UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C.  20549










FORM
10-K





ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d)


OF
THE SECURITIES EXCHANGE ACT OF 1934


(Mark
One)


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





For
      the fiscal year ended December 31,
2009


OR


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





For the transition period
from                        to





Commission
File Number 000-49757







FIRST
RELIANCE BANCSHARES, INC.


(Exact
Name of Registrant as Specified in its Charter)





South
      Carolina
              
              80-0030931(State
      of Incorporation)
              
              (I.R.S.
      Employer Identification No.)2170
      W. Palmetto Street, Florence, South Carolina
              
              29501(Address
      of Principal Executive Offices)
              
              (Zip
      Code)


(843)
656-5000


(Registrant’s
telephone number, including area code)





Securities
Registered Pursuant to Section 12(b) of the Act:


None





Securities
Registered Pursuant to Section 12(g) of the Act:


Common
Stock, $0.01 Par Value





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


Yes
 ̈   No
x





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


Yes  ̈   No
x





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





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





Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K (229.405 of this chapter) is not contained herein, and will not
be contained, to the best of registrant’s knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K.  ̈





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company.  See the definitions of “accelerated filer,” “large
accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange
Act.


Large
accelerated filer  ̈  Accelerated
filer  ̈   Non-accelerated
filer  ̈   Smaller
reporting company x





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





The
aggregate market value of the registrant’s outstanding common stock held by
nonaffiliates of the registrant as of June 30, 2009 was approximately $11.0
million, based on the registrant’s closing sales price of $3.50 as
reported on the Over-the Counter Bulletin Board on June 30,
2009.  There were 3,582,691 shares of the registrant’s common
stock outstanding as of March 24, 2010.





DOCUMENTS
INCORPORATED BY REFERENCE





Document
                  
                  Parts Into Which
    IncorporatedAnnual
      Report to Shareholders for the Year Ended December 31,
2009
                  
                  Part
      IIProxy
      Statement for the Annual Meeting of Shareholders to be held June 17,
      2010
                  
                  Part
      III















TABLE
OF CONTENTS





PART
      I
                                    
                                    PageItem
      1.
                                    Business
                                    
                                    1Item
      1A.
                                    Risk
      Factors
                                    
                                    17Item
      1B.
                                    Unresolved
      Staff Comments
                                    
                                    24Item
      2.
                                    Properties
                                    
                                    24Item
      3.
                                    Legal
      Proceedings
                                    
                                    25PART
      IIItem
      4.
                                    Market
      for the Registrant’s Common Equity, Related Stockholder Matters and Issuer
      Purchases of Equity Securities
                                    
                                    25Item
      5.
                                    Selected
      Financial Data
                                    
                                    26Item
      6.
                                    Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                                    
                                    27Item
      6A.
                                    Quantitative
      and Qualitative Disclosures About Market Risk
                                    
                                    48Item
      7.
                                    Financial
      Statements and Supplementary Data
                                    
                                    49Item
      8.
                                    Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosure
                                    
                                    84Item
      8A(T).
                                    Controls
      and Procedures
                                    
                                    84Item
      8B.
                                    Other
      Information
                                    
                                    85PART
      IIIItem
      9.
                                    Directors,
      Executive Officers and Corporate Governance
                                    
                                    85Item
      10.
                                    Executive
      Compensation
                                    
                                    85Item
      11.
                                    Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters
                                    
                                    86Item
      12.
                                    Certain
      Relationships and Related Transactions, and Director
      Independence
                                    
                                    86Item
      13.
                                    Principal
      Accountant Fees and Services
                                    
                                    87PART
      IVItem
      14.
                                    Exhibits
      and Financial Statement Schedules
                                    
                                    87







PART
I





ITEM
1.           BUSINESS





Special
Cautionary Notice Regarding Forward-Looking Statements





This
Report contains statements that constitute forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended (the
“Securities Act”), and the Securities Exchange Act of 1934, as amended (the
“Exchange Act”).  Various matters discussed in this document and in
documents incorporated by reference herein, including matters discussed under
the caption “Management’s Discussion and Analysis of Financial Condition and
Results of Operations,” may constitute forward-looking statements for purposes
of the Securities Act and the Exchange Act.  These forward-looking
statements are based on many assumptions and estimates and are not guarantees of
future performance, and may involve known and unknown risks, uncertainties and
other factors which may cause the actual results, performance or achievements of
First Reliance Bancshares, Inc. (the “Company”) or its wholly owned subsidiary,
First Reliance Bank (the “Bank”), to be materially different from future
results, performance or achievements expressed or implied by such
forward-looking statements. The words “expect,” “anticipate,” “intend,’ “plan,”
“believe,” “seek,’ “estimate,” and similar expressions are intended to identify
such forward-looking statements. The Company’s and the Bank’s actual results may
differ materially from the results anticipated in these forward-looking
statements due to a variety of factors, including, without
limitation:




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




·
            changes
      in the interest rate environment that could reduce anticipated or actual
      margins;




·
            changes
      in political conditions or the legislative or regulatory
      environment;




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




·
            changes
      occurring in business conditions and
inflation;




·
            changes
      in technology;




·
            changes
      in monetary and tax policies;




·
            the
      level of allowance for loan loss;




·
            the
      rate of delinquencies and amounts of
  charge-offs;




·
            the
      rates of loan growth;




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




·
            changes
      in the securities markets; and




·
            other
      risks and uncertainties detailed from time to time in our filings with the
      Securities and Exchange Commission (the
“SEC”).





All
written or oral forward-looking statements attributable to the Company are
expressly qualified in their entirety by these cautionary
statements.





General




The Company was incorporated under the
laws of the State of South Carolina on April 12, 2001 to be the holding company
for the Bank, and the Company acquired all of the shares of the Bank on April 1,
2002 in a statutory share exchange.  The Bank, a South Carolina
banking corporation, is the Company’s only subsidiary, and the Company conducts
no business other than through its ownership of the Bank.  The Company
has no indirect subsidiaries or special purpose entities.  The Bank
commenced operations in August 1999 and currently operates out of its main
office and five branch offices.  The Bank serves the Florence,
Lexington, Charleston, and West Columbia areas in South Carolina as an
independent, community-oriented commercial bank emphasizing high-quality,
responsive and personalized service.  The Bank provides a broad range
of consumer and business banking services, concentrating on individuals and
small and medium-sized businesses desiring a high level of personalized
services.


-1-




The Company’s stock is traded on the
OTC Bulletin Board under the symbol “FSRL.”  Information about the
Company is available on our website atwww.firstreliance.com.  Information on the Company’s website is
not incorporated by reference and is not a part of this Report.




Location
and Service Area




The executive or main office facilities
of the Company and the Bank are located at 2170 W. Palmetto Street, Florence,
South Carolina 29501.  The Bank also has branches located at 411
Second Loop Road, Florence, South Carolina; 801 North Lake Drive,
Lexington, South Carolina; 800 South Shelmore Boulevard, Mount Pleasant, South
Carolina; 25 Cumberland Street, Suite 101, Charleston, South Carolina; and 2805A
Sunset Boulevard, West Columbia, South Carolina.   The Bank’s primary
market areas are the cities of Florence, Lexington, West Columbia, and
Charleston, and the surrounding areas.




According to United States Census
Bureau estimates, in 2008, Florence County had an estimated population of
132,800.  Florence County, which covers approximately 805 square
miles, is located in the eastern portion of South Carolina and is bordered by
Darlington, Marlboro, Dillon, Williamsburg, Marion, Clarendon, Sumter, and Lee
Counties.  Florence County has a number of large employers, including,
Wellman, Inc., Honda, Nan Ya Plastics, ESAB, McLeod Regional Medical Center, and
Carolinas Medical Center.  The principal components of the economy of
Florence County are the wholesale and retail trade sector, the manufacturing
sector, the services sector and the financial, insurance and real estate
sector.




According
to the United States Census Bureau, Lexington County had an estimated population
in 2008 of 248,518.  The primary market area is the City of Lexington and
the surrounding areas of Lexington County, South Carolina.  Lexington
County is centrally located in the Midlands of South Carolina just outside the
capital city in Columbia and is bordered by Richland, Newberry, Saluda, Aiken,
Orangeburg, and Calhoun Counties.  Lexington County has a number of large
employers, including, Westinghouse Electric Corporation, Michelin North America,
Winnsboro Assembly Opera, Amick Farms, Inc., and Bose Corporation. 
Lexington County is a major transportation crossroads for the Midlands with
I-26, I-77, and I-20 bordering or running through the county.  The Columbia
Metropolitan Airport is located in Lexington County, just 10 miles from the town
of Lexington, and is the Southeastern hub for the United Parcel Service. 
The principal components of the economy of Lexington County are the wholesale
and retail trade sector, the manufacturing sector, the government sector, the
services sector and the financial, insurance and real estate
sector.




The
United States Census Bureau estimates that in 2008, Charleston County had a
population of 348,046 and the Metro Area had a population of
644,506.  Charleston is located on the central and southern east coast
surrounded by Berkley and Dorchester counties.  Major employers in the
area include the United States Navy, the Medical University of South Carolina,
and the Charleston Air Force Base.




Our
Business Strategy




The Bank’s goal is to be the largest,
most profitable bank in South Carolina. First Reliance is committed to earning
customer loyalty by providing customers with products and services that fit
their individual needs through differentiated banking services, convenience, and
programs in the market place. The customer experience in all these areas is
delivered through our marketing tag line “Easy to Do Business With.”
The Bank also focuses on three primary customers segments, Middle America, Gen
"Y," and small business.  As customer loyalty grows, customer actions
drive growth and profitability.  Customers who do more business with
the Bank provide a cost effective source of new business as customers refer
family and friends.




Our
business strategy also involves the following:




·
              Focus
      on our communities:




o
            Founded
      in 1999, First Reliance is one of the only locally owned and operated
      banks in Florence, South
Carolina;


-2-





o
            We
      are one of the fastest-growing banks in South Carolina, with assets of
      nearly $700 million, and over 145 highly talented
    employees;


o
            We
      are headquartered in Florence, and span the Columbia, Lexington and
      Charleston regions of South Carolina;
and


o
            Our
      hallmarks are exceptional customer service, convenience, and
      custom-designed programs that fit the needs of the communities we
      serve.





·
            Strong
      leadership:




o
            First
      Reliance has a well-seasoned, veteran leadership team, with an average of
      30 years of banking experience;


o
            Our
      board of directors is composed of successful professionals,
      businesspeople, and entrepreneurs – all of whom live in markets served and
      have a vital interest in the Bank’s long-term success;
  and


o
            The
      Bank has a board of advisors comprised of well-known professionals and
      community leaders who contribute to our growth through referrals and
      networking.





·
            A
      belief that “There’s More to Banking than Money,”TM
  meaning:




o
            Banking
      is not just about dollars and cents, it is about customer
      service;


o
            We
      serve hard-working Americans who prefer to bank with people who understand
      their needs, and who are committed to helping them achieve their financial
      goals; and


o
            We
      are deeply committed to this brand promise and, as a result, we have
      earned a consistent customer satisfaction rating of
  98%.





·
            An
      intent to capitalize on opportunities arising from
    adversity:




o
            We
      recognized the economic downturn early in 2008 and developed a strategic
      plan to ensure that First Reliance would remain a safe and sound
      institution;


o
            During
      six months of 2009, First Reliance had achieved a 17% growth in total
      customer households compared to 2.8% customer household growth for the
      overall banking industry; and


o
            Our
      growth has been the result of referrals from our customers to friends or
      family, our strong brand, and our unique
  programs.





·
            Building
      and maintaining a strong capital
base:




o
            First
      Reliance is capitalized above minimum regulatory
    requirements;


o
            During
      the later part of 2008 and early 2009, when the economy was in turmoil and
      there was limited access to the capital markets, we applied for and
      received $15.3 million in Troubled Assets Relief Program (“TARP”) funding;
      and


o
            Now,
      as capital markets have started to free up, we believe we have an
      opportunity to raise capital on terms attractive to us and to new
      investors.





·
            Increasing
      deposit market share through local core
funding:




o
            Strong
      levels of liquidity allow us to meet our customer loan
      demands;


o
            Keeping
      our deposit gathering local is important to reduce the risk exposure
      associated with wholesale funding sources;
and


o
              Our
      strategic initiatives to attract local deposits and decrease dependence on
      non-local funding sources have resulted in our attaining the No. 1 deposit
      market share in the City of Florence and increasing market share in our
      Lexington and Charleston markets.


-3-





·
            Consider
      opportunistic acquisition opportunities in markets with favorable growth
      characteristics where we have identified experienced bankers to help
      execute our growth strategy,
including:




o
            Healthy
      whole bank and branch acquisitions;
and


o
            Subject
      to regulatory approval, FDIC-assisted purchases of failed bank assets and
      liabilities.





·
            Focus
      on profitability:




o
            We
      implemented several process redesign initiatives in 2008 and 2009 to
      streamline work flow, ensure higher service quality and provide better
      risk controls, scale processes and lower operating
  costs;


o
            Our
      management team is focused on measuring the return on every dollar spent;
      and


o
            As
      we manage expenses, we expect our profitability to
  improve.




Lending
Activities




General.The
Bank offers a full range of commercial and consumer loans, as well as real
estate, construction, and acquisition loans.  Commercial loans are extended
primarily to small and middle market customers.  Such loans include both
secured and unsecured loans for working capital needs (including loans secured
by inventory and accounts receivable), business expansion (including acquisition
of real estate and improvements), asset acquisition and agricultural purposes.
 Commercial term loans generally will not exceed a five-year maturity and
may be based on a ten or fifteen-year amortization.  The extensions of term
loans are based upon (1) the ability and stability of current management; (2)
earnings and trends in cash flow; (3) earnings projections based on reasonable
assumptions; (4) the financial strength of the industry and the business itself;
and (5) the value and marketability of the collateral.  In considering
loans for accounts receivable and inventory, the Bank generally uses a declining
scale for advances based on an aging of the accounts receivable or the quality
and utility of the inventory.  With respect to loans for the acquisition of
equipment and other assets, the terms depend on the economic life of the
respective assets.




Loan Limits and
Approval. The Bank’s lending activities are subject to a variety of
lending limits imposed by federal law.  Under South Carolina law,
loans by the Bank to a single customer may not exceed 7.5% of the Bank’s
unimpaired capital, except that by two-thirds vote of the directors of the Bank
such limit may be increased to 15% of the Bank’s unimpaired
capital.  The Bank’s Board of Directors has approved that increase in
its lending limit.  Based on the Bank’s unimpaired capital as of
December 31, 2009, the Bank’s lending limit to a single customer is
approximately $8.7 million.  Even with the increase, the size of the
loans that the Bank is able to offer to potential customers is less than the
size of the loans that the Bank’s competitors with larger lending limits are
able to offer.  This limit affects the ability of the Bank to seek
relationships with the area’s larger businesses.  However, the Bank
may request other banks to participate in loans to customers when requested loan
amounts exceed the Bank’s legal lending limit.




Allowance for
Loan Losses.  We maintain an
allowance for loan losses, which has been established through a provision for
loan losses charged against income.  We charge loans against this
allowance when we believe that the collectibility of the loan is
unlikely.  The allowance is an estimated amount that we believe is
adequate to absorb losses inherent in the loan portfolio based on evaluations of
its collectibility.  As of  December 31, 2009, our allowance
for loan losses equaled approximately 2.38% of the average outstanding balance
of our loans.  Over time, we will base the loan loss reserves on our
evaluation of factors including: changes in the nature and volume of the loan
portfolio, overall portfolio quality, specific problem loans and commitments,
and current anticipated economic conditions that may affect the borrower’s
ability to pay.




-4-




Loan
Distribution.  As of December 31, 2009, the composition of our
loan portfolio by category was approximately as follows :




Industry
      Categories
                                
                                Percentage
      (%)Real
      estate secured
                                
                                
                                86.41
                                %Commercial
      and industrial
                                
                                
                                11.28
                                %Consumer
      loans
                                
                                
                                1.95
                                %Other
      loans
                                
                                
                                0.36
                                %Total
                                
                                
                                100
                                %




Real Estate
Secured.  The Bank has
established a mortgage loan division through which it has broadened the range of
services that it offers to its customers.  The mortgage loan division
originates secured real estate loans to purchase existing or to construct new
homes and to refinance existing mortgages.  The following are the
types of real estate loans originated by the Bank and the general loan-to-value
limits set by the Bank with respect to each type.




•
                                  Raw
      Land
                                  65%•
                                  Land
      Development
                                  75%•
                                  Commercial,
      multifamily and other nonresidential construction
                                  80%•
                                  One
      to four family residential construction
                                  85%•
                                  Improved
      property
                                  85%•
                                  Owner
      occupied, one to four family and home equity
                                  90%
      (or less)•
                                  Commercial
      property
                                  80%
      (or
less)




As of December 31, 2009, total loans
secured by first or second mortgages on real estate comprised approximately
86.4% of the Bank’s loan portfolio, and the classification of the mortgage loans
of the Bank and the respective percentage of the Bank’s total loan portfolio of
each are as follows (dollars in thousands):




Description
                                  
                                  Total
      Amount
                                    as of
                                    December
      31, 2009
                                  
                                  
                                  Percentage
      of
                                    Total Loan PortfolioResidential
      1-4 family
                                  
                                  $
                                  57,539
                                  
                                  
                                  
                                  14.15
                                  %Multifamily
                                  
                                  $
                                  9,963
                                  
                                  
                                  
                                  2.45
                                  %Commercial
                                  
                                  $
                                  169,993
                                  
                                  
                                  
                                  41.79
                                  %Construction
                                  
                                  $
                                  77,567
                                  
                                  
                                  
                                  19.08
                                  %Second
      mortgage
                                  
                                  $
                                  4,747
                                  
                                  
                                  
                                  1.16
                                  %Equity
      lines of credit
                                  
                                  $
                                  31,596
                                  
                                  
                                  
                                  7.77
                                  %




Of the loan types listed above,
commercial real estate loans are generally more risky because they are the most
difficult to liquidate.  Construction loans also involve risks due to
weather delays and cost overruns.




-5-


The Bank generates additional fee
income by selling most of its mortgage loans in the secondary market and
cross-selling other products and services to its mortgage
customers.  In 2009, the Bank sold mortgage loans in a total amount of
approximately $162.1 million, or 97.9% of the total number of mortgage loans
originated by the Bank.  The Bank does not originate or hold subprime
residential mortgage loans that were originally intended for sale on the
secondary mortgage market.




All Federal Housing Agency (“FHA”),
Veterans Administration (“VA”) and South Carolina State Housing Finance and
Development Authority (“State Housing”) loans sold by the Bank involve the right
to recourse. The FHA and VA loans are subject to recourse if the loan shows 60
days or more past due in the first four months or goes in to foreclosure within
the first 12 months.  The State Housing loans are subject to recourse
if the loan becomes delinquent prior to purchase by State Housing or if final
documentation is not delivered within 90 days of purchase.  All
investors have a right to require the Bank to repurchase a loan in the event the
loan involved fraud.  In 2009, of the 933 loans sold by the Bank, 277
were FHA or VA loans and 53 were State Housing Loans, compared to 2008 where, of
the 692 loans sold by the Bank, 53 were FHA or VA loans and 69 were State
Housing loans.  Such loans represented 29.7% of the dollar volume or
25.6% of the total number of loans sold by the Bank in 2009.




In addition, an increase in interest
rates may decrease the demand for consumer and commercial credit, including real
estate loans.  Gross fees from residential mortgage originations were
$2.0 million in 2009.




Commercial
andIndustrial.As of December
31, 2009, $45.9 million, or 11.28% of the Bank’s total loan portfolio, was
comprised of commercial and industrial loans.  Commercial loans involve
significant risk because there is generally a small market available for an
asset held as collateral that needs to be liquidated.  Commercial
loans for working capital needs are typically difficult to
monitor.  We focus our efforts on commercial loans of less than $3
million.  Working capital loans typically have terms not exceeding one
year and are usually secured by accounts receivable, inventory, or personal
guarantees of the principals of the business.  For loans secured by
accounts receivable or inventory, principal is typically repaid as the assets
securing the loan are converted into cash, and in other cases principal is
typically due at maturity.




Consumer.The Bank makes a
variety of loans to individuals for personal and household purposes, including
secured and unsecured installment loans and revolving lines of credit such as
credit cards.  Installment loans typically carry balances of less than
$50,000 and are amortized over periods up to 60 months.  Consumer
loans are offered on a single maturity basis where a specific source of
repayment is available.  Revolving loan products typically require
monthly payments of interest and a portion of the principal.




As of December 31, 2009, the
classification of the consumer loans of the Bank and the respective percentage
of the Bank’s total loan portfolio of each were as follows (dollars in
thousands):




Description
                              
                              Total Outstanding
                                as of
                                December
      31, 2009
                              
                              
                              Percentage of
                                Total Loan PortfolioIndividuals
      (household, personal, single pay, installment and other)
                              
                              $
                              7,295
                              
                              
                              
                              0.02
                              %Individuals
      (household, family, personal credit cards and overdraft
      protection)
                              
                              $
                              648
                              
                              
                              
                              0.001
                              %All
      other consumer loans
                              
                              $
                              —
                              
                              
                              
                              —
                              %




The risks associated with consumer
lending are largely related to economic conditions and increase during economic
downturns.  Other major risk factors relating to consumer loans
include high debt to income ratios and poor loan-to-value ratios.  All
of the consumer loans set forth above require a debt service income ratio of no
greater than 36% based on gross income.




Deposit
Services




The Bank offers a full range of deposit
services that are typically available in most banks and savings and loan
associations, including checking accounts, NOW accounts, savings accounts and
other time deposits of various types, ranging from money market accounts to
longer-term certificates of deposit.  The transaction accounts and
time certificates are tailored to the Bank’s principal market area at rates
competitive to those offered by other banks in the area.  In addition,
the Bank offers certain retirement account services, such as Individual
Retirement Accounts (“IRAs”).  The Bank also offers free courier
service for business accounts and offers remote deposit capture.   The
Bank solicits deposit  accounts from individuals, businesses, associations
and organizations and, governmental authorities.   All deposit
accounts are insured by the FDIC up to the maximum amount allowed by
law.  See “Supervision and Regulation.”


-6-


Other
Banking Services




The Bank focuses heavily on personal
customer service and offers a full range of financial
services.  Personal products include free checking, and savings
accounts, money market accounts, CDs and IRAs, and personal mortgage loans,
while business products include free checking and savings accounts, commercial
lending services, money market accounts,  cash management services
including remote deposit capture  and business deposit courier
service.  The Bank also offers wholesale mortgage, title insurance and
provides Internet banking and e-statements, electronic bill paying services,
free ATMs, free coin machines at all branches, and an overdraft privilege to its
customers.




Investments




In addition to its loan operations, the
Bank makes other investments primarily in obligations of the United States or
obligations guaranteed as to principal and interest by the United States and
other taxable and nontaxable securities.  The Bank also invests in
certificates of deposits in other financial institutions.  The amount
invested in such time deposits, as viewed on an institution by institution
basis, does not exceed $250,000.  Therefore, the amounts invested in
certificates of deposit are fully insured by the FDIC.  No investment
held by the Bank exceeds any applicable limitation imposed by law or
regulation.  The Bank’s finance committee reviews the investment
portfolio on an ongoing basis to ascertain investment profitability and to
verify compliance with investment policies.




Other
Services




In addition to its banking and
investment services, the Bank offers securities brokerage services and life
insurance products to its customers through a networking arrangement with an
independent registered broker-dealer firm.




Competition




The Bank faces strong competition for
deposits, loans, and other financial services from numerous other banks,
thrifts, credit unions, other financial institutions, and other entities that
provide financial services, some of which are not subject to the same degree of
regulation as the Bank.  Because South Carolina law permits statewide
branching by banks and savings and loan associations, many financial
institutions in the state have extensive branch networks.  In
addition, subject to certain conditions, South Carolina law permits interstate
banking.  Reflecting this opportunity provided by law plus the growth
prospects of the Charleston, Florence, and Lexington markets, all of the five
largest (in terms of local deposits) commercial banks in our market are branches
of or affiliated with regional or super-regional banks.




According to the FDIC, as of
June 30, 2009, 30 banks and 6 savings institutions operated 262
offices within Charleston, Florence, and Lexington Counties.  All of these
institutions aggressively compete for business in the Bank’s market area. 
Some of these competitors have been in business for many years have established
customer bases, are larger than the Bank, have substantially higher lending
limits than the Bank has and are able to offer certain services, including trust
and international banking services, that the Bank is able to offer only through
correspondents, if at all.




The Bank currently conducts business
principally through its six branches in Charleston, Florence, and Lexington
Counties, South Carolina.  Based upon data available on the FDIC’s
website as of June 30, 2009, the Bank’s total deposits ranked sixth among
financial institutions in our market area, representing approximately 4.51% of
the total deposits in our market area.  The table below shows our
deposit market share in the counties we serve according to data from the FDIC
website as of June 30, 2009.


-7-




Market
                    
                    Number of
                      Branches
                    
                    
                    Our Market
                      Deposits
                    
                    
                    Total
                      Market
                      Deposits
                    
                    
                    Ranking
                    
                    
                    Market
                      Share
                      Percentage(in
      millions)South
      Carolina (by county):Charleston
      County
                    
                    
                    2
                    
                    
                    $
                    72
                    
                    
                    $
                    7,693
                    
                    
                    
                    16
                    
                    
                    
                    0.94
                    %Florence
      County
                    
                    
                    2
                    
                    
                    
                    395
                    
                    
                    
                    2,126
                    
                    
                    
                    2
                    
                    
                    
                    18.57Lexington
      County
                    
                    
                    2
                    
                    
                    
                    110
                    
                    
                    
                    2,971
                    
                    
                    
                    8
                    
                    
                    
                    3.71First
      Reliance Bank (statewide)
                    
                    
                    6
                    
                    
                    $
                    580
                    
                    
                    $
                    69,795
                    
                    
                    
                    17
                    
                    
                    
                    0.83
                    %




The Bank competes based on providing
its customers with high-quality, prompt, and knowledgeable personalized service
at competitive rates, which is a combination that the Bank believes customers
generally find lacking at larger institutions.  The Bank offers a wide
variety of financial products and services at fees that it believes are
competitive with other financial institutions.




Employees




On December 31, 2009, the Bank had 118
full-time employees and 25 part-time employees.  The executive
officers of the Company also serve as executive officers of and are compensated
by the Bank.  The Company has no employees.




Legal
Proceedings





Neither the Company nor any of its
properties are subject to any material legal proceedings.


-8-


SUPERVISION
AND REGULATION




We are
subject to extensive state and federal banking regulations that impose
restrictions on and provide for general regulatory oversight of our
operations.  These laws generally are intended to protect depositors
and not shareholders.  Legislation and regulations authorized by
legislation influence, among other things:




·
            how,
      when and where we may expand
geographically;


·
            into
      what product or service market we may
enter;


·
            how
      we must manage our assets; and


·
            under
      what circumstances money may or must flow between the parent bank holding
      company and the subsidiary bank.




Set forth
below is an explanation of the major pieces of legislation affecting our
industry and how that legislation affects our actions.  The following
summary is qualified by reference to the statutory and regulatory provisions
discussed.  Changes in applicable laws or regulations may have a
material effect on our business and prospects, and legislative changes and the
policies of various regulatory authorities may significantly affect our
operations.  We cannot predict the effect that fiscal or monetary
policies, or new federal or state legislation may have on our business and
earnings in the future.




First
Reliance Bancshares, Inc.




Because
we own all of the capital stock of First Reliance Bank, we are a bank holding
company under the federal Bank Holding Company Act of 1956.  As a
result, we are primarily subject to the supervision, examination and reporting
requirements of the Bank Holding Company Act and the regulations of the Board of
Governors of the Federal Reserve System (the “Federal Reserve”).  As a
bank holding company located in South Carolina, the SC State Board of Financial
Institutions also regulates and monitors all significant aspects of our
operations.




Acquisitions of
Banks.  The Bank Holding Company Act requires every bank
holding company to obtain the prior approval of the Federal Reserve
before:




·
            acquiring
      direct or indirect ownership or control of any voting shares of any bank
      if, after the acquisition, the bank holding company will directly or
      indirectly own or control more than 5% of the bank’s voting
      shares;


·
            acquiring
      all or substantially all of the assets of any bank;
  or


·
            merging
      or consolidating with any other bank holding
  company.




Additionally, the Bank Holding Company
Act provides that the Federal Reserve may not approve any of these transactions
if it would result in or tend to create a monopoly or, substantially lessen
competition or otherwise function as a restraint of trade, unless the
anti-competitive effects of the proposed transaction are clearly outweighed by
the public interest in meeting the convenience and needs of the community to be
served.  The Federal Reserve is also required to consider the
financial and managerial resources and future prospects of the bank holding
companies and banks concerned and the convenience and needs of the community to
be served.  The Federal Reserve’s consideration of financial resources
generally focuses on capital adequacy, which is discussed below.




Under the Bank Holding Company Act, if
adequately capitalized and adequately managed, the Company or any other bank
holding company located in South Carolina may purchase a bank located outside of
South Carolina.  Conversely, an adequately capitalized and adequately
managed bank holding company located outside of South Carolina may purchase a
bank located inside South Carolina.  In each case, however,
restrictions may be placed on the acquisition of a bank that has only been in
existence for a limited amount of time or will result in specified
concentrations of deposits.  For example, South Carolina law prohibits
a bank holding company from acquiring control of a financial institution until
the target financial institution has been incorporated for five
years.




Additionally,
in July 1994, South Carolina enacted legislation which effectively provided
that, after June 30, 1996, out-of-state bank holding companies could acquire
other banks or bank holding companies in South Carolina, subject to certain
conditions.  Accordingly, effective July 1, 1996, South Carolina law
was amended to permit interstate branching but not de novo branching by an
out-of-state bank.  The Company believes that the foregoing
legislation has increased takeover activity of South Carolina financial
institutions by out-of-state financial institutions.


-9-




Change in Bank
Control. Subject to
various exceptions, the Bank Holding Company Act and the Change in Bank Control
Act, together with related regulations, require Federal Reserve approval prior
to any person or company acquiring “control” of a bank holding
company.  Control is conclusively presumed to exist if an individual
or company acquires 25% or more of any class of voting securities of the bank
holding company.  Control is rebuttably presumed to exist if a person
or company acquires 10% or more, but less than 25%, of any class of voting
securities and either:




·
            the
      bank holding company has registered securities under Section 12 of the
      Securities Act of 1934; or


·
            no
      other person owns a greater percentage of that class of voting securities
      immediately after the transaction.




Our
common stock is registered under Section 12 of the Securities Exchange Act
of 1934.  The regulations provide a procedure for challenging
rebuttable presumptions of control.




