Servicing of Financial Assets and Extinguishment of
Liabilities," and are included in gain on sale of mortgage loans in the
consolidated statements of income.





Other
Real Estate Owned - Other real estate owned includes real estate acquired
through foreclosure.  Other real estate owned is carried at the lower
of cost (principal balance at the date of foreclosure) or fair value minus
estimated costs to sell.  Any write-downs at the date of foreclosure
are charged to the allowance for loan losses.  Expenses to maintain
such assets, subsequent changes in the valuation allowance, and gains and losses
on disposal are included in other expenses.





Premises,
Furniture and Equipment - Premises, furniture and equipment are stated at
cost, less accumulated depreciation.  The provision for depreciation
is computed by the straight-line method, based on the estimated useful lives for
buildings of 40 years and furniture and equipment of 5 to 10
years.  Leasehold improvements are being amortized over 20
years.  The cost of assets sold or otherwise disposed of and the
related allowance for depreciation is eliminated from the accounts and the
resulting gains or losses are reflected in the income statement when
incurred.  Maintenance and repairs are charged to current
expense.  The costs of major renewals and improvements are capitalized
based upon the Company's policy.





Cash
Surrender Value of Life Insurance - Cash surrender value of life
insurance represents the cash value of policies on certain current and former
officers of the Bank.





Residential
Mortgage Origination Fees-Residential mortgage
origination fees include fees from residential mortgage loans originated by the
Company and subsequently sold in the secondary market.  These fees are
recognized as income at the time of the sale to the investor.





Income
Taxes - Income taxes are the sum of amounts currently payable to taxing
authorities and the net changes in income taxes payable or refundable in future
years.  Income taxes deferred to future years are determined utilizing
a liability approach.  This method gives consideration to the future
tax consequences associated with differences between financial accounting and
tax bases of certain assets and liabilities which are principally the allowance
for loan losses and depreciable premises and equipment.





-31-




FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY
 Notes
to Consolidated Financial Statements


NOTE 1 -
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - continued





Income
Taxes–continued





In 2006,
the FASB issued Interpretation No. 48 (FIN 48), "Accounting for Uncertainty in
Income Taxes - an Interpretation of SFAS No. 109."  FIN 48 clarifies
the accounting for uncertainty in income taxes recognized in an enterprise's
financial statements in accordance with SFAS No. 109, "Accounting for Income
Taxes."  FIN 48 also prescribes a recognition threshold and
measurement of a tax position taken or expected to be taken in an enterprise's
tax return.  The Company adopted FIN 48 effective January 1,
2007.  The adoption of FIN 48 did not have any impact on the Company's
consolidated financial position.





Advertising
Expense - Advertising and public relations costs are generally expensed
as incurred.  External costs incurred in producing media advertising
are expensed the first time the advertising takes place.  External
costs relating to direct mailing costs are expended in the period in which the
direct mailings are sent.  Advertising and public relations costs of
$345,389 and $525,787 were included in the Company's results of operations for
2008 and 2007, respectively.





Retirement
Benefits - A trusteed retirement savings plan is sponsored by the Company
and provides retirement benefits to substantially all officers and employees who
meet certain age and service requirements.  The plan includes a
“salary reduction” feature pursuant to Section 401(k) of the Internal Revenue
Code.  In 2004, the Company converted the 401(k) plan to a 404(c)
plan.  The 404 (c) plan changes investment alternatives to include the
Company's stock.  Under the plan and present policies, participants
are permitted to make contributions up to 15% of their annual
compensation.  At its discretion, the Company can make matching
contributions up to 6% of the participants’ compensation.  The Company
charged $121,972 and $152,243 to earnings for the retirement savings plan in
2008 and 2007, respectively.





During
2006, the Board of Directors approved a supplemental retirement plan for the
directors and certain officers. These benefits are not qualified under the
Internal Revenue Code and they are not funded.  For 2008 and 2007 the
supplemental retirement expense was $237,000 and $209,746,
respectively.  The current accrued but unfunded amount is $598,377 and
$361,377 at December 31, 2008 and 2007, respectively.  However,
certain funding is provided informally and indirectly by bank owned life
insurance policies.  The cash surrender value of the life insurance
policies are recorded as a separate line item in the accompanying consolidated
balances sheets at $10,986,484 and $10,540,273 at December 31, 2008 and 2007,
respectively.





In
September 2006, the EITF reached a final consensus on Issue 06-4, “Accounting
for Deferred Compensation and Postretirement Benefit Aspects of Endorsement
Split-Dollar Life Insurance Arrangements.”  EITF 06-4 requires that
for a split-dollar life insurance arrangement, an employer should recognize a
liability for future benefits in accordance with SFAS 106, “Employers’ Account
for Postretirement Benefits Other Than Pensions.”  The Company adopted
EITF 06-4 as of January 1, 2008 as a change in accounting principle through a
cumulative-effect adjustment to retained earnings.  The amount of the
adjustment was $203,902.  For the year ended December 31, 2008, the
split-dollar liability totaled $216,647 and the related expense for 2008 was
$12,745.





Equity
Incentive Plan - On January 19, 2006, the Company approved the 2006
Equity Incentive Plan.  This plan provides for the granting of
dividend equivalent rights, options, performance unit awards, phantom shares,
stock appreciation rights and stock awards, each of which shall be subject to
such conditions based upon continued employment, passage of time or satisfaction
of performance criteria or other criteria as permitted by the
plan.  The plan allows granting up to 350,000 shares of stock, to
officers, employees, and directors, consultants and service providers of the
Company or its affiliates.  Awards may be granted for a term of up to
ten years from the effective date of grant. Under this Plan, our Board of
Directors has sole discretion as to the exercise date of any awards
granted.  The per-share exercise price of incentive stock options may
not be less than the market value of a share of common stock on the date the
option is granted.  Any options that expire unexercised or are
canceled become available for re-issuance. The Company's equity incentive plan
is further described in Note 17.





Stock-Based
Compensation - The Company uses the fair value recognition provisions of
Financial Accounting Standards Board ("FASB") Statement of Financial Accounting
Standards ("SFAS") No. 123(R), "Share-Based Payment," ("SFAS 123(R)") to account
for compensation costs under its stock option and other equity incentive
plans.





-32-




FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY
 Notes
to Consolidated Financial Statements


NOTE 1 -
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - continued





Common
Stock Owned by the 401(k) Plan and Employee Stock Ownership Plan (ESOP) -
All shares held by the 401(k) and ESOP Plans, collectively referred to as the
"404(c)," are treated as outstanding for purposes of computing earnings per
share. 404(c) purchases and redemptions of the Company's common stock are at
estimated fair value as determined by independent
valuations.  Dividends on 404 (c) shares are charged to retained
earnings.  At December 31, 2008, the 404 (c) owned 143,240 shares of
the Company’s common stock with an estimated value of $928,086.  At
December 31, 2007, the 404 (c) owned 116,227 shares of the Company’s common
stock with an estimated value of $1,361,664.  All of these shares were
allocated.  Contributions to the 404 (c) in 2008 and 2007 were
$121,972 and $152,243, respectively.





Earnings
Per Share - Basic earnings per share represents income available to
shareholders divided by the weighted-average number of common shares outstanding
during the period.  Diluted earnings per share reflect 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 similar share-based
compensation instruments and are determined using the treasury stock method (see
Note 16).





Comprehensive
Income - Accounting principles generally require that recognized income,
expenses, gains, and losses be included in net income.  Although
certain changes in assets and liabilities, such as unrealized gains and losses
on available-for-sale securities, are reported as a separate component of the
equity section of the balance sheet, such items, along with net income, are
components of comprehensive income.





The
components of other comprehensive income (loss) and related tax effects are as
follows:


Pre-tax
                      
                      
                      Tax
                      
                      
                      Net-of-taxAmount
                      
                      
                      Benefit
                      
                      
                      AmountFor the Year Ended December 31,
      2008:Net
      unrealized losses on securities available-for-sale
                      
                      $
                      (303,270
                      )
                      
                      $
                      103,112
                      
                      
                      $
                      (200,158
                      )For the Year Ended December 31,
      2007:Net
      unrealized losses on securities available-for-sale
                      
                      $
                      (20,080
                      )
                      
                      $
                      6,828
                      
                      
                      $
                      (13,252
                      )Reclassification
      adjustment for gains (losses)realized
      in net income
                      
                      
                      3,496
                      
                      
                      
                      (1,189
                      )
                      
                      
                      2,307$
                      (16,584
                      )
                      
                      $
                      5,639
                      
                      
                      $
                      (10,945
                      )





Derivative
Instruments - SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities," establishes comprehensive accounting and reporting
standards for derivative instruments and hedging activities.  SFAS No.
133 requires that all derivative instruments be recorded in the statement of
financial position at fair value.  The accounting for the gain or loss
due to change in fair value of the derivative instrument depends on whether the
derivative instrument qualifies as a hedge.  If the derivative does
not qualify as a hedge, the gains or losses are reported in earnings when they
occur.  However, if the derivative instrument qualifies as a hedge,
the accounting varies based on the type of risk being hedged.





The
Company has no material embedded derivative instruments requiring separate
accounting treatment.  The Company has freestanding derivative
instruments consisting of fixed rate conforming loan commitments and commitments
to sell fixed rate conforming loans.  The Company does not currently
engage in hedging activities.





-33-




FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY
 Notes
to Consolidated Financial Statements


NOTE 1 -
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - continued





Statements
of Cash Flows - For purposes of reporting cash flows in the consolidated
financial statements, the Company considers certain highly liquid debt
instruments purchased with a maturity of three months or less to be cash
equivalents. Cash equivalents include amounts due from banks and federal funds
sold.  Generally, federal funds are sold for one-day
periods.





Changes
in the valuation account of securities available-for-sale, including the
deferred tax effects, are considered noncash transactions for purposes of the
statement of cash flows and are presented in detail in the notes to the
consolidated financial statements.





Off-Balance-Sheet
Financial Instruments - In the ordinary course of business, the Company
enters into off-balance-sheet financial instruments consisting of commitments to
extend credit and letters of credit.  These financial instruments are
recorded in the consolidated financial statements when they become payable by
the customer.





Recently
Issued Accounting Pronouncements–The following is a summary
of recent authoritative pronouncement that may affect accounting, reporting and
disclosure of financial information by the Company:





In March
2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments
and Hedging Activities,” (“SFAS 161”).  SFAS 161 requires enhanced
disclosures about an entity’s derivative and hedging activities, thereby
improving the transparency of financial reporting.  It is intended to
enhance the current disclosure framework in SFAS 133 by requiring that
objectives for using derivative instruments be disclosed in terms of underlying
risk and accounting designation. This disclosure is intended to convey the
purpose of derivative use in terms of the risks that the entity is intending to
manage. SFAS 161 was effective for the Company on January 1, 2009 and will
result in additional disclosures if the Company enters into any material
derivative or hedging activities.





