UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C. 20549


———————


FORM 10-K


———————


þAnnual report under
Section 13 or 15(d) of the Securities Exchange Act of
1934


For
fiscal year ended December 31, 2009





 ̈  Transition
report under Section 13 or 15(d) of the Securities Exchange Act of
1934


For
the transition period from      to





Commission
File Number 000-28333


———————


COASTAL
BANKING COMPANY, INC.


(A
South Carolina Corporation)


IRS
Employer Identification Number: 58-2455445


36
Sea Island Parkway, Beaufort, South Carolina 29907


Telephone
Number: (843) 522-1228


———————





Securities
registered pursuant to Section 12(b) of the
Act:        None.




Securities
registered pursuant to Section 12(g) of the
Act:        Common Stock, $.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 þ




Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or 15(d) of the Act. Yes  ̈  No þ




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




Indicate
by check mark if the registrant if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not 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 “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.




Large
      accelerated filer  ̈
            Accelerated
      filer  ̈Non-accelerated
      filer  ̈
              (Do
      not check if a smaller reporting company)
            Smaller
      reporting company þ





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




The
aggregate value of the voting common equity held by nonaffiliates as of
June 30, 2009, the last business day of the registrant’s most recently
completed second fiscal quarter, was $7,895,079 based on the price at which the
common stock last sold on such day. This price reflects inter-dealer prices
without retail mark up, mark down, or commissions, and may not represent actual
transactions.




2,568,707
shares of common stock were outstanding as of March 17, 2010.




DOCUMENTS
INCORPORATED BY REFERENCE




Portions
of the registrant’s Proxy Statement for the 2010 Annual Meeting of Shareholders,
scheduled to be held on May 26, 2010, are incorporated by reference into
Part III.





Table
of Contents




PagePART 1.Item 1.
            Business
            
            
            1Item
      1A.
            Risk
    Factors
            
            
            17Item
    1B.
            Unresolved Staff
      Comments
            
            
            25Item
      2.
            Properties
            
            
            26Item
      3.
            Legal
      Proceedings
            
            
            26Item
      4.
            Reserved
            
            
            26PART II.Item
    5.
            Market for
      Registrant’s Common Equity, Related Stockholder Matters, and Issuer
      Purchases of Equity Securities
            
            
            27Item
    6.
            Selected Financial
      Data
            
            
            27Item
    7.
            Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operation
            
            
            28Item
    7A.
            Quantitative and
      Qualitative Disclosures About Market Risks
            
            
            52Item
      8.
            Financial Statements
      and Supplementary Data
            
            
            53Item 9.
            Changes In and
      Disagreements With Accountants on Accounting and Financial
      Disclosure
            
            
            91Item
    9A.
            Controls and
      Procedures
            
            
            91Item 9B.
            Other
      Information
            
            
            92PART
      III.Item
    10.
            Directors, Executive
      Officers, and Corporate Governance
            
            
            93Item 11.
            Executive
      Compensation.
            
            
            93Item
      12.
            Security Ownership
      of Certain Beneficial Owners and Management and Related Stockholder Matters.
            
            
            93Item
      13.
            Certain
      Relationships and Related Transactions, and Director
Independence
            
            
            94Item
      14.
            Principal Accountant
      Fees and Services
            
            
            94Item
      15.
            Exhibits
            
            
            94





PART I.




ITEM 1. BUSINESS




This
Report contains statements which constitute forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933, as amended and
the Securities Exchange Act of 1934, as amended. These statements are based on
many assumptions and estimates and are not guarantees of future performance. Our
actual results may differ materially from those projected in any
forward-looking statements, as they will depend on many factors about which we
are unsure, including many factors which are beyond our control. The words
“may,” “would,” “could,” “will,” “expect,” “anticipate,” “believe,” “intend,”
“plan,” and “estimate,” as well as similar expressions, are meant to identify
such forward-looking statements. Potential risks and uncertainties include, but
are not limited to those described below under “Risk Factors.”