Permitted
Activities.  The Bank Holding Company Act has generally
prohibited a bank holding company from engaging in activities other than banking
or managing or controlling banks or other permissible subsidiaries and from
acquiring or retaining direct or indirect control of any company engaged in any
activities other than those determined by the Federal Reserve to be closely
related to banking or managing or controlling banks as to be a proper incident
thereto.  Provisions of the Gramm-Leach-Bliley Act have expanded the
permissible activities of a bank holding company that qualifies as a financial
holding company.  Under the regulations implementing the Gramm-Leach-Bliley
Act, a financial holding company may engage in additional activities that are
financial in nature or incidental or complementary to financial
activities.  Those activities include, among other activities, certain
insurance and securities activities.




To qualify to become a financial
holding company, the Bank and any other depository institution subsidiary of the
Company must be well capitalized and well managed and must have a Community
Reinvestment Act rating of at least “satisfactory.”  Additionally, the
Company must file an election with the Federal Reserve to become a financial
holding company and must provide the Federal Reserve with 30 days’ written
notice prior to engaging in a permitted financial activity. While the Company
meets the qualification standards applicable to financial holding companies, the
Company has not elected to become a financial holding company at this
time.




Support of
Subsidiary Institutions.   Under Federal Reserve policy, the
Company is expected to act as a source of financial strength for the Bank and to
commit resources to support the Bank.  This support may be required at
times when, without this Federal Reserve policy, the Company might not be
inclined to provide it.  In addition, any capital loans made by the
Company to the Bank will be repaid only after its deposits and various other
obligations are repaid in full.  In the unlikely event of the
Company’s bankruptcy, any commitment by it to a federal bank regulatory agency
to maintain the capital of the Bank will be assumed by the bankruptcy trustee
and entitled to a priority of payment.




South Carolina
Law.
As a bank holding company with its principal offices in South Carolina, the
Company is subject to limitations on sale or merger and to regulation by the
South Carolina State Board of Financial Institutions (the “SC State
Board”).  The Company must receive the approval of the SC State Board
prior to acquiring control of a bank or bank holding company or all or
substantially all of the assets of a bank or a bank holding
company.  The Company also must file with the SC State Board periodic
reports with respect to its financial condition, operations and management, and
the intercompany relationships between the Company and its
subsidiaries.




TARP
Participation.On October 14, 2008, the U.S. Treasury
announced the capital purchase component of TARP.  This program was
instituted by the U.S. Treasury pursuant to the Emergency Economic Stabilization
Act of 2008, which provides up to $700 billion to the U.S. Treasury to, among
other things, take equity ownership positions in financial
institutions.  The TARP capital purchase program is intended to
encourage financial institutions to build capital and thereby increase the flow
of financing to businesses and consumers.  We participated in the
capital purchase component of TARP.




-10-


Use of TARP
Proceeds.On March 6, 2009, the Company received an investment
of $15.3 million  under the Troubled Asset Relief Program-Capital
Purchase Program (“CPP”).  The CPP funds were initially placed in the
Company’s demand deposit account with the Bank, providing liquidity to the Bank
while preserving the Company’s flexibility in how to best support the Bank,
including the Bank’s lending efforts.  On March 20, 2009, the Company
contributed $7.8 million to the Bank as capital, increasing the Bank’s capital
level from 10.75% of total risk weighted assets to 12.23% of total risk weighted
assets.  Due to the Bank’s capital policy, which requires the Bank to
maintain no less than 10% capital, the CPP proceeds enabled the Bank to increase
its lending capacity by approximately $78 million.  The Company is
ready to contribute additional funds as capital to the Bank to support further
increases in lending when and if loan demand increases.  We believe
the CPP funds have strengthened the Bank’s capacity to respond to the legitimate
credit needs of our customers and communities.  We have advised our
customers, employees and community of our commitment to support our communities’
growth and of our receipt of CPP funds, which strengthens our ability to make
loans.  By protecting our capital ratios with the CPP injection we
have not found it necessary to send good customers away.  We are in a
recession and loan demand is lower than in recent years, but we remain committed
to supporting the future growth of our markets.  The CPP proceeds give
us the flexibility and strength to pursue these and other legitimate credit
requests.  CPP funds have not only provided us with additional lending
capacity, but have also permitted us to strengthen our balance
sheet.  That strength allows us the flexibility to offer innovative
programs, such as Hometown
Heroes checking account with embedded loan program offers.  We
also received statewide recognition for lending performance in 2009, receiving
Lender of the Year honors from the South Carolina Finance and Housing
Authority.




First
Reliance Bank




Because
the Bank is a commercial bank chartered under the laws of the State of South
Carolina, it is primarily subject to the supervision, examination and reporting
requirements of the FDIC and the SC State Board.  The FDIC and the SC
State Board regularly examine the Bank’s operations and have the authority to
approve or disapprove mergers, the establishment of branches and similar
corporate actions.  Both regulatory agencies have the power to prevent
the continuance or development of unsafe or unsound banking practices or other
violations of law.  Additionally, the Bank’s deposits are insured by
the FDIC to the maximum extent provided by law.  The Bank is also
subject to numerous state and federal statutes and regulations that affect our
business, activities and operations.




South Carolina
Law.  Commercial banks chartered in South Carolina have only
those powers granted by law or the regulations of the SC State
Board.  State law sets specific requirements for bank capital and
regulates deposits in and loans and investments by banks, including the amounts,
types and, in some cases, rates.  In addition, the SC State Board
regulates, among other activities, the payment of dividends, the opening of
branches, loans to officers and directors, record keeping and the use of
automated teller machines.  The SC State Board periodically examines
state banks to determine their compliance with the law and regulations, and
state banks must make periodic reports of their condition to the SC State
Board.




Prompt Corrective
Action. The Federal
Deposit Insurance Corporation Improvement Act of 1991 establishes a system of
prompt corrective action to resolve the problems of undercapitalized financial
institutions.  Under this system, the federal banking regulators have
established five capital categories (well capitalized, adequately capitalized,
undercapitalized, significantly undercapitalized and critically
undercapitalized) in which all institutions are placed.  Federal
banking regulators are required to take various mandatory supervisory actions
and are authorized to take other discretionary actions with respect to
institutions in the three undercapitalized categories.  The severity
of the action depends upon the capital category in which the institution is
placed.  Generally, subject to a narrow exception, the banking
regulator must appoint a receiver or conservator for an institution that is
critically undercapitalized.  The federal banking agencies have
specified by regulation the relevant capital level for each
category.  As of December 31, 2009, the Bank qualified for the
well-capitalized category.




A “well-capitalized” bank is one that
significantly exceeds all of its capital requirements, which include maintaining
a total risk-based capital ratio of at least 10%, a tier 1 risk-based capital
ratio of at least 6%, and a tier 1 leverage ratio of at least
5%.  Generally, a classification as well capitalized will place a bank
outside of the regulatory zone for purposes of prompt corrective
action.  However, a well-capitalized bank may be reclassified as
“adequately capitalized” based on criteria other than capital, if the federal
regulator determines that a bank is in an unsafe or unsound condition, or is
engaged in unsafe or unsound practices and has not corrected the
deficiency.




-11-




FDIC Insurance
Assessments.The FDIC is an independent agency of the United
States government that uses the Deposit Insurance Fund to protect against the
loss of insured deposits if an FDIC-insured bank or savings association fails.
The FDIC must maintain the Deposit Insurance Fund within a range between 1.15
percent and 1.50 percent of all insured deposits.  The FDIC has
adopted a risk-based assessment system for insured depository institutions that
accounts for the risks attributable to different categories and concentrations
of assets and liabilities.  The system is designed to assess higher
rates on those institutions that pose greater risks to the Deposit Insurance
Fund.  The FDIC places each institution in one of four risk categories
using a two-step process based first on capital ratios (the capital group
assignment) and then on other relevant information (the supervisory group
assignment).  Within the lowest risk category, Risk Category I, rates
vary based on each institution’s CAMELS component ratings, certain financial
ratios, and long-term debt issuer ratings, if any.




Capital
group assignments are made quarterly and an institution is assigned to one of
three capital categories: (1) well capitalized, (2) adequately capitalized,
or (3) undercapitalized.  These three categories are substantially
similar to the prompt corrective action categories described above, with the
“undercapitalized” category including institutions that are undercapitalized,
significantly undercapitalized, and critically undercapitalized for prompt
corrective action purposes.  The FDIC also assigns an institution to
one of three supervisory subgroups based on a supervisory evaluation that the
institution’s primary federal banking regulator provides to the FDIC and
information that the FDIC determines to be relevant to the institution’s
financial condition and the risk posed to the deposit insurance
funds.




For 2008,
assessments ranged from 5 to 43 cents per $100 of deposits, depending on the
institution’s risk category.  Institutions in the lowest risk
category, Risk Category I, were charged a rate between 5 and 7 cents per $100 of
deposits.  Risk Categories II, III, and IV were charged 10 basis
points, 28 basis points and 43 basis points, respectively.




Because
the Deposit Insurance Fund reserve fell below 1.15 percent as of June 30, 2008,
and was expected to remain below 1.15 percent, the Federal Deposit Insurance
Reform Act of 2005 required the FDIC to establish and implement a restoration
plan to restore the reserve ratio to no less than 1.15 percent within five
years, absent extraordinary circumstances.




On
December 16, 2008, the FDIC adopted, as part of its restoration plan, a uniform
increase to the assessment rates by 7 basis points (annualized) for the first
quarter 2009 assessments.  As a result, institutions in Risk Category
I will be charged a rate between 12 and 14 cents per $100 of
deposits.  Risk Categories II, III, and IV will be charged 17 basis
points, 35 basis points, and 50 basis points, respectively.




On
February 27, 2009, the FDIC amended its restoration plan to extend the period
for restoration to seven years and further revised the risk-based assessment
system.  Starting with the second quarter of 2009, institutions in
Risk Category I will have a base assessment rate between 12 and 16 cents per
$100 of deposits.  Risk Categories II, III, and IV will be have base
assessment rates of 22 basis points, 32 basis points, and 45 basis points,
respectively.  These base assessments will be subject to adjustments
based on each institution’s unsecured debt, secured liabilities, and use of
brokered deposits.  As a result of these adjustments, institutions in
Risk Category I will be charged rate between 7 and 24 cents per $100 of
deposits.  Risk Categories II, III, and IV will be charged between 17
and 43 basis points, 27 and 58 basis points, and 40 and 77.5 basis points,
respectively.




Under a
final rule adopted on May 22, 2009, the FDIC imposed an emergency special
assessment of 5 basis points of a bank’s assets, less tier 1 capital, as of
June 30, 2009, up to a maximum of 10 basis points times the bank’s
deposits.  The FDIC may impose additional emergency special
assessments of up to 5 basis points of a bank’s assets, less tier 1
capital, thereafter if the reserve ratio is estimated to fall to a level that
the FDIC believes would adequately affect public confidence or to a level that
is close to zero or negative at the end of a calendar quarter.




On
November 12, 2009, the FDIC announced that nearly all FDIC-insured
depositor-institutions would be required to prepay their DIF assessments for the
next three years on December 30, 2009.  This did not affect the Bank’s
reporting of net income, but did have a negative effect on the Bank’s cash
flow.  The FDIC has indicated that the prepayment of DIF assessments
would be in lieu of additional special assessments.




The FDIC
may, without further notice-and-comment, adopt rates that are higher or lower
than the stated base assessment rates, provided that the FDIC cannot (i)
increase or decrease the total rates from one quarter to the next by more than
three basis points, or (ii) deviate by more than three basis points from the
stated assessment rates. The FDIC has proposed maintaining current assessment
rates through December 31, 2010, followed by a uniform increase in risk-based
assessment rates of three basis points effective January 1,
2011.


-12-


The FDIC
may terminate its insurance of deposits if it finds that the institution has
engaged in unsafe and unsound practices, is in an unsafe or unsound condition to
continue operations, or has violated any applicable law, regulation, rule,
order, or condition imposed by the FDIC.




FDIC Temporary
Liquidity Guarantee Program.On October 14, 2008, the FDIC
announced that its Board of Directors, under the authority to prevent “systemic
risk” in the banking system of the United States, approved the Temporary
Liquidity Guarantee Program (“TLGP”). The purpose of the TLGP is to strengthen
confidence and encourage liquidity in the banking system.  The TLGP is
composed of two components, the Debt Guarantee Program and the Transaction
Account Guarantee Program, and institutions had the opportunity, prior to
December 5, 2008, to opt-out of either or both components of the
TLGP.




The Debt Guarantee
Program:Under the TLGP, the FDIC is permitted to guarantee
certain newly issued senior unsecured debt issued through October 31, 2009 by
participating financial institutions.  The annualized fee that the
FDIC will assess to guarantee the senior unsecured debt varies by the length of
maturity of the debt.  For debt with a maturity of 180 days or less
(excluding overnight debt), the fee is 50 basis points; for debt with a maturity
between 181 days and 364 days, the fee is 75 basis points, and for debt with a
maturity of 365 days or longer, the fee is 100 basis points.  The Bank
did not opt-out of the Debt Guarantee component of the TLGP.




The Transaction Account Guarantee
Program:Under the TLGP, the FDIC is permitted to fully insure
non-interest bearing deposit accounts held at participating FDIC-insured
institutions, regardless of dollar amount. The temporary guarantee was initially
set to expire on December 31, 2009, but on August 26, 2009, the FDIC announced
that the program would be extended through June 30, 2010.  For the
eligible noninterest-bearing transaction deposit accounts (including accounts
swept from a noninterest bearing transaction account into an noninterest bearing
savings deposit account), through December 31, 2009, a 10 basis point annual
rate surcharge was applied to noninterest-bearing transaction deposit amounts
over $250,000.  Starting on January 1, 2010, the assessment will range
from 15 to 25 basis points depending on an institution’s Risk Category
rating.  Institutions will not be assessed on amounts that are
otherwise insured.  The Bank did not opt-out of the Transaction
Account Guarantee component of the TLGP for the initial or extension
periods.




Community
Reinvestment Act.  The Community Reinvestment Act requires
that, in connection with examinations of financial institutions within their
respective jurisdictions, the federal banking regulators shall evaluate the
record of each financial institution in meeting the credit needs of its local
community, including low and moderate-income neighborhoods.  These
facts are also considered in evaluating mergers, acquisitions and applications
to open a branch or facility.  Failure to adequately meet these
criteria could impose additional requirements and limitations on the
Bank.  Additionally, we must publicly disclose the terms of various
Community Reinvestment Act-related agreements.




Allowance for
Loan and Lease Losses.  The Allowance for Loan and Lease Losses
(the “ALLL”) represents one of the most significant estimates in
the  Bank’s financial statements and regulatory
reports.  Because of its significance, the Bank has developed a system
by which it develops, maintains and documents a comprehensive, systematic and
consistently applied process for determining the amounts of the ALLL and the
provision for loan and lease losses.  The Interagency Policy Statement
on the Allowance for Loan and Lease Losses, issued on December 13, 2006,
encourages all banks to ensure controls are in place to consistently determine
the ALLL in accordance with GAAP, the Bank’s stated policies and procedures,
management’s best judgment and relevant supervisory
guidance.  Consistent with supervisory guidance, the Bank maintains a
prudent and conservative, but not excessive, ALLL, that is at a level that is
appropriate to cover estimated credit losses on individually evaluated loans
determined to be impaired as well as estimated credit losses inherent in the
remainder of the loan and lease portfolio.  The Bank’s estimate of
credit losses reflects consideration of all significant factors that affect the
collectability of the portfolio as of the evaluation date.




Commercial Real
Estate Lending.  Our lending operations may be subject to
enhanced scrutiny by federal banking regulators based on its concentration of
commercial real estate loans.  On December 6, 2006, the federal
banking regulators issued final guidance to remind financial institutions of the
risk posed by commercial real estate (“CRE”) lending
concentrations.  CRE loans generally include land development,
construction loans and loans secured by multifamily property, and nonfarm,
nonresidential real property where the primary source of repayment is derived
from rental income associated with the property. The guidance prescribes the
following guidelines for its examiners to help identify institutions that are
potentially exposed to significant CRE risk and may warrant greater supervisory
scrutiny:


-13-





            total
      reported loans for construction, land development and other land represent
      100% or more of the institutions total capital, or
            total
      commercial real estate loans represent 300% or more of the institution’s
      total capital, and the outstanding balance of the institution’s commercial
      real estate loan portfolio has increased by 50% or
  more.




Other
Regulations.  Interest and other charges collected or
contracted for by the Bank are subject to state usury laws and federal laws
concerning interest rates.  Our loan operations will be subject to
federal laws applicable to credit transactions, such as the:




·
            Federal
      Truth-In-Lending Act, governing disclosures of credit terms to consumer
      borrowers;


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


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


·
            Fair
      Credit Reporting Act of 1978, as amended by the Fair and Accurate Credit
      Transactions Act, governing the use and provision of information to credit
      reporting agencies, certain identity theft protections, and certain credit
      and other disclosures;


·
            Fair
      Debt Collection Act, governing the manner in which consumer debts may be
      collected by collection agencies;


·
            Soldiers’
      and Sailors’ Civil Relief Act of 1940, as amended by the Servicemembers’
      Civil Relief Act, governing the repayment terms of, and property rights
      underlying, secured obligations of persons currently on active duty with
      the United States military;


·
            Talent
      Amendment in the 2007 Defense Authorization Act, establishing a 36% annual
      percentage rate ceiling, which includes a variety of charges including
      late fees, for consumer loans to military service members and their
      dependents; and


·
            rules
      and regulations of the various federal banking regulators charged with the
      responsibility of implementing these federal
  laws.




The
Bank’s deposit operations are subject to federal laws applicable to depository
accounts, such as:




·
            Truth-In-Savings
      Act, requiring certain disclosures of consumer deposit
      accounts:


·
            Right
      to Financial Privacy Act, which imposes a duty to maintain confidentiality
      of consumer financial records and prescribes procedures for complying with
      administrative subpoenas of financial
records;


·
            Electronic
      Funds Transfer Act and Regulation E issued by the Federal Reserve to
      implement that act, which govern automatic deposits to and withdrawals
      from deposit accounts and customers’ rights and liabilities arising from
      the use of automated teller machines and other electronic banking
      services; and


·
            rules
      and regulations of the various federal banking regulators charged with the
      responsibility of implementing these federal
  laws.




Capital
Adequacy




We are
required to comply with the capital adequacy standards established by the
Federal Reserve.  The Federal Reserve has established a risk-based and
a leverage measure of capital adequacy for member banks and bank holding
companies.




The
risk-based capital standards are designed to make regulatory capital
requirements more sensitive to differences in risk profiles among banks and bank
holding companies, to account for off-balance-sheet exposure, and to minimize
disincentives for holding liquid assets.  Assets and off-balance-sheet
items, such as letters of credit and unfunded loan commitments, are assigned to
broad risk categories, each with appropriate risk weights.  The
resulting capital ratios represent capital as a percentage of total
risk-weighted assets and off-balance-sheet items.


-14-




The
minimum guideline for the ratio of total capital to risk-weighted assets, and
classification as adequately capitalized, is 8%.  A bank that fails to
meet the required minimum guidelines is classified as undercapitalized and
subject to operating and managerial restrictions.  A bank, however,
that significantly exceeds its capital requirements and maintains a ratio of
total capital to risk-weighted assets of 10% is classified as well capitalized
unless it is subject to a regulatory order requiring it to maintain specified
capital levels, in which case it is considered adequately
capitalized.




Total
capital consists of two components:  Tier 1 Capital and Tier 2
Capital.  Tier 1 Capital generally consists of common stockholders’
equity, minority interests in the equity accounts of consolidated subsidiaries,
qualifying noncumulative perpetual preferred stock and a limited amount of
qualifying cumulative perpetual preferred stock, less goodwill and other
specified intangible assets.  Tier 1 Capital must equal at least
4% of risk-weighted assets.  Tier 2 Capital generally consists of
subordinated debt, other preferred stock and hybrid capital, and a limited
amount of loan loss reserves.  The total amount of Tier 2 Capital is
limited to 100% of Tier 1 Capital.  Our ratio of total capital to
risk-weighted assets and ratio of Tier 1 Capital to risk-weighted assets were
12.78% and 11.52% at December 31, 2009, respectively, compared 13.96% and
12.71%, as of December 31, 2008.




In
addition, the Federal Reserve has established minimum leverage ratio guidelines
for bank holding companies.  These guidelines provide for a minimum
ratio of Tier 1 Capital to average assets, less goodwill and other specified
intangible assets, of 3% for bank holding companies that meet specified
criteria, including having the highest regulatory rating and implementing the
Federal Reserve risk-based capital measure for market risk.  All other
bank holding companies generally are required to maintain a leverage ratio of at
least 4%.  At December 31, 2009, our leverage ratio was 8.25%, as
compared to 8.81% on December 31, 2008.  The guidelines also provide
that bank holding companies experiencing internal growth or making acquisitions
will be expected to maintain strong capital positions substantially above the
minimum supervisory levels without reliance on intangible assets.  The
Federal Reserve considers the leverage ratio and other indicators of capital
strength in evaluating proposals for expansion or new activities.




Failure
to meet capital guidelines could subject a bank and a bank holding company to a
variety of enforcement remedies, including issuance of a capital directive, the
termination of deposit insurance by the FDIC, a prohibition on accepting
brokered deposits and certain other restrictions on its business.  As
described above, significant additional restrictions can be imposed on
FDIC-insured depository institutions that fail to meet applicable capital
requirements.




Payment
of Dividends




The
Company is a legal entity separate and distinct from the Bank.  The
principal sources of our cash flow, including cash flow to pay dividends to
shareholders, are dividends that we receive from the Bank.  Statutory
and regulatory limitations apply to the payment of dividends by a subsidiary
bank to its bank holding company.




Under South Carolina law, the Bank is
authorized to upstream to the Company, by way of a cash dividend, up to 100% of
the Bank’s net income in any calendar year without obtaining the prior approval
of the SC 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 SC
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.




The payment of dividends by the Company
and the Bank may also be affected by other factors, such as the requirement to
maintain adequate capital above regulatory guidelines.  If, in the
opinion of the FDIC, the Bank were engaged in or about to engage in an unsafe or
unsound practice, the FDIC could require, after notice and a hearing, that the
Bank stop or refrain engaging in the practice.  The federal banking
agencies have indicated that paying dividends that deplete a depository
institution’s capital base to an inadequate level would be an unsafe and unsound
banking practice.  Under the Federal Deposit Insurance Corporation
Improvement Act of 1991, a depository institution may not pay any dividend if
payment would cause it to become undercapitalized or if it already is
undercapitalized.  Moreover, the federal agencies have issued policy
statements that provide that bank holding companies and insured banks should
generally only pay dividends out of current operating earnings.


-15-


The Company received a capital
investment from the U.S. Treasury under the capital purchase component of TARP
on March 6, 2009.  Concurrent with the closing of that transaction,
the Company became subject to additional limitations on the payment of
dividends.  These limitations require, among other things, that (i)
all dividends for the securities purchased under TARP be paid before other
dividends can be paid (including dividends on Shares of Series C preferred stock
sold in this offering) and (ii) the U.S. Treasury must approve any payment of
dividends on our common stock for three years following the U.S. Treasury’s
investment.




Any
future determination relating to dividend policy will be made at the discretion
of our Board of Directors and will depend on many of the statutory and
regulatory factors mentioned above.




Restrictions
on Transactions with Affiliates




The
Company and the Bank are subject to the provisions of Section 23A of the Federal
Reserve Act.  Section 23A places limits on the amount of:




·
            a
      bank’s loans or extensions of credit to
  affiliates;


·
            a
      bank’s investment in affiliates;


·
            assets
      a bank may purchase from affiliates, except for real and personal property
      exempted by the Federal Reserve;


·
            loans
      or extensions of credit to third parties collateralized by the securities
      or obligations of affiliates; and


·
            a
      bank’s guarantee, acceptance or letter of credit issued on behalf of an
      affiliate.




The total
amount of the above transactions is limited in amount, as to any one affiliate,
to 10% of a bank’s capital and surplus and, as to all affiliates combined, to
20% of a bank’s capital and surplus.  In addition to the limitation on
the amount of these transactions, each of the above transactions must also meet
specified collateral requirements.  We must also comply with other
provisions designed to avoid the taking of low-quality assets.




We are
subject to the provisions of Section 23B of the Federal Reserve Act which, among
other things, prohibit an institution from engaging in the above transactions
with affiliates unless the transactions are on terms substantially the same, or
at least as favorable to the institution or its subsidiaries, as those
prevailing at the time for comparable transactions with nonaffiliated
companies.




We are
subject to restrictions on extensions of credit to our executive officers,
directors, principal shareholders and their related interests.  These
extensions of credit (1) must be made on substantially the same terms, including
interest rates and collateral, as those prevailing at the time for comparable
transactions with third parties and (2) must not involve more than the normal
risk of repayment or present other unfavorable features.




Limitations
on Senior Executive Compensation




Because the Company received an
investment from the U.S. Treasury under the capital purchase component of TARP,
the Company and certain executive officers and employees agreed to certain
compensation limitations.  These limitations include:




·
            ensuring
      that executive incentive compensation packages do not encourage excessive
      risk;




·
            subjecting
      certain executive officers’ and employees’ bonus compensation to
      “clawback” if the compensation was based on inaccurate financial
      information or performance metrics;
and




·
            prohibiting
      any golden parachute payments to certain executive officers and
      employees




In addition, the Company agreed not to
deduct for tax purposes more than $500,000 for certain executive officers and
employees.  These limitations may have a material impact upon certain
compensation arrangements we have with our senior executive
officers.




Proposed
Legislation and Regulatory Action




New
regulations and statutes are regularly proposed that contain wide-ranging
proposals for altering the structures, regulations and competitive relationships
of financial institutions operating and doing business in the United
States.  We cannot predict whether or in what form any proposed
regulation or statute will be adopted or the extent to which our business may be
affected by any new regulation or statute.




-16-


Effect of Governmental Monetary
Policies




The
Bank’s earnings are affected by domestic economic conditions and the monetary
and fiscal policies of the United States government and its
agencies.  The Federal Reserve’s monetary policies have had, and are
likely to continue to have, an important impact on the operating results of
commercial banks through its power to implement national monetary policy in
order, among other things, to curb inflation or combat a
recession.  The monetary policies of the Federal Reserve affect the
levels of bank loans, investments and deposits through its control over the
issuance of United States government securities, its regulation of the discount
rate applicable to member banks, and its influence over reserve requirements to
which member banks are subject.  The Bank cannot predict the nature or
impact of future changes in monetary and fiscal policies.





Selected
Statistical Information





The
selected statistical information required by Item 1 is included in the Company’s
2008 Annual Report to Shareholders, which is Exhibit 13.1 to this Report, under
the heading “Management’s Discussion and Analysis of Financial Condition and
Results of Operations” and is incorporated herein by reference.





ITEM
1A.  RISK FACTORS





An investment in our common stock
involves risks.  If any of the following risks or other risks, which
have not been identified or which we may believe are immaterial or unlikely,
actually occur, our business, financial condition and results of operations
could be harmed.  In such a case, the trading price of our common
stock could decline, and you may lose all or part of your
investment.  The risks discussed below also include forward-looking
statements, and our actual results may differ substantially from those discussed
in these forward-looking statements.





We
may continue to suffer loan losses from a decline in credit
quality.




We have sustained and could continue to
sustain losses if borrowers, guarantors, and related parties fail to perform in
accordance with the terms of their loans.  We have adopted
underwriting and credit monitoring procedures and credit policies, including the
establishment and review of the allowance for credit losses, which we believe
are appropriate to minimize this risk by assessing the likelihood of
nonperformance, tracking loan performance, and diversifying our credit
portfolio.  These policies and procedures, however, may not prevent
unexpected losses that could materially adversely affect our results of
operations.




We
are subject to the local economies in Charleston, Florence, and Lexington
Counties, South Carolina.




Our success depends upon the growth in
population, income levels, deposits, and housing starts in our primary market
areas. If the communities in which the Bank operates do not grow, or if
prevailing economic conditions locally or nationally continue to be unfavorable,
our business may not succeed.  Unpredictable economic conditions may
have an adverse effect on the quality of our loan portfolio and our financial
performance.  Economic recession over a prolonged period or other
economic problems in our market areas could have a material adverse impact on
the quality of the loan portfolio and the demand for our products and
services.  Future adverse changes in the economies in our market areas
may have a material adverse effect on our financial condition, results of
operations or cash flows.  Further, the banking industry in South
Carolina is affected by general economic conditions such as inflation,
recession, unemployment and other factors beyond our control.  As a
community bank, we are less able to spread the risk of unfavorable local
economic conditions than larger or more regional banks.  Moreover, we
cannot give any assurance that we will benefit from any market growth or
favorable economic conditions in our primary market areas if market growth and
favorable economic conditions do occur.




In addition to considering the
financial strength and cash flow characteristics of borrowers, we often secure
loans with real estate collateral. The real estate collateral in each case
provides an alternate source of repayment in the event of default by the
borrower and may deteriorate in value during the time the credit is extended.
The market value of the real estate securing our loans as collateral has been
adversely affected by the slowing economy and unfavorable changes in economic
conditions in our market areas and could be further adversely affected in the
future.




As of December 31, 2009, approximately
89.8% of our loans receivable were secured by real estate. Any sustained period
of increased payment delinquencies, foreclosures, or losses caused by the
adverse market and economic conditions, including the downturn in the real
estate market, in our markets will adversely affect the value of our assets,
revenues, results of operations and financial condition. Currently, we are
experiencing such an economic downturn, and if it continues, our operations
could be further adversely affected.


-17-




We
are subject to increased FDIC deposit insurance assessments that could have an
adverse effect on our earnings.




As an insured depository institution,
we are required to pay quarterly deposit insurance premium assessments to the
FDIC.  These assessments are required to ensure that FDIC deposit
insurance reserve ratio is at least 1.15% of insured deposits.  Under
the Federal Deposit Insurance Act, the FDIC, absent extraordinary circumstances,
must establish and implement a plan to restore the deposit insurance reserve
ratio to 1.15% of insured deposits, over a five-year period, when the reserve
ratio falls below 1.15%.  The recent failures of numerous financial
institutions have significantly increased the Deposit Insurance Fund’s loss
provisions, resulting in a decline in the reserve ratio.  The FDIC
expects a higher rate of insured institution failures in the next few years,
which may result in a continued decline in the reserve ratio.




Market
developments have significantly depleted the insurance fund of the FDIC and
reduced the ratio of reserves to insured deposits. As a result, beginning on
January 1, 2009, there was a uniform seven basis points (annualized) increase to
the assessments that banks pay for deposit insurance.  The increased
assessment rates range from 12 to 50 basis points (annualized) for the first
quarter 2009 assessment, which was payable on June 30, 2009.  On April
1, 2009, the FDIC modified the risk-based assessments to account for each
institution’s unsecured debt, secured liabilities and use of brokered
deposits.  Assessment rates will range from 7 to 77.5 basis points
(annualized) starting with the second quarter 2009 assessments, which was
payable on November 15, 2009.  In addition, on May 22, 2009,
the FDIC adopted a final rule imposing an emergency special assessment of 5
basis points of a bank’s total assets less tier 1 capital as of June 30,
2009, up to a maximum of 10 basis points times the bank’s
deposits.  This special assessment was payable on November 15,
2009.