In
February 2008, the FASB issued FASB Staff Position No. 140-3, “Accounting for
Transfers of Financial Assets and Repurchase Financing Transactions,” (“FSP
140-3”).  This FSP provides guidance on accounting for a transfer of a
financial asset and the transferor’s repurchase financing of the asset.
 This FSP presumes that an initial transfer of a financial asset and a
repurchase financing are considered part of the same arrangement (linked
transaction) under SFAS


140.
However, if certain criteria are met, the initial transfer and repurchase
financing are not evaluated as a linked transaction and are evaluated separately
under SFAS 140.  FSP 140-3 was effective for the Company on January 1,
2009.  The adoption of FSP 140-3 had no impact on the Company’s financial
position, results of operations or cash flows.





In April
2008, the FASB issued FASB Staff Position No. 142-3, “Determination of the
Useful Life of Intangible Assets,” (“FSP 142-3”).  This FSP amends the
factors that should be considered in developing renewal or extension assumptions
used to determine the useful life of a recognized intangible asset under SFAS
No. 142, “Goodwill and Other Intangible Assets,” (“SFAS 142”).  The
intent of this FSP is to improve the consistency between the useful life of a
recognized intangible asset under SFAS 142 and the period of expected cash flows
used to measure the fair value of the asset under SFAS 141(R) and other U.S.
generally accepted accounting principles.  This FSP was effective for
the Company on January 1, 2009 and had no material impact on the Company’s
financial position, results of operations or cash flows.





-34-




FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY
 Notes
to Consolidated Financial Statements


NOTE 1 -
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES– continued





Recently
Issued Accounting Pronouncements - continued





In May,
2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted
Accounting Principles,” (“SFAS 162”).  SFAS 162 identifies the sources
of accounting principles and the framework for selecting the principles used in
the preparation of financial statements of nongovernmental entities that are
presented in conformity with generally accepted accounting principles (GAAP) in
the United States (the GAAP hierarchy).  SFAS 162 is effective
November 15, 2008.  The FASB has stated that it does not expect SFAS
162 will result in a change in current practice. The application of SFAS 162 had
no effect on the Company’s financial position, results of operations or cash
flows.





The FASB
issued FASB Staff Position No. APB 14-1, “Accounting forConvertible
Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial
Cash Settlement),” (“FSP APB 14-1”). The Staff Position specifies that issuers
of convertible debt instruments that may be settled in cash upon conversion
should separately account for the liability and equity components in a manner
that will reflect the entity’s nonconvertible debt borrowing rate when interest
cost is recognized in subsequent periods.  FSP APB 14-1 provides
guidance for initial and subsequent measurement as well as derecognition
provisions.  The Staff Position was effective as of January 1, 2009
and had no material effect on the Company’s financial position, results of
operations or cash flows.





In June,
2008, the FASB issued FASB Staff Position No. EITF 03-6-1, “Determining Whether
Instruments Granted in Share-Based Payment Transactions are Participating
Securities,” (“FSP EITF 03-6-1”).  The Staff Position provides that
unvested share-based payment awards that contain nonforfeitable rights to
dividends or dividend equivalents are participating securities and must be
included in the earnings per share computation.  FSP EITF 03-6-1 was
effective January 1, 2009 and had no effect on the Company’s financial position,
results of operations, earnings per share or cash flows.





FSP SFAS
133-1 and FIN 45-4, “Disclosures about Credit Derivatives and Certain
Guarantees: An Amendment of FASB Statement No. 133 and FASB Interpretation No.
45; and Clarification of the Effective Date of FASB Statement No. 161,” (“FSP
SFAS 133-1 and FIN 45-4”) was issued September 2008, effective for reporting
periods (annual or interim) ending after November 15, 2008.  FSP SFAS
133-1 and FIN 45-4 amends SFAS 133 to require the seller of credit derivatives
to disclose the nature of the credit derivative, the maximum potential amount of
future payments, fair value of the derivative, and the nature of any recourse
provisions.  Disclosures must be made for entire hybrid instruments
that have embedded credit derivatives.





The Staff
Position also amends FASB Interpretation No. (“FIN”) 45 to require disclosure of
the current status of the payment/performance risk of the credit derivative
guarantee.  If an entity utilizes internal groupings as a basis for
the risk, how the groupings are determined must be disclosed as well as how the
risk is managed.





The Staff
Position encourages that the amendments be applied in periods earlier than the
effective date to facilitate comparisons at initial adoption.  After
initial adoption, comparative disclosures are required only for subsequent
periods.





FSP SFAS
133-1 and FIN 45-4 clarifies the effective date of SFAS 161 such that required
disclosures should be provided for any reporting period (annual or quarterly
interim) beginning after November 15, 2008.  The adoption of this
Staff Position had no material effect on the Company’s financial position,
results of operations or cash flows.





The SEC’s
Office of the Chief Accountant and the staff of the FASB issued press release
2008-234 on September 30, 2008 (“Press Release”) to provide clarifications on
fair value accounting.  The Press Release includes guidance on the use
of management’s internal assumptions and the use of “market”
quotes.  It also reiterates the factors in SEC Staff Accounting
Bulletin (“SAB”) Topic 5M which should be considered when determining
other-than-temporary impairment: the length of time and extent to which the
market value has been less than cost; financial condition and near-term
prospects of the issuer; and the intent and ability of the holder to retain its
investment for a period of time sufficient to allow for any anticipated recovery
in market value.





-35-




FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY
 Notes
to Consolidated Financial Statements


NOTE 1 -
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES– continued





Recently
Issued Accounting Pronouncements - continued





On
October 10, 2008, the FASB issued FSP SFAS 157-3, “Determining the Fair Value of
a Financial Asset When the Market for That Asset Is Not Active” (“FSP SFAS
157-3”). This FSP clarifies the application of SFAS No. 157, “Fair Value
Measurements” (see Note 21) in a market that is not active and provides an
example to illustrate key considerations in determining the fair value of a
financial asset when the market for that asset is not active.  The FSP
is


effective
upon issuance, including prior periods for which financial statements have not
been issued. For the Company, this FSP was effective for the quarter ended
September 30, 2008.





The
Company considered the guidance in the Press Release and in FSP SFAS 157-3 when
conducting its review for other-than-temporary impairment as of December 31,
2008 as discussed in Note 21.





FSP SFAS
140-4 and FIN 46(R)-8, “Disclosures by Public Entities (Enterprises) about
Transfers of Financial Assets and Interests in Variable Interest Entities,”
(“FSP SFAS 140-4 and FIN 46(R)-8”) was issued in December 2008 to require public
entities to disclose additional information about transfers of financial assets
and to require public enterprises to provide additional disclosures about their
involvement with variable interest entities.  The FSP also requires
certain disclosures for public enterprises that are sponsors and servicers of
qualifying special purpose entities.  The FSP is effective for the
first reporting period ending after December 15, 2008.  This FSP had
no material impact on the financial position of the Company.





FSP SFAS
132(R)-1, “Employers’ Disclosures about Postretirement Benefit Plan Assets,”
(“FSP SFAS 132(R)-1”) issued in December 2008, provides guidance on an
employer’s disclosures about plan assets of a defined benefit pension or other
postretirement plan to provide the users of financial statements with an
understanding of: (a) how investment allocation decisions are made, including
the factors that are pertinent to an understanding of investment policies and
strategies; (b) the major categories of plan assets; (c) the inputs and
valuation techniques used to measure the fair value of plan assets; (d) the
effect of fair value measurements using significant unobservable inputs (Level
3) on changes in plan assets for the period; and (e) significant concentrations
of risk within plan assets.  FSP SFAS 132(R)-1 is effective for fiscal
years ending after December 15, 2009.  The Staff Position will require
the Company to provide additional disclosures related it to its benefit
plans.





FSP EITF
99-20-1, “Amendments to the Impairment Guidance of EIFT Issue No. 99-20,” (“FSP
EITF 99-20-1”) was issued in January 2009.  Prior to the Staff
Position, other-than-temporary impairment was determined by using either EITF
Issue No. 99-20, “Recognition of Interest Income and Impairment on Purchased
Beneficial Interests and Beneficial Interests that Continue to be Held by a
Transferor in Securitized Financial Assets,” (“EITF 99-20”) or SFAS No. 115,
“Accounting for Certain Investments in Debt and Equity Securities,” (“SFAS 115”)
depending on the type of security.  EITF 99-20 required the use of
market participant assumptions regarding future cash flows regarding the
probability of collecting all cash flows previously projected.  SFAS
115 determined impairment to be other than temporary if it was probable that the
holder would be unable to collect all amounts due according to the contractual
terms. To achieve a more consistent determination of other-than-temporary
impairment, the Staff Position amends EITF 99-20 to determine any
other-than-temporary impairment based on the guidance in SFAS 115, allowing
management to use more judgment in determining any other-than-temporary
impairment.  The Staff Position is effective for interim and annual
reporting periods ending after December 15, 2008 and shall be applied
prospectively.  Retroactive application is not
permitted.  Management has reviewed the Company’s security portfolio
and evaluated the portfolio for any other-than-temporary impairments as
discussed in Note 3.





-36-




FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY
 Notes
to Consolidated Financial Statements


NOTE 1 -
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES– continued





Recently
Issued Accounting Pronouncements - continued





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





Risks and
Uncertainties - In the normal course of its business, the Company
encounters two significant types of risks: economic and
regulatory.  There are three main components of economic
risk:  interest rate risk, credit risk and market risk.  The
Company is subject to interest rate risk to the degree that its interest-bearing
liabilities mature or reprice at different speeds, or on different basis, than
its interest-earning assets.  Credit risk is the risk of default on
the Company's loan portfolio that results from borrower's inability or
unwillingness to make contractually required payments.  Market risk
reflects changes in the value of collateral underlying loans receivable and the
valuation of real estate held by the Company.





The
Company is subject to the regulations of various governmental
agencies.  These regulations can and do change significantly from
period to period.  The Company also undergoes periodic examinations by
the regulatory agencies, which may subject it to further changes with respect to
asset valuations, amounts of required loss allowances and operating restrictions
from the regulators' judgments based on information available to them at the
time of their examination.





Reclassifications
- Certain captions and amounts in the 2007 consolidated financial statements
were reclassified to conform with the 2008 presentation.





NOTE 2 - CASH AND DUE FROM
BANKS





The
Company is required to maintain balances with The Federal Reserve computed as a
percentage of deposits.  At December 31, 2008 and 2007, this
requirement was $25,000.  This requirement was met by vault cash and
balances on deposit with the Federal Reserve.