General




Coastal
Banking Company, Inc. (the “Company”) is organized under the laws of the
State of South Carolina for the purpose of operating as a bank holding company
for CBC National Bank (the “Bank”). The Bank commenced business on May 10,
2000 as Lowcountry National Bank. The Company acquired First National Bank of
Nassau County, which began its operations in 1999, through its merger with First
Capital Bank Holding Corporation on October 1, 2005. On October 27,
2006, the Company acquired the Meigs, Georgia office of the Bank through merger
of Cairo Banking Co. with and into the Bank. On August 10, 2008, Lowcountry
National Bank and First National Bank of Nassau County merged into one charter.
Immediately after the merger, the name of the surviving bank was changed to CBC
National Bank and the main office relocated to 1891 South 14th
Street, Fernandina Beach, Nassau County, Florida. The Bank’s branches continue
to do business under the trade names “Lowcountry National Bank,” “First National
Bank of Nassau County,” and “The Georgia Bank” in their respective markets. The
Bank provides full commercial banking services to customers throughout Beaufort
County, South Carolina; Nassau County, Florida; and Thomas County, Georgia and
is subject to regulation by the Office of the Comptroller of the Currency (the
“OCC”) and the Federal Deposit Insurance Corporation (the “FDIC”). The Bank also
has loan production offices in Savannah, Georgia and Jacksonville, Florida, as
well as a wholesale mortgage banking office in Atlanta, Georgia. The Company is
subject to regulation by the Board of Governors of the Federal Reserve System
(the "Federal Reserve Board").




On August
26, 2009, the Bank entered into a formal agreement with the OCC (the
"Agreement").  The Agreement contains certain operational and
financial restrictions, which address the following items: reducing the high
level of credit risk in the Bank; taking immediate and continuing action to
protect the Bank’s interest in criticized assets; ensuring the Bank’s adherence
to its written profit plan to improve and sustain earnings; limiting brokered
deposits, excluding reciprocal CDARS, that would cause the Bank’s level of
brokered deposits to be in excess of ten percent of total deposits; and
establishing a Compliance Committee to monitor the Bank’s adherence to the
Agreement.




Additionally
on January 27, 2010, pursuant to a request by the Federal Reserve Bank of
Richmond, the board of directors of Coastal Banking Company, Inc. adopted a
resolution, which provides that the Company must obtain prior approval of the
Federal Reserve Board before incurring additional debt, purchasing or redeeming
its capital stock, or declaring or paying dividends, excluding dividends on
preferred stock related to our participation in the TARP Capital Purchase
Program (“CPP”).  The Company must also provide the Federal Reserve
Board with prior notification before using its cash assets, unless the use of
such assets is related to an investment in obligations or equity of the
Bank, an investment in short-term, liquid assets, or normal and customary
expenses, including regularly scheduled interest payments on existing
debt.




Location
and Service Area




Our
primary service areas consist of the areas within a 20 mile radius of the main
offices of Lowcountry National Bank in Beaufort County, South Carolina, First
National Bank in Nassau County, Florida, and The Georgia Bank in Thomas County,
Georgia. The primary service area of Lowcountry National Bank covers a large
portion of Beaufort County, including Beaufort, Bluffton, Burton, Callawassie
Island, Coosaw, Dataw Island, Harbor Island, Hilton Head Island, Hunting Island,
Fripp Island, Ladys Island, Port Royal, Spring Island, St. Helena Island, and
Sun City, South Carolina. The primary service area of First National Bank
includes the communities of Amelia Island, Fernandina Beach, O’Neil and Yulee,
Florida. First National Bank also serves the Savannah, Georgia; Atlanta,
Georgia; and Jacksonville, Florida market areas through loan production
offices.  The primary service area of The Georgia Bank is Thomas
County, Georgia.


1


Lending
Activities




General: We emphasize a range
of lending services, including real estate, commercial and consumer loans to
individuals and small- to medium-sized business and professional firms that are
located in or conduct a substantial portion of their business in the Bank’s
market areas.