Further,
on November 12, 2009, the FDIC announced that it would require banks to prepay
their insurance premiums for 2010-2012 on December 30,
2009.  This did not affect the Bank’s reporting of net income, but has
a negative effect on the Bank’s cash flow.


It is
also possible that the FDIC may impose additional special assessments in the
future as part of its restoration plan.  If the FDIC does impose
additional special assessments, or otherwise further increases assessment rates,
our earnings could be further adversely impacted.
  Current
and anticipated deterioration in the housing market and the homebuilding
industry may lead to increased losses and further worsening of delinquencies and
non-performing assets in our loan portfolios. Consequently, our results of
operations may be adversely impacted.




There has been substantial industry
concern and publicity over decreasing asset quality among financial institutions
due in large part to issues related to subprime mortgage lending, declining real
estate values and general economic concerns. As of December 31, 2009, our
non-performing assets had increased significantly to $34.4 million, or 8.46%, of
our loan portfolio plus other real estate owned, compared to $22.1 million, or
4.70%, as of December 31, 2008.  Furthermore, the housing and the
residential mortgage markets recently have experienced a variety of difficulties
and changed economic conditions.  If market conditions continue to
deteriorate, they may lead to additional valuation adjustments on our loan
portfolios and real estate owned as we continue to reassess the market value of
our loan portfolio, the losses associated with the loans in default and the net
realizable value of real estate owned.





The homebuilding industry has
experienced a significant and sustained decline in demand for new homes and an
oversupply of new and existing homes available for sale in various markets,
including some of the markets in which we lend. Our customers who are builders
and developers face greater difficulty in selling their homes in markets where
these trends are more pronounced.  Consequently, we are facing
increased delinquencies and non-performing assets as these builders and
developers are forced to default on their loans with us.  We do not
know when the housing market will improve, and accordingly, additional
downgrades, provisions for loan losses and charge-offs related to our loan
portfolio may occur.


-18-


If
our allowance for loan losses is not sufficient to cover actual loan losses, our
earnings could decrease.





Our
success depends to a significant extent upon the quality of our assets,
particularly loans. In originating loans, there is a substantial likelihood that
we will experience credit losses.  The risk of loss will vary with,
among other things, general economic conditions, the type of loan, the
creditworthiness of the borrower over the term of the loan and, in the case of a
collateralized loan, the quality of the collateral for the loan.




Our loan customers may not repay their
loans according to the terms of these loans, and the collateral securing the
payment of these loans may be insufficient to assure repayment.  As a
result, we may experience significant loan losses, which could have a material
adverse effect on our operating results.  Management makes various
assumptions and judgments about the collectability of our loan portfolio,
including the creditworthiness of our borrowers and the value of the real estate
and other assets serving as collateral for the repayment of many of our
loans.  We maintain an allowance for loan losses in an attempt to
cover any loan losses that may occur. In determining the size of the allowance,
we rely on an analysis of our loan portfolio based on historical loss
experience, volume and types of loans, trends in classification, volume and
trends in delinquencies and non-accruals, national and local economic
conditions, and other pertinent information.




If our
assumptions are wrong, our current allowance may not be sufficient to cover
future loan losses, and we may need to make adjustments to allow for different
economic conditions or adverse developments in our loan
portfolio.  Material additions to our allowance would materially
decrease our net income.  As a result of a difficult real estate
market, we increased our allowance from $8.2 million as of December 31,
2008 to $9.8 million as of December 31, 2009.  We expect our allowance
to continue to fluctuate throughout 2010 and into 2011; however, given current
and future market conditions, we can make no assurance that our allowance will
be adequate to cover future loan losses.




In
addition, federal and state regulators periodically review our allowance for
loan losses and may require us to increase our provision for loan losses or
recognize further loan charge-offs, based on judgments different than those of
our management. Any increase in our allowance for loan losses or loan
charge-offs as required by these regulators could have a negative effect on our
operating results.




Our
business strategy includes the continuation of growth plans, and our financial
condition and results of operations could be negatively affected if we fail to
grow or fail to manage our growth effectively.




We intend
to continue pursuing a growth strategy for our business.  Our
prospects must be considered in light of the risks, expenses, and difficulties
frequently encountered by companies in significant growth stages of
development.  We cannot assure you we will be able to expand our
market presence in our existing markets or successfully enter new markets or
that any such expansion will not adversely affect our results of
operations.  Failure to manage our growth effectively could have a
material adverse effect on our business, future prospects, financial condition
or results of operations, and could adversely affect our ability to successfully
implement our business strategy.  Also, if our growth occurs more
slowly than anticipated or declines, our operating results could be materially
adversely affected.




Our
ability to successfully grow will depend on a variety of factors including the
continued availability of desirable business opportunities, the competitive
responses from other financial institutions in our market areas and our ability
to manage our growth.  While we believe we have the management
resources and internal systems in place to successfully manage our future
growth, there can be no assurance growth opportunities will be available or
growth will be successfully managed.




Our
pace of growth and results of operations may require us to raise additional
capital in the future, but that capital may not be available when it is
needed.




We are
required by federal and state regulatory authorities to maintain adequate levels
of capital to support our operations.  We anticipate our capital
resources following these offerings will satisfy our capital requirements for
the foreseeable future.  We may at some point need to raise additional
capital to support our operations and any future growth, as well as to protect
against any further deterioration in our loan portfolio.




Recently, the volatility and disruption
in the capital and credit markets have reached unprecedented
levels.  In some cases, the markets have produced downward pressure on
stock prices and credit availability for certain issuers without regard to those
issuers’ underlying financial strength.  If current levels of market
disruption and volatility continue or worsen, our ability to raise additional
capital may be disrupted.  If we cannot raise additional capital when
needed, our ability to further expand our operations through internal growth and
acquisitions could be materially impaired, and our results of operations and
financial condition may be adversely affected.




-19-


Changes
in the interest rate environment could reduce our profitability.




As a
financial institution, our earnings are significantly dependent upon our net
interest income, which is the difference between the interest income that we
earn on interest-earning assets, such as investment securities and loans, and
the interest expense that we pay on interest-bearing liabilities, such as
deposits and borrowings.  Therefore, any change in general market
interest rates, including changes resulting from changes in the Federal
Reserve’s fiscal and monetary policies, affects us more than nonfinancial
institutions and can have a significant effect on our net interest income and
total income. Our assets and liabilities may react differently to changes in
overall market rates or conditions because there may be mismatches between the
repricing or maturity characteristics of the assets and
liabilities.  As a result, an increase or decrease in market interest
rates could have material adverse effects on our net interest margin and results
of operations.




Since
January 2008, in response to the dramatic deterioration of the subprime,
mortgage, credit, and liquidity markets, the Federal Reserve has taken action on
seven occasions to reduce interest rates by a total of 400 to 425 basis points,
which has reduced our net interest income and will likely continue to reduce
this income for the foreseeable future.  Any reduction in our net
interest income will negatively affect our business, financial condition,
liquidity, operating results, cash flows and, potentially, the price of our
securities.  Additionally, throughout 2010, we expect to have
continued margin pressure given these historically low interest rates, along
with elevated levels of non-performing assets.




Recent
negative developments in the financial industry, and the domestic and
international credit markets may adversely affect our operations and
results.




Negative
developments during 2008 and 2009 in the global credit and derivative markets
have resulted in uncertainty in the financial markets in general with the
expectation of the general economic downturn continuing through
2010.  As a result of this “credit crunch,” commercial as well as
consumer loan portfolio performances have deteriorated at many institutions and
the competition for deposits and quality loans has increased
significantly.  In addition, the values of real estate collateral
supporting many commercial loans and home mortgages have declined and may
continue to decline. Global securities markets, and bank holding company stock
prices in particular, have been negatively affected, as has the ability of banks
and bank holding companies to raise capital or borrow in the debt
markets.  If these negative trends continue, our business operations
and financial results may be negatively affected.




We
face strong competition from larger, more established competitors.




The banking business is highly
competitive, and we experience strong competition from many other financial
institutions.  We compete with commercial banks, credit unions,
savings and loan associations, mortgage banking firms, consumer finance
companies, securities brokerage firms, insurance companies, money market funds
and other financial institutions that operate in our primary market areas and
elsewhere.




We compete with these institutions both
in attracting deposits and in making loans.  In addition, we have to
attract our customer base from other existing financial institutions and from
new residents.  Many of our competitors are well-established and much
larger financial institutions.  While we believe we can and do
successfully compete with these other financial institutions in our markets, we
may face a competitive disadvantage as a result of our smaller size and lack of
geographic diversification.




Although we compete by concentrating
our marketing efforts in our primary market area with local advertisements,
personal contacts and greater flexibility in working with local customers, we
can give no assurance that this strategy will be successful.




We
face risks with respect to future expansion and acquisitions or
mergers.




We
continually seek to acquire other financial institutions or parts of those
institutions and may continue to engage in de novo branch expansion in the
future.  Acquisitions and mergers involve a number of risks,
including:




•
                the
      time and costs associated with identifying and evaluating potential
      acquisitions and merger partners may negatively affect our
      business;•
                the
      estimates and judgments used to evaluate credit, operations, management,
      and market risks with respect to the target institution may not be
      accurate;•
                the
      time and costs of evaluating new markets, hiring experienced local
      management, and opening new offices and the time lags between these
      activities and the generation of sufficient assets and deposits to support
      the costs of the expansion may negatively affect our
    business;


-20-





•
                    we
      may not be able to finance an acquisition without diluting our existing
      shareholders;•
                    the
      diversion of our management’s attention to the negotiation of a
      transaction may detract from their business
  productivity;•
                    we
      may enter into new markets where we lack experience;•
                    we
      may introduce new products and services into our business with which we
      have no prior experience; and•
                    we
      may incur an impairment of goodwill associated with an acquisition and
      experience adverse short-term effects on our results of
      operations.




In
addition, no assurance can be given that we will be able to integrate our
operations after an acquisition without encountering difficulties including,
without limitation, the loss of key employees and customers, the disruption of
our respective ongoing businesses or possible inconsistencies in standards,
controls, procedures and policies.  Successful integration of our
operations with another entity’s will depend primarily on our ability to
consolidate operations, systems, and procedures and to eliminate redundancies
and costs.  If we have difficulties with the integration, we might not
achieve the economic benefits we expect to result from any particular
acquisition or merger.  In addition, we may experience greater than
expected costs or difficulties relating to such integration.




Hurricanes
or other adverse weather events could negatively affect our local economies or
disrupt our operations, which could have an adverse effect on our business or
results of operations.




The
economy of South Carolina’s coastal region is affected, from time to time, by
adverse weather events, particularly hurricanes.  Our Charleston
County market area consists primarily of coastal communities, and we cannot
predict whether, or to what extent, damage caused by future hurricanes will
affect our operations, our customers, or the economies in our banking
markets.  However, weather events could cause a decline in loan
originations, destruction or decline in the value of properties securing our
loans, or an increase in the risks of delinquencies, foreclosures, and loan
losses.  Even if a hurricane does not cause any physical damage in our
market area, a turbulent hurricane season could significantly affect the market
value of all coastal property.




Our
recent results may not be indicative of our future results.




We may
not be able to sustain our historical rate of growth or may not even be able to
grow our business at all.  In addition, our growth over the past few
years may distort some of our historical financial ratios and
statistics.  In the future, we may not have the benefit of several
recently favorable factors, such as a generally predictable interest rate
environment, a strong residential mortgage market or the ability to find
suitable expansion opportunities.  Various factors, such as economic
conditions, regulatory and legislative considerations and competition, may also
impede or prohibit our ability to expand our market presence.  If we
experience a significant decrease in our historical rate of growth, our results
of operations and financial condition may be adversely affected due to a high
percentage of our operating costs being fixed expenses.




Our
corporate culture has contributed to our success, and if we cannot maintain this
culture as we grow, we could lose the teamwork and increased productivity
fostered by our culture, which could harm our business.




We
believe that a critical contributor to our success has been our corporate
culture, which we believe fosters teamwork and increased
productivity.  As our organization grows and we are required to
implement more complex organization management structures, we may find it
increasingly difficult to maintain the beneficial aspects of our corporate
culture.  This could negatively impact our future
success.




As
a community bank, we have different lending risks than larger
banks.




We
provide services to our local communities.  Our ability to diversify
our economic risks is limited by our own local markets and
economies.  We lend primarily to individuals and to small to
medium-sized businesses, which may expose us to greater lending risks than those
of banks lending to larger, better-capitalized businesses with longer operating
histories.


-21-




We manage
our credit exposure through careful monitoring of loan applicants and loan
concentrations in particular industries, and through loan approval and review
procedures.  We have established an evaluation process designed to
determine the adequacy of our allowance for loan losses.  While this
evaluation process uses historical and other objective information, the
classification of loans and the establishment of loan losses is an estimate
based on experience, judgment and expectations regarding our borrowers, the
economies in which we and our borrowers operate, as well as the judgment of our
regulators.  We cannot assure you that our loan loss reserves will be
sufficient to absorb future loan losses or prevent a material adverse effect on
our business, profitability or financial condition.




We
are subject to extensive regulation that could limit or restrict our activities
and impose financial requirements or limitations on the conduct of our
business.




As a bank
holding company, we are primarily regulated by the Federal Reserve. Our bank
subsidiary is primarily regulated by the South Carolina State Board of Financial
Institutions (the “SC State Board”) and the FDIC.  Our compliance with
Federal Reserve, SC State Board, and FDIC regulations is costly and may limit
our growth and restrict certain of our activities, including payment of
dividends, mergers and acquisitions, investments, loans and interest rates
charged, interest rates paid on deposits and locations of offices. We are also
subject to capital requirements of our regulators.




The laws and regulations applicable to
the banking industry could change at any time, especially in light of political,
legal, and regulatory reactions to the recent economic downturn, and we cannot
predict the effects of these changes on our business and
profitability.  Because government regulation greatly affects the
business and financial results of all commercial banks and bank holding
companies, our cost of compliance could adversely affect our ability to operate
profitably.




The Sarbanes-Oxley Act of 2002 and the
related rules and regulations promulgated by the SEC, have increased the scope,
complexity and cost of corporate governance, reporting and disclosure
practices.  As a result, we may experience greater compliance
costs.




Weakness
in the economy and in the real estate market, including specific weakness within
our geographic footprint, has adversely affected us and may continue to
adversely affect us.




Declines in the United States economy
and our local real estate markets contributed to our increasing provisions for
loan losses during 2009, and may result in additional loan losses and loss
provisions in 2010 and 2011.  These factors could result in further
increases in loan loss provisions, delinquencies, and/or charge-offs in future
periods, which may adversely affect our financial condition and results of
operations.  If the strength of the United States economy in general
and the strength of the local economies in which we conduct operations continue
to decline, this could result in, among other things, further deterioration in
credit quality or a reduced demand for credit, including a resultant adverse
effect on our loan portfolio and allowance for loan and lease
losses.




In addition, deterioration of the
United States economy may adversely impact our banking business more generally.
Economic declines may be accompanied by a decrease in demand for consumer or
commercial credit and declining real estate and other asset values. Declining
real estate and other asset values may reduce the ability of borrowers to use
such equity to support borrowings.  Delinquencies, foreclosures, and
losses generally increase during economic slowdowns or
recessions.  Additionally, our servicing costs, collection costs and
credit losses may also increase in periods of economic slowdown or
recessions.  Effects of the current real estate slowdown have not been
limited to those directly involved in the real estate construction industry
(such as builders and developers).  Rather, it has impacted a number
of related businesses such as building materials suppliers, equipment leasing
firms, and real estate attorneys, among others.  All of these affected
businesses have banking relationships, and when their businesses suffer from
recession, the banking relationship suffers as well.




We
are subject to liquidity risk in our operations.




Liquidity risk is the possibility of
being unable to satisfy obligations as they come due, capitalize on growth
opportunities as they arise, or pay regular dividends because of an inability to
liquidate assets or obtain adequate funding on a timely basis, at a reasonable
cost and within acceptable risk tolerances.  Liquidity is required to
fund various obligations, including credit obligations to borrowers, mortgage
originations, withdrawals by depositors, repayment of debt, dividends to
shareholders, operating expenses and capital expenditures.  Liquidity
is derived primarily from retail deposit growth and retention, principal and
interest payments on loans and investment securities, net cash provided from
operations and access to other funding sources.  Our access to funding
sources in amounts adequate to finance our activities could be impaired by
factors that affect us specifically or the financial services industry in
general.  Factors that could detrimentally affect our access to
liquidity sources include a decrease in the level of our business activity due
to a market downturn or adverse regulatory action against us.  Our
ability to borrow could also be impaired by factors that are not specific to us,
such as a severe disruption in the financial markets or negative views and
expectations about the prospects for the financial services industry as a whole,
given the recent turmoil faced by banking organizations in the domestic and
worldwide credit markets.


-22-




The
impact of the current economic downturn on the performance of other financial
institutions in our geographic area, actions taken by our competitors to address
the current economic downturn, and the public perception of and confidence in
the economy generally, and the banking industry specifically, could
negatively impact our performance and operations.




All financial institutions are subject
to the same risks resulting from a weakening economy such as increased
charge-offs and levels of past due loans and nonperforming assets.  As
troubled institutions in our market area continue to dispose of problem assets,
the already excess inventory of residential homes and lots will continue to
negatively affect home values and increase the time it takes us or our borrowers
to sell existing inventory.  The perception that troubled banking
institutions (and smaller banking institutions that are not “in trouble”) are
risky institutions for purposes of regulatory compliance or safeguarding
deposits may cause depositors nonetheless to move their funds to larger
institutions.  If our depositors should move their funds based on
events happening at other financial institutions, our operating results would
suffer.




Our
agreement with the U.S. Treasury under the capital purchase component of the
Troubled Asset Relief Program is subject to unilateral change by the U.S.
Treasury, which could adversely affect our business, financial condition, and
results of operations.




Under the capital purchase component of
the Troubled Asset Relief Program (“TARP”), the U.S. Treasury may unilaterally
amend the terms of its agreement with us in order to comply with any changes in
federal law.  We cannot predict the effects of any of these changes
and of the associated amendments.




The Emergency
Economic Stabilization Act of 2008 (“EESA”) or other governmental actions may
not stabilize the financial services industry.




The EESA,
which was signed into law on October 3, 2008, is intended to alleviate the
financial crisis affecting the United States banking system.  A number
of programs have been, and are being, developed and implemented under
EESA.  The EESA may not have the intended effect, however, and as a
result, the condition of the financial services industry could decline instead
of improve.  The failure of the EESA to improve the condition of the
United States banking system could significantly adversely affect our access to
funding or capital, the trading price of our stock, and other elements of our
business, financial condition, and results of operations.




In addition to EESA, a variety of
legislative, regulatory, and other proposals have been discussed or may be
introduced in an effort to address the financial crisis.  Depending on
the scope of such proposals, if they are adopted and applied to the Company, our
financial condition, results of operations or liquidity could, directly or
indirectly, benefit or be adversely affected in a manner that could be material
to our business.




The short term
and long term impact of a likely new capital framework, whether through the
current proposal for non-Basel II United States banking institutions
or through another set of capital standards, is uncertain.




For
United States banking institutions with assets of less than
$250 billion and foreign exposures of less than $10 billion, including
the Company and the Bank, a proposal is currently pending that would apply to
them the “standardized approach” of the new risk-based capital standards
developed by the Basel Committee on Banking Supervision (Basel
II).  As a result of the recent deterioration in the global credit
markets and increases in credit, liquidity, interest rate, and other risks, the
United States banking regulators have for the last several months discussed
possible increases in capital requirements for all financial institutions,
separate from the current proposal for the standardized approach of Basel
II.  In August 2009, the Treasury issued principles for international
regulatory reform, which included recommendations for higher capital standards
for all banking organizations. Any new capital framework is likely to affect the
cost and availability of different types of credit.  United
States banking organizations are likely to be required to hold higher
levels of capital and could incur increased compliance costs. Any of these
developments, including increased capital requirements, could have a material
negative effect on our business, results of operations and financial
condition.




-23-




We may lose
members of our management team due to compensation
restrictions.




Our ability to retain key officers and
employees may be negatively impacted by recent legislation and regulation
affecting the financial services industry.  On February 17, 2009, the
American Recovery and Reinvestment Act of 2009 (“ARRA”) was signed into
law.  While the Treasury must promulgate regulations to implement the
restrictions and standards set forth in the new law, the ARRA, among other
things, significantly expands the executive compensation restrictions previously
imposed by the EESA.  Such restrictions apply to any entity that has
received or will receive financial assistance under the TARP, and will generally
continue to apply for as long as any obligation arising from financial
assistance provided under the TARP, including preferred stock issued under the
TARP capital purchase program, remains outstanding. As a result of our
participation in the TARP capital purchase program, the restrictions and
standards set forth in the ARRA are applicable to us.  Such
restrictions and standards may impact management’s ability to retain key
officers and employees as well as our ability to compete with financial
institutions that are not subject to the same limitations as we are under the
ARRA.




ITEM
1B.  UNRESOLVED STAFF COMMENTS





Not
Applicable.





ITEM
2.  PROPERTIES





The executive and main offices of the
Company and the Bank are located at 2170 W. Palmetto Street in Florence, South
Carolina.  The facility at that location is owned by the
Bank.  The Bank also owns an adjacent lot that is used as a parking
lot.  The headquarters building is a two-story building having
approximately 12,000 square feet.  The building has six inside teller
stations, two teller stations servicing four drive-through lanes and a night
depository and automated teller machine drive-through lane that is accessible
after the Bank’s normal business hours.





On April 26, 2000, the Bank opened a
branch at 411 Second Loop Road in Florence, South Carolina.  The
Second Loop branch facility, which is owned by the Bank, is located on
approximately one acre of land and contains approximately 3,000 square
feet.





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 will serve as additional space for the
operational and information technology activities of the Bank, including data
processing and auditing.  No customer services will be conducted in
this facility.





On June 17, 2004, the Bank opened a
temporary branch at 709 North Lake Drive in Lexington, South Carolina.  On
July 1, 2008, the bank subsequently moved into its permanent branch facility at
801 North Lake Drive in Lexington, South Carolina.  The Lexington
branch facility, which is owned by the Bank, is located on approximately two
acres of land and contains approximately 13,000 square feet.





On March
15, 2005, the Bank opened a branch at 51 State Street, Charleston, South
Carolina.  This property is leased.  On August 8, 2005, the
bank changed the street address of this location to 25 Cumberland Street,
Charleston, South Carolina because of a change in the primary entrance to the
branch.





On March 24, 2005, the Bank leased
approximately five acres at 2211 West Palmetto Street in Florence, South
Carolina for possible development of a future headquarters
location.  This property and an adjacent parcel were purchased by the
Company on November 24, 2008 and are leased by the Bank.





On October 3, 2005, the Bank opened a
branch office at 800 South Shelmore Blvd., Mount Pleasant, South
Carolina.  The Mount Pleasant branch facility is located on
approximately one acre of land and contains approximately 6,500 square
feet.




On February 9, 2006, the Bank purchased
approximately 0.75 acres at 2148 West Palmetto Street, Florence, South Carolina
for a future training facility.  On April 1, 2007, the Bank opened its
Learning Center  which contains approximately 6,000 square
feet.


-24-





The Bank
owns property at 44th
Business Park, Lots 1, 2 & 3, North Myrtle Beach, South Carolina, which is
an abandoned branch site listed for sale.





In March
2008, the Bank purchased 1.37 acres at 8551 Rivers Avenue, North Charleston,
South Carolina and one acre at 950 Lake Murray Boulevard, Columbia, South
Carolina, which are expected to be future branch office locations.





On July
24, 2009, the Bank opened a branch office at 2005A Sunset Boulevard, West
Columbia, South Carolina in a facility leased by the Bank.





Other than the Bank facilities
described in the preceding paragraphs and the real estate-related loans funded
by the Bank previously described in “Item 1.  Business—First Reliance
Bank,” the Company does not invest in real estate, interests in real estate,
real estate mortgages, or securities of or interests in persons primarily
engaged in real estate activities.





ITEM
3.  LEGAL PROCEEDINGS





None.




PART
II





ITEM
      4.
            MARKET
      FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
      PURCHASES OF EQUITY SECURITIES





(a)           The
response to this Item 5(a) is included in the Company’s 2009 Annual Report to
Shareholders under the heading, “Market for First Reliance Bancshares, Inc.’s
Common Stock; Payment of Dividends,” and is incorporated herein by
reference.





(b)
            Not
      Applicable





(c)           Not
Applicable




-25-


ITEM
5.              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,
                
                2009
                
                
                2008
                
                
                2007
                
                
                2006
                
                
                2005except
      per share data)Income
      Statement Data:Interest
      income
                
                $
                32,025
                
                
                $
                36,243
                
                
                $
                37,540
                
                
                $
                31,717
                
                
                $
                23,131Interest
      expense
                
                
                15,341
                
                
                
                17,298
                
                
                
                18,433
                
                
                
                14,214
                
                
                
                8,979Net
      interest income
                
                
                16,684
                
                
                
                18,945
                
                
                
                19,107
                
                
                
                17,503
                
                
                
                14,152Provision
      for loan losses
                
                
                14,401
                
                
                
                4,935
                
                
                
                1,643
                
                
                
                1,393
                
                
                
                1,811Net interest income
      after provision for
      loan losses
                
                
                2,283
                
                
                
                14,010
                
                
                
                17,464
                
                
                
                16,110
                
                
                
                12,341Noninterest
      income
                
                
                7,545
                
                
                
                5,009
                
                
                
                5,302
                
                
                
                4,591
                
                
                
                2,871Noninterest
      expense
                
                
                19,853
                
                
                
                18,852
                
                
                
                18,961
                
                
                
                16,272
                
                
                
                12,475Income
      (loss) before income taxes
                
                
                (10,025
                )
                
                
                167
                
                
                
                3,805
                
                
                
                4,429
                
                
                
                2,737Income
      tax expense (benefit)
                
                
                (4,181
                )
                
                
                (459
                )
                
                
                1,245
                
                
                
                1,183
                
                
                
                789Net
      income (loss)
                
                
                (5,844
                )
                
                
                626
                
                
                
                2,560
                
                
                
                3,246
                
                
                
                1,948Preferred
      stock dividends
                
                
                837
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -Net
      income (loss) available to common shareholders
                
                $
                (6,681
                )
                
                $
                626
                
                
                $
                2,560
                
                
                $
                3,246
                
                
                $
                1,948Balance
      Sheet Data:Assets
                
                $
                645,508
                
                
                $
                603,434
                
                
                $
                591,704
                
                
                $
                456,211
                
                
                $
                403,038Earning
      assets
                
                
                589,657
                
                
                
                560,032
                
                
                
                550,559
                
                
                
                412,687
                
                
                
                381,158Securities available
      for sale(1)
                
                
                121,949
                
                
                
                76,311
                
                
                
                58,580
                
                
                
                35,931
                
                
                
                37,121Loans (2)
                
                
                411,728
                
                
                
                478,579
                
                
                
                487,739
                
                
                
                360,123
                
                
                
                319,539Allowance
      for loan losses
                
                
                9,801
                
                
                
                8,224
                
                
                
                5,271
                
                
                
                4,002
                
                
                
                3,419Deposits
                
                
                552,763
                
                
                
                461,135
                
                
                
                449,498
                
                
                
                372,938
                
                
                
                334,437Shareholders’
      equity
                
                
                45,224
                
                
                
                37,426
                
                
                
                37,028
                
                
                
                34,093
                
                
                
                29,651Per
      Common Share Data:Basic
      earnings (loss)
                
                $
                (1.87
                )
                
                $
                0.18
                
                
                $
                0.74
                
                
                $
                0.96
                
                
                $
                0.60Diluted
      earnings (loss)
                
                
                (1.87
                )
                
                
                0.18
                
                
                
                0.72
                
                
                
                0.91
                
                
                
                0.57Common
      book value
                
                
                8.37
                
                
                
                10.65
                
                
                
                10.63
                
                
                
                9.95
                
                
                
                8.97Performance
      Ratios:Return
      on average assets
                
                
                (0.88
                )%
                
                
                0.11
                %
                
                
                0.52
                %
                
                
                0.75
                %
                
                
                0.54
                %Return
      on average equity
                
                
                (12.14
                )
                
                
                1.65
                
                
                
                7.16
                
                
                
                10.19
                
                
                
                6.82Net
      interest margin (3)
                
                
                2.81
                
                
                
                3.53
                
                
                
                4.20
                
                
                
                4.42
                
                
                
                4.20Efficiency
      (4)
                
                
                81.94
                
                
                
                78.80
                
                
                
                77.69
                
                
                
                73.65
                
                
                
                73.28Capital
      and Liquidity Ratios:Average
      equity to average assets
                
                
                7.28
                %
                
                
                6.42
                %
                
                
                7.15
                %
                
                
                7.39
                %
                
                
                7.96
                %Leverage
      (4.00% required minimum)
                
                
                8.25
                
                
                
                9.28
                
                
                
                9.46
                
                
                
                9.90
                
                
                
                10.02Risk-based
      capitalTier
      1
                
                
                11.52
                
                
                
                10.73
                
                
                
                9.26
                
                
                
                11.42
                
                
                
                12.02Total
                
                
                12.78
                
                
                
                11.97
                
                
                
                10.29
                
                
                
                12.45
                
                
                
                13.05Average
      loans to average deposits
                
                
                86.07
                
                
                
                106.63
                
                
                
                99.37
                
                
                
                96.86
                
                
                
                102.07





(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.


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


-26-





ITEM
      6.
            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.  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.


-27-





On
December 28, 2008, the Company injected $3,000,000 into the Bank as permanent
capital.





On March
6, 2009, the Company completed a transaction with the United States Treasury
(“Treasury”) under the Troubled Asset Relief Program Capital Purchase Program
(“TARP CPP”).  Under the TARP CPP, the Company received $15,225,312,
net of expenses of $123,688, in exchange for 15,349 and 767 shares of its Series
A and Series B Cumulative Perpetual Preferred Stock,
respectively.  The preferred shares issued to the Treasury qualify as
tier 1 capital for regulatory purposes.





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.




Results
of Operations




We
realized a net loss available to common shareholders for the year ended December
31, 2009, of $6,680,787, or a loss of $1.87 per diluted share, compared to a net
income of $625,632, or earnings of $0.18 per diluted share, for the year ended
December 31, 2008.




Our
operating results for 2009 were negatively impacted by the credit crisis that
began in 2008, continuing into 2009, which resulted in rising unemployment,
substantial decrease in consumer confidence and spending, and declining real
estate values throughout our market area.  During 2009, the existing
weak economic environment and the depressed real estate valuations in our market
had an adverse impact on our borrowers, which has resulted in a negative impact
on our asset quality.  Defaults by borrowers, especially in the
residential and commercial real estate sectors, increased substantially in 2009,
resulting in the recording of higher provisions for credit losses and higher net
charge-offs.  For the year ended December 31, 2009, we recorded a
provision for loan losses of $14,400,652 compared to $4,934,912 for the year
ended 2008.  Our net charge offs for the comparable periods were
$12,823,805 and $1,981,620, respectively. In addition, these factors contributed
materially to the $2,260,204 decrease in our net interest income for the year
ended 2009 compared to 2008.