NOTE 3 - INVESTMENT
SECURITIES





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





Amortized
                
                
                Gross Unrealized
                
                
                EstimatedCost
                
                
                Gains
                
                
                Losses
                
                
                Fair ValueDecember
      31, 2008U.S.
      Government agencies
                
                $
                88,013
                
                
                $
                -
                
                
                $
                16
                
                
                $
                87,997Mortgage-backed
      securities
                
                
                46,465,667
                
                
                
                1,108,354
                
                
                
                -
                
                
                
                47,574,021Municipals
                
                
                29,843,730
                
                
                
                155,047
                
                
                
                1,474,279
                
                
                
                28,524,498Other
                
                
                218,750
                
                
                
                -
                
                
                
                94,450
                
                
                
                124,300$
                76,616,160
                
                
                $
                1,263,401
                
                
                $
                1,568,745
                
                
                $
                76,310,816December
      31, 2007U.S.
      Government agencies
                
                $
                189,745
                
                
                $
                3,001
                
                
                $
                -
                
                
                $
                192,746Mortgage-backed
      securities
                
                
                27,028,064
                
                
                
                152,788
                
                
                
                113,890
                
                
                
                27,066,962Municipals
                
                
                31,145,829
                
                
                
                181,973
                
                
                
                258,847
                
                
                
                31,068,955Other
                
                
                218,750
                
                
                
                32,900
                
                
                
                -
                
                
                
                251,650$
                58,582,388
                
                
                $
                370,662
                
                
                $
                372,737
                
                
                $
                58,580,313





-37-




FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY
 Notes
to Consolidated Financial Statements


NOTE 3 -
INVESTMENT SECURITIES – continued





The
following is a summary of maturities of securities available-for-sale as of
December 31, 2008.  The amortized cost and estimated fair values are
based on the contractual maturity dates.  Actual maturities may differ
from contractual maturities because borrowers may have the right to call or
prepay obligations with or without penalty.





SecuritiesAvailable-For-SaleAmortized
                
                
                EstimatedCost
                
                
                Fair ValueDue
      within one year
                
                $
                63,362
                
                
                $
                63,360Due
      after one year but within five years
                
                
                1,115,672
                
                
                
                1,123,032Due
      after five years but within ten years
                
                
                1,714,721
                
                
                
                1,753,147Due
      after ten years
                
                
                27,037,988
                
                
                
                25,672,95629,931,743
                
                
                
                28,612,495Mortgage-backed
      securities
                
                
                46,465,667
                
                
                
                47,574,021Other
                
                
                218,750
                
                
                
                124,300Total
                
                $
                76,616,160
                
                
                $
                76,310,816





The
following table shows gross unrealized losses and fair value, aggregated by
investment category, and length of time that individual securities have been in
a continuous unrealized loss position, at December 31, 2008 and
2007.







Less
      than
                    
                    
                    Twelve
      monthstwelve months
                    
                    
                    or more
                    
                    
                    TotalUnrealized
                    
                    
                    
                    
                    
                    Unrealized
                    
                    
                    
                    
                    
                    UnrealizedDecember
      31, 2008
                    
                    Fair value
                    
                    
                    losses
                    
                    
                    Fair value
                    
                    
                    losses
                    
                    
                    Fair value
                    
                    
                    lossesU.S.
      government agencies
                    
                    $
                    87,997
                    
                    
                    $
                    16
                    
                    
                    $
                    -
                    
                    
                    $
                    -
                    
                    
                    $
                    87,997
                    
                    
                    $
                    16Municipals
                    
                    
                    16,846,808
                    
                    
                    
                    836,446
                    
                    
                    
                    3,719,646
                    
                    
                    
                    637,833
                    
                    
                    
                    20,566,454
                    
                    
                    
                    1,474,279Other
                    
                    
                    124,300
                    
                    
                    
                    94,450
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    124,300
                    
                    
                    
                    94,450Total
                    
                    $
                    17,059,105
                    
                    
                    $
                    930,912
                    
                    
                    $
                    3,719,646
                    
                    
                    $
                    637,833
                    
                    
                    $
                    20,778,751
                    
                    
                    $
                    1,568,745December
      31, 2007Municipals
                    
                    $
                    10,733,254
                    
                    
                    $
                    258,847
                    
                    
                    $
                    -
                    
                    
                    $
                    -
                    
                    
                    $
                    10,733,254
                    
                    
                    $
                    258,847Mortgage-backed
      securities
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    6,426,610
                    
                    
                    
                    113,890
                    
                    
                    
                    6,426,610
                    
                    
                    
                    113,890Total
                    
                    $
                    10,733,254
                    
                    
                    $
                    258,847
                    
                    
                    $
                    6,426,610
                    
                    
                    $
                    113,890
                    
                    
                    $
                    17,159,864
                    
                    
                    $
                    372,737





At
December 31, 2008, securities classified as available-for-sale are recorded at
fair market value.  Approximately 40.66% of the unrealized losses, or
6 individual securities, consisted of securities in a continuous loss position
for twelve months or more.  The Company has the ability and intent to
hold these securities until such time as the value recovers or the securities
mature. The Company believes, based on industry analyst reports and credit
ratings, that the deterioration in value is attributable to changes in market
interest rates and is not in the credit quality of the issuer and therefore,
these losses are not considered other-than-temporary.





At
December 31, 2008 and 2007, investment securities with a par value of
$74,210,000 and $27,303,216 and a fair market value of $73,204,733 and
$27,602,849, respectively, were pledged as collateral to secure public deposits
and borrowings.  There were no sales of investment securities for the
year ended December 31, 2008.  During 2007, $9,785,569 of
available-for-sale securities were sold at a gain of $3,496.





-38-




FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY
 Notes
to Consolidated Financial Statements


NOTE 4 - LOANS
RECEIVABLE




Major
classifications of loans receivable are summarized as follows:


December 31,2008
                
                
                2007Mortgage
      loans on real estate:Residential
      1-4 family
                
                $
                72,245,289
                
                
                $
                66,259,730Multifamily
                
                
                7,104,889
                
                
                
                9,822,699Commercial
                
                
                201,318,345
                
                
                
                195,992,305Construction
                
                
                60,744,432
                
                
                
                65,431,302Second
      mortgages
                
                
                4,989,538
                
                
                
                4,611,341Equity
      lines of credit
                
                
                37,792,852
                
                
                
                39,503,898384,195,345
                
                
                
                381,621,275Commercial
      and industrial
                
                
                70,877,890
                
                
                
                67,771,665Consumer
                
                
                8,974,448
                
                
                
                11,342,435Other
                
                
                4,942,519
                
                
                
                7,402,315Total
      gross loans
                
                $
                468,990,202
                
                
                $
                468,137,690Included
      in the gross loans above are:Nonaccrual
      loans
                
                $
                19,591,982
                
                
                $
                1,657,607Loans
      past due 90 days still accruing interest
                
                
                2,097,426
                
                
                
                1,780,505





The
Company has pledged certain loans as collateral to secure its borrowings from
the Federal Home Loan Bank.  The total of loans pledged was
$142,883,621 at December 31, 2008.





The
Company identifies impaired loans through its normal internal loan review
process.  Loans on the Company’s problem loan watch list are
considered potentially impaired loans.  These loans are evaluated in
determining whether all outstanding principal and interest are expected to be
collected.  Loans are not considered impaired if a minimal delay
occurs and all amounts due including accrued interest at the contractual
interest rate for the period of delay are expected to be collected.





The
following tables summarize information on impaired loans at and for the years
ended December 31, 2008 and 2007.





2008
                
                
                2007Impaired
      loans with specific allowance
                
                $
                20,235,727
                
                
                $
                1,876,221Impaired
      loans with no specific allowance
                
                
                5,947,874
                
                
                
                -Total
      impaired loans – year end
                
                $
                26,183,601
                
                
                $
                1,876,221Related
      specific allowance – year end
                
                $
                3,658,653
                
                
                $
                -Average
      recorded investment in impaired loans – year end
                
                
                8,509,024
                
                
                
                903,980Impaired
      loans included in non accrual
                
                
                19,591,982
                
                
                
                1,657,607





Interest
income recognized on impaired loans during 2008 was $568,735.  If the
impaired loans had been accruing interest at their original contracted rates,
related income would have been $1,972,354.





Transactions
in the allowance for loan losses are summarized below:





For
      the years endedDecember 31,2008
                
                
                2007Balance,
      beginning of year
                
                $
                5,270,607
                
                
                $
                4,001,881Provision
      charged to operations
                
                
                4,934,912
                
                
                
                1,643,100Recoveries
      on loans previously charged-off
                
                
                386,017
                
                
                
                81,761Loans
      charged-off
                
                
                (2,367,637
                )
                
                
                (456,135
                )Balance,
      end of year
                
                $
                8,223,899
                
                
                $
                5,270,607





-39-




FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY
 Notes
to Consolidated Financial Statements


NOTE 4 -
LOANS RECEIVABLE-continued




Loans
sold with limited recourse are 1-4 family residential mortgages originated by
the Company and sold to various other financial institutions.  These
loans are sold with the agreement that a loan may be returned to the Company
within 90 days of purchase, or at any time in the event the Company fails to
provide necessary documents related to the mortgages to the buyers, or if it
makes false representations or warranties to the buyers.  Loans sold
under these agreements in 2008 totaled $121,738,883.  The Company uses
the same credit policies in making loans held for sale as it does for
on-balance-sheet instruments.





The
Company is a party to financial instruments with off-balance-sheet risk in the
normal course of business to meet the financing needs of its
customers.  These financial instruments consist of commitments to
extend credit and standby letters of credit.  Commitments to extend
credit are agreements to lend to a customer as long as there is no violation of
any condition established in the contract.  Commitments generally have
fixed expiration dates or other termination clauses and may require payment of a
fee.  A commitment involves, to varying degrees, elements of credit
and interest rate risk in excess of the amount recognized in the balance
sheet.  The Company’s exposure to credit loss in the event of
nonperformance by the other parties to the instrument is represented by the
contractual notional amount of the instrument. Since certain commitments are
expected to expire without being drawn upon, the total commitment amounts do not
necessarily represent future cash requirements.  The Company uses the
same credit policies in making commitments to extend credit as it does for
on-balance-sheet instruments.  Letters of credit are conditional
commitments issued to guarantee a customer’s performance to a third party and
have essentially the same credit risk as other lending facilities.





Collateral
held for commitments to extend credit and standby letters of credit varies but
may include accounts receivable, inventory, property, plant, equipment, and
income-producing commercial properties.





The
following table summarizes the Company’s off-balance-sheet financial instruments
whose contract amounts represent credit risk:


December 31,2008
                  
                  
                  2007Commitments
      to extend credit
                  
                  $
                  53,812,183
                  
                  
                  $
                  76,545,909Standby
      letters of credit
                  
                  
                  3,006,214
                  
                  
                  
                  2,721,249





The
Company originates certain fixed rate residential mortgage loans and commits
these loans for sale based on best efforts contracts.  The commitments
to originate fixed rate residential mortgage loans and the sales commitments are
freestanding derivative instruments.  At December 31, 2008 and 2007,
the Company has no material embedded derivative instruments requiring separate
accounting treatment.  At December 31, 2008 and 2007, the amount of
the forward sales commitments approximates the carrying value of the mortgage
loans held for sale of $9,589,081 and $19,600,850,
respectively.  Sales commitments are to sell loans at par value and
are generally funded within 60 days.