Loan Underwriting: The
fundamental objective of our underwriting policies and procedures are to
establish minimum requirements for borrower creditworthiness, application
documentation and credit analysis upon which a decision to extend credit is
based.  The key principals of our underwriting policies are consistent
across all types of loans with variations to specific procedures driven by
characteristics such as the loan amount, purpose, collateral type and repayment
terms.





Our
underwriting policies require that we independently gather and verify sufficient
documentation to establish a borrower or guarantor’s credit worthiness, level of
financial reserves, capacity to repay the loan and the value of any
collateral.  Credit worthiness is validated with personal or business
credit reports from independent credit reporting agencies.  The level
of financial reserves is established from independent verifications of deposits,
investments or other assets.  Capacity to repay the loan is based on
verifiable earnings capacity as shown on up to three years of financial
statements and/or tax returns, banking activity levels, operating statements,
rent rolls or independent verification of employment.  Finally, as to
the value of collateral, we obtain appraisals from independent, professionally
designated property appraisers and will make personal inspections of the subject
collateral for larger balance loans.





Once the
appropriate documentation has been gathered, the analysis phase of the
underwriting process is completed.  This includes determination of
debt to income ratios, loan to value ratios, debt coverage ratios, global cash
flow analysis, stress tests to measure the impact of increasing interest rates
or falling collateral values and assessment of industry specific or general
economic trends on the borrower’s ability to repay the loan.  Our
policy establishes minimum acceptable levels for these credit metrics based on
the objective to produce investment grade loans. Further, our maximum acceptable
loan to collateral value percentages are less than or equal to applicable
regulatory guideline maximums.  In the case of acquisition and
development loans or construction loans, we also obtain and review project
budgets, periodic inspection reports by qualified engineering firms and site
visits by account officers not less than quarterly.  In all cases, the
underwriting documentation and analysis is completed as part of the initial
credit decision process; however, for loans that involve additional extensions
of credit or periodic renewals, the underwriting documentation is updated and
re-analyzed not less than annually.





Our
written loan underwriting policy provides general guidance on the appropriate
underwriting considerations, objectives and documentation.  To augment
the general policy guidance, we establish target criteria to define an
acceptable level of credit underwriting risk.  It is important to note
that these criteria are designated as targets rather than absolute limits to
allow for a degree of judgment in the underwriting process so that consideration
can be given to other compensating factors.  The following is a
summary of our more critical target underwriting criteria by major loan
categories in use as of December 31, 2009.  Where noted, DTI refers to
debt to income ratio and NADA refers to National Automobile Dealers
Association.  2