Our 2009
operating results were also negatively impacted by an increase in our deposit
insurance premiums.  Like all federally insured financial
institutions, we have been subjected to substantial increases in deposit
insurance premiums, as well as a special assessment levied by the FDIC in the
second quarter of 2009.  For the year ended December 31, 2009, our
deposit insurance premiums, including the special assessment, were $1,348,914
and $378,904 for the year ended December 31, 2009 and 2008,
respectively.




In spite
of the difficult challenges we faced during 2009, we were able to increase our
total assets and core deposits by $41,303,424 and $33,726,271, respectively; to
improve our liquidity; and to maintain our regulatory capital ratios in excess
of those required for being a well capitalized financial
institution.




Net
Interest Income





The
largest component of our net income is its net interest income, which is the
difference between the income earned on assets and interest paid on deposits and
on the borrowings used to support such assets.  Net interest income is
determined by the yields earned on our interest-earning assets and the rates
paid on 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 our net interest rate
spread.




-28-


Net
interest income for 2009 was $16,684,142 compared to $18,944,346 for 2008, a
decrease of $2,260,204, or 11.93%.  This decrease was the product of
the substantial increase of $10,842,185 in our net loans charged off and the
substantial increase in the average balance of our nonperforming loans for 2009
compared to 2008.  Interest lost on our nonaccruing loans was
$2,450,489 and $1,403,619 for 2009 and 2008, respectively.  This
negatively affected our 2009 net interest income by
$1,046,870.  Further impacting our 2009 net interest income is the
fact that our annualized yield on average earning assets decreased 138 basis
points for 2009 compared to 2008, while our annualized average cost of our
interest-bearing liabilities decreased only 71 basis points for 2009 compared to
2008.  See “Rate/Volume Analysis” below for a more detailed
discussion.





For 2009,
average-earning assets totaled $617,075,948 with an annualized average yield of
5.29% compared to $549,691,569 and 6.67%, respectively, for
2008.  Average interest-bearing liabilities totaled $566,202,286 with
an annualized average cost of 2.71% for 2009 compared to $506,359,427 and 3.42%,
respectively, for 2008.





Our net
interest margin and net interest spread was 2.81% and 2.58%, respectively, for
2009 compared to 3.53% and 3.25%, respectively, for 2008.





Because
loans often provide a higher yield than other types of earning assets, one of
our goals is to maintain our loan portfolio as the largest component of total
earning assets.  Loans comprised 74.93% and 87.61% of average earning
assets for December 31, 2009 and 2008, respectively.  Loan interest
income for the years ended December 31, 2009 and 2008 was $27,758,195 and
$33,150,366, respectively.  The annualized average yield on loans was
6.00% and 6.88% for 2009 and 2008, respectively.  Average balances of
loans decreased to $462,400,290 during 2009, a decrease of $19,171,818 from the
average of $481,572,108 during 2008.  Our loan income for 2009 was
significantly impacted by the depressed real estate market and the significant
increase in charged off loans and the average volume of nonperforming
loans.  The combined decreases in loan and yield volume had a
significant impact on our net interest income.  Because of the
economic downturn in our markets that caused the volume of new loan customers to
decrease, we shifted our asset mix toward securities in 2009.





Available-for-sale
investment securities averaged $94,506,986, or 15.32% of average earning assets,
for December 31, 2009 compared to approximately $60,187,152, or 10.95% of
average earning assets for 2008.  Interest earned on investment
securities amounted to $4,103,831 for the year ended December 31, 2009, compared
to $2,818,078 for the same period last year.  Our fully tax-equivalent
yield was 5.03% and 5.42% for the period ended December 31, 2009 and 2008,
respectively.





Our total
average interest-bearing deposits were $492,325,051 and $407,813,354 for 2009
and 2008, respectively, which represented an increase of $84,511,697, or
20.72%.  The increase in deposits resulted from successful pricing and
marketing promotions, a key strategic initiative for our
Company.  Total interest paid on deposits for the years ended December
31, 2009 and 2008 was $12,560,062 and $13,620,344, respectively.  The
annualized average cost of deposits was 2.55% and 3.34% for the year ended
December 31, 2009 and 2008, respectively.  The decline in average rate
paid for deposits during 2009 is mainly due to the decline in market interest
rates.





The
average balance of other interest-bearing liabilities was $73,877,235 and
$98,546,073 for 2009 and 2008, respectively.


This
represented a decrease of $24,668,838, or 25.03%.  The decrease is
partially attributable to the decrease of $12,844,098 in our average borrowings
from the Federal Home Loan Bank.  With the availability of
interest-bearing deposits at lower cost during 2009, we became less reliant on
using borrowings from the Federal Home Loan Bank to fund loan
demands.  The extremely low market interest rates that existed during
2009 for federal funds purchased and securities sold under agreements to
repurchase resulted in an average decrease of $9,921,420 in the use of these
types of financial instruments.


-29-





Average Balances,
Income and Expenses, and Rate -The following table
sets forth, for the years indicated, certain information related to our 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.





Year
      ended December 31,
                      
                      2009
                      
                      
                      2008
                      
                      
                      2007Average
                      
                      
                      Income/
                      
                      
                      Yield/
                      
                      
                      Average
                      
                      
                      Income/
                      
                      
                      Yield/
                      
                      
                      Average
                      
                      
                      Income/
                      
                      
                      Yield
      /(Dollars
      in thousands)
                      
                      Balance
                      
                      
                      Expense
                      
                      
                      Rate
                      
                      
                      Balance
                      
                      
                      Expense
                      
                      
                      Rate
                      
                      
                      Balance
                      
                      
                      Expense
                      
                      
                      RateAssetsEarning
      assets:Loans(2)
                      
                      $
                      462,400
                      
                      
                      $
                      27,758
                      
                      
                      
                      6.00
                      %
                      
                      $
                      481,572
                      
                      
                      $
                      33,150
                      
                      
                      
                      6.88
                      %
                      
                      $
                      414,907
                      
                      
                      $
                      35,325
                      
                      
                      
                      8.51
                      %Securities,
      taxable
                      
                      
                      51,837
                      
                      
                      
                      2,199
                      
                      
                      
                      4.24
                      
                      
                      
                      30,075
                      
                      
                      
                      1,519
                      
                      
                      
                      5.05
                      
                      
                      
                      17,967
                      
                      
                      
                      892
                      
                      
                      
                      4.96Securities, nontaxable(1)
                      
                      
                      42,670
                      
                      
                      
                      2,552
                      
                      
                      
                      5.98
                      
                      
                      
                      30,112
                      
                      
                      
                      1,741
                      
                      
                      
                      5.75
                      
                      
                      
                      18,204
                      
                      
                      
                      1,045
                      
                      
                      
                      5.74Federal
      funds sold
                      
                      
                      512
                      
                      
                      
                      1
                      
                      
                      
                      0.26
                      
                      
                      
                      2,838
                      
                      
                      
                      56
                      
                      
                      
                      1.97
                      
                      
                      
                      7,479
                      
                      
                      
                      391
                      
                      
                      
                      5.23Other
      earning assets
                      
                      
                      59,656
                      
                      
                      
                      163
                      
                      
                      
                      .27
                      
                      
                      
                      5,095
                      
                      
                      
                      218
                      
                      
                      
                      4.28
                      
                      
                      
                      2,529
                      
                      
                      
                      152
                      
                      
                      
                      6.01Total
      earning assets
                      
                      
                      617,075
                      
                      
                      
                      32,673
                      
                      
                      
                      5.29
                      
                      
                      
                      549,692
                      
                      
                      
                      36,684
                      
                      
                      
                      6.67
                      
                      
                      
                      461,086
                      
                      
                      
                      37,805
                      
                      
                      
                      8.20Cash
      due from banks
                      
                      
                      2,421
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      5,524
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      8,586Premises
      and equipment
                      
                      
                      26,863
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      23,983
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      18,049Other
      assets
                      
                      
                      23,871
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      17,490
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      16,758Allowance
      for loan losses
                      
                      
                      (8,427
                      )
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      (5,819
                      )
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      (4,433
                      )Total
      assets
                      
                      $
                      661,803
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      $
                      590,870
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      $
                      500,046Liabilities
      and Shareholders' EquityInterest-bearing
      deposits:Transaction
      accounts
                      
                      $
                      37,516
                      
                      
                      $
                      214
                      
                      
                      
                      0.57
                      %
                      
                      $
                      28,761
                      
                      
                      $
                      184
                      
                      
                      
                      .64
                      %
                      
                      $
                      36,625
                      
                      
                      $
                      710
                      
                      
                      
                      1.94
                      %Savings
      and moneymarket
      accounts
                      
                      
                      104,429
                      
                      
                      
                      1,743
                      
                      
                      
                      1.67
                      
                      
                      
                      98,210
                      
                      
                      
                      2,123
                      
                      
                      
                      2.16
                      
                      
                      
                      80,943
                      
                      
                      
                      3,184
                      
                      
                      
                      3.93Time
      deposits
                      
                      
                      350,380
                      
                      
                      
                      10,603
                      
                      
                      
                      3.03
                      
                      
                      
                      280,842
                      
                      
                      
                      11,313
                      
                      
                      
                      4.03
                      
                      
                      
                      254,934
                      
                      
                      
                      12,874
                      
                      
                      
                      5.05Total
      interest-bearing deposits
                      
                      
                      492,325
                      
                      
                      
                      12,560
                      
                      
                      
                      2.55
                      
                      
                      
                      407,813
                      
                      
                      
                      13,620
                      
                      
                      
                      3.34
                      
                      
                      
                      372,502
                      
                      
                      
                      16,768
                      
                      
                      
                      4.50Other
      interest-bearing liabilities:Securities
      sold under agreement to repurchase
                      
                      
                      2,261
                      
                      
                      
                      1
                      
                      
                      
                      0.05
                      
                      
                      
                      7,845
                      
                      
                      
                      121
                      
                      
                      
                      1.54
                      
                      
                      
                      9,128
                      
                      
                      
                      400
                      
                      
                      
                      4.38Federal
      funds purchased
                      
                      
                      21
                      
                      
                      
                      
                      
                      
                      
                      0.82
                      
                      
                      
                      4,359
                      
                      
                      
                      130
                      
                      
                      
                      2.99
                      
                      
                      
                      1,809
                      
                      
                      
                      92
                      
                      
                      
                      5.09Federal
      Home Loan Bank borrowing
                      
                      
                      59,800
                      
                      
                      
                      2,137
                      
                      
                      
                      3.57
                      
                      
                      
                      72,644
                      
                      
                      
                      2,675
                      
                      
                      
                      3.68
                      
                      
                      
                      22,986
                      
                      
                      
                      553
                      
                      
                      
                      2.41Junior
      subordinated debentures
                      
                      
                      10,310
                      
                      
                      
                      613
                      
                      
                      
                      5.95
                      
                      
                      
                      10,310
                      
                      
                      
                      616
                      
                      
                      
                      5.98
                      
                      
                      
                      10,310
                      
                      
                      
                      620
                      
                      
                      
                      6.01Note
      payable
                      
                      
                      1,485
                      
                      
                      
                      30
                      
                      
                      
                      2.01
                      
                      
                      
                      3,388
                      
                      
                      
                      136
                      
                      
                      
                      4.00
                      
                      
                      
                      8
                      
                      
                      
                      -
                      
                      
                      
                      0.00Total
      other interest-bearing liabilities
                      
                      
                      73,877
                      
                      
                      
                      2,781
                      
                      
                      
                      3.76
                      
                      
                      
                      98,546
                      
                      
                      
                      3,678
                      
                      
                      
                      3.73
                      
                      
                      
                      44,241
                      
                      
                      
                      1,665
                      
                      
                      
                      3.76Total
      interest-bearing liabilities
                      
                      
                      566,202
                      
                      
                      
                      15,341
                      
                      
                      
                      2.71
                      
                      
                      
                      506,359
                      
                      
                      
                      17,298
                      
                      
                      
                      3.42
                      
                      
                      
                      416,743
                      
                      
                      
                      18,433
                      
                      
                      
                      4.42Noninterest-bearing
      deposits
                      
                      
                      44,900
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      43,812
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      45,038Other
      liabilities
                      
                      
                      2,552
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      2,732
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      2,513Shareholders'
      equity
                      
                      
                      48,149
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      37,967
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      35,752Total
      liabilities and equity
                      
                      $
                      661,803
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      $
                      590,870
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      $
                      500,046Net
      interest income/interest spread
                      
                      
                      
                      
                      
                      $
                      17,332
                      
                      
                      
                      2.58
                      %
                      
                      
                      
                      
                      
                      $
                      19,386
                      
                      
                      
                      3.25
                      %
                      
                      
                      
                      
                      
                      $
                      19,372
                      
                      
                      
                      3.78
                      %Net
      yield on earning assets
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      2.81
                      %
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      3.53
                      %
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      4.20
                      %





(1)
            Fully
      tax-equivalent basis at 34% tax rate for nontaxable
    securities


(2)
            Includes
      mortgage loans held for sale and nonaccruing
  loans


-30-


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.





2009
      Compared to 2008
                
                
                2008
      Compared to2007Due
      to increase (decrease) in
                
                
                Due
      to increase (decrease) in(Dollars
      in thousands)
                
                Volume
                
                
                Rate
                
                
                Total
                
                
                Volume
                
                
                Rate
                
                
                TotalInterest
      income:Loans
                
                $
                (1,280
                )
                
                $
                (4,112
                )
                
                $
                (5,392
                )
                
                $
                5,178
                
                
                $
                (7,353
                )
                
                $
                (2,175
                )Securities,
      taxable
                
                
                955
                
                
                
                (275
                )
                
                
                680
                
                
                
                611
                
                
                
                16
                
                
                
                627Securities,
      tax exempt
                
                
                741
                
                
                
                71
                
                
                
                812
                
                
                
                689
                
                
                
                7
                
                
                
                696Federal
      funds sold
                
                
                (27
                )
                
                
                (28
                )
                
                
                (55
                )
                
                
                (167
                )
                
                
                (168
                )
                
                
                (335
                )Other
      earning assets
                
                
                324
                
                
                
                (380
                )
                
                
                (56
                )
                
                
                120
                
                
                
                (54
                )
                
                
                66Total
      interest income
                
                
                713
                
                
                
                (4,724
                )
                
                
                (4,011
                )
                
                
                6,431
                
                
                
                (7,552
                )
                
                
                (1,121
                )Interest
      expense:Interest-bearing
      depositsInterest-bearing
      transaction accounts
                
                
                52
                
                
                
                (21
                )
                
                
                31
                
                
                
                (128
                )
                
                
                (398
                )
                
                
                (526
                )Savings
      and money market accounts
                
                
                127
                
                
                
                (507
                )
                
                
                (380
                )
                
                
                580
                
                
                
                (1,641
                )
                
                
                (1,061
                )Time
      deposits
                
                
                2,450
                
                
                
                (3,161
                )
                
                
                (711
                )
                
                
                1,218
                
                
                
                (2,779
                )
                
                
                (1,561
                )Total
      interest-bearing deposits
                
                
                2,629
                
                
                
                (3,689
                )
                
                
                (1,060
                )
                
                
                1,670
                
                
                
                (4,818
                )
                
                
                (3,148
                )Other
      interest-bearing liabilitiesSecurities
      sold under agreement to repurchase
                
                
                (51
                )
                
                
                (69
                )
                
                
                (120
                )
                
                
                (50
                )
                
                
                (229
                )
                
                
                (279
                )Federal
      funds purchased
                
                
                (75
                )
                
                
                (55
                )
                
                
                (130
                )
                
                
                89
                
                
                
                (51
                )
                
                
                38Federal
      Home Loan Bank borrowings
                
                
                (460
                )
                
                
                (78
                )
                
                
                (538
                )
                
                
                1,702
                
                
                
                420
                
                
                
                2,122Junior
      subordinated debentures
                
                
                -
                
                
                
                (3
                )
                
                
                (3
                )
                
                
                -
                
                
                
                (4
                )
                
                
                (4
                )Note
      payable
                
                
                (56
                )
                
                
                (50
                )
                
                
                (106
                )
                
                
                136
                
                
                
                -
                
                
                
                136Total
      other interest-bearing liabilities
                
                
                (642
                )
                
                
                (255
                )
                
                
                (897
                )
                
                
                1,877
                
                
                
                136
                
                
                
                2,013Total
      interest expense
                
                
                1,988
                
                
                
                (3,944
                )
                
                
                (1,957
                )
                
                
                3,547
                
                
                
                (4,682
                )
                
                
                (1,135
                )Net
      interest income
                
                $
                (1,274
                )
                
                $
                (780
                )
                
                $
                (2,054
                )
                
                $
                2,884
                
                
                $
                (2,870
                )
                
                $
                14




-31-





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, 2009.




GreaterAfter
      One
                  
                  
                  After
      Three
                  
                  
                  
                  
                  
                  Than
      OneThrough
                  
                  
                  Through
                  
                  
                  Within
                  
                  
                  Year
      orDecember
      31, 2009
                  
                  Within
      One
                  
                  
                  Three
                  
                  
                  Twelve
                  
                  
                  One
                  
                  
                  Non-(Dollars
      in thousands)
                  
                  Month
                  
                  
                  Months
                  
                  
                  Months
                  
                  
                  Year
                  
                  
                  Sensitive
                  
                  
                  TotalAssetsInterest-earning
      assetsInterest-bearing
      deposits in other banks
                  
                  $
                  50,356
                  
                  
                  $
                  -
                  
                  
                  $
                  -
                  
                  
                  $
                  50,356
                  
                  
                  $
                  -
                  
                  
                  $
                  50,356Loans,
      including held for sale
                  
                  
                  51,169
                  
                  
                  
                  22,847
                  
                  
                  
                  83,985
                  
                  
                  
                  158,001
                  
                  
                  
                  253,727
                  
                  
                  
                  411,728Securities,
      taxable
                  
                  
                  68
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  68
                  
                  
                  
                  61,144
                  
                  
                  
                  61,212Securities,
      nontaxable
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  60,737
                  
                  
                  
                  60,737Nonmarketable
      securities
                  
                  
                  4,812
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  4,812
                  
                  
                  
                  
                  
                  
                  
                  4,812Time
      deposits in other banks
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  502
                  
                  
                  
                  502
                  
                  
                  
                  
                  
                  
                  
                  502Investment
      in trust
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  310
                  
                  
                  
                  310Total
      earning assets
                  
                  
                  106,405
                  
                  
                  
                  22,847
                  
                  
                  
                  84,487
                  
                  
                  
                  213,739
                  
                  
                  
                  375,918
                  
                  
                  
                  589,657LiabilitiesInterest-bearing
      liabilities:Interest-bearing
      deposits:Transaction
      accounts
                  
                  
                  47,733
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  47,733
                  
                  
                  
                  -
                  
                  
                  
                  47,733Savings
      deposits
                  
                  
                  103,605
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  103,605
                  
                  
                  
                  -
                  
                  
                  
                  103,605Time
      deposits
                  
                  
                  19,078
                  
                  
                  
                  33,260
                  
                  
                  
                  143,998
                  
                  
                  
                  196,336
                  
                  
                  
                  160,790
                  
                  
                  
                  357,126Total
      interest-bearing deposits
                  
                  
                  170,416
                  
                  
                  
                  33,260
                  
                  
                  
                  143,998
                  
                  
                  
                  347,674
                  
                  
                  
                  160,790
                  
                  
                  
                  508,464Advances
      from Federal Home Loan Bank
                  
                  
                  7,000
                  
                  
                  
                  -
                  
                  
                  
                  14,000
                  
                  
                  
                  21,000
                  
                  
                  
                  13,000
                  
                  
                  
                  34,000Junior
      subordinated debentures
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  10,310
                  
                  
                  
                  10,310Repurchase
      agreements
                  
                  
                  598
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  598
                  
                  
                  
                  -
                  
                  
                  
                  598Total
      interest-bearing liabilities
                  
                  
                  178,014
                  
                  
                  
                  33,260
                  
                  
                  
                  157,998
                  
                  
                  
                  369,272
                  
                  
                  
                  184,100
                  
                  
                  
                  553,372Period
      gap
                  
                  $
                  (71,609
                  )
                  
                  $
                  (10,413
                  )
                  
                  $
                  (73,511
                  )
                  
                  $
                  (155,533
                  )
                  
                  $
                  191,818Cumulative
      gap
                  
                  $
                  (71,609
                  )
                  
                  $
                  (82,022
                  )
                  
                  $
                  (155,533
                  )
                  
                  $
                  (155,533
                  )
                  
                  $
                  36,285Ratio
      of cumulative gap to total earning assets
                  
                  
                  (12.14
                  )%
                  
                  
                  (13.91
                  )%
                  
                  
                  (26.38
                  )%
                  
                  
                  (26.38
                  )%
                  
                  
                  6.15
                  %


-32-





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 us the opportunity
to vary the rates paid on those deposits within one month or shorter
period.  However, we are 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.





We are in
a liability sensitive position (or a negative gap) of $155.5 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 2009 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.





Our Board
of Directors and management review the asset liability management with
information produced by a quantitative model that measures our interest rate
sensitivity.  Our asset and liability policies are focused upon
maximizing long term profitability while managing acceptable interest rate
risk.





However,
our gap analysis is not a precise indicator of our interest rate 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.  We believe we have positioned ourselves
to where there is minimal impact on interest income in a rising or falling rate
environment.


-33-




Provision
and Allowance for Loan Losses





We have
developed policies and procedures for evaluating the overall quality of our
credit portfolio and the timely identification of potential problem
credits.  On a quarterly basis, our Board of Directors reviews and
approves the appropriate level for the 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 our
market.  The objective of management has been to fund the allowance
for loan losses at a level greater than or equal to our internal risk
measurement system for loan risk.





Additions
to the allowance for loan losses, which are expensed as the provision for loan
losses on our 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
as to the adequacy of the allowance for loan losses is based on a number of
assumptions about future events, which we believe to be reasonable, but which
may or may not prove to be accurate. Our determination of the allowance for loan
losses is based on evaluations of the collectability 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 historical loan loss experience, and a review of specific problem
loans. We also consider subjective issues such as changes in the lending
policies and procedures, changes in the local and national economy, changes in
volume or type of credits, changes in the volume or severity of problem loans,
quality of loan review and board of director oversight, concentrations of
credit, and peer group comparisons.





More
specifically, in determining our allowance for loan loss, we review loans for
specific and impaired reserves based on current appraisals less estimated
closing costs. General and unallocated reserves are determined using historical
loss trends applied to risk rated loans grouped by loan type. The general and
unallocated reserves are calculated by applying the appropriate historical loss
ratio to the loan categories. Impaired loans are excluded from this analysis.
The sum of all such amounts determines our general and unallocated
reserves.





We also
track our portfolio and analyze loans grouped by loan type categories. The first
step in this process is to risk grade each and every loan in the portfolio based
on one common set of parameters. These parameters include items like
debt-to-worth ratio, liquidity of the borrower, net worth, experience in a
particular field and other factors such as underwriting exceptions. Weight is
also given to the relative strength of any guarantors on the loan. Due to our
short operating history and only recent experience with problem assets, the
results of our migration analysis have yet to provide significant relevant
information with respect to determining the general allowance related to
nonimpaired loans.  We anticipate, however, that this analysis will
eventually provide us with historical behavioral indications by credit grading
as we develop sufficient history to analyze the general allowance related to
non-impaired loans.





After
risk grading each loan, we then use 15 qualitative factors to analyze the trends
in the portfolio. These 15 factors include both internal and external factors.
The internal factors are the concentration of credit across the portfolio,
current delinquency ratios and trends, the experience level of management and
staff, our adherence to lending policies and procedures, current loss and
recovery trends, the nature and volume of the portfolio’s categories, current
non-accrual and problem loan trends, the quality of our loan review system, and
other factors which include collateral, loan to value ratio, and policy
exceptions. The external factors are the current economic and business
environment, which includes indicators such as national GDP, pricing indicators,
employment statistics, housing statistics, market indicators, financial
regulatory economic analysis, and economic forecasts from reputable sources. A
quantitative value is assigned to each of the 15 internal and external factors,
which, when added together, creates a net qualitative weight. The net
qualitative weight is then added to the minimum loss ratio. Negative trends in
the loan portfolio increase the quantitative values assigned to each of the
qualitative factors and, therefore, increase the loss ratio. As a result, an
increased loss ratio will result in a higher allowance for loan loss. For
example, as general economic and business conditions decline, this qualitative
factor’s quantitative value will increase, which will increase the net
qualitative weight and the loss ratio (assuming all other qualitative factors
remain constant). Similarly, positive trends in the loan portfolio, such as an
improvement in general economic and business conditions, will decrease the
quantitative value assigned to this qualitative factor, thereby decreasing the
net qualitative weight (assuming all other qualitative factors remain constant).
These factors are reviewed and updated by our risk management committee on a
quarterly basis to arrive at a consensus for our qualitative
adjustments.


-34-





We then
create a loss range by applying average historical industry loss rates for the
last 10 years to determine the level of the allowance for loan and lease losses
on the non-impaired loans in the portfolio. We utilize a 10 year time frame, as
we believe it includes numerous complete economic cycles. As such, we consider
the time frame long enough to include both favorable and problematic industry
trends relevant in determining historical loss rates. The resulting unadjusted
historical loss factor is used as a beginning point upon which we add our
quantitative adjustments based on the qualitative factors discussed above. Once
the qualitative adjustments are made, we refer to the final amount as the
historical loss factor. The historical loss factor is then multiplied by the
loans outstanding for the period ended, except for any loans classified as
non-performing, which are addressed specifically as discussed
below.





Separately,
we review all impaired loans individually to determine a specific allocation for
each. In our assessment of impaired loans, we consider the primary source of
repayment when determining whether loans are collateral dependent or
not.





Periodically,
we adjust the amount of the allowance based on changing circumstances. We
recognize loan losses to the allowance and add subsequent recoveries back to the
allowance for loan losses. In addition, on a quarterly basis we informally
compare our allowance for loan losses to various peer institutions; however, we
recognize that allowances will vary as financial institutions are unique in the
make-up of their loan portfolios and customers, which necessarily creates
different risk profiles for the institutions. We would only consider further
adjustments to our allowance for loan losses based on this peer review if our
allowance was significantly different from our peer group. To date, we have not
made any such adjustment. There can be no assurance that charge-offs of loans in
future periods will not exceed the allowance for loan losses as estimated at any
point in time or that provisions for loan losses will not be significant to a
particular accounting period, especially considering the overall weakness in the
commercial real estate market in our market areas.





Our
various regulatory agencies review our 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. Our 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, 2009 and 2008, the allowance for loan losses was $9,800,746 and
$8,223,899, respectively, an increase of $1,576,847, or 19.17%, over the 2008
allowance.  As a percentage of total loans, the allowance for loan
losses was 2.41% and 1.75% at December 31, 2009 and 2008,
respectively.  The increase in the allowance for loan losses was
driven by the significant increase in net loans charged off during 2009 and
continuing adverse economic trends in our markets.  During 2009, net
loans charged off totaled $12,823,805 compared to $1,981,620 for the year ended
December 31, 2008, an increase of $10,842,185.  See “Nonperforming
Assets” below for additional information regarding our asset quality and loan
portfolio.





For the
years 2009 and 2008, the provision for loan losses was $14,400,652 and
$4,934,912, respectively.  This represents an increase of $9,465,740,
which is primarily attributable to the significant increase in our net loans
charged off.





We
believe the allowance for loan losses at December 31, 2009, is adequate to meet
potential loan losses inherent in the loan portfolio.


-35-





The
following table sets forth certain information with respect to the Company’s
allowance for loan losses and the composition of charge-offs and recoveries for
the five years ended December 31, 2009.




Allowance
for Loan Losses




(Dollars
      in thousands)
                
                2009
                
                
                2008
                
                
                2007
                
                
                2006
                
                
                2005Total
      loans outstanding at end of year
                
                $
                406,627
                
                
                $
                468,990
                
                
                $
                468,138
                
                
                $
                353,491
                
                
                $
                311,544Average
      loans outstanding
                
                $
                462,400
                
                
                $
                481,572
                
                
                $
                414,907
                
                
                $
                348,709
                
                
                $
                294,740Balance
      of allowance for loan losses at beginning of year
                
                $
                8,224
                
                
                $
                5,271
                
                
                $
                4,002
                
                
                $
                3,419
                
                
                $
                2,758Loans
      charged off:Real
      estate – construction
                
                
                7,114
                
                
                
                -
                
                
                
                -
                
                
                
                17
                
                
                
                142Real
      estate – mortgage
                
                
                4,197
                
                
                
                1,136
                
                
                
                205
                
                
                
                718
                
                
                
                472Commercial
      and industrial
                
                
                2,530
                
                
                
                997
                
                
                
                58
                
                
                
                170
                
                
                
                317Consumer
      and other
                
                
                446
                
                
                
                235
                
                
                
                193
                
                
                
                151
                
                
                
                300Total
      loan losses
                
                
                14,287
                
                
                
                2,368
                
                
                
                456
                
                
                
                1,056
                
                
                
                1,231Recoveries
      of previous loan losses:Real
      estate – construction
                
                
                985
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -Real
      estate – mortgage
                
                
                390
                
                
                
                322
                
                
                
                36
                
                
                
                105
                
                
                
                38Commercial
      and industrial
                
                
                68
                
                
                
                10
                
                
                
                24
                
                
                
                111
                
                
                
                12Consumer
      and other
                
                
                20
                
                
                
                54
                
                
                
                22
                
                
                
                31
                
                
                
                31Total
      recoveries
                
                
                1,463
                
                
                
                386
                
                
                
                82
                
                
                
                247
                
                
                
                81Net
      charge-offs
                
                
                12,824
                
                
                
                1,982
                
                
                
                374
                
                
                
                809
                
                
                
                1,150Provision
      for loan losses
                
                
                14,401
                
                
                
                4,935
                
                
                
                1,643
                
                
                
                1,392
                
                
                
                1,811Balance
      of allowance for loan losses at end of year
                
                $
                9,801
                
                
                $
                8,224
                
                
                $
                5,271
                
                
                $
                4,002
                
                
                $
                3,419Ratios:Net
      charge-offs to average loans outstanding
                
                
                2.77
                %
                
                
                0.41
                %
                
                
                0.09
                %
                
                
                0.23
                %
                
                
                0.39
                %Net
      charge-offs to loans at end of year
                
                
                3.15
                
                
                
                0.42
                
                
                
                0.08
                
                
                
                0.23
                
                
                
                0.37Allowance
      for loan losses to average loans
                
                
                2.12
                
                
                
                1.71
                
                
                
                1.27
                
                
                
                1.15
                
                
                
                1.16Allowance
      for loan losses to loans at end of year
                
                
                2.41
                
                
                
                1.75
                
                
                
                1.13
                
                
                
                1.13
                
                
                
                1.10Net
      charge-offs to allowance for loan losses
                
                
                130.84
                
                
                
                24.10
                
                
                
                7.10
                
                
                
                20.21
                
                
                
                33.64Net
      charge-offs to provisions for loan losses
                
                
                89.05
                
                
                
                40.16
                
                
                
                22.76
                
                
                
                58.11
                
                
                
                63.50


-36-


Nonperforming
Assets- At
December 31, 2009 and 2008, loans totaling $25,406,383 and $19,591,982,
respectively, were in nonaccrual status, total loans of $40,197 and $2,097,426,
respectively, were ninety days or more overdue and still accruing interest, and
restructured loans were $420,033 and $566,161, 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, 2009.