NOTE 5 - PREMISES, FURNITURE
AND EQUIPMENT





Premises,
furniture and equipment consisted of the following:


December 31,2008
                
                
                2007Land
                
                $
                13,032,561
                
                
                $
                6,446,267Building
                
                
                13,645,412
                
                
                
                6,679,702Leasehold
      improvements
                
                
                145,497
                
                
                
                145,497Furniture
      and equipment
                
                
                5,045,108
                
                
                
                4,367,496Construction
      in progress
                
                
                575,979
                
                
                
                7,689,612Total
                
                
                32,444,557
                
                
                
                25,328,574Less,
      accumulated depreciation
                
                
                3,832,535
                
                
                
                3,094,828Premises
      and equipment, net
                
                $
                28,612,022
                
                
                $
                22,233,746





Depreciation
expense for the years ended December 31, 2008 and 2007 amounted to $784,210 and
$554,760, respectively.





At
December 31, 2008 and 2007, construction in progress consists mainly of
architect fees and site work for new branches.  Construction in
progress also included renovations to the Company's corporate
office.





-40-


FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY
 Notes
to Consolidated Financial Statements


NOTE 6 -
DEPOSITS





At
December 31, 2008, the scheduled maturities of time deposits were as
follows:





Maturing In
                
                Amount2009
                
                $
                218,102,6072010
                
                
                51,206,1982011
                
                
                6,294,6322012
                
                
                440,3532013
                
                
                286,029Total
                
                $
                276,329,819





Included
in total time deposits at December 31, 2008 and 2007 were brokered time deposits
of $96,652,000 and $85,330,473, respectively.





NOTE 7 – Securities Sold
Under Agreements To Repurchase





Short-term
borrowings payable are securities sold under agreements to repurchase which
generally mature on a one to thirty day basis.  Information concerning
securities sold under agreements to repurchase is summarized as
follows:





For
      the years endedDecember 31,2008
                
                
                2007Balance
      at end of the year
                
                $
                8,197,451
                
                
                $
                7,927,754Maximum
      month-end balance during the year
                
                
                9,290,691
                
                
                
                11,651,480Average
      balance during the year
                
                
                7,844,809
                
                
                
                9,127,643Average
      interest rate at the end of the year
                
                
                0.25
                %
                
                
                4.43
                %Average
      interest rate during the year
                
                
                1.54
                %
                
                
                4.39
                %





Under the
terms of the repurchase agreement, the Company sells an interest in securities
issued by United States Government agencies and agrees to repurchase the same
securities the following business day.  As of December 31, 2008 and
2007, the par value and market value of the securities held by the third-party
for the underlying agreements were $13,240,000 and $8,303,216, respectively, and
$12,713,996 and $8,391,834, respectively.








-41-




FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY
 Notes
to Consolidated Financial Statements


NOTE 8 - ADVANCES FROM
FEDERAL HOME LOAN BANK





Advances
from the Federal Home Loan Bank consisted of the following:





December 31,Description
                
                Interest Rate
                
                
                2008
                
                
                2007Fixed
      rate advances maturing:January
      28, 2008
                
                
                4.59
                %
                
                $
                -
                
                
                $
                5,000,000February
      28, 2008
                
                
                4.58
                %
                
                
                -
                
                
                
                5,000,000March
      28, 2008
                
                
                4.57
                %
                
                
                -
                
                
                
                5,000,000April
      8, 2008
                
                
                3.46
                %
                
                
                -
                
                
                
                1,000,000September
      27, 2008
                
                
                4.71
                %
                
                
                -
                
                
                
                5,000,000October
      14, 2008
                
                
                4.86
                %
                
                
                -
                
                
                
                5,000,000December
      22, 2008
                
                
                4.14
                %
                
                
                -
                
                
                
                5,000,000January
      22, 2009
                
                
                2.875
                %
                
                
                4,000,000
                
                
                
                -March
      09, 2009
                
                
                4.94
                %
                
                
                6,000,000
                
                
                
                6,000,000May
      28, 2009
                
                
                2.957
                %
                
                
                5,000,000
                
                
                
                -May
      29, 2009
                
                
                4.078
                %
                
                
                8,000,000
                
                
                
                8,000,000July
      30, 2009
                
                
                2.87
                %
                
                
                5,500,000
                
                
                
                -August
      13, 2009
                
                
                2.59
                %
                
                
                3,000,000
                
                
                
                -November
      5, 2009
                
                
                2.76
                %
                
                
                5,000,000
                
                
                
                -November
      30, 2009
                
                
                4.028
                %
                
                
                9,000,000
                
                
                
                9,000,000April
      8, 2010
                
                
                2.66
                %
                
                
                1,000,000
                
                
                
                -November
      5, 2010
                
                
                3.457
                %
                
                
                5,000,000
                
                
                
                -November
      29, 2010
                
                
                4.11
                %
                
                
                8,000,000
                
                
                
                8,000,000November
      7, 2011
                
                
                3.886
                %
                
                
                10,000,000
                
                
                
                -Variable
      rate advances maturing:March
      19, 2009
                
                
                2.48
                %
                
                
                3,000,000
                
                
                
                3,000,000July
      5, 2012
                
                
                4.08
                %
                
                
                1,000,000
                
                
                
                1,000,000Daily
      variable rate advances maturing:Daily
                
                Variable
                
                
                
                4,500,000
                
                
                
                3,000,000$
                78,000,000
                
                
                $
                69,000,000





Scheduled
principal reductions of Federal Home Loan Bank advances are as
follows:


Amount2009
                
                $
                53,000,0002010
                
                
                14,000,0002011
                
                
                10,000,0002012
                
                
                1,000,000Total
                
                $
                78,000,000





The
Company has pledged certain loans as collateral to secure its borrowings from
the Federal Home Loan Bank.  The total of loans pledged was
$142,883,621 and $147,655,969 at December 31, 2008 and 2007,
respectively.  At December 31, 2008 and 2007, investment securities
with a par value of $45,000,000 and $19,000,000 and a fair market value of
$45,300,859 and $19,211,015, respectively, were also pledged as collateral to
secure the borrowings.  Finally, the Company’s Federal Home Loan Bank
stock is pledged to secure the borrowings.





-42-




FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY
 Notes
to Consolidated Financial Statements


NOTE 9 -JUNIOR SUBORDINATED
DEBENTURES





On June
30, 2005, First Reliance Capital Trust I (a non-consolidated affiliate) issued
$10,000,000 in trust preferred securities with a maturity of November 23,
2035 and may be redeemed by the Company after five years, and sooner in
certain specific events.  The rate is fixed at 5.93% until August 23,
2010, at which point the rate adjusts quarterly to the three-month LIBOR plus
1.83%, and can be called without penalty beginning on June 15,
2011.  In accordance with the revised FIN 46, the Trust has not been
consolidated in these financial statements.  The Company received from
the trust the $10,000,000 proceeds from the issuance of the securities and the
$310,000 initial proceeds from the capital investment in the trust, and
accordingly has shown the funds due to the trust as $10,310,000 junior
subordinated debentures.  Current regulations allow the entire amount
of junior subordinated debentures to be included in the calculation of
regulatory capital.





NOTE 10 – NOTE
PAYABLE





Note
payable consists of a $20,000,000 revolving line of credit, that expires on June
23, 2009, with interest payable quarterly at a fluctuating rate equal to the
prime rate minus 1.25%.  The note is secured by 100% of the
outstanding capital stock of the Company’s banking subsidiary, First Reliance
Bank.  The note is subject to certain financial covenants relating to
performance ratios the Company must meet and restriction on indebtedness of the
banking subsidiary.  At December 31, 2008 and 2007, $6,950,000 and
$3,000,000 had been drawn on this line, respectively.  See Note 22 for
additional information regarding this line of credit.





NOTE 11 - RESTRICTIONS ON
SHAREHOLDERS’ EQUITY





South
Carolina banking regulations restrict the amount of dividends that can be paid
to shareholders.  All of the Bank’s dividends to First Reliance
Bancshares, Inc. are payable only from the undivided profits of the
Bank.  At December 31, 2008, the Bank had undivided profits of
$12,522,545. The Bank is authorized to upstream 100% of net income in any
calendar year without obtaining the prior approval of the Commissioner of
Banking provided that the Bank received a composite rating of one or two at the
last Federal or State regulatory examination.  Under Federal Reserve
Board regulations, the amounts of loans or advances from the Bank to the parent
company are also restricted.





NOTE 12- OTHER OPERATING
EXPENSE





Other
operating expenses are summarized below:


For
      the years endedDecember 31,2008
                  
                  
                  2007Advertising
                  
                  $
                  345,389
                  
                  
                  $
                  525,787Office
      supplies and printing
                  
                  
                  236,940
                  
                  
                  
                  327,537Computer
      supplies and software amortization
                  
                  
                  482,577
                  
                  
                  
                  266,634Telephone
                  
                  
                  261,604
                  
                  
                  
                  315,201Professional
      fees and services
                  
                  
                  819,835
                  
                  
                  
                  634,214Meetings
      and travel expenses
                  
                  
                  372,418
                  
                  
                  
                  503,792Supervisory
      fees and assessments
                  
                  
                  378,904
                  
                  
                  
                  263,219Debit
      and credit card expenses
                  
                  
                  352,731
                  
                  
                  
                  290,845Other
                  
                  
                  2,341,221
                  
                  
                  
                  2,750,679Total
                  
                  $
                  5,591,619
                  
                  
                  $
                  5,877,908





-43-




FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY
 Notes
to Consolidated Financial Statements


NOTE 13 - INCOME
TAXES





Income
tax expense is summarized as follows:


For
      the years endedDecember 31,2008
                
                
                2007Currently
      payableFederal
                
                $
                1,018,874
                
                
                $
                1,534,994State
                
                
                32,823
                
                
                
                117,553Total
      current
                
                
                1,051,697
                
                
                
                1,652,547Deferred
      income taxes
                
                
                (1,613,849
                )
                
                
                (413,004
                )Total
      income tax expense (benefit)
                
                $
                (562,152
                )
                
                $
                1,239,543Income
      tax expense (benefit) is allocated as follows:To
      continuing operations
                
                $
                (459,040
                )
                
                $
                1,245,182To
      shareholders' equity
                
                
                (103,112
                )
                
                
                (5,639
                )$
                (562,152
                )
                
                $
                1,239,543





The
components of deferred tax assets and deferred tax liabilities are as
follows:


December 31,2008
                                    
                                    
                                    2007Deferred
      tax assets:Allowance
      for loan losses
                                    
                                    $
                                    2,594,609
                                    
                                    
                                    $
                                    1,532,913Net
      operating losses
                                    
                                    
                                    93,771
                                    
                                    
                                    
                                    66,384Non-accrual
      interest
                                    
                                    
                                    483,766
                                    
                                    
                                    
                                    44,936Unrealized
      loss on securities available for sale
                                    
                                    
                                    103,817
                                    
                                    
                                    
                                    705Deferred
      compensation
                                    
                                    
                                    313,588
                                    
                                    
                                    
                                    122,868Other
                                    
                                    
                                    71,210
                                    
                                    
                                    
                                    42,913Gross
      deferred tax assets
                                    
                                    
                                    3,660,761
                                    
                                    
                                    
                                    1,810,719Less,
      valuation allowance
                                    
                                    
                                    (93,771
                                    )
                                    
                                    
                                    (66,384
                                    )Net
      deferred tax assets
                                    
                                    
                                    3,566,990
                                    
                                    
                                    
                                    1,744,335Deferred
      tax liabilities:Accumulated
      depreciation
                                    
                                    
                                    361,336
                                    
                                    
                                    
                                    159,140Prepaid
      expenses
                                    
                                    
                                    93,002
                                    
                                    
                                    
                                    88,657Other
                                    
                                    
                                    62,363
                                    
                                    
                                    
                                    60,098Total
      gross deferred tax liabilities
                                    
                                    
                                    516,701
                                    
                                    
                                    
                                    307,895Net
      deferred tax asset recognized
                                    
                                    $
                                    3,050,289
                                    
                                    
                                    $
                                    1,436,440





Deferred
tax assets represent the future tax benefit of deductible differences and, if it
is more likely than not that a tax asset will not be realized, a valuation
allowance is required to reduce the recorded deferred tax assets to net
realizable value.  As of December 31, 2008, management has determined
that it is more likely than not that the total deferred tax asset will be
realized except for the deferred tax asset associated with State net operating
loss carryforwards, and, accordingly, has established a valuation allowance only
for this item.  Net deferred tax assets are included in other assets
at December 31, 2008 and 2007.