Loan
      Product Type
            Max.
      Loan
              to
      Value
            Max
      Loan
              to
      Cost
            Min.
      Debt Service Coverage Ratio
            Max.
      Term
            Amortization
      PeriodCommercial
      and FinancialAccounts
      Receivable
            75%
      of eligible accts.
            75%
      of eligible accts.
            N/A
            12
      mos.
            N/AInventory
            50%
      of qualified inventory
            50%
      of qualified inventory
            N/A
            12
      mos.
            N/AEquipment
            80%
      of cost or appraised value
            80%
      of cost or appraised value
            1.25
            60
      mos.
            60
      mos.Real
      Estate – commercialConstruction
            70-80%
            80-90%
            N/A
            24
      mos.
            N/AUndeveloped land
            65%
            65%
            N/A
            12
      mos.
            N/AImproved
      lot
            75%
            75%
            N/A
            24
      mos.
            N/ALand
      Development
            80%
            80%
            N/A
            24
      mos.
            N/AReal
      Estate – residentialConstruction
            80%
            100%
            N/A
            24
      mos.
            N/AUndeveloped land
            65%
            65%
            N/A
            12
      mos.
            N/AImproved lot
            75%
            75%
            N/A
            24
      mos.
            N/ALand Development
            80%
            90%
            N/A
            24 mos.
            N/AReal
      Estate – mortgage, commercial
            75%
            85%
            1.25
            60
      mos.
            25
      yrs.Real
      Estate – mortgage, residential
            80%
            80%
            40%
      DTI
            30
      yrs.
            30
      yrs.Consumer
      Installment LoansAutomobiles
      – New
            90%
      of Cost
            90%
            40%  DTI
            72
      mos.
            72
      mos.Automobiles
      - Used
            100%
      of NADA loan value
            100%
      of NADA loan value
            40%
      DTI
            60
      mos.
            60
      mos.Recreational
      Equipment
            80%
      of cost or 90% of NADA loan value
            80%
      of cost or 90% of NADA loan value
            40%
      DTI
            60
      mos.
            60
      mos.Aircraft
            80%
      of cost
            80%
      of cost
            40%
      DTI
            60
      mos.
            120
      mos.Home
      Equity (Term)
            89%
            89%
            40%
      DTI
            60
      mos.
            180
      mos.Home
      Equity Line of Credit
            89%
            89%
            40%
      DTI
            120
      mos.
            Interest
      Only MonthlyOther
      LoansSecured
      by Certificates of Deposit
            100%
            100%
            N/A
            Term
      of C.D.
            Term
      of C.D.Secured
      by Listed Stock
            70%
            70%
            N/A
            36
      mos.
            36
      mos.Unsecured
            N/A
            N/A
            36%
      DTI
            24
      mos.
            24
      mos.





Generally,
we require a minimum credit score of 680 for secured loans and a minimum credit
score of 700 for unsecured loans.





These
criteria are monitored on an ongoing basis and adjusted as needed to manage the
risk profile of different loan categories based on changes to economic
conditions and loan category concentration levels within the Company’s overall
loan portfolio.  Our policy is generally not to originate hybrid
loans, which we define as loans having one or more underwriting characteristics
that are inconsistent with investment grade loans, such as limited
documentation, LTVs in excess of 100%, negative interest amortization, high debt
to income ratios or poor borrower credit.  We have never originated
payment option ARMs which allow for negative interest amortization or subprime
loans, either for retention in our portfolio or for sale in the secondary
market.  In the case of residential loans, we do not originate loans
with any underwriting characteristic that are contrary with the underwriting
guidelines of Federal National Mortgage Association, Federal Home Loan Mortgage
Corporation, or the Federal Housing Authority.  3
 Loan Approval and Review:The
Bank’s loan approval policies provide for various levels of officer lending
authority. When the amount of aggregate loans to a single borrower exceeds an
individual officer’s lending authority, the loan request will be considered and
approved by an officers’ loan committee with a higher lending limit or the
directors’ loan committee, which has the authority to approve loans up to the
legal lending limit of the Bank. The Bank may not make any loans to any
director, officer, or employee of the Bank that, in the aggregate, exceeds
$1,000,000 unless approved by the board of directors of the Bank and made on
terms not more favorable to such person than would be available to a person not
affiliated with the Bank. The bank’s mortgage loan review process currently
adheres to guidelines from the Federal National Mortgage Association, the
Federal Home Loan Mortgage Corporation, and where applicable the Federal Housing
Administration, but the Bank reserves the right to alter this policy in the
future. The bank currently sells mortgage loans on the secondary market, but
has, on occasion, chosen to hold them in the portfolio.




Lending Limits:The bank’s
lending activities are subject to a variety of lending limits imposed by federal
law. In general, the Bank is subject to a legal limit on loans to a single
borrower equal to 15% of the Bank’s capital and unimpaired surplus. Different
limits may apply in certain circumstances based on the type of loan or the
nature of the borrower, including the borrower’s relationship to the Bank. These
limits will increase or decrease as the Bank’s capital increases or decreases.
Based upon CBC National Bank’s capitalization of $40,608,000 as of
December 31, 2009, the Bank has a self-imposed loan limit of $6,212,000,
which represents 98% of our regulatory legal lending limit of $6,339,000. Based
upon the Bank’s current lending limit, unless the Bank is able to sell
participations in its loans to other financial institutions, the Bank will be
unable to meet all of the lending needs of loan customers requiring aggregate
extensions of credit above this limit.