(Dollars
      in thousands)
                                                
                                                2009
                                                
                                                
                                                2008
                                                
                                                
                                                2007
                                                
                                                
                                                2006
                                                
                                                
                                                2005Loans
      over 90 days past due and still accruing
                                                
                                                $
                                                40
                                                
                                                
                                                $
                                                2,097
                                                
                                                
                                                $
                                                1,781
                                                
                                                
                                                $
                                                464
                                                
                                                
                                                $
                                                705Loans
      on nonaccrual:Real
      Estate Construction
                                                
                                                
                                                16,380
                                                
                                                
                                                
                                                6,250
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -Real
      Estate Mortgage
                                                
                                                
                                                8,840
                                                
                                                
                                                
                                                12,573
                                                
                                                
                                                
                                                1,465
                                                
                                                
                                                
                                                637
                                                
                                                
                                                
                                                1,619Commercial
                                                
                                                
                                                154
                                                
                                                
                                                
                                                563
                                                
                                                
                                                
                                                114
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                95Consumer
                                                
                                                
                                                32
                                                
                                                
                                                
                                                206
                                                
                                                
                                                
                                                79
                                                
                                                
                                                
                                                34
                                                
                                                
                                                
                                                78Total
      nonaccrual loans
                                                
                                                
                                                25,406
                                                
                                                
                                                
                                                19,592
                                                
                                                
                                                
                                                1,658
                                                
                                                
                                                
                                                671
                                                
                                                
                                                
                                                1,792Total
      of nonperforming loans
                                                
                                                
                                                25,446
                                                
                                                
                                                
                                                21,689
                                                
                                                
                                                
                                                3,439
                                                
                                                
                                                
                                                1,135
                                                
                                                
                                                
                                                2,497Other
      nonperforming assets
                                                
                                                
                                                8,954
                                                
                                                
                                                
                                                380
                                                
                                                
                                                
                                                197
                                                
                                                
                                                
                                                1,386
                                                
                                                
                                                
                                                346Total
      nonperforming assets
                                                
                                                $
                                                34,400
                                                
                                                
                                                $
                                                22,069
                                                
                                                
                                                $
                                                3,636
                                                
                                                
                                                $
                                                2,521
                                                
                                                
                                                $
                                                2,843Percentage
      of nonperforming assets to total assets
                                                
                                                
                                                5.33
                                                %
                                                
                                                
                                                3.66
                                                %
                                                
                                                
                                                0.61
                                                %
                                                
                                                
                                                0.55
                                                %
                                                
                                                
                                                0.71
                                                %Percentage
      of nonperforming loans to total loans
                                                
                                                
                                                8.46
                                                %
                                                
                                                
                                                4.71
                                                %
                                                
                                                
                                                0.73
                                                %
                                                
                                                
                                                0.32
                                                %
                                                
                                                
                                                0.80
                                                %Allowance
      for loan losses as a percentage of non-performing loans
                                                
                                                
                                                38.52
                                                %
                                                
                                                
                                                37.92
                                                %
                                                
                                                
                                                153.27
                                                %
                                                
                                                
                                                352.60
                                                %
                                                
                                                
                                                136.92
                                                %





Generally,
loans are placed on nonaccrual status if principal or interest payments become
90 days past due and/or we deem 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, 2009 and 2008 had been recognized on a fully accruing basis, we
would have recorded an additional $2,450,489 and $1,403,619 of interest income
for the years ended December 31, 2009 and 2008, respectively.  All
nonaccruing loans at December 31, 2009 and 2008 were included in our
classification of impaired loans at those dates.





We
implanted a number of initiatives in 2009 to strengthen credit administration to
better control, account and prepare for the increase in nonperforming assets
created by economic duress in our markets.  These initiatives
include:





·
              closing
      of newer offices with little core deposit
base;


·
              establishment
      of a distinct loss mitigation
team;


·
              formalized
      and updated our policies and procedures for loss mitigation and
      nonperforming asset
management;


·
              enhanced
      internal reporting for problem loans, monitoring, and
    grading;


·
              improved
      monitoring for potential nonperforming
loans;


·
              purchase
      of software to be installed in the second quarter of 2010 to improve our
      modeling for allowance for loan  losses;
  and


·
              enhanced
      monitoring and controls of other real estate owned to pursue the highest
      and quickest recovery
possible.


-37-


Impaired
loans - At December 31, 2009, we had impaired loans totaling $48,692,632,
as compared to $26,183,601 at December 31, 2008.  Included in the
impaired loans at December 31, 2009, were 40 borrowers that accounted for
approximately 83.32% of the total amount of the impaired loans at that
date.  These loans were primarily commercial real estate loans
isolated to the coastal regions of South Carolina.  Impaired loans, as
a percentage of total loans, were 11.97% at December 31, 2009 as compared to
5.58% at December 31, 2008.





During
the year ended December 31, 2009, the average investment in impaired loans was
$43,537,156 as compared to $8,509,024 during the year ended December 31,
2008.  Impaired loans with a specific allocation of the allowance for
loan losses totaled $17,526,321 and $20,235,727 at December 31, 2009 and 2008,
respectively.  The amount of the specific allocation at December 31,
2009 and 2008 was $3,755,475 and $3,658,653, respectively.




The
recent downturn in the real estate market has resulted in an increase in loan
delinquencies, defaults and foreclosures; however, we believe these trends are
slowing. In some cases, this downturn has resulted in a significant impairment
to the value of our collateral and ability to sell the collateral upon
foreclosure at its appraised value. However, there is a risk that these trends
could continue at a higher pace.  If real estate values continue to
decline, it is also more likely that we would be required to increase our
allowance for loan losses.





On a
monthly basis, we analyze 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.




Noninterest
Income and Expense




Noninterest
Income -The following table sets forth the principal components of
noninterest income for the years ended December 31, 2009 and 2008.





(Dollars
      in thousands)
                
                2009
                
                
                2008Service
      fees on deposit accounts
                
                $
                1,969
                
                
                $
                2,019Other
      service charges, commissions and fees
                
                
                559
                
                
                
                477Gain
      on sale of mortgage loans
                
                
                2,464
                
                
                
                1,700Gain
      on sale of securities available-for-sale
                
                
                1,877
                
                
                
                -Income
      from bank owned life insurance
                
                
                423
                
                
                
                446Other
      income
                
                
                253
                
                
                
                367Total
      noninterest income
                
                $
                7,545
                
                
                $
                5,009





Noninterest
income for 2009 was $2,535,716 higher than for 2008.  The increase is
largely attributable to the $1,876,560 gain on sale of securities
available-for-sale and to the increase in gain on sale of mortgage
loans.  The underlying available-for-sale securities were sold in
accordance with our strategy to reposition the investment portfolio in order to
maximize the yield on our investment securities.  Gain on sale of
mortgage loans was $763,466 higher for 2009 compared to 2008 as a result of the
increase in volume of residential mortgages being refinanced due to the low
interest rate environment.




Noninterest
Expense -Total noninterest
expense increased by $1,001,038, or 5.31%, to $19,852,684 in 2009 from
$18,851,646 in 2008. The increase was largely attributable to our FDIC insurance
premiums, which were $970,010 higher than the premiums for 2008 and to the
increase of approximately $497,000 in expenses relating to other real estate
owned.   Before the expense of the FDIC insurance premiums, an
expense that we feel that we have no control over, our noninterest expense for
2009 was only $31,028, or 0.16%, higher than for 2008.  This minimal
increase is the result of our continuing emphasis on expense
management.


-38-




For the
year 2009, our salary and employee expense was $148,758, or 1.46%, higher than
for the year 2008.   Occupancy expense was $1,529,844 and
$1,926,547 for the years ended December 31, 2009 and 2008,
respectively.  The decrease of $396,703 in occupancy expense is
partially attributable to the reduction in rental expenses relating to a
facility that we acquired in December of 2008 that we were formerly
leasing.  Other noninterest expense for the year 2009 was $6,856,438
compared to $5,676,096 for the year 2008.  This represented an
increase of $1,180,342, which was mainly due to the increase in our FDIC
insurance premiums and to the increase in other real estate owned
expenses.





The
following table sets forth the primary components of noninterest expense for the
years ended December 31, 2009 and 2008.





(Dollars
      in thousands)
                
                2009
                
                
                2008Salaries
      and employee benefits
                
                $
                10,330
                
                
                $
                10,181Net
      occupancy
                
                
                1,530
                
                
                
                1,927Furniture
      and equipment
                
                
                1,136
                
                
                
                1,068Advertising
                
                
                264
                
                
                
                345Office
      supplies and printing
                
                
                238
                
                
                
                237Computer
      supplies and software amortization
                
                
                257
                
                
                
                483Telephone
                
                
                262
                
                
                
                262Professional
      fees and services
                
                
                812
                
                
                
                820Meetings
      and travel expenses
                
                
                220
                
                
                
                372Supervisory
      fees and assessment
                
                
                1,349
                
                
                
                379Debit
      and credit card expenses
                
                
                357
                
                
                
                353Other
      real estate owned expenses
                
                
                545
                
                
                
                48Mortgage
      loan expenses
                
                
                665
                
                
                
                289Other
                
                
                1,888
                
                
                
                2,088Total
      noninterest expense
                
                $
                19,853
                
                
                $
                18,852Efficiency
      ratio
                
                
                81.94
                %
                
                
                78.80
                %





The
change from the income tax benefit of $459,040 for the year ended December 31,
2008, to the income tax benefit of $4,180,521 for the year ended December 31,
2009 is attributable to the net operating loss incurred before our income tax
provision and to the increase in nontaxable investment income.




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 $462,400,290 in 2009 compared to
$481,572,108 in 2008, a decrease of $19,171,818, or 3.98%.  At
December 31, 2009, total loans were $411,728,010 compared to $478,579,283 at
December 31, 2008, a decrease of $66,851,273, or 13.97%.  Excluding
loans held for sale, loans were $406,627,401 at December 31, 2009 compared to
$468,990,202 at December 31, 2008, which equated to a decrease of $62,362,801,
or 13.30%. This decrease is the result of the economic downturn in our markets
that caused the volume of new loan customers to decrease and to the $14,287,439
of loans that were charged off during the year.


-39-


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 PortfolioDecember
      31,
                
                2009
                
                
                2008
                
                
                2007(Dollars
      in thousands)
                
                
                
                
                Percent
                
                
                
                
                
                Percent
                
                
                
                
                
                PercentAmount
                
                
                of total
                
                
                Amount
                
                
                of Total
                
                
                Amount
                
                
                of TotalCommercial
      and industrial
                
                $
                45,887
                
                
                
                11.28
                %
                
                $
                70,878
                
                
                
                15.11
                %
                
                $
                67,772
                
                
                
                14.48
                %Real
      estateConstruction
                
                
                77,567
                
                
                
                19.08
                
                
                
                60,744
                
                
                
                12.95
                
                
                
                65,432
                
                
                
                13.98Mortgage-residential
                
                
                103,845
                
                
                
                25.54
                
                
                
                122,133
                
                
                
                26.04
                
                
                
                120,198
                
                
                
                25.67Mortgage-nonresidential
                
                
                169,934
                
                
                
                41.79
                
                
                
                201,318
                
                
                
                42.94
                
                
                
                195,992
                
                
                
                41.87Consumer
                
                
                7,943
                
                
                
                1.95
                
                
                
                8,974
                
                
                
                1.91
                
                
                
                11,342
                
                
                
                2.42Other
                
                
                1,452
                
                
                
                .36
                
                
                
                4,943
                
                
                
                1.05
                
                
                
                7,402
                
                
                
                1.58Total
      loans
                
                
                406,628
                
                
                
                100.00
                %
                
                
                468,990
                
                
                
                100.00
                %
                
                
                468,138
                
                
                
                100.00
                %Allowance
      for loan losses
                
                
                (9,801
                )
                
                
                
                
                
                
                (8,224
                )
                
                
                
                
                
                
                (5,271
                )Net
      loans
                
                $
                396,827
                
                
                
                
                
                
                $
                460,766
                
                
                
                
                
                
                $
                462,867





December
      31
                  
                  2006
                  
                  
                  2005(Dollars
      in thousands)
                  
                  
                  
                  
                  Percent
                  
                  
                  
                  
                  
                  PercentAmount
                  
                  
                  of Total
                  
                  
                  Amount
                  
                  
                  of TotalCommercial
      and industrial
                  
                  $
                  51,710
                  
                  
                  
                  14.63
                  %
                  
                  $
                  50,320
                  
                  
                  
                  16.15
                  %Real
      estateConstruction
                  
                  
                  64,118
                  
                  
                  
                  18.14
                  
                  
                  
                  52,268
                  
                  
                  
                  16.78Mortgage-residential
                  
                  
                  91,039
                  
                  
                  
                  25.75
                  
                  
                  
                  86,716
                  
                  
                  
                  27.83Mortgage-nonresidential
                  
                  
                  127,214
                  
                  
                  
                  35.99
                  
                  
                  
                  106,125
                  
                  
                  
                  34.06Consumer
                  
                  
                  12,729
                  
                  
                  
                  3.60
                  
                  
                  
                  13,953
                  
                  
                  
                  4.48Other
                  
                  
                  6,681
                  
                  
                  
                  1.89
                  
                  
                  
                  2,162
                  
                  
                  
                  0.70Total
      loans
                  
                  
                  353,491
                  
                  
                  
                  100.00
                  %
                  
                  
                  311,544
                  
                  
                  
                  100.00
                  %Allowance
      for loan losses
                  
                  
                  (4,002
                  )
                  
                  
                  
                  
                  
                  
                  (3,419
                  )Net
      loans
                  
                  $
                  349,489
                  
                  
                  
                  
                  
                  
                  $
                  308,125





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 our 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 our loan portfolio is real estate mortgage
loans.  At December 31, 2009, real estate mortgage loans totaled
$273,778,501 and represented 67.33% of the total loan portfolio, compared to
$323,450,913, or 68.97%, at December 31, 2008.


-40-


Residential
mortgage loans totaled $103,845,154 at December 31, 2009, and represented 25.54%
of the total loan portfolio, compared to $122,132,568 and 26.04%, respectively,
at December 31, 2008.  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
$169,933,348 at December 31, 2009, compared to $201,318,345 at December 31,
2008.  This represents a decrease of $31,384,997, or 15.59%, from the
December 31, 2008 balance.  Real estate construction loans were
$77,566,504 and $60,744,432 at December 31, 2009 and 2008, respectively, and
represented 19.08% and 12.95% of the total loan portfolio,
respectively.  The increase in our real estate construction loans is
primarily attributable to the reclassification of loans that were previously
classified as commercial and industrial loans.  Currently, the demand
for all types of real estate mortgage loans in our market area is very
weak.





Commercial
and industrial loans decreased $24,990,653, or 35.26%, to $45,887,237 at
December 31, 2009, from $70,877,890 at December 31, 2008.  The
decrease is mainly due to the economic downturn in our markets that caused the
demand for these types of loans to decrease and to the reclassification of
certain loans to real estate construction loans.





Our loan
portfolio is also comprised of consumer loans.  Consumer loans
decreased $1,031,780, or 11.50%, to $7,942,668 at December 31, 2009, from
$8,974,448 at December 31, 2008.





Our loan
portfolio reflects the diversity of its markets.  The economies of our
markets contain elements of medium and light manufacturing, higher education,
regional health care, and distribution facilities. We expect the area to remain
stable; however due to the current depressed economies of our markets, we do not
expect any material growth in the near future.  The diversity of the
economy creates opportunities for all types of lending.  We do not
engage in foreign lending.





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,
2009.





Loan
Maturity Schedule and Sensitivity to Changes in Interest Rates





Over
      One YearDecember
      31, 2009
                  
                  One
      Year or
                  
                  
                  Through
                  
                  
                  Over
      Five(Dollars
      in thousands)
                  
                  Less
                  
                  
                  Five Years
                  
                  
                  Years
                  
                  
                  TotalCommercial
      and industrial
                  
                  $
                  2,684
                  
                  
                  $
                  40,602
                  
                  
                  $
                  2,601
                  
                  
                  $
                  45,887Real
      estate
                  
                  
                  32,188
                  
                  
                  
                  254,228
                  
                  
                  
                  64,929
                  
                  
                  
                  351,345Consumer
      and other
                  
                  
                  1,047
                  
                  
                  
                  7,115
                  
                  
                  
                  1,233
                  
                  
                  
                  9,395$
                  35,919
                  
                  
                  $
                  301,945
                  
                  
                  $
                  68,763
                  
                  
                  $
                  406,627Loans
      maturing after one year with:Fixed
      interest rates
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  $
                  187,446Floating
      interest rates
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  183,262$
                  370,708





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, we believe 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
our total earning assets.  Investment securities consist of securities
available-for-sale and nonmarketable equity securities. Total securities
available-for-sale averaged $94,506,986 in 2009, compared to $60,187,152 in
2008.  Available-for-sale securities increased $45,637,928, or 59.81%,
to $121,948,744 at December 31, 2009, from $76,310,816 at December 31,
2008.  As the volume of our loans declined during 2009, we shifted our
investable funds toward investment securities.


-41-


At
December 31, 2009 and 2008, nonmarketable equity securities consist of Federal
Home Loan Bank stock, which is recorded at its original cost of $4,812,100 and
$4,574,700 at December 31, 2009 and 2008, respectively.





The
following table sets forth the fair market value of the securities
available-for-sale held by the Company at December 31, 2009 and
2008.




Fair
Value of Securities available-for-sale




December
      31,
                  
                  2009
                  
                  
                  2008(Dollars
      in thousands)U.S.
      government agencies and corporations
                  
                  $
                  3,011
                  
                  
                  $
                  88Mortgage-backed
      securities
                  
                  
                  58,133
                  
                  
                  
                  47,574Municipals
                  
                  
                  60,737
                  
                  
                  
                  28,525Other
      Securities
                  
                  
                  68
                  
                  
                  
                  124Total
      securities available-for-sale
                  
                  $
                  121,949
                  
                  
                  $
                  76,311





The
following table sets forth the scheduled maturities and average yields of
securities held at December 31, 2009.




Investment
Securities Maturity Distribution and Yields




After
      One But
                  
                  
                  After
      Five ButDecember
      31, 2009
                  
                  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
                  
                  $
                  -
                  
                  
                  
                  -
                  
                  
                  $
                  16
                  
                  
                  
                  6.32
                  %
                  
                  $
                  -
                  
                  
                  
                  -
                  %
                  
                  $
                  2,996
                  
                  
                  
                  4.17
                  %
                  
                  $
                  3,012
                  
                  
                  
                  4.19
                  %Municipals(2)
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  1,234
                  
                  
                  
                  4.35
                  
                  
                  
                  59,503
                  
                  
                  
                  6.36
                  
                  
                  
                  60,737
                  
                  
                  
                  6.32Total securities(1)
                  
                  $
                  -
                  
                  
                  
                  -
                  
                  
                  $
                  16
                  
                  
                  
                  6.32
                  %
                  
                  $
                  1,234
                  
                  
                  
                  4.35
                  %
                  
                  $
                  62,499
                  
                  
                  
                  6.26
                  %
                  
                  $
                  63,749
                  
                  
                  
                  6.22
                  %





(1)
            Excludes
      mortgage-backed securities totaling $58,132,671 with a yield of 3.96 % and
      other securities totaling $67,515.


(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.”





Interest-Bearing Deposits with Other
Banks– At December 31, 2009 and 2008, interest-bearing deposits with
other banks totaled $50,356,191 and $0, respectively.  For the years
2009 and 2008, the average balance of these deposits was $53,492,638 and $0,
respectively.





Federal Funds Sold - Federal
funds sold averaged $512,079 in 2009 compared to $2,837,541 in
2008.  At December 31, 2009 and 2008, federal funds sold totaled $0
and $257,000, respectively.




Deposits
and Other Interest-Bearing Liabilities
 
 Average
interest-bearing liabilities increased $59,842,859, or 11.82%, to $566,202,286
in 2009, from $506,359,427 in 2008.  The increase is primarily a
result of the increase in our total deposits.


-42-




Deposits -
Average total deposits increased $85,600,182, or 18.95%, to $537,225,053 in
2009, from $451,624,870 in 2008.  At December 31, 2009, total deposits
were $552,762,979 compared to $461,135,384 a year earlier, an increase of
$91,627,595, or 19.87%.





Average
interest-bearing deposits increased $84,511,697, or 20.72%, to $492,325,051 in
2009, from $407,813,354 in 2008. The
average balance of non-interest bearing deposits increased $1,088,485, or 2.48%,
to $44,900,002 in 2009, from $43,811,517 in 2008. The
following table sets forth the average balance amounts and the average rates
paid on deposits of the Company by category at December 31, 2009 and
2008.




Deposits




2009
                    
                    
                    2008Average
                    
                    
                    
                    
                    
                    AverageAverage
                    
                    
                    Rate
                    
                    
                    Average
                    
                    
                    Rate(Dollars
      in thousands)
                    
                    Amount
                    
                    
                    Paid
                    
                    
                    Amount
                    
                    
                    PaidDemand
      deposit accounts
                    
                    $
                    44,900
                    
                    
                    
                    -
                    %
                    
                    $
                    43,812
                    
                    
                    
                    -
                    %NOW
      accounts
                    
                    
                    37,516
                    
                    
                    
                    0.57
                    
                    
                    
                    28,760
                    
                    
                    
                    0.64Savings
      accounts
                    
                    
                    104,429
                    
                    
                    
                    1.67
                    
                    
                    
                    98,210
                    
                    
                    
                    2.16Time
      deposits $100,000 and over
                    
                    
                    188,744
                    
                    
                    
                    2.95
                    
                    
                    
                    164,409
                    
                    
                    
                    4.08Other
      time deposits
                    
                    
                    161,636
                    
                    
                    
                    3.11
                    
                    
                    
                    116,434
                    
                    
                    
                    3.95Total
      deposits
                    
                    $
                    537,225
                    
                    
                    
                    2.34
                    %
                    
                    $
                    451,625
                    
                    
                    
                    3.02
                    %




Core
deposits, which exclude time deposits of $100,000 or more, provide a relatively
stable funding source for our loan portfolio and other earning
assets.  Our core deposits were $357,416,788 and $323,690,517 at
December 31, 2009 and 2008, respectively.  This equates to an increase
in core deposits of $33,726,271, or 10.42%.  The increase in core
deposits resulted from successful pricing and marketing promotions.




Included
in time deposits $100,000 and over, at December 31, 2009 and 2008 are brokered
time deposits of $124,468,000 and $96,652,000, respectively.  We
anticipate being able to either renew or replace brokered deposits when they
mature, although we may not be able to replace them with deposits with the same
terms or rates.




Deposits,
and particularly core deposits, have been our primary source of funding and have
enabled us to meet successfully both our short-term and long-term liquidity
needs.  We anticipate that such deposits will continue to be our
primary source of funding in the future.  However, advances from the
Federal Home Loan Bank are being used as an alternative source of
funds.  Our loan-to-deposit ratio was 73.56% at December 31, 2009, and
101.70% at December 31, 2008.  The maturity distribution of our time
deposits over $100,000 and over at December 31, 2009, is set forth in the
following table:


-43-




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
                  
                  $
                  13,264
                  
                  
                  $
                  9,364
                  
                  
                  $
                  41,774
                  
                  
                  $
                  130,944
                  
                  
                  $
                  195,346




Maturities
of Time Deposits of $100,000 or over





Approximately
32.96% of our time deposits of $100,000 or more had scheduled maturities within
one year.  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.  We
expect most certificates of deposits with maturities less than one year to be
renewed upon maturity. However, there is the possibility that some certificates
may not be renewed.  We believe that, should that occur, the impact
would be minimal on our operations and liquidity due to the availability of
other funding sources.  We have available line to borrow funds from
the Federal Home Loan Bank up to 30% of the our total assets which provided
additional available funds of approximately $178,210,000 at December 31, 2009
and available lines to purchase federal funds with various financial
institutions up to $69,000,000 at December 31, 2009.  We believe that
these funds would be sufficient to meet future liquidity needs.





Other
Borrowings - The following table summarizes the Company's borrowings for
the years ended December 31, 2009 and 2008.  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, 2009Securities
      sold under agreement to repurchase
                    
                    $
                    7,664
                    
                    
                    $
                    2,262
                    
                    
                    
                    0.05
                    %
                    
                    $
                    598
                    
                    
                    
                    0.25
                    %Advances
      from Federal Home Loan Bank
                    
                    
                    93,500
                    
                    
                    
                    59,800
                    
                    
                    
                    3.57
                    
                    
                    
                    34,000
                    
                    
                    
                    3.17Federal
      funds purchased
                    
                    
                    11,482
                    
                    
                    
                    21
                    
                    
                    
                    0.82
                    
                    
                    
                    -
                    
                    
                    
                    -Note
      payable
                    
                    
                    6,950
                    
                    
                    
                    1,485
                    
                    
                    
                    2.01
                    
                    
                    
                    -
                    
                    
                    
                    -Junior
      subordinated debentures
                    
                    
                    10,310
                    
                    
                    
                    10,310
                    
                    
                    
                    5.95
                    
                    
                    
                    10,310
                    
                    
                    
                    5.93December
      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
                    
                    
                    
                    5.93


-44-




Capital




We,
including our banking subsidiary, 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 our consolidated financial statements.  Under
capital adequacy guidelines and the regulatory framework for prompt corrective
action, our banking subsidiary must meet specific capital guidelines that
involve quantitative measures of our assets, liabilities, and certain
off-balance sheet items as calculated under regulatory accounting
practices.  Our 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 us 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 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 regulatory minimum requirements are 4% for Tier 1
capital and 8% for total risk-based capital.





We and
our banking subsidiary 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, 2009.  The following table shows the Company's and the
Bank's ratios at December 31, 2009.




Analysis
of Capital and Capital Ratios





Company
                      
                      
                      Bank(Dollars
      in thousands)Tier
      1 capital
                      
                      $
                      54,375
                      
                      
                      $
                      50,689Tier
      2 capital
                      
                      
                      5,946
                      
                      
                      
                      5,942Total
      qualifying capital
                      
                      $
                      60,321
                      
                      
                      $
                      56,631Risk-adjusted
      total assets (including off-balance sheet exposures)
                      
                      $
                      471,831
                      
                      
                      $
                      471,501Risk-based
      capital ratios:Total
      risk-based capital ratio
                      
                      
                      12.78
                      %
                      
                      
                      12.01
                      %Tier
      1 risk-based capital ratio
                      
                      
                      11.52
                      
                      
                      
                      10.75Tier
      1 leverage ratio
                      
                      
                      8.25
                      
                      
                      
                      7.69





Impact
of Off-Balance Sheet Instruments




We are a
party to financial instruments with off-balance sheet risk in the normal course
of business to meet the financing needs of our 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.


-45-


We use
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.





We are
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, 2009, commitments to extend credit totaled $39,873,440.08 and its
standby letters of credit totaled $2,583,465.85. These Commitments include
$32,436,036.81 of credits with variable interest rates.





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,
2009.


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
                
                $
                5,054
                
                
                $
                321
                
                
                $
                14,124
                
                
                $
                19,499
                
                
                $
                20,374
                
                
                $
                39,873Standby
      letters of credit
                
                
                863
                
                
                
                75
                
                
                
                47
                
                
                
                985
                
                
                
                1,598
                
                
                
                2,583Totals
                
                $
                5,917
                
                
                $
                396
                
                
                $
                14,171
                
                
                $
                20,484
                
                
                $
                21,972
                
                
                $
                42,456




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 our service
area.  Core deposits (total deposits less time deposits greater than
$100,000) provide a relatively stable funding base, and were equal to 55.37% of
total assets at December 31, 2009.  Asset liquidity is provided from
several sources, including amounts due from banks, interest-bearing deposits
with other banks, federal funds sold, securities available for sale, and funds
from maturing loans.  At December 31, 2009, other than loan
repayments, our main sources of asset liquidity were the $53,298,486 we had in
cash and due from banks and interest-bearing deposits with other banks and our
investment of $121,948,744 in securities available-for-
sale.  However, at December 31, 2009, $115,289,760 of our
available-for-sale securities were pledged as collateral to secure public
deposits and borrowings.  As of December 31, 2009, we had available
unused short-term lines of credit to borrow up to $69,000,000 from unrelated
financial institutions as an additional source of liquidity
funding.  Additionally, we have a line of credit to borrow funds from
the Federal Home Loan Bank up to $178,210,000, of which $34,000,000 had been
drawn on this line as of December 31, 2009.


-46-


Contractual
Obligations




The
following table provides payments due by period for various contractual
obligations as of December 31, 2009:




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)
                  
                  $
                  196,336
                  
                  
                  $
                  66,293
                  
                  
                  $
                  34,656
                  
                  
                  $
                  52,436
                  
                  
                  $
                  7,405
                  
                  
                  $
                  357,126Short-term
      borrowings (2)
                  
                  
                  598
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  598Long-term
      debt (3)
                  
                  
                  21,000
                  
                  
                  
                  12,000
                  
                  
                  
                  1,000
                  
                  
                  
                  -
                  
                  
                  
                  10,310
                  
                  
                  
                  44,310Purchases
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Operating
      lease obligations (4)
                  
                  
                  364
                  
                  
                  
                  334
                  
                  
                  
                  301
                  
                  
                  
                  604
                  
                  
                  
                  5,745
                  
                  
                  
                  7,348Totals
                  
                  $
                  218,298
                  
                  
                  $
                  78,627
                  
                  
                  $
                  35,957
                  
                  
                  $
                  53,040
                  
                  
                  $
                  23,460
                  
                  
                  $
                  409,382





(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.





During
2009, our primary sources of cash were generated from the issuance of
$15,225,312 of preferred stock, net increase in deposits of $91,627,595 and the
net decrease in loans of $37,482,526.  The primary uses of our cash
resources were to fund our net loss for the year of $5,844,153, to reduce other
borrowings by $58,549,109 and to fund the net acquisition of securities
available-for sale of $45,553,690.  We believe that our overall
liquidity sources are adequate to meet our operating needs in the ordinary
course of our business.