The
Company has state net operating losses of $2,841,542 and $2,011,636 for the
years ended December 31, 2008 and 2007, respectively.





-44-




FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY
 Notes
to Consolidated Financial Statements


NOTE 13 -
INCOME TAXES - continued





A
reconciliation between the income tax expense and the amount computed by
applying the federal statutory rate of 34% to income before income taxes
follows:


For
      the years endedDecember 31,2008
                
                
                2007Tax
      expense at statutory rate
                
                $
                56,641
                
                
                $
                1,293,599State
      income tax, net of federal income tax benefit
                
                
                21,663
                
                
                
                77,585Tax-exempt
      interest income
                
                
                (441,528
                )
                
                
                (265,265
                )Disallowed
      interest expense
                
                
                57,486
                
                
                
                43,884Life
      insurance surrender value
                
                
                (151,712
                )
                
                
                (138,121
                )Other,
      net
                
                
                (1,590
                )
                
                
                233,500$
                (459,040
                )
                
                $
                1,245,182





The
Company had analyzed the tax positions taken or expected to be taken in an its
tax returns and concluded it has no liability related to uncertain tax positions
in accordance with FIN 48.





NOTE 14 - RELATED PARTY
TRANSACTIONS





Certain
parties (principally certain directors and executive officers of the Company,
their immediate families and business interests) were loan customers of and had
other transactions in the normal course of business with the
Company.  Related party loans are made on substantially the same
terms, including interest rates and collateral, as those prevailing at the time
for comparable transactions with unrelated persons and do not involve more than
the normal risk of collectibility.  As of December 31, 2008 and 2007,
the Company had related party loans totaling $3,159,586 and $3,433,523,
respectively. During 2008, $654,657 of advances were made to related parties and
repayments totaled $928,594.  As of December 31, 2008, all related
party loans were current.





Deposits
from directors and executive officers and their related interests totaled
$2,262,296 and $4,591,514 at December 31, 2008 and 2007,
respectively.





In 2008,
real estate commissions of $175,393, relating to the purchase of properties by
the Company, were paid to a director of the Company.  There were no
real estate commissions paid to a related party during 2007.





During
2005, the Company entered into a lease agreement with SP Financial LLC (the
LLC), a limited liability company owned by two of the Bank's executive
officers.  The LLC obtained third party financing to purchase the
property, which was leased, to the Bank until December 1, 2008, at which time
the Company acquired the property from the LLC for
$3,959,268.   The LLC was not considered a Variable Interest
Entity under FIN 46(R), and accordingly its financial statements have not been
previously consolidated with the Company’s.  Total lease and property
tax payments to the LLC during 2008 and 2007 were $281,004 and $288,000,
respectively.





NOTE 15 -
COMMITMENTS AND CONTINGENCIES





In the
ordinary course of business, the Company may, from time to time, become a party
to legal claims and disputes.  At December 31, 2008, management and
legal counsel are not aware of any pending or threatened litigation or
unasserted claims or assessments that could result in losses, if any, that would
be material to the consolidated financial statements.





The
Company has entered into a number of operating leases for properties relating to
its branch banking and mortgage operations.  The leases have various
initial terms and expire on various dates. The lease agreements generally
provide that the Bank is responsible for ongoing repairs and maintenance,
insurance and real estate taxes.  The leases also provide for renewal
options and certain scheduled increases in monthly lease payments. Rental
expenses recorded under leases for the years ended December 31, 2008 and 2007
were $638,839 and $645,353, respectively.





-45-


FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY
 Notes
to Consolidated Financial Statements


NOTE 15 -
COMMITMENTS AND CONTINGENCIES - continued





The
minimal future rental payments under non-cancelable operating leases having
remaining terms in excess of one year, for each of the next five years in the
aggregate are:





2009
                  
                  $
                  396,6032010
                  
                  
                  347,4652011
                  
                  
                  327,8042012
                  
                  
                  295,2662013
                  
                  
                  301,945Greater
      than five years
                  
                  
                  6,047,029$
                  7,716,112





NOTE 16 - EARNINGS PER
SHARE





Earnings
per share - basic is computed by dividing net income by the weighted average
number of common shares outstanding.  Earnings per share - diluted is
computed by dividing net income by the weighted average number of common shares
outstanding and dilutive common share equivalents using the treasury stock
method.  Dilutive common share equivalents include common shares
issuable upon exercise of outstanding stock options and similar share-based
compensation instruments.


For
      the years endedDecember 31,2008
                
                
                2007Basic
      earnings per share:Net
      income available to common shareholders
                
                $
                625,632
                
                
                $
                2,559,520Average
      common shares outstanding - basic
                
                
                3,513,201
                
                
                
                3,466,008Basic
      earnings per share
                
                $
                0.18
                
                
                $
                0.74Diluted
      earnings per share:Net
      income available to common shareholders
                
                $
                625,623
                
                
                $
                2,559,520Average
      common shares outstanding - basic
                
                
                3,513,201
                
                
                
                3,466,008Dilutive
      potential common shares
                
                
                2,482
                
                
                
                70,953Average
      common shares outstanding - diluted
                
                
                3,515,683
                
                
                
                3,536,961Diluted
      earnings per share
                
                $
                0.18
                
                
                $
                0.72





For 2008
and 2007, options to purchase 97,950 shares and 0 shares, respectively, were not
included in the computation of diluted earnings per share because the options
average exercise price was greater than the average market price.





NOTE 17 - EQUITY INCENTIVE
PLAN





On
January 19, 2006, the Company adopted the 2006 Equity Incentive Plan, which
provides for the granting of dividend equivalent rights options, performance
unit awards, phantom shares, stock appreciation rights and stock awards, each of
which shall be subject to such conditions based upon continued employment,
passage of time or satisfaction of performance criteria or other criteria as
permitted by the plan. The plan allows granting up to 350,000 shares of stock,
to officers, employees, and directors, consultants and service providers of the
Company or its affiliates.  Awards may be granted for a term of up to
ten years from the effective date of grant. Under this Plan, our Board of
Directors has sole discretion as to the exercise date of any awards
granted.  The per-share exercise price of incentive stock awards may
not be less than the market value of a share of common stock on the date the
award is granted.  Any awards that expire unexercised or are canceled
become available for re-issuance.





-46-




FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY
 Notes
to Consolidated Financial Statements


NOTE 17 -
EQUITY INCENTIVE PLAN - continued





The
Company can issue the restricted shares as of the grant date either by the
issuance of share certificate(s) evidencing restricted shares or by documenting
the issuance in uncertificated or book entry form on the Company's stock
records. Except as provided by the Plan, the employee does not have the right to
make or permit to exist any transfer or hypothecation of any restricted
shares.  When restricted shares vest the employee must either pay the
Company within two business days the amount of all tax withholding obligations
imposed on the Company or make an election pursuant to Section 83(b) of the
Internal Revenue Code to pay taxes at grant date.





Restricted
shares may be subject to one or more objective employment, performance or other
forfeiture conditions as established by the Plan Committee at the time of
grant.  Any shares of restricted stock that are forfeited will again
become available for issuance under the Plan.  An employee or director
has the right to vote the shares of restricted stock after grant until they are
forfeited or vested.  Compensation cost for restricted stock is equal
to the market value of the shares at the date of the award and is amortized to
compensation expense over the vesting period.  Dividends, if any, will
be paid on awarded but unvested stock.





During
2008 and 2007, the Company issued 22,275 and 12,987 shares, respectively, of
restricted stock pursuant to the 2006 Equity Incentive Plan.  The
shares cliff vest in three years and are fully vested in, 2011 and 2010,
respectively.  The weighted-average fair value of restricted stock
issued during 2008 and 2007 was $9.04 and $13.99,
respectively.  Compensation cost associated with the issuances was
$201,385 and $178,574 for the years ended December 31, 2008 and 2007,
respectively.  There were no restricted stock forfeitures during
2008.  During 2007 there were 1,306 shares forfeited with a weighted
average exercised price of $14.30.  The restricted stock compensation
expense for 2008 and 2007 was $146,495 and $76,379, respectively.





The 2006
Equity Incentive Plan allows for the issuance of Stock Appreciation Rights
("SARs").  The SARs entitle the participant to receive the excess of
(1) the market value of a specified or determinable number of shares of the
stock at the exercise date over the fair value at grant date or (2) a specified
or determinable price which may not in any event be less than the fair market
value of the stock at the time of the award.  Upon exercise, the
Company can elect to settle the awards using either Company stock or
cash.  The shares start vesting after five years and vest at 20% per
year until fully vested.  Compensation cost for SARs is amortized to
compensation expense over the vesting period.





The
Company measures compensation cost based on the fair value of SARs awards on the
date of grant using the Black-Scholes option pricing model using the following
assumptions:  the risk-free interest rate is based on the U.S.
Treasury yield curve in effect at the time of the grant; the dividend yield is
based on the Company's dividend yield at the time of the grant subject to
adjustment if the dividend yield on the grant date is not expected to
approximate the dividend yield over the expected life of the options; the
volatility factor is based on the historical volatility of the Company's stock
(subject to adjustment if historical volatility is reasonably expected to differ
from the past); the weighted-average expected life is based on the historical
behavior of employees related to exercises, forfeitures and
cancellations.





There
were no SARs awarded in 2008.  For 2007, the fair value of the SARs
granted is estimated as of the date granted using the Black-Scholes option
pricing model using the following weighted-average assumptions: Dividend yield
of 0.00%, expected volatility of 26.00%, risk-free interest rate of 4.78% and
expected life of 10 years.





The SARs
compensation expense for 2008 and 2007 was $74,649 and $74,487,
respectively.





As of
December 31, 2008, there was $566,850 of total unrecognized compensation cost
related to nonvested SARs.  The cost is expected to be recognized over
a weighted-average period of 7.64 years.





-47-


FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY
 Notes
to Consolidated Financial Statements


NOTE 17 -
EQUITY INCENTIVE PLAN – continued





A summary
of the status of the Company’s SARs as of December 31, 2008 and 2007 is
presented below.