Real Estate and Mortgage Loans:Loans secured by first or second mortgages on real estate make up
approximately 95% of the Bank’s loan portfolio. These loans generally fall into
one of three categories: commercial real estate loans, construction and
development loans, or residential real estate loans. Each of these categories is
discussed in more detail below, including their specific risks. Home equity
loans are not included because they are classified as consumer loans, which are
discussed below. Interest rates for all categories may be fixed or
adjustable, and will more likely be fixed for shorter-term loans. The bank has
not in the past and does not have plans in the future to originate loans that
would be considered sub-prime or that allow for negative amortization. The bank
generally charges origination fees for each loan.




Real
estate loans are subject to the same general risks as other loans. They are
particularly sensitive to fluctuations in the value of real estate. Fluctuations
in the value of real estate, as well as other factors arising after a loan has
been made, could negatively affect a borrower’s cash flow, creditworthiness, and
ability to repay the loan.




Through
our wholesale mortgage banking office, we originate residential real estate
loans for sale into the secondary market. We limit our interest rate and credit
risk on these loans by locking the interest rate for each loan in a forward sale
commitment with the secondary market investor and then selling the loan to that
investor after the loan is funded.




Commercial Real Estate Loans:Commercial real estate loans generally have terms of five years or less,
although payments may be structured on a longer amortization basis. We
evaluate each borrower on an individual basis and attempt to determine its
business risks and credit profile. We attempt to reduce credit risk in the
commercial real estate portfolio by emphasizing loans on owner-occupied office
and retail buildings where the loan-to-value ratio, established by independent
appraisals, does not exceed 80%. We generally require that debtor cash flow
exceed 125% of monthly debt service obligations. We typically review all of the
personal financial statements of the principal owners at the time we originate
the loan and annually thereafter. We also require borrowers to execute personal
guarantees at the time of origination. These reviews of personal financial
statements generally reveal secondary sources of payment and liquidity to
support a loan request.




Construction and Development Real
Estate Loans:We offer adjustable and fixed rate residential and
commercial construction loans to builders and developers and to consumers who
wish to build their own home. The term of construction and development loans
generally is limited to eighteen months, although payments may be
structured on a longer amortization basis. Most loans will mature and require
payment in full upon the sale of the property. Construction and development
loans generally carry a higher degree of risk than long term financing of
existing properties. Repayment depends on the ultimate completion of the project
and usually on the sale of the property. Specific risks include cost overruns,
mismanaged construction, inferior or improper construction techniques, economic
changes or downturns during construction, a downturn in the real estate market,
rising interest rates which may prevent sale of the property, and failure
to sell completed projects in a timely manner.




4


We
attempt to reduce risk by obtaining personal guarantees where possible, and by
keeping the loan-to-value ratio of the completed project below
specified percentages. We may also reduce risk by selling
participations in larger loans to other institutions when possible.




Residential Real Estate Loans:Residential real estate loans generally have longer terms of up to 30
years. We offer fixed and adjustable rate mortgages in conforming loan amounts.
We have a limited amount of interest only loans, but we do not offer negative
amortization loans. We have limited credit risk on these loans as most are sold
to third parties soon after closing.




Commercial Loans:Our bank
makes loans for commercial purposes in various lines of businesses. Commercial
loans are generally considered to have greater risk than first or second
mortgages on real estate because they may be unsecured, or if they are
secured, the value of the security may be difficult to assess and more
likely to decrease than real estate.