Impact
of Inflation





Unlike
most industrial companies, the assets and liabilities of financial institutions
such as us are primarily monetary in nature.  Therefore, interest
rates have a more significant effect on our 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, we seek 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





We have
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, 2009 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.  We consider 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.


-47-


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.





Effect
of Governmental Policies





We are affected by the policies of
regulatory authorities, including Federal Reserve Board and the FDIC. An
important function of the Federal Reserve Board is to regulate the national
money supply.  Among the instruments of monetary policy used by the
Federal Reserve Board are: purchase and sale of U.S. Government securities in
the market place; changes in the discount rate, which is the rate any depository
institution must pay to from the Federal Reserve; and changes in the reserve
requirements of depository institutions. These instruments are effective in
influencing the economic and monetary growth, interest rate levels and
inflation.





The monetary policies of the Federal
Reserve Board and other governmental policies have had a significant effect on
the operating results of commercial banks in the past and are expected to
continue to do so in the future. Because of changing conditions in the national
and international economy and in the money markets, as well as the result of
actions by monetary and fiscal authorities, it is not possible to predict with
certainty future changes in interest rates, deposit levels or loan demand or
whether the changing economic conditions will have a positive or negative effect
on operations and earnings.





Legislation from time to time is
introduced into the United States Congress and the South Carolina Legislature
and other state legislatures, and regulations are proposed by the regulatory
agencies that could affect our business. It cannot be predicted whether or in
what form any of these proposals will be adopted or the extent to which our
business may be affected thereby.





ITEM
      6A.
            QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK





Pursuant to the revised disclosure
requirements for smaller reporting companies effective February 4, 2008, no
disclosure under this Item is required.




-48-


ITEM
7.           FINANCIAL
STATEMENTS AND SUPPLEMENTARY DATA




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, 2009.  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, 2009.





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.


-49-




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, 2009 and
2008, and the related consolidated statements of income (loss), changes in
shareholders’ equity and comprehensive income (loss), 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, 2009 and 2008, 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, 2009 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 29,
2010


-50-


FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY




Consolidated
Balance Sheets





December 31,2009
                
                
                2008AssetsCash
      and cash equivalents:Cash
      and due from banks
                
                $
                2,942,295
                
                
                $
                5,451,607Interest-bearing
      deposits with other banks
                
                
                50,356,191
                
                
                
                -Federal
      funds sold
                
                
                -
                
                
                
                257,000Total
      cash and cash equivalents
                
                
                53,298,486
                
                
                
                5,708,607Time
      deposits in other banks
                
                
                502,089
                
                
                
                -Securities
      available-for-sale
                
                
                121,948,744
                
                
                
                76,310,816Nonmarketable
      equity securities
                
                
                4,812,100
                
                
                
                4,574,700Total
      investment securities
                
                
                126,760,844
                
                
                
                80,885,516Loans
      held for sale
                
                
                5,100,609
                
                
                
                9,589,081Loans
      receivable
                
                
                406,627,401
                
                
                
                468,990,202Less
      allowance for loan losses
                
                
                (9,800,746
                )
                
                
                (8,223,899
                )Loans,
      net
                
                
                396,826,655
                
                
                
                460,766,303Premises,
      furniture and equipment, net
                
                
                26,469,436
                
                
                
                28,612,022Accrued
      interest receivable
                
                
                2,661,030
                
                
                
                2,653,260Other
      real estate owned
                
                
                8,954,214
                
                
                
                379,950Cash
      surrender value life insurance
                
                
                11,409,937
                
                
                
                10,986,484Other
      assets
                
                
                13,525,073
                
                
                
                4,623,726Total
      assets
                
                $
                645,508,373
                
                
                $
                604,204,949Liabilities
      and Shareholders’ EquityLiabilitiesDepositsNoninterest-bearing
      transaction accounts
                
                $
                44,298,626
                
                
                $
                39,467,609Interest-bearing
      transaction accounts
                
                
                47,733,229
                
                
                
                34,708,951Savings
                
                
                103,604,793
                
                
                
                110,629,005Time
      deposits $100,000 and over
                
                
                195,346,191
                
                
                
                137,444,867Other
      time deposits
                
                
                161,780,140
                
                
                
                138,884,952Total
      deposits
                
                
                552,762,979
                
                
                
                461,135,384Securities
      sold under agreement to repurchase
                
                
                598,342
                
                
                
                8,197,451Advances
      from Federal Home Loan Bank
                
                
                34,000,000
                
                
                
                78,000,000Note
      payable
                
                
                -
                
                
                
                6,950,000Junior
      subordinated debentures
                
                
                10,310,000
                
                
                
                10,310,000Accrued
      interest payable
                
                
                680,880
                
                
                
                623,330Other
      liabilities
                
                
                1,932,345
                
                
                
                1,563,026Total
      liabilities
                
                
                600,284,546
                
                
                
                566,779,191Commitments
      and contingencies (Notes 4, and 16)Shareholders’
      EquityPreferred
      stock, no par value, authorized 10,000,000 shares:Series
      A cumulative perpetual preferred stock 15,349 and 0 shares issued and
      outstanding at December 31, 2009 and  2008,
      respectively
                
                $
                14,536,176
                
                
                $
                -Series
      B cumulative perpetual preferred stock 767 and 0 shares issued and
      outstanding at December 31, 2009 and  2008,
      respectively
                
                
                835,960
                
                
                
                -Common
      stock, $0.01 par value; 20,000,000 shares authorized,3,582,691 and
      3,525,004 shares issued and outstanding at December 31, 2009
      and  2008, respectively
                
                
                35,827
                
                
                
                35,250Capital
      surplus
                
                
                26,181,576
                
                
                
                26,120,460Treasury
      stock, at cost, 11,535 and 10,829 shares at December 31, 2009
      and  2008, respectively
                
                
                (163,936
                )
                
                
                (159,777
                )Nonvested
      restricted stock
                
                
                (206,004
                )
                
                
                (207,653
                )Retained
      earnings
                
                
                5,269,463
                
                
                
                11,839,005Accumulated
      other comprehensive loss
                
                
                (1,265,235
                )
                
                
                (201,527
                )Total
      shareholders’ equity
                
                
                45,223,827
                
                
                
                37,425,758Total
      liabilities and shareholders’ equity
                
                $
                645,508,373
                
                
                $
                604,204,949




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




-51-


FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY




Consolidated
Statements of Income (Loss)





For
      the years endedDecember 31,2009
                
                
                2008Interest
      income:Loans,
      including fees
                
                $
                27,758,195
                
                
                $
                33,150,366Investment
      securities:Taxable
                
                
                2,199,143
                
                
                
                1,519,466Tax
      exempt
                
                
                1,904,688
                
                
                
                1,298,612Federal
      funds sold
                
                
                1,346
                
                
                
                56,343Other
      interest income
                
                
                162,165
                
                
                
                217,931Total
                
                
                32,025,537
                
                
                
                36,242,718Interest
      expense:Time
      deposits $100,000 and over
                
                
                5,576,275
                
                
                
                6,714,460Other
      deposits
                
                
                6,983,787
                
                
                
                6,905,884Other
      interest expense
                
                
                2,781,333
                
                
                
                3,678,028Total
                
                
                15,341,395
                
                
                
                17,298,372Net
      interest income
                
                
                16,684,142
                
                
                
                18,944,346Provision
      for loan losses
                
                
                14,400,652
                
                
                
                4,934,912Net
      interest income after provision for loan losses
                
                
                2,283,490
                
                
                
                14,009,434Noninterest
      income:Service
      charges on deposit accounts
                
                
                1,968,616
                
                
                
                2,018,725Gain
      on sale of mortgage loans
                
                
                2,463,628
                
                
                
                1,700,162Income
      from bank owned life insurance
                
                
                423,453
                
                
                
                446,211Other
      service charges, commissions, and fees
                
                
                559,122
                
                
                
                477,418Gain
      on sale of available-for-sale securities
                
                
                1,876,560
                
                
                
                -Gain
      (loss) on sale of other real estate
                
                
                (65,598
                )
                
                
                22,000Gain
      on sale of premises, furniture and equipment
                
                
                81,718
                
                
                
                7,091Other
                
                
                237,021
                
                
                
                337,197Total
                
                
                7,544,520
                
                
                
                5,008,804Noninterest
      expenses:Salaries
      and benefits
                
                
                10,329,908
                
                
                
                10,181,158Occupancy
                
                
                1,529,844
                
                
                
                1,926,547Furniture
      and equipment related expenses
                
                
                1,136,494
                
                
                
                1,067,845Other
      operating
                
                
                6,856,438
                
                
                
                5,676,096Total
                
                
                19,852,684
                
                
                
                18,851,646Income
      (loss) before income taxes
                
                
                (10,024,674
                )
                
                
                166,592Income
      tax expense (benefit)
                
                
                (4,180,521
                )
                
                
                (459,040
                )Net
      income(loss)
                
                
                (5,844,153
                )
                
                
                625,632Preferred
      stock dividends accrued
                
                
                689,810
                
                
                
                -Deemed
      dividends on preferred stock resulting from net accretion of discount and
      amortization of premium
                
                
                146,824
                
                
                
                -Net
      income (loss) available to common shareholders
                
                $
                (6,680,787
                )
                
                $
                625,632Average
      common shares outstanding, basic
                
                
                3,565,188
                
                
                
                3,513,201Average
      common shares outstanding, diluted
                
                
                3,565,188
                
                
                
                3,515,683Earnings
      (loss) per common share:Basic
                
                $
                (1.87
                )
                
                $
                0.18Diluted
                
                $
                (1.87
                )
                
                $
                0.18




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




-52-


FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY




Consolidated
Statements of Changes in Shareholders’ Equity and Comprehensive Income
(Loss)


For
the years ended December 31, 2009 and 2008





AccumulatedSeries
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        OtherA
      and B
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        Nonvested
                                        
                                        
                                        
                                        
                                        
                                        ComprehensivePreferred
                                        
                                        
                                        Common
                                        
                                        
                                        Capital
                                        
                                        
                                        Treasury
                                        
                                        
                                        Restricted
                                        
                                        
                                        Retained
                                        
                                        
                                        IncomeStock
                                        
                                        
                                        Stock
                                        
                                        
                                        Surplus
                                        
                                        
                                        Stock
                                        
                                        
                                        Stock
                                        
                                        
                                        Earnings
                                        
                                        
                                        (Loss)
                                        
                                        
                                        TotalBalance,December 31,
      2007
                                        
                                        $
                                        -
                                        
                                        
                                        $
                                        34,946
                                        
                                        
                                        $
                                        25,875,012
                                        
                                        
                                        $
                                        (145,198
                                        )
                                        
                                        $
                                        (152,762
                                        )
                                        
                                        $
                                        11,417,275
                                        
                                        
                                        $
                                        (1,369
                                        )
                                        
                                        $
                                        37,027,904Adjustment
      to reflect the cumulative-effect of change in accounting for life
      insurance arrangements
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        (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
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        425,474Issuance
      of stock to employees
                                        
                                        
                                        
                                        
                                        
                                        
                                        1
                                        
                                        
                                        
                                        1,009Issuance
      of restricted stock
                                        
                                        
                                        
                                        
                                        
                                        
                                        223
                                        
                                        
                                        
                                        201,163
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        (54,891
                                        )
                                        
                                        
                                        
                                        
                                        
                                        
                                        146,495Purchase
      of treasury stock
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        (14,579
                                        )
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        (14,579
                                        )Issuance
      of shares to advisory board
                                        
                                        
                                        
                                        
                                        
                                        
                                        11
                                        
                                        
                                        
                                        5,675
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        5,686Exercise
      of stock options
                                        
                                        
                                        
                                        
                                        
                                        
                                        69
                                        
                                        
                                        
                                        37,601
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        37,670Balance,
      December 31, 2008
                                        
                                        
                                        -
                                        
                                        
                                        
                                        35,250
                                        
                                        
                                        
                                        26,120,460
                                        
                                        
                                        
                                        (159,777
                                        )
                                        
                                        
                                        (207,653
                                        )
                                        
                                        
                                        11,839,005
                                        
                                        
                                        
                                        (201,527
                                        )
                                        
                                        
                                        37,425,758Issuance
      of Series A preferred stock, net of issuance cost of
    $116,786
                                        
                                        
                                        14,375,740
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        14,375,740Issuance
      of Series B preferred stock, net of issuance cost $6,902
                                        
                                        
                                        849,572
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        849,572Net
      loss
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        (5,844,153
                                        )
                                        
                                        
                                        
                                        
                                        
                                        
                                        (5,844,153
                                        )Other
      comprehensive loss, net of tax benefit of $547,971
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        (1,063,708
                                        )
                                        
                                        
                                        (1,063,708
                                        )Comprehensive
      loss
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        (6,907,861
                                        )Preferred
      stock dividends
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        (578,565
                                        )
                                        
                                        
                                        
                                        
                                        
                                        
                                        (578,565
                                        )Accretion
      of Series A Preferred stock discount
                                        
                                        
                                        160,436
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        (160,436
                                        )
                                        
                                        
                                        
                                        
                                        
                                        
                                        -Amortization
      of Series B Preferred stock premium
                                        
                                        
                                        (13,612
                                        )
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        13,612
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        -Issuance
      of stock to employees
                                        
                                        
                                        
                                        
                                        
                                        
                                        2
                                        
                                        
                                        
                                        998Issuance
      of restricted stock
                                        
                                        
                                        
                                        
                                        
                                        
                                        557
                                        
                                        
                                        
                                        53,771
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        1,649
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        55,977Issuance
      of stock to advisory board
                                        
                                        
                                        
                                        
                                        
                                        
                                        18
                                        
                                        
                                        
                                        6,347
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        6,365Purchase
      of treasury stock
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        (4,159
                                        )
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        (4,159
                                        )Balance,
      December 31, 2009
                                        
                                        $
                                        15,372,136
                                        
                                        
                                        $
                                        35,827
                                        
                                        
                                        $
                                        26,181,576
                                        
                                        
                                        $
                                        (163,936
                                        )
                                        
                                        $
                                        (206,004
                                        )
                                        
                                        $
                                        5,269,463
                                        
                                        
                                        $
                                        (1,265,235
                                        )
                                        
                                        $
                                        45,223,827





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




-53-




FIRST
RELIANCE BANCSHARES, INC. AND SUBSIDIARY




Consolidated
Statements of Cash Flows


For
      the years endedDecember 31,2009
                
                
                2008Cash
      flows from operating activities:Net
      income (loss)
                
                $
                (5,844,153
                )
                
                $
                625,632Adjustments
      to reconcile net income to net cash provided by operating
      activities:Provision
      for loan losses
                
                
                14,400,652
                
                
                
                4,934,912Depreciation
      and amortization expense
                
                
                1,120,746
                
                
                
                1,033,696Gain
      on sales of securities available-for sale
                
                
                (1,876,560
                )
                
                
                -Gain
      on sale of premises, furniture and equipment
                
                
                (81,718
                )
                
                
                (7,091
                )(Gain)
      loss on sale of other real estate owned
                
                
                65,598
                
                
                
                (22,000
                )Discount
      accretion and premium amortization
                
                
                180,643
                
                
                
                52,856Disbursements
      for mortgages held for sale
                
                
                (170,081,763
                )
                
                
                (115,615,922
                )Proceeds
      from sales of mortgages held for sale
                
                
                174,570,235
                
                
                
                125,627,691Write
      down of other real estate owned
                
                
                40,000
                
                
                
                277,000Deferred
      income tax benefit
                
                
                (2,058,704
                )
                
                
                (1,613,849
                )(Increase)
      decrease in interest receivable
                
                
                (7,770
                )
                
                
                439,507Increase
      (decrease) in interest payable
                
                
                57,550
                
                
                
                (144,247
                )Increase
      for cash surrender value of life insurance
                
                
                (423,453
                )
                
                
                (446,211
                )Amortization
      of deferred compensation on restricted stock
                
                
                55,977
                
                
                
                146,495(Increase)
      decrease in other assets
                
                
                (6,434,734
                )
                
                
                237,817Increase
      in other liabilities
                
                
                265,503
                
                
                
                647,973Net
      cash provided by operating activities
                
                
                3,948,049
                
                
                
                16,174,259Cash
      flows from investing activities:Purchases
      of securities available-for-sale
                
                
                (162,082,989
                )
                
                
                (24,151,692
                )Maturities
      of securities available-for-sale
                
                
                13,355,576
                
                
                
                6,065,064Proceeds
      on sale of securities available-for-sale
                
                
                103,173,723
                
                
                
                -Purchases
      of nonmarketable equity securities
                
                
                (237,400
                )
                
                
                (644,300
                )Increase
      in time deposits in other banks
                
                
                (502,089
                )
                
                
                -Net
      (increase) decrease in loans receivable
                
                
                37,482,526
                
                
                
                (3,389,932
                )Purchases
      of premises, furniture and equipment
                
                
                (940,373
                )
                
                
                (7,179,668
                )Proceeds
      from disposal of premises, furniture and equipment
                
                
                2,287,809
                
                
                
                24,273Proceeds
      from sale of other real estate owned
                
                
                3,376,608
                
                
                
                117,800Net
      cash used by investing activities
                
                
                (4,086,609
                )
                
                
                (29,158,455
                )Cash
      flows from financing activities:Net
      increase in demand deposits, interest-bearing transaction accounts and
      savings accounts
                
                
                10,831,083
                
                
                
                15,993,163Net
      increase (decrease) in certificates of deposit and other time
      deposits
                
                
                80,796,512
                
                
                
                (4,355,494
                )Increase
      (decreases) in advances from Federal Home Loan Bank
                
                
                (44,000,000
                )
                
                
                9,000,000Decrease
      in federal funds purchased
                
                
                -
                
                
                
                (13,359,000
                )Net
      increase (decrease) in securities sold under agreements to
      repurchase
                
                
                (7,599,109
                )
                
                
                269,697Proceeds
      from note payable
                
                
                3,950,000Repayment
      of note payable
                
                
                (6,950,000
                )
                
                
                -Net
      proceeds from issuance of preferred stock
                
                
                15,225,312
                
                
                
                -Preferred
      stock dividends paid
                
                
                (578,565
                )
                
                
                -Exercise
      of stock options
                
                
                -
                
                
                
                37,670Issuance
      of shares to employees
                
                
                1,000
                
                
                
                1,010Issuance
      of shares to advisory board
                
                
                6,365
                
                
                
                5,686Purchase
      of treasury stock
                
                
                (4,159
                )
                
                
                (14,579
                )Net
      cash provided by financing activities
                
                
                47,728,439
                
                
                
                11,528,153Net
      increase (decrease) in cash and cash equivalents
                
                
                47,589,879
                
                
                
                (1,456,043
                )Cash
      and cash equivalents, beginning of year
                
                
                5,708,607
                
                
                
                7,164,650Cash
      and cash equivalents, end of year
                
                $
                53,298,486
                
                
                $
                5,708,607Cash
      paid during the year for:Income
      taxes
                
                $
                4,257
                
                
                $
                1,404,499Interest
                
                $
                15,283,845
                
                
                $
                17,442,619Supplemental
      noncash investing and financing activities:Foreclosures
      on loans
                
                $
                12,056,470
                
                
                $
                555,800




-54-





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, 2009, 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.


-55-




NOTE 1 -
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - continued




The
Company’s investment portfolio consists principally of obligations of the United
States and its agencies or its corporations and obligations of state and local
governments.  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.





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, 2009 and 2008, the
Company’s investment in Federal Home Loan Bank stock was $4,812,100 and
$4,574,700, respectfully. Dividends received on this stock are included as a
separate component of interest income.





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 and are included in gain on sale
of mortgage loans in the consolidated statements of 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.




-56-




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.





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.





Other
Real Estate Owned - Other real estate owned includes real estate acquired
through foreclosure.  Other real estate owned is carried at fair
market 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 and subsequent changes in
the valuation allowance are included in other noninterest expenses, while gains
and losses on disposal are included in noninterest income.





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 - Provisions for income taxes are based on taxes payable or
refundable for the current year and deferred taxes on temporary differences
between the amount of taxable income and pretax financial income and between the
tax bases of assets and liabilities and their reported amounts in the financial
statements. Deferred tax assets and liabilities are included in the financial
statements at currently enacted income tax rates applicable to the period in
which the deferred tax assets and liabilities are expected to be realized or
settled. As changes in tax laws or rates are enacted, deferred tax assets and
liabilities are adjusted through the provision for income taxes. In addition,
deferred tax assets are reduced by a valuation allowance when, in the opinion of
management, it is more likely than  not that some portion or all of
the deferred tax assets will not be realized.  Interest and penalties
related to income tax matters is recognized in income tax
expense.


-57-





NOTE 1 -
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - continued





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
$264,422 and $345,389 were included in the Company's results of operations for
2009 and 2008, 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 $153,597 and $121,972 to earnings for the retirement savings plan in
2009 and 2008, 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 2009 and 2008 the
supplemental retirement expense was $152,659 and $237,000,
respectively.  The current accrued but unfunded amount is $726,580 and
$598,377 at December 31, 2009 and 2008, 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 $11,409,937 and $10,986,484 at December 31, 2009 and 2008,
respectively.





Effective
January 1, 2008, the Company changed its method of accounting for its
split-dollar life insurance arrangements, which resulted in a cumulative-effect
adjustment to retained earnings of $203,902.  As of December 31, 2009
and 2008, the split-dollar liability totaled $230,833 and $216,647, respectively
and the related expense for 2009 and 2008 was $14,186 and $12,745,
respectively.





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 Notes 17 and 18.





Stock-Based
Compensation-Compensation cost for all stock-based awards is measured at fair value
on date of grant and recognized over the service period for awards expected to
vest. Such value is recognized as expense over the service period.


-58-


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, 2009, the 404 (c) owned 196,282 shares of
the Company’s common stock with an estimated value of $724,430.  At
December 31, 2008, the 404 (c) owned 143,240 shares of the Company’s common
stock with an estimated value of $928,086.  All of these shares were
allocated.  Contributions to the 404 (c) in 2009 and 2008 were
$153,597 and $121,972, respectively.





Earnings
(Loss) Per Share - Basic earnings (loss) per share represents income
(loss) available to common shareholders divided by the weighted-average number
of common shares outstanding during the period.  Diluted earnings
(loss) 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
19).





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:





TaxPre-tax
                
                
                (Expense)
                
                
                Net-of-taxAmount
                
                
                Benefit
                
                
                AmountFor
      the Year Ended December 31, 2009:Net
      unrealized gains on securities available-for-sale arising during the
      period
                
                $
                264,881
                
                
                $
                (90,059
                )
                
                $
                174,822Less,
      reclassification adjustment for net (gains) realized in net
      income
                
                
                (1,876,560
                )
                
                
                638,030
                
                
                
                (1,238,530
                )$
                (1,611,679
                )
                
                $
                547,971
                
                
                $
                (1,063,708
                )For
      the Year Ended December 31, 2008:Net
      unrealized (losses) on securities available-for-sale arising during the
      period
                
                $
                (303,270
                )
                
                $
                103,112
                
                
                $
                (200,158
                )Less,
      reclassification adjustment for net (gains) realized in net
      income
                
                
                -
                
                
                
                -
                
                
                
                -$
                (303,270
                )
                
                $
                103,112
                
                
                $
                (200,158
                )





Derivative
Instruments - 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.


-59-


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 an original 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 pronouncements:





In June
2009, the Financial Accounting Standards Board (“FASB”) issued guidance which
restructured generally accepted accounting principles (“GAAP”) and simplified
access to all authoritative literature by providing a single source of
authoritave nongovernmental GAAP.  The guidance is presented in a
topically organized structure referred to as the FASB Accounting Standards
Codification (“ASC”). The new structure is effective for interim or annual
periods ending after September 15, 2009. All existing accounting standards have
been superseded and all other accounting literature not included is considered
nonauthoritative.





The FASB
issued new accounting guidance on accounting for transfers of financial assets
in June 2009.  The guidance limits the circumstances in which a
financial asset should be derecognized when the transferor has not transferred
the entire financial asset by taking into consideration the transferor’s
continuing involvement.  The standard requires that a transferor
recognize and initially measure at fair value all assets obtained (including a
transferor’s beneficial interest) and liabilities incurred as a result of a
transfer of financial assets accounted for as a sale.  The concept of
a qualifying special-purpose entity is no longer applicable.  The
standard is effective for the first annual reporting period that begins after
November 15, 2009, for interim periods within the first annual reporting period,
and for interim and annual reporting periods thereafter.  Earlier
application is prohibited.  The Company does not expect the guidance
to have any impact on the Company’s financial statements.  The ASC was
amended in December 2009, to include this guidance.





Guidance
was issued in June 2009 requiring a company to analyze whether its interest in a
variable interest entity (“VIE”) gives it a controlling financial interest that
should be included in consolidated financial statements.  A company
must assess whether it has an implicit financial responsibility to ensure that
the VIE operates as designed when determining whether it has the power to direct
the activities of the VIE that significantly impact its economic performance,
making it the primary beneficiary.  Ongoing reassessments of whether a
company is the primary beneficiary are also required by the
standard.  This guidance amends the criteria to qualify as a primary
beneficiary as well as how to determine the existence of a VIE.  The
standard also eliminates certain exceptions that were previously
available.  This guidance is effective as of the beginning of each
reporting entity’s first annual reporting period that begins after November 15,
2009, for interim periods within that first annual reporting period, and for
interim and annual reporting periods thereafter.  Earlier application
is prohibited.  Comparative disclosures will be required for periods
after the effective date.  The Company does not expect the guidance to
have any impact on the Company’s financial position.  An update was
issued in December, 2009, to include this guidance in the
ASC.


-60-


NOTE 1 -
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - continued





Recently
Issued Accounting Pronouncements - continued





In
October 2009, updated guidance was issued to provide for accounting and
reporting for own-share lending arrangements issued in contemplation of a
convertible debt issuance.  At the date of issuance, a share-lending
arrangement entered into on an entity’s own shares should be measured at fair
value in accordance with prior guidance and recognized as an issuance cost, with
an offset to additional paid-in capital.  Loaned shares are excluded
from basic and diluted earnings per share unless default of the share-lending
arrangement occurs.  The amendment also requires several disclosures
including a description and the terms of the arrangement and the reason for
entering into the arrangement.  The effective dates of the amendment
are dependent upon the date the share-lending arrangement was entered into and
include retrospective application for arrangements outstanding as of the
beginning of fiscal years beginning on or after December 15,
2009.   The Company has no plans to issue convertible debt and,
therefore, does not expect the update to have an impact on its financial
statements.





In
January 2010, guidance was issued to alleviate diversity in the accounting for
distributions to shareholders that allow the shareholder to elect to receive
their entire distribution in cash or shares but with a limit on the aggregate
amount of cash to be paid.  The amendment states that the stock
portion of a distribution to shareholders that allows them to elect to receive
cash or shares with a potential limitation on the total amount of cash that all
shareholders can elect to receive in the aggregate is considered a share
issuance.  The amendment is effective for interim and annual periods
ending on or after December 15, 2009 and had no impact on the Company’s
financial statements.





Also in
January 2010, an amendment was issued to clarify the scope of subsidiaries for
consolidation purposes.  The amendment provides that the decrease in
ownership guidance should apply to (1) a subsidiary or group of assets that is a
business or nonprofit activity, (2) a subsidiary that is a business or nonprofit
activity that is transferred to an equity method investee or joint venture, and
(3) an exchange of a group of assets that constitutes a business or nonprofit
activity for a noncontrolling interest in an entity.  The guidance
does not apply to a decrease in ownership in transactions related to sales of in
substance real estate or conveyances of oil and gas mineral
rights.  The update is effective for the interim or annual reporting
periods ending on or after December 15, 2009 and had no impact on the Company’s
financial statements.





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 2008 consolidated financial statements
were reclassified to conform with the 2009 presentation.  The
reclassifications did not have an impact on net income or shareholders’
equity.


-61-





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, 2009 and 2008, 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, 2009U.S.
      Government agencies
                
                $
                3,021,782
                
                
                $
                751
                
                
                $
                11,167
                
                
                $
                3,011,366Mortgage-backed
      securities
                
                
                59,324,978
                
                
                
                -
                
                
                
                1,192,307
                
                
                
                58,132,671Municipals
                
                
                61,300,256
                
                
                
                460,262
                
                
                
                1,023,326
                
                
                
                60,737,192Other
                
                
                218,750
                
                
                
                -
                
                
                
                151,235
                
                
                
                67,515$
                123,865,766
                
                
                $
                461,013
                
                
                $
                2,378,035
                
                
                $
                121,948,744December
      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
                
                
                $
                76,310,816





The
following is a summary of maturities of securities available-for-sale as of
December 31, 2009.  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
      after one year but within five years
                
                $
                14,986
                
                
                $
                15,737Due
      after five years but with ten years
                
                
                1,215,283
                
                
                
                1,233,781Due
      after ten years
                
                
                63,091,769
                
                
                
                62,499,04064,322,038
                
                
                
                63,748,558Mortgage-backed
      securities
                
                
                59,324,978
                
                
                
                58,132,671Other
                
                
                218,750
                
                
                
                67,515Total
                
                $
                123,865,766
                
                
                $
                121,948,744





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, 2009 and
2008.


-62-


NOTE 3 -
INVESTMENT SECURITIES - continued





December 31, 2009
                
                
                December 31, 2008Fair
                
                
                Unrealized
                
                
                Fair
                
                
                UnrealizedValue
                
                
                Losses
                
                
                Value
                
                
                LossesLess
      Than 12 MonthsU.S.
      government agencies and corporations
                
                $
                2,995,629
                
                
                $
                11,167
                
                
                $
                87,997
                
                
                $
                16Mortgage-backed
      securities
                
                
                58,132,671
                
                
                
                1,192,307
                
                
                
                -
                
                
                
                -Municipals
                
                
                27,850,269
                
                
                
                688,885
                
                
                
                16,846,808
                
                
                
                836,446Other
                
                
                -
                
                
                
                -
                
                
                
                124,300
                
                
                
                94,45088,978,569
                
                
                
                1,892,359
                
                
                
                17,059,105
                
                
                
                930,91212
      Months or MoreMunicipals
                
                
                4,314,797
                
                
                
                334,441
                
                
                
                3,719,646
                
                
                
                637,833Other
                
                
                67,515
                
                
                
                151,235
                
                
                
                -
                
                
                
                -4,382,312
                
                
                
                485,676
                
                
                
                3,719,646
                
                
                
                637,833Total
      securities available-for-sale
                
                $
                93,360,881
                
                
                $
                2,378,035
                
                
                $
                20,778,751
                
                
                $
                1,568,745





At
December 31, 2009, securities classified as available-for-sale are recorded at
fair market value.  Approximately 20.42% of the unrealized losses, or
10 individual securities, consisted of securities in a continuous loss position
for twelve months or more.  The Company does not intend to sell these
securities and it is more likely than not that the Company will not be required
to sell these securities before recovery of their amortized cost. 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.