2008
                      
                      
                      2007Weighted-
                      
                      
                      
                      
                      
                      Weighted-Average
                      
                      
                      
                      
                      
                      AverageExercise
                      
                      
                      
                      
                      
                      ExerciseShares
                      
                      
                      Price
                      
                      
                      Shares
                      
                      
                      PriceOutstanding
      at beginning of year
                      
                      
                      93,981
                      
                      
                      $
                      14.95
                      
                      
                      
                      45,501
                      
                      
                      $
                      14.87Granted
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      62,481
                      
                      
                      
                      15.00Exercised
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -Forfeited
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      (14,001
                      )
                      
                      
                      14.94Outstanding
      at end of year
                      
                      
                      93,981
                      
                      
                      $
                      14.95
                      
                      
                      
                      93,981
                      
                      
                      $
                      14.95





At
December 31, 2008, we had 305,586 stock awards available for grant under the
2006 Equity Incentive Plan.





NOTE 18 – STOCK-BASED
COMPENSATION





The
Company terminated its 2003 Employee Stock Option Plan and replaced it with the
2006 Equity Incentive Plan.  Outstanding options issued under any
former stock option plans will be honored in accordance with the terms and
conditions in effect at the time they were granted, except that they are not
subject to reissuance.  At December 31, 2008, 269,447 options were
outstanding, which had been previously issued.





A summary
of the status of the Company’s 2003 stock option plan as of December 31, 2008
and 2007, and changes during the period is presented below:


2008
                          
                          
                          2007Weighted-
                          
                          
                          
                          
                          
                          Weighted-Average
                          
                          
                          
                          
                          
                          AverageExercise
                          
                          
                          
                          
                          
                          ExerciseShares
                          
                          
                          Price
                          
                          
                          Shares
                          
                          
                          PriceOutstanding
      at beginning of year
                          
                          
                          278,847
                          
                          
                          $
                          8.32
                          
                          
                          
                          321,992
                          
                          
                          $
                          7.95Granted
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -Exercised
                          
                          
                          (6,900
                          )
                          
                          
                          5.46
                          
                          
                          
                          (43,145
                          )
                          
                          
                          5.56Forfeited
                          
                          
                          (2,500
                          )
                          
                          
                          11.00
                          
                          
                          
                          -
                          
                          
                          
                          -Expired
                          
                          
                          -
                          
                          
                          
                          -Outstanding
      at end of year
                          
                          
                          269,447
                          
                          
                          $
                          8.36
                          
                          
                          
                          278,847
                          
                          
                          $
                          8.32





No stock
options have been granted since June 2005.





The fair
value of each outstanding option was measured on the date of grant using the
Black-Scholes option pricing model.





The
Company received $37,670 and $239,746 from the stock options exercised during
the years ended December 31, 2008 and 2007, respectively.  The
intrinsic value of options exercised during 2008 and 2007 was $26,540 and
$375,627, respectively





At
December 31, 2008, all options outstanding were exercisable and had a weighted
average remaining life of 4.10 years. The exercise price for the outstanding
options range from $5.09 to $10.29.





The
aggregate intrinsic value of options outstanding at December 31, 2008 and 2007
was $27,389 and $731,057, respectively.  The aggregate intrinsic value
is the difference between the Company’s closing stock price on the last trading
day of the year and the exercise price, multiplied by the number of in-the-money
options) for options outstanding and exercisable at year-end.  This
amount changes based on changes in the fair market value of the Company’s
stock.





-48-


FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY
 Notes
to Consolidated Financial Statements


NOTE 19 - REGULATORY
MATTERS





The
Company and the Bank are subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory and possibly additional
discretionary actions by regulators that, if undertaken, could have a material
effect on the Company’s financial statements.  Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the
Company and the Bank must meet specific capital guidelines that involve
quantitative measures of the Company’s and the Bank’s assets, liabilities, and
certain off-balance-sheet items as calculated under regulatory accounting
practices.  The Company’s and 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
Company and the Bank to maintain minimum ratios (set forth in the table below)
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 Company and the Bank consists of common shareholders’ equity,
excluding the unrealized gain or loss on securities available-for-sale, minus
certain intangible assets.  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
Company and the Bank are also required to maintain capital at a minimum level
based on average assets (as defined), which is known as the leverage
ratio.  Only the strongest institutions are allowed to maintain
capital at the minimum requirement of 3%.  All others are subject to
maintaining ratios 1% to 2% above the minimum.





As of the
most recent regulatory examination, the Bank was deemed well-capitalized under
the regulatory framework for prompt corrective action.  To be
categorized well capitalized, the Bank must maintain total risk-based, Tier 1
risk-based, and Tier 1 leverage ratios as set forth in the table
below.  There are no conditions or events that management believes
have changed the Bank’s categories.





The
following table summarizes the capital amounts and ratios of the Company and the
Bank and the regulatory minimum requirements.


To Be Well-Minimum Requirement
                
                
                Capitalized UnderFor Capital
                
                
                Prompt Corrective(Dollars
      in thousands)
                
                Actual
                
                
                Adequacy Purposes
                
                
                Action ProvisionsAmount
                
                
                Ratio
                
                
                Amount
                
                
                Ratio
                
                
                Amount
                
                
                RatioDecember
      31, 2008The
      CompanyTotal
      capital (to risk-weighted assets)
                
                $
                61,247
                
                
                
                11.97
                %
                
                $
                40,933
                
                
                
                8.00
                %
                
                $
                N/A
                
                
                
                N/ATier
      1 capital (to risk-weighted assets)
                
                
                54,888
                
                
                
                10.73
                %
                
                
                20,466
                
                
                
                4.00
                %
                
                
                N/A
                
                
                
                N/ATier
      1 capital (to average assets)
                
                
                54,888
                
                
                
                9.28
                %
                
                
                23,650
                
                
                
                4.00
                %
                
                
                N/A
                
                
                
                N/AThe
      BankTotal
      capital (to risk-weighted assets)
                
                $
                55,037
                
                
                
                10.86
                %
                
                $
                40,546
                
                
                
                8.00
                %
                
                $
                50,683
                
                
                
                10.00
                %Tier
      1 capital (to risk-weighted assets)
                
                
                48,678
                
                
                
                9.60
                %
                
                
                20,273
                
                
                
                4.00
                %
                
                
                30,410
                
                
                
                6.00
                %Tier
      1 capital (to average assets)
                
                
                48,678
                
                
                
                8.18
                %
                
                
                23,802
                
                
                
                4.00
                %
                
                
                29,753
                
                
                
                5.00
                %December
      31, 2007The
      CompanyTotal
      capital (to risk-weighted assets)
                
                $
                52,586
                
                
                
                10.29
                %
                
                $
                40,883
                
                
                
                8.00
                %
                
                
                N/A
                
                
                
                N/ATier
      1 capital (to risk-weighted assets)
                
                
                47,315
                
                
                
                9.26
                %
                
                
                20,438
                
                
                
                4.00
                %
                
                
                N/A
                
                
                
                N/ATier
      1 capital (to average assets)
                
                
                47,315
                
                
                
                9.46
                %
                
                
                20,006
                
                
                
                4.00
                %
                
                
                N/A
                
                
                
                N/AThe
      BankTotal
      capital (to risk-weighted assets)
                
                $
                53,824
                
                
                
                10.53
                %
                
                $
                40,877
                
                
                
                8.00
                %
                
                $
                51,096
                
                
                
                10.00
                %Tier
      1 capital (to risk-weighted assets)
                
                
                48,554
                
                
                
                9.50
                %
                
                
                20,438
                
                
                
                4.00
                %
                
                
                30,658
                
                
                
                6.00
                %Tier
      1 capital (to average assets)
                
                
                48,554
                
                
                
                8.85
                %
                
                
                21,945
                
                
                
                4.00
                %
                
                
                27,445
                
                
                
                5.00
                %





-49-




FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY
 Notes
to Consolidated Financial Statements


NOTE 20 - UNUSED LINES OF
CREDIT





As of
December 31, 2008, the Bank had unused lines of credit to purchase federal funds
from unrelated companies totaling $44,500,000.  These lines of credit
are available on a one to fourteen day basis for general corporate purposes. The
Company also has a line of credit to borrow funds from the Federal Home Loan
Bank of up to $115,661,261.  As of December 31, 2008 and 2007, the
Bank had borrowed $78,000,000 and $69,000,000, respectively, on this
line.





NOTE 21 - FAIR VALUE OF
FINANCIAL INSTRUMENTS





The fair
value of a financial instrument is the amount for which the asset or obligation
could be exchanged in a current transaction between willing parties, other than
in a forced or liquidation sale.  Fair value estimates are made at a
specific point in time based on relevant market information and information
about the financial instruments.  Because no market value exists for a
significant portion of the financial instruments, fair value estimates are based
on judgments regarding future expected loss experience, current economic
conditions, risk characteristics of various financial instruments, and other
factors.





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


Cash and Due from
Banks- The
carrying amount is a reasonable estimate of fair value.


Federal Funds
Sold and Purchased- Federal funds sold and
purchased are for a term of one day and the carrying amount approximates the
fair value.





Securities
Available-for-Sale- Fair value equals the
carrying amount which is the quoted market price.  If quoted market
prices are not available, fair values are based on quoted market prices of
comparable securities.





Nonmarketable
Equity Securities - The carrying amount of nonmarketable equity
securities is a reasonable estimate of fair value since no ready market exists
for these securities.





Loans
Held-for-Sale - The carrying amount of loans held for sale is a
reasonable estimate of fair value.





Loans
Receivable-
For certain categories of loans, such as variable rate loans, which are repriced
frequently and have no significant change in credit risk and credit card
receivables, fair values are based on the carrying amounts.  The fair
value of other types of loans is estimated by discounting the future cash flows
using the current rates at which similar loans would be made to the borrowers
with similar credit ratings and for the same remaining maturities.





Deposits- The fair value of
demand deposits, savings, and money market accounts is the amount payable on
demand at the reporting date.  The fair values of certificates of
deposit are estimated using a discounted cash flow calculation that applies
current interest rates to a schedule of aggregated expected
maturities.





Securities Sold
Under Agreements to Repurchase- The carrying amount is
a reasonable estimate of fair value because these instruments typically have
terms of one day.





Advances From
Federal Home Loan Bank-The fair values of fixed
rate borrowings are estimated using a discounted cash flow calculation that
applies the Company’s current borrowing rate from the Federal Home Loan
Bank.  The carrying amounts of variable rate borrowings are reasonable
estimates of fair value because they can be repriced frequently.





Junior
Subordinated Debentures and Note
Payable - The carrying value of the junior subordinated debentures and
note payable approximates there fair value since they were issued at a floating
rate.





Accrued Interest
Receivable and Payable- The carrying value of
these instruments is a reasonable estimate of fair value.





Off-Balance-Sheet
Financial Instruments- Fair values of
off-balance sheet lending commitments are based on fees currently charged to
enter into similar agreements, taking into account the remaining terms of the
agreements and the counterparties' credit standing.