Equipment
loans typically are made for a term of five years or less at fixed or variable
rates, with the loan fully amortized over the term and secured by the financed
equipment and with a loan-to-value ratio of 80% or less. We focus our efforts on
commercial loans with principal amounts less than $500,000. Working capital
loans typically have terms not exceeding one year and usually are secured by
accounts receivable, inventory, or personal guarantees of the principals of the
business. For loans secured by accounts receivable or inventory, principal
typically is repaid as the assets securing the loan are converted into cash, and
in other cases principal typically will be due at maturity.  While
trade letters of credit and standby letters of credit are processed by the Bank,
foreign exchange services are handled through a correspondent bank as agent for
the Bank.




We offer
small business loans utilizing government enhancements such as the Small
Business Administration’s (“SBA”) 7(a) program and 504 programs. These
loans typically are partially guaranteed by the government, which may help
to reduce the Bank’s risk. Government guarantees of SBA loans generally do not
exceed 75% of the loan value.




The
larger banks in the Beaufort County and Nassau County areas make proportionately
more loans to medium to large-sized businesses than we do. Many of the Bank’s
commercial loans are made to small- to medium-sized businesses, which
may be less able to withstand competitive, economic, and financial
conditions than larger borrowers.




Consumer Loans:Our bank
makes a variety of loans to individuals for personal and household purposes,
including secured and unsecured installment loans and revolving lines of credit.
Installment loans typically carry balances of less than $50,000 and are
amortized over periods up to 72 months. Consumer loans may be 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. Consumer loans are generally considered to have
greater risk than first or second mortgages on real estate because they
may be unsecured, or if they are secured, the value of the security
may be difficult to assess and more likely to decrease than real
estate.




We also
offer home equity loans. Our underwriting criteria for and the risks associated
with home equity loans and lines of credit generally are the same as those for
first mortgage loans. Home equity lines of credit typically have terms of 15
years or less, carry balances less than $125,000, and may extend up to
89.9% of the available equity of each property.




Deposits:The bank offers a
wide range of commercial and consumer deposit accounts, including checking
accounts, money market accounts, a variety of certificates of deposit, and
individual retirement accounts. The primary sources of deposits are residents
of, and businesses and their employees located in, our primary market areas.
Deposits are obtained through personal solicitation by officers and directors,
direct mail solicitations and advertisements published in the local media. To
attract deposits, the Bank offers a broad line of competitively priced deposit
products and services.  5
 Supervision
And Regulation




Both the
Company and the Bank are subject to extensive state and federal banking laws and
regulations that impose restrictions on and provide for general regulatory
oversight of their operations. These laws and regulations are generally 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.





Coastal
Banking Company, Inc.




Because
the Company owns all of the capital stock of the Bank, it is a bank holding
company under the federal Bank Holding Company Act of 1956, as amended. 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 Board”). As a bank
holding company located in South Carolina, the South Carolina Board of Financial
Institutions also regulates and monitors our operations.




Acquisitions of
Banks.The Bank
Holding Company Act requires every bank holding company to obtain the Federal
Reserve Board’s approval in advance of:




·
            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 Board may not
approve any of these transactions if it would result in or tend to create a
monopoly, substantially lessen competition, or otherwise function as a restraint
of trade, unless the anticompetitive 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 Board 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 Board’s consideration of financial
resources generally focuses on capital adequacy, which is discussed
below.




Under the
Bank Holding Company Act, if we are adequately capitalized and adequately
managed, we may purchase a bank located outside of South Carolina, Georgia
or Florida. However, the laws of the other state may impose restrictions on
the acquisition of a bank that has only been in existence for a limited amount
of time or that would result in specified concentrations of deposits. For
example, South Carolina law prohibits a bank holding company from acquiring
control of a bank until the target bank has been incorporated for five years.
Because CBC National Bank has been chartered for more than five years, this
restriction would not limit our ability to be acquired.


6


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 Board
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 a bank holding
company. Control is also presumed to exist, although rebuttable, 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 Exchange Act of 1934, as amended;
  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, as amended.  The regulations provide a procedure for challenging
the rebuttable presumption 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 Board 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 activity. 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 Board
to become a financial holding company and must provide the Federal Reserve Board
with 30 days’ written notice prior to engaging in a permitted financial
activity. The Company does not meet the qualification standards applicable to
financial holding companies at this time.