During
2009, gross proceeds from the sale of available-for-sale securities were
$103,173,723.  Gains on available-for-sale securities totaled
$1,876,560 for the year ended December 31, 2009.  There were no sales
of investment securities for the year ended December 31, 2008.





At
December 31, 2009 and 2008, investment securities with a par value of
$115,152,339 and $74,210,000 and a fair market value of $115,289,760 and
$73,204,733, respectively, were pledged as collateral to secure public deposits
and borrowings.





NOTE 4 - LOANS
RECEIVABLE




Major
classifications of loans receivable are summarized as follows:





December 31,2009
                
                
                2008Mortgage
      loans on real estate:Residential
      1-4 family
                
                $
                57,539,371
                
                
                $
                72,245,289Multifamily
                
                
                9,962,625
                
                
                
                7,104,889Commercial
                
                
                169,933,348
                
                
                
                201,318,345Construction
                
                
                77,566,504
                
                
                
                60,744,432Second
      mortgages
                
                
                4,746,686
                
                
                
                4,989,538Equity
      lines of credit
                
                
                31,596,471
                
                
                
                37,792,852351,345,005
                
                
                
                384,195,345Commercial
      and industrial
                
                
                45,887,237
                
                
                
                70,877,890Consumer
                
                
                7,942,668
                
                
                
                8,974,448Other
                
                
                1,452,491
                
                
                
                4,942,519Total
      gross loans
                
                $
                406,627,401
                
                
                $
                468,990,202Included
      in the gross loans above are:Nonaccrual
      loans
                
                $
                25,406,383
                
                
                $
                19,591,982Loans
      past due 90 days still accruing interest
                
                
                40,197
                
                
                
                2,097,426


-63-





NOTE 4 -
LOANS RECEIVABLE-continued





The
Company has pledged certain loans as collateral to secure its borrowings from
the Federal Home Loan Bank.  The total of loans pledged was
$130,335,153 at December 31, 2009.





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, 2009 and 2008.





2009
                
                
                2008Impaired
      loans with specific allowance
                
                $
                17,526,321
                
                
                $
                20,235,727Impaired
      loans with no specific allowance
                
                
                31,166,311
                
                
                
                5,947,874Total
      impaired loans – year end
                
                $
                48,692,632
                
                
                $
                26,183,601Related
      specific allowance – year end
                
                $
                3,755,475
                
                
                $
                3,658,653Average
      recorded investment in impaired loans – for the year ended
                
                
                43,537,156
                
                
                
                8,509,024Impaired
      loans included in nonaccrual
                
                
                25,406,383
                
                
                
                19,591,982Troubled
      debt restructurings
                
                
                420,033
                
                
                
                566,161





Interest
income on impaired loans other than nonaccrual loans is recognized on an accrual
basis.  Interest income on nonaccrual loans is recognized only as
collected.  During 2009 and 2008, interest income recognized on
nonaccrual loans was $533,774 and $568,735, respectively.  If the
nonaccrual loans had been accruing interest at their original contracted rates,
related income would have been $2,984,263 and $1,972,354 for 2009 and 2008,
respectively.





Transactions
in the allowance for loan losses are summarized below:





For
      the years endedDecember 31,2009
                  
                  
                  2008Balance,
      beginning of year
                  
                  $
                  8,223,899
                  
                  
                  $
                  5,270,607Provision
      charged to operations
                  
                  
                  14,400,652
                  
                  
                  
                  4,934,912Recoveries
      on loans previously charged-off
                  
                  
                  1,463,634
                  
                  
                  
                  386,017Loans
      charged-off
                  
                  
                  (14,287,439
                  )
                  
                  
                  (2,367,637
                  )Balance,
      end of year
                  
                  $
                  9,800,746
                  
                  
                  $
                  8,223,899





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 2009 totaled $162,182,388.  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.


-64-





NOTE 4 -
LOANS RECEIVABLE-continued




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 31,2009
                        
                        
                        2008Commitments
      to extend credit
                        
                        $
                        39,873,440
                        
                        
                        $
                        53,812,183Standby
      letters of credit
                        
                        
                        2,583,466
                        
                        
                        
                        3,006,214





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, 2009 and 2008,
the Company has no material embedded derivative instruments requiring separate
accounting treatment.  At December 31, 2009 and 2008, the amount of
the forward sales commitments approximates the carrying value of the mortgage
loans held for sale of $5,100,609 and $9,589,081, 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 31,2009
                      
                      
                      2008Land
                      
                      $
                      10,832,561
                      
                      
                      $
                      13,032,561Building
                      
                      
                      13,659,425
                      
                      
                      
                      13,645,412Leasehold
      improvements
                      
                      
                      511,842
                      
                      
                      
                      145,497Furniture
      and equipment
                      
                      
                      5,334,402
                      
                      
                      
                      5,045,108Construction
      in progress
                      
                      
                      831,484
                      
                      
                      
                      575,979Total
                      
                      
                      31,169,714
                      
                      
                      
                      32,444,557Less,
      accumulated depreciation
                      
                      
                      4,700,278
                      
                      
                      
                      3,832,535Premises
      and equipment, net
                      
                      $
                      26,469,436
                      
                      
                      $
                      28,612,022





Depreciation
expense for the years ended December 31, 2009 and 2008 amounted to $876,868 and
$784,210, respectively.





At
December 31, 2009 and 2008, construction in progress consists mainly of
architect fees and site work for potential new branches.  As of
December 31, 2009, there were no material commitments outstanding for the
construction/or purchase of premises, furniture and equipment.





During
2009, gross proceeds of $2,286,810 were received from the sale of land, which
resulted in a gain of $86,810.  Other premises, furniture and
equipment were sold for $999, resulting in a net loss of
$5,092.  During 2008, gross proceeds of $24,273 were received from the
sale of premises, furniture and equipment, resulting in a net gain of
$7,091.


-65-


NOTE 6 - OTHER REAL ESTATE
OWNED





Transactions
in other real estate owned for the years ended December 31, 2009 and 2008 are
summarized below:





December 31,2009
                    
                    
                    2008Balance,
      beginning of year
                    
                    $
                    379,950
                    
                    
                    $
                    196,949Additions
                    
                    
                    12,056,470
                    
                    
                    
                    555,800Sales
                    
                    
                    (3,442,206
                    )
                    
                    
                    (266,409
                    )Write
      downs
                    
                    
                    (40,000
                    )
                    
                    
                    (106,750
                    )Balance,
      end of year
                    
                    $
                    8,954,214
                    
                    
                    $
                    379,950





The
Company recognized a net loss of $65,598 on the sale other real estate owned for
the year ended December 31, 2009.  For the year ended December 31,
2008, the Company recognized a net gain of $22,000 on the sale of other real
estate owned.





NOTE 7 -
DEPOSITS





At
December 31, 2009, the scheduled maturities of time deposits were as
follows:





Maturing In
                  
                  Amount2010
                  
                  $
                  196,335,7772011
                  
                  
                  66,292,8382012
                  
                  
                  34,655,5042013
                  
                  
                  35,283,7202014
                  
                  
                  17,153,492Thereafter
                  
                  
                  7,405,000Total
                  
                  $
                  357,126,331




Included
in total time deposits at December 31, 2009 and 2008 were brokered time deposits
of $124,468,000 and $96,652,000, respectively.





NOTE 8 – 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 31,2009
                  
                  
                  2008Balance
      at end of the year
                  
                  $
                  598,342
                  
                  
                  $
                  8,197,451Maximum
      month-end balance during the year
                  
                  
                  7,663,558
                  
                  
                  
                  9,290,691Average
      balance during the year
                  
                  
                  2,261,509
                  
                  
                  
                  7,844,809Average
      interest rate at the end of the year
                  
                  
                  0.25
                  %
                  
                  
                  0.25
                  %Average
      interest rate during the year
                  
                  
                  0.05
                  %
                  
                  
                  1.54
                  %





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, 2009 and
2008, the par value and market value of the securities held by the third-party
for the underlying agreements were $1,305,000 and $13,240,000, respectively, and
$1,262,601 and $12,713,996, respectively.


-66-


NOTE 9 - ADVANCES FROM
FEDERAL HOME LOAN BANK





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





December 31,Description
                
                Interest Rate
                
                
                2009
                
                
                2008Fixed
      rate advances maturing:January
      22, 2009
                
                
                2.88
                %
                
                $
                -
                
                
                $
                4,000,000March
      09, 2009
                
                
                4.94
                %
                
                
                -
                
                
                
                6,000,000May
      28, 2009
                
                
                2.96
                %
                
                
                -
                
                
                
                5,000,000May
      29, 2009
                
                
                4.08
                %
                
                
                -
                
                
                
                8,000,000July
      30, 2009
                
                
                2.87
                %
                
                
                -
                
                
                
                5,500,000August
      13, 2009
                
                
                2.59
                %
                
                
                -
                
                
                
                3,000,000November
      5, 2009
                
                
                2.76
                %
                
                
                -
                
                
                
                5,000,000November
      30, 2009
                
                
                4.03
                %
                
                
                -
                
                
                
                9,000,000January
      5, 2010
                
                
                1.13
                %
                
                
                5,000,000
                
                
                
                -January
      26, 2010
                
                
                1.14
                %
                
                
                2,000,000
                
                
                
                -April
      8, 2010
                
                
                2.66
                %
                
                
                1,000,000
                
                
                
                1,000,000November
      5, 2010
                
                
                3.46
                %
                
                
                5,000,000
                
                
                
                5,000,000November
      29, 2010
                
                
                4.11
                %
                
                
                8,000,000
                
                
                
                8,000,000January
      26, 2011
                
                
                2.02
                %
                
                
                2,000,000
                
                
                
                -November
      7, 2011
                
                
                3.89
                %
                
                
                10,000,000
                
                
                
                10,000,000Variable
      rate advances maturing:March
      19, 2009
                
                
                2.48
                %
                
                
                -
                
                
                
                3,000,000July
      5, 2012
                
                
                4.08
                %
                
                
                1,000,000
                
                
                
                1,000,000Daily
      variable rate advances maturing:Daily
                
                Variable
                
                
                
                -
                
                
                
                4,500,000$
                34,000,000
                
                
                $
                78,000,000





Scheduled
principal reductions of Federal Home Loan Bank advances as of December 31, 2009
are as follows:




Amount2010
                  
                  $
                  21,000,0002011
                  
                  
                  12,000,0002012
                  
                  
                  1,000,000Total
                  
                  $
                  34,000,000





The
Company has pledged certain loans as collateral to secure its borrowings from
the Federal Home Loan Bank.  The total of loans pledged was
$130,335,153 and $142,883,621 at December 31, 2009 and 2008,
respectively.  At December 31, 2009 and 2008, investment securities
with a par value of $56,162,339 and $45,000,000 and a fair market value of
$58,132,671 and $45,300,859, 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.


-67-





NOTE
10 -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 accounting literature, 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 11 – NOTE
PAYABLE





At
December 31, 2008, note payable consisted of a $20,000,000 revolving line of
credit.  The outstanding balance on the credit line was $6,950,000 at
that date.  On March 20, 2009, the outstanding balance was paid and
the line of credit was terminated.





NOTE 12 –
SHAREHOLDERS’ EQUITY





Common
Stock–The
following is a summary of the changes in common shares outstanding for the years
ended December 31, 2009 and 2008.





For
      years endedDecember 31,2009
                
                
                2008Common
      shares outstanding at beginning of the period
                
                
                3,525,004
                
                
                
                3,494,646Issuance
      of restricted shares
                
                
                62,222
                
                
                
                22,275Forfeitures
      of restricted shares
                
                
                (6,503
                )
                
                
                -Issuance
      of stock to employees
                
                
                200
                
                
                
                100Issuance
      of stock to advisory board
                
                
                1,768
                
                
                
                1,083Exercise
      of stock options
                
                
                -
                
                
                
                6,900Common
      shares outstanding at end of the period
                
                
                3,582,691
                
                
                
                3,525,004





Preferred
Stock-On
February 24, 2009, the Company’s Articles of Incorporation were amended to
authorize the issuance of a class of 10,000,000 shares of preferred stock,
having no par value.  Subject to certain conditions, the amendment
authorizes the Company’s Board of Directors to issue preferred stock without
shareholders’ approval.  Under this amendment, the Board is authorized
to determine the terms of one or more series of preferred stock, including the
preferences, rights, and limitations of each series.




On March
6, 2009, the Company completed a transaction with the United States Treasury
(“Treasury”) under the Troubled Asset Relief Program Capital Purchase Program
(“TARP CPP”), which was amended by the enactment of the American Recovery and
Reinvestment Act of 2009 on February 17, 2009.   Under the TARP
CPP, the Company sold 15,349 shares of its Series A Cumulative Perpetual
Preferred Stock.  In addition, the Treasury received a warrant to
purchase 767 shares of the Company’s Series B Cumulative Perpetual Preferred
Stock, which was immediately exercised by the Treasury for a nominal exercise
price.  The preferred shares issued to the Treasury qualify as tier 1
capital for regulatory purposes.




The
Series A Preferred Stock is a senior cumulative perpetual preferred stock that
has a liquidation preference of $1,000 per share, pays cumulative dividends at a
rate of 5% per year for the first five years and thereafter at a rate of 9% per
year.  Dividends are payable quarterly.  At any time, the
Company may, at its option and with regulatory approval, redeem the Series A
Preferred Stock at par value plus accrued and unpaid dividends.  The
Series A Preferred Stock is generally non-voting. Prior to March 6, 2012, unless
the Company has redeemed the Series A Preferred Stock or the Treasury has
transferred the Series A Preferred Stock to a third party, the consent of the
Treasury will be required for the Company to increase its common stock dividend
or repurchase its common stock  or other equity or capital securities,
other than in connection with benefit plans consistent with past practices and
certain other circumstances. A consequence of the Series A Preferred Stock
purchase includes certain restrictions on executive compensation that could
limit the tax deductibility of compensation the Company pays to executive
management.


-68-




NOTE 11 –
NOTES PAYABLE-continued




The
Series B Preferred Stock is a cumulative perpetual preferred stock that has the
same rights, preferences, privileges, voting rights and other terms as the
Series A Preferred Stock, except that dividends will be paid at the rate of 9%
per year and may not be redeemed until all the Series A Preferred Stock has been
redeemed.




The
proceeds from the issuance of the Series A and Series B were allocated based on
the relative fair value of each series based on a discounted cash flow
model.  As a result of the valuations, $14,492,526 and $856,474 was
allocated to the Series A Preferred Stock and Series B Preferred Stock,
respectively.  This resulted in a discount of $973,260 for the Series
A stock and a premium of $82,572 for the Series B stock.  The discount
and premium are being accreted and amortized, respectively, through retained
earnings over a five-year estimated life using the effective interest
method.  For the year ended December 31, 2009, accretion of the Series
A Preferred Stock discount totaled $160,436 and the amortization of the Series B
Preferred Stock premium totaled $13,612.  The net amount of the
accretion and amortization was treated as a deemed dividend to preferred
shareholders in the computation of earnings per share.





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, 2009, the Bank had
undivided profits of $7,154,328. 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 13- OTHER OPERATING
EXPENSE





Other
operating expenses are summarized below:





For
      the years endedDecember 31,2009
                  
                  
                  2008Advertising
                  
                  $
                  264,422
                  
                  
                  $
                  345,389Office
      supplies and printing
                  
                  
                  238,469
                  
                  
                  
                  236,940Computer
      supplies and software amortization
                  
                  
                  256,528
                  
                  
                  
                  482,577Telephone
                  
                  
                  261,874
                  
                  
                  
                  261,604Professional
      fees and services
                  
                  
                  811,756
                  
                  
                  
                  819,835Meetings
      and travel expenses
                  
                  
                  220,261
                  
                  
                  
                  372,418Supervisory
      fees and assessments
                  
                  
                  1,348,914
                  
                  
                  
                  378,904Debit
      and credit card expenses
                  
                  
                  357,343
                  
                  
                  
                  352,731Other
      real estate owned expenses
                  
                  
                  543,925
                  
                  
                  
                  48,439Mortgage
      loan expenses
                  
                  
                  664,715
                  
                  
                  
                  288,796Other
                  
                  
                  1,888,231
                  
                  
                  
                  2,088,463Total
                  
                  $
                  6,856,438
                  
                  
                  $
                  5,676,096


-69-





NOTE 14 - INCOME
TAXES





Income
tax expense is summarized as follows:





For
      the years endedDecember 31,2009
                  
                  
                  2008Currently
      payableFederal
                  
                  $
                  (2,669,788
                  )
                  
                  $
                  1,018,874State
                  
                  
                  -
                  
                  
                  
                  32,823Total
      current
                  
                  
                  (2,669,788
                  )
                  
                  
                  1,051,697Deferred
      income taxes
                  
                  
                  (2,058,704
                  )
                  
                  
                  (1,613,849
                  )Total
      income tax expense (benefit)
                  
                  $
                  (4,728,492
                  )
                  
                  $
                  (562,152
                  )Income
      tax expense (benefit) is allocated as follows:To
      continuing operations
                  
                  $
                  (4,180,521
                  )
                  
                  $
                  (459,040
                  )To
      shareholders' equity
                  
                  
                  (547,971
                  )
                  
                  
                  (103,112
                  )Total
      income tax expense (benefit)
                  
                  $
                  (4,728,492
                  )
                  
                  $
                  (562,152
                  )





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





December 31,2009
                                
                                
                                2008Deferred
      tax assets:Allowance
      for loan losses
                                
                                $
                                3,217,100
                                
                                
                                $
                                2,594,609Net
      operating losses
                                
                                
                                411,779
                                
                                
                                
                                93,771Non-accrual
      interest
                                
                                
                                1,154,314
                                
                                
                                
                                483,766Unrealized
      loss on securities available for sale
                                
                                
                                651,788
                                
                                
                                
                                103,817Deferred
      compensation
                                
                                
                                393,929
                                
                                
                                
                                313,588Other
                                
                                
                                57,592
                                
                                
                                
                                71,210Gross
      deferred tax assets
                                
                                
                                5,886,502
                                
                                
                                
                                3,660,761Less,
      valuation allowance
                                
                                
                                (113,872
                                )
                                
                                
                                (93,771
                                )Net
      deferred tax assets
                                
                                
                                5,772,630
                                
                                
                                
                                3,566,990Deferred
      tax liabilities:Accumulated
      depreciation
                                
                                $
                                516,122
                                
                                
                                $
                                361,336Prepaid
      expenses
                                
                                
                                100,371
                                
                                
                                
                                93,002Other
                                
                                
                                47,144
                                
                                
                                
                                62,363Total
      gross deferred tax liabilities
                                
                                
                                663,637
                                
                                
                                
                                516,701Net
      deferred tax asset recognized
                                
                                $
                                5,108,993
                                
                                
                                $
                                3,050,289





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, 2009, 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, 2009 and 2008.


-70-


NOTE 14 –
INCOME TAXES-continued





The
Company has federal net operating losses of $876,197 and $0 for the years ended
December 31, 2009 and 2008, respectively.  The Company has state net
operating losses of $3,450,672 and $2,841,542 for the years ended December 31,
2009 and 2008, respectively.





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




For
      the years endedDecember 31,2009
                  
                  
                  2008Tax
      expense (benefit) at statutory rate
                  
                  $
                  (3,408,389
                  )
                  
                  $
                  56,641State
      income tax, net of federal income tax benefit
                  
                  
                  -
                  
                  
                  
                  21,663Tax-exempt
      interest income
                  
                  
                  (647,594
                  )
                  
                  
                  (441,528
                  )Disallowed
      interest expense
                  
                  
                  64,852
                  
                  
                  
                  57,486Life
      insurance surrender value
                  
                  
                  (143,974
                  )
                  
                  
                  (151,712
                  )Other,
      net
                  
                  
                  (45,416
                  )
                  
                  
                  (1,590
                  )$
                  (4,180,521
                  )
                  
                  $
                  (459,040
                  )





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





NOTE 15 - 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, 2009 and 2008,
the Company had related party loans totaling $3,023,889 and $3,072,354
respectively. During 2009, $2,045,991 of advances were made to related parties
and repayments totaled $2,094,456.  As of December 31, 2009, all
related party loans were current.





Deposits
from directors and executive officers and their related interests totaled
$1,477,828 and $2,262,296 at December 31, 2009 and 2008,
respectively.





In 2009
and 2008 real estate commissions of $73,500 and $175,393, respectively, were
paid to a director of the Company in the normal course of business.





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 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 were $281,004.


-71-


NOTE 16 - 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, 2009, 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, 2009 and 2008 were $386,921 and
$638,839, respectively.





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:




2010
                  
                  $
                  364,2552011
                  
                  
                  333,8062012
                  
                  
                  301,2282013
                  
                  
                  301,9062014
                  
                  
                  301,906Thereafter
                  
                  
                  5,745,122$
                  7,348,223




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.





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
2009 and 2008, the Company issued 62,222 and 22,275 shares, respectively, of
restricted stock pursuant to the 2006 Equity Incentive Plan.  The
shares cliff vest in three years, and are fully vested in 2012 and 2011,
respectively.  The weighted-average fair value of restricted stock
issued during 2009 and 2008 was $2.25 and $9.04,
respectively.  Compensation cost associated with the issuances was
$139,999 and $201,385 for the years ended December 31, 2009 and 2008,
respectively.  During 2009, 6,503 shares were forfeited having a
weighted average  price of $13.17.  There were no restricted
stock forfeitures during 2008.  Compensation cost amortized to expense
for 2009 and 2008 was $55,977 and $146,495, respectively.


-72-





NOTE 17 -
EQUITY INCENTIVE PLAN–
continued





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.





The SARs
compensation expense for 2009 and 2008 was $74,445 and $74,649,
respectively.





As of
December 31, 2009, there was $492,404 of total unrecognized compensation cost
related to nonvested SARs.  The cost is expected to be recognized over
a weighted-average period of 6.65 years.





A summary
of the status of the Company’s SARs as of December 31, 2009 and 2008 is
presented below.





2009
                
                
                2008Weighted-
                
                
                
                
                
                Weighted-Average
                
                
                
                
                
                AverageExercise
                
                
                
                
                
                ExerciseShares
                
                
                Price
                
                
                Shares
                
                
                PriceOutstanding
      at beginning of year
                
                
                93,981
                
                
                $
                14.95
                
                
                
                93,981
                
                
                $
                14.95Forfeited
                
                
                (4,688
                )
                
                
                14.90
                
                
                
                -
                
                
                
                -Outstanding
      at end of year
                
                
                89,293
                
                
                
                14.95
                
                
                
                93,981
                
                
                $
                14.95





At
December 31, 2009, we had 160,218 stock awards available for grant under the
2006 Equity Incentive Plan.


-73-





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, 2009, 206,547 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, 2009
and 2008, and changes during the period is presented below:





2009
                
                
                2008Weighted-
                
                
                
                
                
                Weighted-Average
                
                
                
                
                
                AverageExercise
                
                
                
                
                
                ExerciseShares
                
                
                Price
                
                
                Shares
                
                
                PriceOutstanding
      at beginning of year
                
                
                269,447
                
                
                $
                8.36
                
                
                
                278,847
                
                
                $
                8.32Exercised
                
                
                -
                
                
                
                
                
                
                
                (6,900
                )
                
                
                5.46Forfeited
                
                
                (62,900
                )
                
                
                5.00
                
                
                
                (2,500
                )
                
                
                11.00Outstanding
      at end of year
                
                
                206,547
                
                
                $
                9.39
                
                
                
                269,447
                
                
                $
                8.36





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 from the stock options exercised during the year ended
December 31, 2008.  The intrinsic value of options exercised during
2008 was $26,540.





At
December 31, 2009, all options outstanding were exercisable and had a weighted
average remaining life of 4.15 years. The exercise price, for the outstanding
options, range from $5.00 to $10.29.





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.  The outstanding options at December 31,
2009, had no intrinsic value, since there were no options
in-the-money.  The aggregate intrinsic value of options outstanding at
December 31, 2008 was $27,389.





NOTE 19 – EARNINGS (LOSS)
PER SHARE





Net
income available to common shareholders represents net income adjusted for
preferred dividends including dividends declared, accretions of discounts and
amortization of premiums on preferred stock issuances and cumulative dividends
related to the current dividend period that have not been declared as of period
end.





The
following is a summary of the earnings (loss) per common share calculations for
the years ended December 31, 2009 and 2008.




For
      the years endedDecember 31,2009
                
                
                2008Earnings
      (loss) available to common shareholdersNet
      income (loss)
                
                $
                (5,844,153
                )
                
                $
                625,632Preferred
      stock dividends
                
                
                689,810
                
                
                
                -Deemed
      dividends on preferred stock resulting from net accretion of discount and
      amortization of premium
                
                
                146,824
                
                
                
                -Net
      income (loss) available to common shareholders
                
                $
                (6,680,787
                )
                
                $
                625,632


-74-





NOTE 19 –
EARNINGS (LOSS) PER SHARE - continued





For
      the years endedDecember 31,2009
                    
                    
                    2008Basic
      earnings per common share:Net
      income (loss) available to common shareholders
                    
                    $
                    (6,680,787
                    )
                    
                    $
                    625,632Average
      common shares outstanding – basic
                    
                    
                    3,565,188
                    
                    
                    
                    3,513,201Basic
      earnings (loss) per common share
                    
                    $
                    (1.87
                    )
                    
                    $
                    0.18Diluted
      earnings per common share:Net
      income (loss) available to common shareholders
                    
                    $
                    (6,680,787
                    )
                    
                    $
                    625,632Average
      common shares outstanding – basic
                    
                    
                    3,565,188
                    
                    
                    
                    3,513,201Dilutive
      potential common shares
                    
                    
                    -
                    
                    
                    
                    2,482Average
      common shares outstanding - diluted
                    
                    
                    3,565,188
                    
                    
                    
                    3,515,683Diluted
      earnings (loss) per common share
                    
                    $
                    (1.87
                    )
                    
                    $
                    .18





NOTE 20 - 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.


-75-





NOTE 20 -
REGULATORY MATTERS- continued





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, 2009The
      CompanyTotal
      capital (to risk-weighted assets)
                              
                              $
                              60,321
                              
                              
                              
                              12.78
                              %
                              
                              $
                              37,746
                              
                              
                              
                              8.00
                              %
                              
                              $
                              N/A
                              
                              
                              
                              N/ATier
      1 capital (to risk-weighted assets)
                              
                              
                              54,375
                              
                              
                              
                              11.52
                              %
                              
                              
                              18,873
                              
                              
                              
                              4.00
                              %
                              
                              
                              N/A
                              
                              
                              
                              N/ATier
      1 capital (to average assets)
                              
                              
                              54,375
                              
                              
                              
                              8.25
                              %
                              
                              
                              26,362
                              
                              
                              
                              4.00
                              %
                              
                              
                              N/A
                              
                              
                              
                              N/AThe
      BankTotal
      capital (to risk-weighted assets)
                              
                              $
                              56,631
                              
                              
                              
                              12.01
                              %
                              
                              $
                              37,720
                              
                              
                              
                              8.00
                              %
                              
                              $
                              47,150
                              
                              
                              
                              10.00
                              %Tier
      1 capital (to risk-weighted assets)
                              
                              
                              50,689
                              
                              
                              
                              10.75
                              %
                              
                              
                              18,860
                              
                              
                              
                              4.00
                              %
                              
                              
                              28,290
                              
                              
                              
                              6.00
                              %Tier
      1 capital (to average assets)
                              
                              
                              50,689
                              
                              
                              
                              7.69
                              %
                              
                              
                              26,371
                              
                              
                              
                              4.00
                              %
                              
                              
                              32,964
                              
                              
                              
                              5.00
                              %December
      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
                              %





NOTE 21 - UNUSED LINES OF
CREDIT





As of
December 31, 2009, the Bank had unused lines of credit to purchase federal funds
from unrelated companies totaling $17,000,000.  These lines of credit
are available on a one to fourteen day basis for general corporate
purposes.  An approximately $52,000,000 unused line of credit is
available to Bank at the Federal Reserve.  The Company also has a line
of credit to borrow funds from the Federal Home Loan Bank of up to
$178,210,000.  As of December 31, 2009 and 2008, the Bank had borrowed
$34,000,000 and $78,000,000, respectively, on this line.


-76-




NOTE 22 - FAIR VALUE OF
FINANCIAL INSTRUMENTS





The
current accounting literature requires the disclosure of fair value information
for financial instruments, whether or not they are recognized in the
consolidated balance sheets, when it is practical to estimate the fair
value.  The guidance defines a financial instrument as cash, evidence of an
ownership interest in an entity or contractual obligations, which require the
exchange of cash, or other financial instruments.  Certain items are
specifically excluded from the disclosure requirements, including the Company’s
common stock, premises and equipment, accrued interest receivable and payable,
and other assets and liabilities.




The fair
value of a financial instrument is the amount at 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
Company has used management’s best estimate of fair value based on the above
assumptions.  Thus, the fair values presented may not be the amounts, which
could be realized, in an immediate sale or settlement of the instrument. In
addition, any income taxes or other expenses, which would be incurred in an
actual sale or settlement, are not taken into consideration in the fair values
presented.





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





Cash and Due from
Banks and Interest-bearing Deposits with Other 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.





Time Deposits in
other Banks- The carrying amount is
a reasonable estimate of fair value.





Securities
Available-for-Sale - Investment securities available-for-sale are
recorded at fair value on a recurring basis. Fair value measurement is based
upon quoted prices, if available. If quoted prices are not available, fair
values are measured using independent pricing models or other model-based
valuation techniques such as the present value of future cash flows, adjusted
for the security’s credit rating, prepayment assumptions and other factors such
as credit loss assumptions. Level 1 securities include those traded on an active
exchange, such as the New York Stock Exchange, U.S. Treasury securities that are
traded by dealers or brokers in active over-the-counter markets and money market
funds. Level 2 securities include mortgage-backed securities issued by
government sponsored entities, municipal bonds and corporate debt securities.
Securities classified as Level 3 include asset-backed securities in less liquid
markets.





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-
The Company does not record loans at fair value on a recurring basis. However,
from time to time, a loan is considered impaired and an allowance for loan
losses is established. Loans for which it is probable that payment of interest
and principal will not be made in accordance with the contractual terms of the
loan agreement are considered impaired.  The fair value of impaired
loans is estimated using one of several methods, including collateral value,
market value of similar debt, enterprise value, liquidation value and discounted
cash flows. Those impaired loans not requiring an allowance represent loans for
which the fair value of the expected repayments or collateral exceed the
recorded investments in such loans. At December 31, 2009, substantially all of
the total impaired loans were evaluated based on the fair value of the
collateral.  Impaired loans where an allowance is established based on
the fair value of collateral require classification in the fair value hierarchy.
When the fair value of the collateral is based on an observable market price or
a current appraised value, the Company records the impaired
loan as nonrecurring Level 2. When an appraised value is not available or
management determines the fair value of the collateral is further impaired below
the appraised value and there is no observable market price, The Company records
the impaired loan as nonrecurring Level 3.