-50-




FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY
 Notes
to Consolidated Financial Statements


NOTE 21 -
FAIR VALUE OF FINANCIAL INSTRUMENTS - continued





The
carrying values and estimated fair values of the Company’s financial instruments
were as follows:





December 31,2008
                      
                      
                      2007Carrying
                      
                      
                      Estimated
      Fair
                      
                      
                      Carrying
                      
                      
                      Estimated
      FairAmount
                      
                      
                      Value
                      
                      
                      Amount
                      
                      
                      ValueFinancial
      Assets:Cash
      and due from banks
                      
                      $
                      5,451,607
                      
                      
                      $
                      5,451,607
                      
                      
                      $
                      7,164,650
                      
                      
                      $
                      7,164,650Federal
      funds sold
                      
                      
                      257,000
                      
                      
                      
                      257,000
                      
                      
                      
                      -
                      
                      
                      
                      -Securities
      available-for-sale
                      
                      
                      76,310,816
                      
                      
                      
                      76,310,816
                      
                      
                      
                      58,580,313
                      
                      
                      
                      58,580,313Nonmarketable
      equity securities
                      
                      
                      4,574,700
                      
                      
                      
                      4,574,700
                      
                      
                      
                      3,930,400
                      
                      
                      
                      3,930,400Loans,
      including loans held for sale
                      
                      
                      478,579,283
                      
                      
                      
                      480,311,000
                      
                      
                      
                      487,738,540
                      
                      
                      
                      481,470,000Accrued
      interest receivable
                      
                      
                      2,653,260
                      
                      
                      
                      2,653,260
                      
                      
                      
                      3,092,767
                      
                      
                      
                      3,092,767Financial
      Liabilities:Demand
      deposit, interest-bearingtransaction,
      and savings accounts
                      
                      $
                      184,805,565
                      
                      
                      $
                      184,805,565
                      
                      
                      $
                      168,812,402
                      
                      
                      $
                      168,812,402Certificates
      of deposit
                      
                      
                      276,329,819
                      
                      
                      
                      275,825,000
                      
                      
                      
                      280,685,313
                      
                      
                      
                      280,593,000Securities
      sold under agreements to repurchase
                      
                      
                      8,197,451
                      
                      
                      
                      8,197,451
                      
                      
                      
                      7,927,754
                      
                      
                      
                      7,927,754Advances
      from Federal Home Loan Bank
                      
                      
                      78,000,000
                      
                      
                      
                      77,908,015
                      
                      
                      
                      69,000,000
                      
                      
                      
                      69,000,000Federal
      Funds Purchased
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      13,359,000
                      
                      
                      
                      13,359,000Note
      payable
                      
                      
                      6,950,000
                      
                      
                      
                      6,950,000
                      
                      
                      
                      3,000,000
                      
                      
                      
                      3,000,000Junior
      subordinated debentures
                      
                      
                      10,310,000
                      
                      
                      
                      10,310,000
                      
                      
                      
                      10,310,000
                      
                      
                      
                      10,310,000Accrued
      interest payable
                      
                      
                      623,330
                      
                      
                      
                      623,330
                      
                      
                      
                      767,577
                      
                      
                      
                      767,577





Notional
                
                
                Estimated Fair
                
                
                Notional
                
                
                Estimated FairAmount
                
                
                Value
                
                
                Amount
                
                
                ValueOff-Balance-Sheet
      Financial Instruments:Commitments
      to extend credit
                
                $
                53,812,183
                
                
                $
                -
                
                
                $
                76,545,909
                
                
                $
                -Standby
      letters of credit
                
                
                3,006,214
                
                
                
                -
                
                
                
                2,721,249
                
                
                
                -





The
Company adopted Statement No. 157 effective January 1, 2008, which did not have
a material impact on the   financial
statements.  Statement No. 157 applies to all assets and liabilities
that are being measured and reported on a fair value basis.  Statement
No. 157 requires new disclosure that establishes a framework for measuring fair
value in GAAP, and expands disclosure about fair value
measurements.  This statement enables the reader of the financial
statements to assess the inputs used to develop those measurements by
establishing a hierarchy for ranking the quality and reliability of the
information used to determine fair values.  The statement requires
that assets and liabilities carried at fair value will be classified and
disclosed in one of the following three categories:





§
            Level
      1:  Quoted market prices in active markets for identical assets
      or liabilities.





§
            Level
      2:  Observable market based inputs or unobservable inputs that
      are corroborated by market data.





§
            Level
      3:  Unobservable inputs that are not corroborated by market
      data.





In
determining the appropriate levels, the Company performs a detailed analysis of
the assets and liabilities that are subject to Statement No. 157.  At
each reporting period, all assets and liabilities for which the fair value
measurement is based on significant unobservable inputs are classified as Level
3.





The table
below presents the balances of assets and liabilities measured at fair value on
a recurring basis by level within the hierarchy.





December 31, 2008(Dollars
      in thousands)
                                    
                                    Total
                                    
                                    
                                    Level 1
                                    
                                    
                                    Level 2
                                    
                                    
                                    Level 3Available
      for sale securities
                                    
                                    $
                                    76,310,816
                                    
                                    
                                    $
                                    -
                                    
                                    
                                    $
                                    76,310,816
                                    
                                    
                                    $
                                    -Mortgage
      loans held for sale
                                    
                                    
                                    9,589,081
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    9,589,081
                                    
                                    
                                    
                                    -





-51-




FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY
 Notes
to Consolidated Financial Statements


NOTE 21 -
FAIR VALUE OF FINANCIAL INSTRUMENTS – continued





The
Company has no liabilities carried at fair value or measured at fair value on a
nonrecurring basis.





The
Company is predominantly an asset based lender with real estate serving as
collateral on a substantial majority of loans. Loans that are deemed impaired
are primarily valued on a nonrecurring basis at the fair values of the
underlying real estate collateral. Such fair values are obtained using
independent appraisals, which the Company considers to be level 2 inputs. The
aggregate carrying amount of impaired loans at December 31, 2008 was
$26,183,601.





FASB
Staff Position No. FAS 157-2 delays the implementation of SFAS 157 until the
first quarter of 2009 with respect to goodwill, other intangible assets, real
estate and other assets acquired through foreclosure and other non-financial
assets measured at fair value on a nonrecurring basis.





NOTE 22 - SUBSEQUENT
EVENTS





Preferred
Stock - On March 6, 2009, as part of the capital purchase component of
the U.S. Department of the Treasury’s (the “Treasury”) Troubled Asset Relief
Program, the Company entered into a Letter Agreement and a Securities
Purchase Agreement – Standard Terms attached thereto with the Treasury, pursuant
to which the Company agreed to issue and sell, and the Treasury agreed to
purchase (i) 15,349 shares of the Company’s Fixed Rate Cumulative Perpetual
Preferred Stock, Series A, having a liquidation preference of $1,000 per share
(“Series A Preferred Shares”), and (ii) a warrant (the “Warrant”) to purchase up
to 767.00767 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred
Stock, Series B, having a liquidation preference of $1,000 per share (“Series B
Preferred Shares”), at an exercise price of $0.01 per share, for an aggregate
purchase price of $15,349,000 in cash.  The Warrant was exercised by
the Treasury on a net basis immediately following the closing of the
transaction, resulting in the issuance of 767 Series B Preferred
Shares.   The Series A Preferred Shares will qualify as Tier 1 capital
and pay cumulative dividends at a rate of 5% per annum for the first five
years and 9% per annum thereafter.  The Series B Preferred Shares
will pay cumulative dividends at a rate of 9% per annum.  Dividends
are payable on both the Series A Preferred Shares and the Series B Preferred
Shares (collectively, the “Preferred Shares”) quarterly and are payable on
February 15, May 15, August 15, and November 15 of each year.





Revolving
Line of Credit - The Company paid off the outstanding balance of the
revolving line of credit referred to in Note 10 on March 20, 2009, and
terminated the credit agreement.





NOTE 23 - FIRST RELIANCE
BANCSHARES, INC. (PARENT COMPANY ONLY)


Condensed
Balance Sheets





December 31,2008
                
                
                2007AssetsCash
                
                $
                895,976
                
                
                $
                665,117Investment
      in banking subsidiary
                
                
                48,539,657
                
                
                
                48,530,277Marketable
      Investments
                
                
                124,300
                
                
                
                251,650Land
                
                
                3,959,268
                
                
                
                -Investment
      in trust
                
                
                310,000
                
                
                
                310,000Other
      assets
                
                
                1,125,080
                
                
                
                773,761Total
      assets
                
                $
                54,954,281
                
                
                $
                50,530,805LiabilitiesNote
      payable
                
                
                6,950,000
                
                
                
                3,000,000Junior
      subordinated debentures
                
                
                10,310,000
                
                
                
                10,310,000Other
      liabilities
                
                
                268,523
                
                
                
                192,901Total
      liabilities
                
                
                17,528,523
                
                
                
                13,502,901Shareholders’
      equity
                
                
                37,425,758
                
                
                
                37,027,904Total
      liabilities and shareholders’ equity
                
                $
                54,954,281
                
                
                $
                50,530,805





-52-


FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY
 Notes
to Consolidated Financial Statements




NOTE 23 -
FIRST RELIANCE BANCSHARES, INC. (PARENT COMPANY ONLY) - continued





Condensed
Statements of Income


December 31,2008
                
                
                2007IncomeDividends
      from banking subsidiary
                
                $
                1,000,000
                
                
                $
                -Other
      Income
                
                
                20,957
                
                
                
                21,533Total
      Income
                
                
                1,020,957
                
                
                
                21,533Expenses
                
                
                1,065,758
                
                
                
                850,585Loss
      before income taxes and equity in undistributed earnings of banking
      subsidiary
                
                
                (44,801
                )
                
                
                (829,052
                )Equity
      in undistributed earnings of banking subsidiary
                
                
                329,390
                
                
                
                3,112,297Net
      income before income taxes
                
                
                284,589
                
                
                
                2,283,245Income
      tax expense (benefit)
                
                
                (341,043
                )
                
                
                (276,275
                )Net
      income
                
                $
                625,632
                
                
                $
                2,559,520





Condensed
Statements of Cash Flows





December 31,2008
                
                
                2007Cash
      flows from operating activitiesNet
      income
                
                $
                625,632
                
                
                $
                2,559,520Adjustments
      to reconcile net income to net cash provided (used) by operating
      activities:Amortization
      of deferred compensation on restricted stock
                
                
                146,495
                
                
                
                76,379Increase
      in other assets
                
                
                (351,319
                )
                
                
                (276,960
                )Increase
      in other liabilities
                
                
                118,922
                
                
                
                82,980Equity
      in undistributed earnings of banking subsidiary
                
                
                (329,390
                )
                
                
                (3,112,297
                )Net
      cash provided (used) by operating activities
                
                
                210,340
                
                
                
                (670,378
                )Cash
      flows from investing activitiesPurchase
      of land
                
                
                (3,959,268
                )
                
                
                -Investment
      in banking subsidiary
                
                
                -
                
                
                
                (3,000,000
                )Proceeds
      on sale of non marketable securities
                
                
                -
                
                
                
                102,500Net
      cash used by investing activities
                
                
                (3,959,268
                )
                
                
                (2,897,500
                )Cash
      flows from financing activitiesProceeds
      from exercise of stock options
                