-77-


NOTE
22 - FAIR VALUE OF FINANCIAL INSTRUMENTS-continued




Other Real Estate
Owned-Other
real estate owned (“OREO”) is adjusted to fair value upon transfer of the loans
to OREO. Subsequently, OREO is carried at the lower of carrying value or fair
value. Fair value is based upon independent market prices, appraised values of
the collateral or management’s estimation of the value of the collateral. When
the fair value of the collateral is based on an observable market price or a
current appraised value, the Company records the foreclosed asset as
nonrecurring Level 2. When an appraised value is not available or management
determines the fair value of the collateral is further impaired below the
appraised value and there is no observable market price, the Company records the
OREO as nonrecurring Level 3.





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.


-78-


NOTE
22 - FAIR VALUE OF FINANCIAL INSTRUMENTS-continued





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





December 31,2009
                    
                    
                    2008Carrying
                    
                    
                    Estimated Fair
                    
                    
                    Carrying
                    
                    
                    Estimated FairAmount
                    
                    
                    Value
                    
                    
                    Amount
                    
                    
                    ValueFinancial
      Assets:Cash
      and due from banks
                    
                    $
                    2,942,295
                    
                    
                    
                    2,942,295
                    
                    
                    $
                    5,451,607
                    
                    
                    $
                    5,451,607Interest-bearing
      deposits with other banks
                    
                    
                    50,356,191
                    
                    
                    
                    50,356,191
                    
                    
                    
                    -
                    
                    
                    
                    -Federal
      funds sold
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    257,000
                    
                    
                    
                    257,000Time
      deposits in other banks
                    
                    
                    502,089
                    
                    
                    
                    502,089
                    
                    
                    
                    -
                    
                    
                    
                    -Securities
      available-for-sale
                    
                    
                    121,948,744
                    
                    
                    
                    121,948,744
                    
                    
                    
                    76,310,816
                    
                    
                    
                    76,310,816Nonmarketable
      equity securities
                    
                    
                    4,812,100
                    
                    
                    
                    4,812,100
                    
                    
                    
                    4,574,700
                    
                    
                    
                    4,574,700Loans,
      including loans held for sale
                    
                    
                    411,728,010
                    
                    
                    
                    410,265,000
                    
                    
                    
                    478,579,283
                    
                    
                    
                    480,311,000Accrued
      interest receivable
                    
                    
                    2,661,030
                    
                    
                    
                    2,661,030
                    
                    
                    
                    2,653,260
                    
                    
                    
                    2,653,260Financial
      Liabilities:Demand
      deposit, interest-bearing transaction, and savings
accounts
                    
                    
                    195,636,648
                    
                    
                    
                    195,636,648
                    
                    
                    $
                    184,805,565
                    
                    
                    $
                    184,805,565Certificates
      of deposit
                    
                    
                    357,126,331
                    
                    
                    
                    352,318,000
                    
                    
                    
                    276,329,819
                    
                    
                    
                    275,825,000Securities
      sold under agreements to repurchase
                    
                    
                    598,342
                    
                    
                    
                    598,342
                    
                    
                    
                    8,197,451
                    
                    
                    
                    8,197,451Advances
      from Federal Home Loan Bank
                    
                    
                    34,000,000
                    
                    
                    
                    33,992,000
                    
                    
                    
                    78,000,000
                    
                    
                    
                    77,908,015Note
      payable
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    6,950,000
                    
                    
                    
                    6,950,000Junior
      subordinated debentures
                    
                    
                    10,310,000
                    
                    
                    
                    10,310,000
                    
                    
                    
                    10,310,000
                    
                    
                    
                    10,310,000Accrued
      interest payable
                    
                    
                    680,880
                    
                    
                    
                    680,880
                    
                    
                    
                    623,330
                    
                    
                    
                    623,330





Notional
                
                
                Estimated
      Fair
                
                
                Notional
                
                
                Estimated
      FairAmount
                
                
                Value
                
                
                Amount
                
                
                ValueOff-Balance
      Sheet Financial Instruments:Commitments
      to extend credit
                
                $
                39,873,440
                
                
                
                -
                
                
                $
                53,812,183
                
                
                $
                -Standby
      letters of credit
                
                
                2,583,466
                
                
                
                -
                
                
                
                3,006,214
                
                
                
                -





In
determining appropriate levels, the Company performs a detailed analysis of the
assets and liabilities that are subject to fair value disclosures.  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.




Assets
and liabilities that are carried at fair value are classified in one of the
following three categories based on a hierarchy for ranking the quality and
reliability of the information used to determine fair value:





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


-79-


NOTE
22 - FAIR VALUE OF FINANCIAL INSTRUMENTS-continued





The table
below presents the balances of assets measured at fair value on a recurring
basis as of December 31, 2009 and 2008, aggregated by the level in the fair
value hierarchy within which those measurements fall.





Total
                
                
                Level 1
                
                
                Level 2
                
                
                Level3December
      31, 2009Available
      for- sale- securities
                
                $
                121,948,744
                
                
                $
                -
                
                
                $
                121,948,744
                
                
                $
                -Mortgage
      loans held for sale (1)
                
                
                5,100,609
                
                
                
                -
                
                
                
                5,100,609
                
                
                
                -$
                127,049,353
                
                
                $
                -
                
                
                $
                127,049,353
                
                
                $
                -December
      31, 2008Available
      for- sale- securities
                
                $
                76,310,816
                
                
                $
                -
                
                
                $
                76,310,816
                
                
                $
                -Mortgage
      loans held for sale (1)
                
                
                9,589,081
                
                
                
                -
                
                
                
                9,589,081
                
                
                
                -$
                85,899,897
                
                
                $
                -
                
                
                $
                85,899,897
                
                
                $
                -





(1)  Carried
at the lower of cost or market.





There
were no liabilities carried at fair value at December 31, 2009 and
2008.





Certain
assets and liabilities are measured at fair value on a nonrecurring basis; that
is, the instruments are not measured at fair value on an ongoing basis but are
subject to fair value adjustments in certain circumstances (for example, when
there is evidence of impairment).  The following table presents the
assets and liabilities carried on the balance sheet by caption and by level
within the valuation hierarchy (as described above) as of December 31, 2009 and
2008, for which a nonrecurring change in fair value has been recorded during the
years ended December 31, 2009 and 2008, respectively.





Total
                  
                  
                  Level 1
                  
                  
                  Level 2
                  
                  
                  Level 3December
      31, 2009Impaired
      loans receivable
                  
                  $
                  44,937,157
                  
                  
                  $
                  -
                  
                  
                  $
                  44,937,157
                  
                  
                  $
                  -Other
      real estate owned
                  
                  
                  8,954,214
                  
                  
                  
                  -
                  
                  
                  
                  8,954,214
                  
                  
                  
                  -Total
      assets at fair value
                  
                  $
                  53,891,371
                  
                  
                  $
                  -
                  
                  
                  $
                  53,891,371
                  
                  
                  $
                  -December
      31, 2008Impaired
      loans receivable
                  
                  $
                  22,524,948
                  
                  
                  $
                  -
                  
                  
                  $
                  22,524,948
                  
                  
                  $
                  -Other
      real estate owned
                  
                  
                  379,950
                  
                  
                  
                  -
                  
                  
                  
                  379,950
                  
                  
                  
                  -Total
      assets at fair value
                  
                  $
                  22,904,898
                  
                  
                  $
                  -
                  
                  
                  $
                  22,904,898
                  
                  
                  $
                  -





The
Company has no liabilities carried at fair value or measured at fair value on a
nonrecurring basis at December 31, 2009 and 2008.


-80-





NOTE
23 - SUBSEQUENT EVENTS





In
preparing these financial statements, subsequent events were evaluated through
the time the financial statements were issued. Financial statements are
considered issued when they are widely distributed to all shareholders and other
financial statement users, or filed with the Securities and Exchange Commission.
In conjunction with applicable accounting standards, all material subsequent
events have been either recognized in the financial statements or disclosed in
the notes to the financial statements.





NOTE 24 - FIRST RELIANCE
BANCSHARES, INC. (PARENT COMPANY ONLY)




Condensed
Balance Sheets




December 31,2009
                
                
                2008AssetsCash
                
                $
                3,010,410
                
                
                $
                895,976Investment
      in banking subsidiary
                
                
                51,947,813
                
                
                
                48,539,657Marketable
      Investments
                
                
                67,515
                
                
                
                124,300Land
                
                
                3,959,268
                
                
                
                3,959,268Investment
      in trust
                
                
                310,000
                
                
                
                310,000Other
      assets
                
                
                503,612
                
                
                
                1,125,080Total
      assets
                
                $
                59,798,618
                
                
                $
                54,954,281LiabilitiesNote
      payable – revolving line of credit
                
                $
                -
                
                
                $
                6,950,000Note
      payable to banking subsidiary (1)
                
                
                3,961,780
                
                
                
                -Junior
      subordinated debentures
                
                
                10,310,000
                
                
                
                10,310,000Other
      liabilities
                
                
                303,011
                
                
                
                268,523Total
      liabilities
                
                
                14,574,791
                
                
                
                17,528,523Shareholders’
      equity
                
                
                45,223,827
                
                
                
                37,425,758Total
      liabilities and shareholders’ equity
                
                $
                59,798,618
                
                
                $
                54,954,281





(1)
            Collateral
      requirements were met based on the provisions of section 23A of Federal
      Reserve Regulation W.





Condensed
Statements of Income


December 31,2009
                      
                      
                      2008IncomeDividends
      from banking subsidiary
                      
                      $
                      -
                      
                      
                      $
                      1,000,000Rentalincome from
      banking subsidiary
                      
                      
                      270,000
                      
                      
                      
                      -Other
      Income
                      
                      
                      28,183
                      
                      
                      
                      20,957Total
      Income
                      
                      
                      298,183
                      
                      
                      
                      1,020,957Expenses
                      
                      
                      995,489
                      
                      
                      
                      1,065,758Loss
      before income taxes and equity in undistributed earnings of banking
      subsidiary
                      
                      
                      (697,306
                      )
                      
                      
                      (44,801
                      )Equity
      in undistributed earnings (loss) of banking subsidiary
                      
                      
                      (5,368,217
                      )
                      
                      
                      329,390Net
      income (loss) before income taxes
                      
                      
                      (6,065,523
                      )
                      
                      
                      284,589Income
      tax benefit
                      
                      
                      (221,370
                      )
                      
                      
                      (341,043
                      )Net
      income (loss)
                      
                      $
                      (5,844,153
                      )
                      
                      $
                      625,632


-81-


NOTE 24 -
FIRST RELIANCE BANCSHARES, INC. (PARENT COMPANY ONLY)- continued





Condensed
Statements of Cash Flows





December 31,2009
                    
                    
                    2008Cash
      flows from operating activitiesNet
      income (loss)
                    
                    $
                    (5,844,153
                    )
                    
                    $
                    625,632Adjustments
      to reconcile net income to net cash provided (used) by operating
      activities:Amortization
      of deferred compensation on restricted stock
                    
                    
                    55,977
                    
                    
                    
                    146,495Increase
      in other assets
                    
                    
                    (381,135
                    )
                    
                    
                    (351,319
                    )Increase
      in other liabilities
                    
                    
                    53,795
                    
                    
                    
                    118,922Equity
      in undistributed earnings (loss) of banking subsidiary
                    
                    
                    5,368,217
                    
                    
                    
                    (329,390
                    )Net
      cash provided (used) by operating activities
                    
                    
                    (747,299
                    )
                    
                    
                    210,340Cash
      flows from investing activitiesPurchase
      of land
                    
                    
                    -
                    
                    
                    
                    (3,959,268
                    )Investment
      in banking subsidiary
                    
                    
                    (8,800,000
                    )
                    
                    
                    -Net
      cash used by investing activities
                    
                    
                    (8,800,000
                    )
                    
                    
                    (3,959,268
                    )Cash
      flows from financing activitiesNet
      proceeds from issuance of preferred stock
                    
                    
                    15,225,312Proceeds
      from exercise of stock options
                    
                    
                    -
                    
                    
                    
                    37,670Purchase
      of treasury stock
                    
                    
                    (4,159
                    )
                    
                    
                    (14,579
                    )Issuance
      of stock to employees
                    
                    
                    1,000
                    
                    
                    
                    1,010Issuance
      of stock to advisory board
                    
                    
                    6,365
                    
                    
                    
                    5,686Preferred
      stock dividends
                    
                    
                    (578,565
                    )Net
      increase in note payable to banking subsidiary
                    
                    
                    3,961,780
                    
                    
                    
                    -Proceeds
      (payment) note payable – line of credit
                    
                    
                    (6,950,000
                    )
                    
                    
                    3,950,000Net
      cash provided by financing activities
                    
                    
                    11,661,733
                    
                    
                    
                    3,979,787Increase
      in cash
                    
                    
                    2,114,434
                    
                    
                    
                    230,859Cash
      and cash equivalents, beginning of year
                    
                    
                    895,976
                    
                    
                    
                    665,117Cash
      and cash equivalents, ending of year
                    
                    $
                    3,010,410
                    
                    
                    $
                    895,976


-82-


NOTE 25 - QUARTERLY RESULTS
OF OPERATIONS (UNAUDITED)





The
tables below represent the quarterly results of operations for the years ended
December 31, 2009 and 2008, respectively:


December 31, 2009Fourth
                
                
                Third
                
                
                Second
                
                
                FirstTotal
      interest and fee income
                
                $
                7,318,095
                
                
                $
                9,082,567
                
                
                $
                7,801,822
                
                
                $
                7,823,053Total
      interest expense
                
                
                3,728,152
                
                
                
                4,027,170
                
                
                
                3,916,113
                
                
                
                3,669,960Net
      interest income
                
                
                3,589,943
                
                
                
                5,055,397
                
                
                
                3,885,709
                
                
                
                4,153,093Provision
      for loan losses
                
                
                6,278,381
                
                
                
                3,266,449
                
                
                
                3,555,442
                
                
                
                1,300,380Net
      interest income (loss) after provisions for loan losses
                
                
                (2,688,438
                )
                
                
                1,788,948
                
                
                
                330,267
                
                
                
                2,852,713Other
      income
                
                
                1,106,844
                
                
                
                2,430,842
                
                
                
                2,313,717
                
                
                
                1,693,117Other
      expense
                
                
                5,290,032
                
                
                
                5,083,850
                
                
                
                4,753,923
                
                
                
                4,724,879Loss
      before income tax expense
                
                
                (6,871,626
                )
                
                
                (864,060
                )
                
                
                (2,109,939
                )
                
                
                (179,049
                )Income
      tax benefit
                
                
                (2,499,294
                )
                
                
                (532,988
                )
                
                
                (955,325
                )
                
                
                (192,914
                )Net
      income (loss)
                
                
                (4,372,332
                )
                
                
                (331,072
                )
                
                
                (1,154,614
                )
                
                
                13,865Preferred
      stock dividends
                
                
                210,840
                
                
                
                210,839
                
                
                
                208,547
                
                
                
                59,584Deemed
      dividends on preferred stock net accretion of discount and amortization of
      premium
                
                
                44,876
                
                
                
                44,876
                
                
                
                44,388
                
                
                
                12,684Net
      loss available to common shareholders
                
                $
                (4,628,048
                )
                
                $
                (586,787
                )
                
                $
                (1,407,549
                )
                
                $
                (58,403
                )Basic
      loss per common share
                
                $
                (1.29
                )
                
                $
                (0.16
                )
                
                $
                (0.40
                )
                
                $
                (0.02
                )Diluted
      loss per common share
                
                $
                (1.29
                )
                
                $
                (0.16
                )
                
                $
                (0.40
                )
                
                $
                (0.02
                )





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 (benefit)
                
                
                (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
                
                
                $
                .23Diluted
      income (loss) per common share
                
                $
                (0.47
                )
                
                $
                0.22
                
                
                $
                0.20
                
                
                $
                .23


-83-





ITEM
      8.
            CHANGES
      IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
      DISCLOSURE





Not
Applicable





ITEM
      8A(T).
            CONTROLS
      AND PROCEDURES





Disclosure
Controls





As of the end of the period covered by
this Annual Report on Form 10-K, our principal executive officer and principal
financial officer have evaluated the effectiveness of our “disclosure controls
and procedures” (“Disclosure Controls”).  Disclosure Controls, as
defined in Rule 13a-15(e) of the Exchange Act, are procedures that are designed
with the objective of ensuring that information required to be disclosed in our
reports filed under the Exchange Act, such as this Annual Report, is recorded,
processed, summarized and reported within the time periods specified in the
SEC’s rules and forms.  Disclosure Controls are also designed with the
objective of ensuring that such information is accumulated and communicated to
our management, including the Chief Executive Officer (“CEO”)and Chief Financial
Officer (“CFO”) as appropriate to allow timely decisions regarding required
disclosure.





Our management, including the CEO and
CFO, does not expect that our Disclosure Controls will prevent all error and all
fraud.  A control system, no matter how well conceived and operated,
can provide only reasonable, not absolute, assurance that the objectives of the
control system are met.  Further, the design of a control system must
reflect the fact that there are resource constraints, and the benefits of
controls must be considered relative to their costs.  Because of the
inherent limitations in all control systems, no evaluation of controls can
provide absolute assurance that all control issues and instances of fraud, if
any, within the company have been detected.  These inherent
limitations include the realities that judgments in decision-making can be
faulty, and that breakdowns can occur because of simple error or
mistake.  The design of any system of controls also is based in part
upon certain assumptions about the likelihood of future events, and there can be
no assurance that any design will succeed in achieving its stated goals under
all potential future conditions.





Based upon their controls evaluation,
our CEO and CFO have concluded that our Disclosure Controls are effective at a
reasonable assurance level.





Management’s
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 Exchange
Act.  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,
2009.  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 our Board of Directors.


-84-


Based on this assessment, management
believes that First Reliance Bancshares, Inc. maintained effective internal
control over financial reporting as of December 31, 2009.





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





Changes
to Internal Control Over Financial Reporting





There have been no changes in our
internal control over financial reporting during our fourth fiscal quarter that
have materially affected, or are reasonably likely to materially affect, our
internal control over financial reporting.





ITEM
      8B.
            OTHER
      INFORMATION





Not Applicable.





PART
III





ITEM
      9.
            DIRECTORS,
      EXECUTIVE OFFICERS, AND CORPORATE
GOVERNANCE





The Company has adopted a Code of
Ethics that applies to its principal executive, financial and accounting
officers.  The Code of Ethics has been posted to the Company’s website
at www.firstreliance.com.  A copy may also be obtained, without
charge, upon written request addressed to First Reliance Bancshares, Inc., 2170
W. Palmetto Street, , Florence, South Carolina 29501,
Attention:  Corporate Secretary.  The request may be
delivered by letter to the address set forth above or by fax to the attention of
the Company’s Corporate Secretary at (843)656-3045.





The
remaining information for this Item is included in the Company’s Proxy Statement
for the Annual Meeting of Shareholders to be held on June 17, 2010, under the
headings “Proposal:  Election of Directors”, “Security Ownership of
Certain Beneficial Owners and Management,” “Section 16(a) Beneficial Ownership
Reporting Compliance” and “Corporate Governance” and are incorporated herein by
reference.





ITEM
      10.
            EXECUTIVE
      COMPENSATION





The
responses to this Item are included in the Company’s Proxy Statement for the
Annual Meeting of Shareholders to be held on June 17, 2010, under the headings
“Proposal: Election of Directors – Director Compensation”
and  “Executive Compensation” and are incorporated herein by
reference.


-85-


ITEM
      11.
            SECURITY
      OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
      STOCKHOLDER MATTERS





The following table provides
information regarding compensation plans under which equity securities of the
Company are authorized for issuance.  All data is presented as of
December 31, 2009.





EquityCompensationPlanTable(a)
                      
                      
                      (b)
                      
                      
                      (c)Plancategory
                      
                      Numberofsecuritiestobe
                        issueduponexerciseof
                        outstandingoptions,warrants
                        andrights
                      
                      
                      Weighted-averageexercise
                        priceofoutstandingoptions,
                        warrantsandrights
                      
                      
                      Numberofsecurities
                        remainingavailableforfuture
                        issuanceunderequity
                        compensationplans
                        (excludingsecuritiesreflected
                        incolumn(a))Equity
      compensation plans approved by security holders
                      
                      
                      200,946
                      
                      
                      
                      9.36
                      
                      
                      
                      -Equity
      compensation plans not approved by security holders
                      
                      
                      184,300
                      
                      
                      
                      7.55
                      
                      
                      
                      160,218Total
                      
                      
                      385,246
                      
                      
                      
                      8.49
                      
                      
                      
                      160,218





The equity compensation plans not
approved by our shareholders include non-qualified option grants to four
employees of the Company to purchase a total of 5,600 shares of the Company’s
common stock.  All of the non-qualified option grants are fully vested
as of December 31, 2009.  The table below breaks down the exercise
prices of the non-qualified options that have been granted by the
Company.





Price
                
                
                Number
      of Options$
                9.32
                
                
                
                2,800$
                11.00
                
                
                
                5,000$
                13.50
                
                
                
                300





On January 19, 2006, the Board of
Directors approved the First Reliance Bancshares, Inc. 2006 Equity Incentive
Plan (the “2006 Plan”).   The 2006 Plan provides that the Company
may grant stock incentives to participants in the form of nonqualified stock
options, dividend equivalent rights, phantom shares, stock appreciation rights,
stock awards and performance unit awards (each a “Stock
Incentive”).  The Company reserved up to 350,000 shares of the
Company’s common stock for issuance pursuant to awards granted under the
Plan.   This number of shares may change in the event of future
stock dividends, stock splits, recapitalizations and similar
events.   If a Stock Incentive expires or terminates without
being paid, exercised or otherwise settled, the shares subject to that Stock
Incentive may again be available for awards under the 2006 Plan.





The additional responses to this Item
are included in the Company’s Proxy Statement for the Annual Meeting of
Shareholders to be held on June 17, 2010, under the heading “Security Ownership
of Certain Beneficial Owners and Management” and are incorporated herein by
reference.





ITEM
      12.
            CERTAIN
      RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
      INDEPENDENCE





The
responses to this Item are included in the Company’s Proxy Statement for the
Annual Meeting of Shareholders held on June 17, 2010, under the headings
“Related Party Transactions” and “Proposal: Election of Directors – Director
Independence” and are incorporated herein by reference.


-86-


ITEM
      13.
            PRINCIPAL
      ACCOUNTANT FEES AND SERVICES





The responses to this Item are included
in the Company Proxy Statement for the Annual Meeting of Shareholders to be held
on June 17, 2010, under the heading “Audit Committee Matters – Independent
Registered Public Accounting Firm” and are incorporated herein by
reference.





PART
IV





ITEM
      14.
            EXHIBITS
      AND FINANCIAL STATEMENT SCHEDULES





A list of
exhibits included as part of this annual report is set forth in the Exhibit
Index that immediately precedes the exhibits and is incorporated by reference
herein.


-87-


SIGNATURES





In
accordance with Section 13 or 15(d) of the Exchange Act, the Registrant caused
this Report to be signed on its behalf by the undersigned, thereunto duly
authorized.





FIRST
      RELIANCE BANCSHARES, INC.By:
                  /s/ F. R. Saunders, Jr.F.
      R. Saunders, Jr.President
      and ChiefExecutive
      OfficerDate:
                  March
      31, 2010




POWER
OF ATTORNEY





KNOW ALL MEN BY THESE
PRESENTS, that each person whose signature appears on the signature page
to this Report constitutes and appoints F. R. Saunders, Jr. and Jeffrey A.
Paolucci, his or her true and lawful attorneys-in-fact and agents, with full
power of substitution and resubstitution, for him or her and in his or her name,
place, and stead, in any and all capacities, to sign any and all amendments to
this Report, and to file the same, with all exhibits hereto, and other documents
in connection herewith with the Securities and Exchange Commission, granting
unto said attorneys-in-fact and agents, full power and authority to do and
perform each and every act and thing requisite and necessary to be done in and
about the premises, as fully to all intents and purposes as they might or could
do in person, hereby ratifying and confirming all that said attorneys-in-fact
and agents or their substitute or substitutes, may lawfully do or cause to be
done by virtue hereof.





Pursuant
to the requirements of the Securities Exchange Act of 1934, this Report has been
signed below by the following persons on behalf of the Registrant and in the
capacities and on the dates indicated.





Signature
              
              Title
              
              Date/s/ F. R. Saunders, Jr.
              
              Director,
      President and Chief Executive Officer
                (Principal
      Executive Officer)
              
              March
      31, 2010F.
      R. Saunders, Jr./s/ Paul C. Saunders
              
              Director
              
              March
      31, 2010Paul
      C. Saunders/s/ A. Dale Porter
              
              Director
              
              March
      31, 2010A.
      Dale Porter/s/ Leonard A. Hoogenboom
              
              Chairman
      of the Board
              
              March
      31, 2010Leonard
      A. Hoogenboom/s/ John M. Jebaily
              
              Director
              
              March
      31, 2010John
      M. Jebaily


-88-





Signature
                    
                    Title
                    
                    Date/s/ Andrew G. Kampiziones
                    
                    Director
                    
                    March
      31, 2010Andrew
      G. Kampiziones/s/ C. Dale Lusk
                    
                    Director
                    
                    March
      31, 2010C.
      Dale Lusk/s/ J. Munford Scott
                    
                    Director
                    
                    March
      31, 2010J.
      Munford Scott/s/ A. Joe Willis
                    
                    Director
                    
                    March
      31, 2010A.
      Joe Willis/s/ Jeffrey A. Paolucci
                    
                    Director,
      Senior Vice President and
                    
                    March
      31, 2010Jeffrey
      A. Paolucci
                    
                    Chief
      Financial Officer (Principal Financial and
                      Accounting
      Officer)
                    
                    March
      31,
2010


-89-


EXHIBIT
INDEX





Exhibit
                  Number
              
              Description3.1
              
              Articles
      of Incorporation of First Reliance Bancshares, Inc. 13.2
              
              Articles
      of Amendment to the Articles of Incorporation authorizing a class of
      preferred stock23.3
              
              Articles
      of Amendment to the Articles of Incorporation establishing the terms of
      the Series A Preferred Stock and the Series B Preferred Stock23.4
              
              Bylaws
      of First Reliance Bancshares, Inc.4.1
              
              See
      Articles of Incorporation, as amended at Exhibit 3.1, 3.2 and 3.3 hereto
      and Bylaws at Exhibit 3.2 hereto.4.2
              
              Indenture
      between the Registrant and the Trustee. 34.3
              
              Guarantee
      Agreement.34.4
              
              Amended
      and Restated Declaration.34.5
              
              Form
      of Certificate for the Series A Preferred Stock24.6
              
              Form
      of Certificate for the Series B Preferred Stock24.7
              
              Warrant
      to Purchase up to 767.00767 shares of Series B Preferred Stock, dated
      March 6, 2009210.1*
              
              1999
      First Reliance Bank Employee Stock Option Plan. 410.2*
              
              Amendment
      No. 1 to the 1999 First Reliance Bank Employee Stock Option Plan. 410.3*
              
              Amendment
      No. 2 to the 1999 First Reliance Bank Employee Stock Option Plan. 510.4*
              
              First
      Reliance Bancshares, Inc. 2003 Stock Incentive Plan. 610.5*
              
              First
      Reliance Bancshares, Inc. 2006 Equity Incentive Plan. 710.6
              
              Lease
      Agreement between SP Financial, LLC and First Reliance Bank. 710.7*
              
              Employment
      Agreement with F. R. Saunders, Jr., dated November 24, 2006. 810.8*
              
              Salary
      Continuation Agreement with F. R. Saunders, Jr., dated November 24, 2006.
      810.9*
              
              Endorsement
      Split Dollar Agreement with F. R. Saunders, Jr., dated November 24, 2006.
      810.10*
              
              Amended
      Supplemental Life Insurance Agreement with F. R. Saunders, Jr., dated
      December 28, 2007. 910.11*
              
              Employment
      Agreement with Jeffrey A. Paolucci, dated November 24, 2006. 810.12*
              
              Salary
      Continuation Agreement with Jeffrey A. Paolucci, dated November 24, 2006.
      810.13*
              
              Endorsement
      Split Dollar Agreement with Jeffrey A. Paolucci, dated November 24, 2006.
      810.14*
              
              Employment
      Agreement with Paul Saunders, dated November 24, 2006. 810.15*
              
              Salary
      Continuation Agreement with Paul Saunders, dated November 24, 2006. 810.16*
              
              Endorsement
      Split Dollar Agreement with Paul Saunders, dated November 24, 2006. 810.17*
              
              Form
      of Director Retirement Agreement, with Schedule. 810.18*
              
              Amended
      and Restated Employment Agreement with Dale Porter. 810.19*
              
              Employment
      Agreement with Thomas C. Ewart, Sr. 610.20
              
              Letter
      Agreement, dated March 6, 2009, including Securities Purchase Agreement –
      Standard Terms, incorporated by reference therein, between the Company and
      the United States Department of the Treasury210.21
              
              Side
      Letter Agreement, dated March 6, 20092







1
Incorporated by reference to Quarterly Report on Form 10-QSB, for the quarter
ended September 30, 2007.


2
Incorporated by reference to Current Report on Form 8-K, dated March 10,
2009


3
Incorporated by reference to Current Report on Form 8-K, dated July 1,
2005.


4
Incorporated by reference to Quarterly Report on Form 10-QSB, for the quarter
ended March 31, 2002.


5
Incorporated by reference to Quarterly Report on Form 10-QSB, for the quarter
ended June 30, 2002.


6
Incorporated by reference to Annual Report on Form 10-KSB for the year ended
December 31, 2003.


7
Incorporated by reference to Annual Report on Form 10-KSB for the year ended
December 31, 2005.


8
Incorporated by reference to Annual Report on Form 10-K for the year ended
December 31, 2006.


9
Incorporated by reference to Current Report on Form 8-K, dated December 28,
2007.


-90-





10.22*
                
                Form
      of Waiver210.23*
                
                Form
      of Senior Executive Officer Agreement210.24
                
                Employment
      Agreement with Craig S. Evans*10.25
                
                Salary
      Continuation Agreement with Craig S. Evans*21.1
                
                Subsidiaries
      of First Reliance Bancshares, Inc. 723.1
                
                Consent
      of Elliot Davis, LLC.24.1
                
                Power
      of Attorney (appears on the signature page to this Annual Report on Form
      10-K.31.1
                
                Certification
      of Chief Executive Officer pursuant to Rule
      13a-14(a)/15(d)-14(a).31.2
                
                Certification
      of Chief Financial Officer pursuant to Rule
      13a-14(a)/15(d)-14(a).32.1
                
                Certification
      of Chief Executive and Financial Officers pursuant to 18 U.S.C. Section
      1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
      2002.99.1
                
                Certification
      of Compliance with EESA Section 111 by Chief Executive
    Officer99.2
                
                Certification
      of Compliance with EESA Section 111 by Chief Financial
    Officer





*Indicates
management contract or compensatory plan or arrangement.


-91-