                
                37,670
                
                
                
                239,746Issuance
      of shares to ESOP
                
                
                -
                
                
                
                198,380Purchase
      of treasury stock
                
                
                (14,579
                )
                
                
                (145,198
                )Issuance
      of shares to employees
                
                
                1,010
                
                
                
                -Issuance
      of shares to Advisory Board
                
                
                5,686
                
                
                
                16,759Proceeds
      from note payable
                
                
                3,950,000
                
                
                
                3,000,000Net
      cash provided by financing activities
                
                
                3,979,787
                
                
                
                3,309,687Increase
      (decrease) in cash
                
                
                230,859
                
                
                
                (258,191
                )Cash
      and cash equivalents, beginning of year
                
                
                665,117
                
                
                
                923,308Cash
      and cash equivalents, ending of year
                
                $
                895,976
                
                
                $
                665,117





-53-


FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY
 Notes
to Consolidated Financial Statements




NOTE 24 - QUARTERLY RESULTS
OF OPERATIONS (UNAUDITED)





The
tables below represent the quarterly results of operations for the years ended
December 31, 2008 and 2007, respectively:


December 31, 2008Fourth
                
                
                Third
                
                
                Second
                
                
                FirstTotal
      interest and fee income
                
                $
                8,073,635
                
                
                $
                9,051,507
                
                
                $
                9,290,924
                
                
                $
                9,826,652Total
      interest expense
                
                
                3,828,643
                
                
                
                4,147,387
                
                
                
                4,463,674
                
                
                
                4,858,668Net
      interest income
                
                
                4,244,992
                
                
                
                4,904,120
                
                
                
                4,827,250
                
                
                
                4,967,984Provision
      for loan losses
                
                
                3,177,548
                
                
                
                609,967
                
                
                
                645,794
                
                
                
                501,603Net
      interest income after provisions for loan losses
                
                
                1,067,444
                
                
                
                4,294,153
                
                
                
                4,181,456
                
                
                
                4,466,381Other
      income
                
                
                1,115,352
                
                
                
                1,162,158
                
                
                
                1,399,501
                
                
                
                1,331,793Other
      expense
                
                
                4,910,279
                
                
                
                4,479,294
                
                
                
                4,727,677
                
                
                
                4,734,396Income
      (loss) before income tax expense
                
                
                (2,727,483
                )
                
                
                977,017
                
                
                
                853,280
                
                
                
                1,063,778Income
      tax expense
                
                
                (1,078,393
                )
                
                
                211,839
                
                
                
                169,859
                
                
                
                237,655Net
      income (loss)
                
                $
                (1,649,090
                )
                
                $
                765,178
                
                
                $
                683,421
                
                
                $
                826,123Basic
      income (loss) per common share
                
                $
                (0.47
                )
                
                $
                0.22
                
                
                $
                0.20
                
                
                $
                0.23Diluted
      income (loss) per common share
                
                $
                (0.47
                )
                
                $
                0.22
                
                
                $
                0.20
                
                
                $
                0.23








December 31, 2007Fourth
                
                
                Third
                
                
                Second
                
                
                FirstTotal
      interest and fee income
                
                $
                10,097,678
                
                
                $
                9,708,595
                
                
                $
                9,318,103
                
                
                $
                8,416,112Total
      interest expense
                
                
                4,740,765
                
                
                
                5,011,381
                
                
                
                4,653,632
                
                
                
                4,027,431Net
      interest income
                
                
                5,356,913
                
                
                
                4,697,214
                
                
                
                4,664,471
                
                
                
                4,388,681Provision
      for loan losses
                
                
                773,702
                
                
                
                408,961
                
                
                
                325,202
                
                
                
                135,234Net
      interest income after provisions for loan losses
                
                
                4,583,211
                
                
                
                4,288,253
                
                
                
                4,339,269
                
                
                
                4,253,447Other
      income
                
                
                1,420,328
                
                
                
                1,264,560
                
                
                
                1,423,726
                
                
                
                1,193,185Other
      expense
                
                
                5,344,626
                
                
                
                4,624,605
                
                
                
                4,486,802
                
                
                
                4,505,242Income
      before income tax expense
                
                
                658,913
                
                
                
                928,208
                
                
                
                1,276,193
                
                
                
                941,390Income
      tax expense
                
                
                299,182
                
                
                
                343,331
                
                
                
                368,486
                
                
                
                234,183Net
      income
                
                $
                359,731
                
                
                $
                584,877
                
                
                $
                907,708
                
                
                $
                707,207Basic
      income per common share
                
                $
                .10
                
                
                $
                .17
                
                
                $
                .26
                
                
                $
                .21Diluted
      income per common share
                
                $
                .10
                
                
                $
                .17
                
                
                $
                .26
                
                
                $
                .20








-54-


FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY


Corporate
Data





ANNUAL
MEETING:





The
annual meeting of Shareholders of First Reliance Bancshares, Inc. and Subsidiary
will be held at First Reliance Bank on June 18, 2009 at 4:00 PM.




CORPORATE
      OFFICE:
              INDEPENDENT
      AUDITORS:2170
      West Palmetto Street
              Elliott
      Davis, LLCFlorence,
      South Carolina 29501
              1901
      Main Street, Suite 1650Phone
      (843) 662-8802
              P.O.
      Box 2227Fax
      (843) 662-8373
              Columbia,
      S.C. 29202





STOCK
TRANSFER DEPARTMENT:





Registrar
and Transfer Company


10
Commerce Drive


Cranford,
New Jersey 07016-3572





MARKET
FOR FIRST RELIANCE BANCSHARES, INC. AND SUBSIDIARY COMMON STOCK;


PAYMENT
OF DIVIDENDS





On March
30, 2004, the Company’s common stock became listed on the Over The Counter
Bulletin Board.  Arms-length transactions in the common stock are
anticipated to be infrequent and negotiated privately between the persons
involved in those transactions.





High and Low Stock Price
Information for First Reliance Bancshares, Inc. and
Subsidiary





2008
                
                
                2007Applicable Period
                
                High
                
                
                Low
                
                
                High
                
                
                LowFirst
      Quarter
                
                $
                12.15
                
                
                $
                9.80
                
                
                $
                15.60
                
                
                $
                14.75Second
      Quarter
                
                $
                11.10
                
                
                $
                8.05
                
                
                $
                15.00
                
                
                $
                14.00Third
      Quarter
                
                $
                10.00
                
                
                $
                6.10
                
                
                $
                13.75
                
                
                $
                12.00Fourth
      Quarter
                
                $
                7.80
                
                
                $
                5.05
                
                
                $
                12.85
                
                
                $
                9.85





-55-




FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY
  Corporate Data-
continued





As of
March 8, 2004, the Company's common stock began trading in the over-the-counter
market under the symbol FSRL. The development of an active secondary market
requires the existence of an adequate number of willing buyers and sellers. The
Company’s current reported average daily trading volume is approximately 716
shares.  This level of trading volume in the secondary market for the
Company's common stock may materially impact a shareholder's ability to promptly
sell a large block of the Company’s common stock at a price acceptable to the
selling shareholder.  According to the Company's transfer agent, there
are approximately 1,323 shareholders of record as of January 1,
2009.





The
Company is a legal entity separate and distinct from the Bank.  The
principal sources of the Company’s cash flow, including cash flow to pay
dividends to its shareholders, are dividends that the Bank pays to its sole
shareholder, the Company.  Statutory and regulatory limitations apply
to the Bank’s payment of dividends to the Company as well as to the Company’s
payment of dividends to its shareholders. Statutory and regulatory limitations
apply to the Bank’s payment of dividends to the Company as well as to the
Company’s payment of dividends to its shareholders.  For example, all
FDIC insured institutions, regardless of their level of capitalization, are
prohibited from paying any dividend or making any other kind of distribution if
following the payment or distribution the institution would be
undercapitalized.  Moreover, federal agencies having regulatory
authority over the Company or the Bank have issued policy statements that
provide that bank holding companies and insured banks should generally only pay
dividends out of current operating earnings.





Additionally,
under South Carolina law, the Bank is authorized to pay cash dividends up to
100% of net income in any calendar year without obtaining the prior approval of
the State Board, provided that the Bank received a composite rating of one or
two at the last examination conducted by a state or federal regulatory
authority.  All other cash dividends require prior approval by the
State Board.  South Carolina law requires each state nonmember bank to
maintain the same reserves against deposits as are required for a state member
bank under the Federal Reserve Act.  This requirement is not expected
to limit the ability of the Bank to pay dividends on its common
stock.





It is the
current policy of the Bank to retain earnings to permit possible future
expansion.  As a result, the Company has no current plans to initiate
the payment of cash dividends, and its future dividend policy will depend on the
Bank’s earnings, capital requirements, financial condition and other factors
considered relevant by the board of directors of the Company and the
Bank.





Shareholders
may obtain, without charge, a copy of the Company’s Annual Report filed with the
Securities and Exchange Commission on Form 10-K for the period ended December
31, 2008.  Written requests should be addressed to Jeffrey A.
Paolucci, 2170 W. Palmetto Street, Florence, South Carolina 29501.





-56-




FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY


Corporate Data-
continued





EXECUTIVE OFFICERS OF FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY





F.
R. Saunders, Jr.


President
and Chief Executive Officer




Jeffrey
A. Paolucci


Senior
Vice President, Chief Financial Officer and Secretary




Craig
S. Evans


Senior
Vice President and Chief Operating Officer




Thomas
C. Ewart


Senior
Vice President and Chief Banking Officer




Jess
Nance


Senior
Vice President and Chief Credit Officer




Kenneth
R. Cox, Jr.


Senior
Vice President, Mortgage Banking




Paul
C. Saunders


Senior
Vice President and Senior Retail Banking Officer





DIRECTORS OF FIRST RELIANCE
BANCSHARES, INC. AND SUBSIDIARY





F.
R. Saunders, Jr.


President
and Chief Executive Officer of First Reliance Bancshares, Inc. and First
Reliance Bank




Jeffrey
A. Paolucci


Senior
Vice President, Chief Financial Officer and Secretary of First Reliance
Bancshares, Inc. and First Reliance Bank




Paul
C. Saunders


Senior
Vice President of First Reliance Bancshares, Inc. and First Reliance
Bank




A.
Dale Porter


Credit
Portfolio Manger for First Reliance Bank




Leonard
A. Hoogenboom


Chairman
of the Board of Directors of First Reliance Bancshares, Inc.; Owner and Chief
Executive Officer of Hoogenboom, CPA




John
M. Jebaily


Owner and
President of Jebaily Properties, Inc, a real estate agency




Andrew
G. Kampiziones


Owner,
President and Treasurer of Fairfax Development Corporation, a real estate
development corporation; Professor, Florence-Darlington Technical College and
Francis Marion University




C.
Dale Lusk, MD


Physician
and Owner/Partner of Advanced Women’s Care




A.
Joe Willis, DC


Retired
and former President of Willis Chiromed, a chiropractic practice





J.
Munford Scott, Jr.


Attorney,
Turner Padget Graham & Laney Attorneys





-57-