Support of
Subsidiary Institution.Under Federal Reserve Board policy, we are 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 Board
policy, we might not be inclined to provide it. In addition, any capital loans
made by us to the Bank will be repaid only after the Bank’s deposits and various
other obligations are repaid in full. In the unlikely event of our bankruptcy,
any commitment that we give to a bank regulatory agency to maintain the capital
of the Bank will be assumed by the bankruptcy trustee and entitled to a priority
of payment.




CBC
National Bank




Because
the Bank is chartered as a national bank, it is primarily subject to the
supervision, examination, and reporting requirements of the National Bank Act
and the regulations of the OCC. The OCC regularly examines the Bank’s operations
and has the authority to approve or disapprove mergers, the establishment of
branches and similar corporate actions. The OCC also has the power to prevent
the continuance or development of unsafe or unsound banking practices or other
violations of law. Because the Bank’s deposits are insured by the FDIC to the
maximum extent provided by law, it is also subject to certain FDIC regulations
and the FDIC also has examination authority and back-up enforcement power over
the Bank. The Bank is also subject to numerous state and federal statutes and
regulations that affect the Bank’s business, activities, and
operations.  7
 Formal
Agreement. On August 26, 2009, the Bank entered into a formal agreement
with the OCC (the “Agreement”).  The Agreement contains certain
operational and financial restrictions, which address the concerns identified in
the Bank’s report of examination.




Under the
terms of the Agreement, the Bank has prepared and provided written plans and/or
reports to the regulators that address the following items: reducing the high
level of credit risk in the Bank, taking immediate and continuing action to
protect its interest in criticized assets, ensuring the Bank’s adherence to its
written profit plan to improve and sustain earnings, limiting brokered deposits,
excluding reciprocal CDARS, that would cause the Bank’s level of brokered
deposits to be in excess of ten percent of total deposits, and establishing a
Compliance Committee to monitor the Bank’s adherence to the
Agreement.




Branching.National banks are required
by the National Bank Act to adhere to branching laws applicable to state banks
in the states in which they are located. Under South Carolina, Georgia and
Florida law, the Bank may open branch offices throughout each respective state
with the prior approval of the OCC. In addition, with prior regulatory approval,
the Bank may acquire branches of existing banks located in South Carolina,
Georgia and Florida. The Bank and any other national or state-chartered bank
generally may branch across state lines by merging with banks in other
states if allowed by the applicable states’ laws.




Under the
Federal Deposit Insurance Act, states may “opt-in” and allow out-of-state banks
to branch into their state by establishing a new start-up branch in the state.
Currently, neither Georgia, South Carolina nor Florida has opted-in to this
provision. Therefore, interstate merger is the only method through which a bank
located outside of these states may branch into them. This provides a limited
barrier of entry into the South Carolina, Florida and Georgia banking markets,
which protects us from an important segment of potential competition. However,
because neither South Carolina, Georgia nor Florida has elected to
opt-in, our ability to establish a new start-up branch in another state may be
limited. Many states that have elected to opt in have done so on a reciprocal
basis, meaning that an out-of-state bank may establish a new start-up branch
only if its home state has also elected to opt in. Consequently, until Florida
changes its election, the only way the Bank will be able to branch into states
that have elected to opt-in on a reciprocal basis will be through interstate
merger.




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. The federal banking agencies have also specified by regulation the
relevant capital levels for each category.




As a
bank’s capital position deteriorates, 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. As of December 31, 2009, the Bank was
considered well-capitalized.




A
“well-capitalized” bank is one that is not required to meet and maintain a
specific capital level for any capital measure, pursuant to any written
agreement, order, capital directive, or other remedial action, and 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, which requires
certain remedial action.  8
 An
“adequately-capitalized” bank meets the required minimum level for each relevant
capital measure, including a total risk-based capital ratio of at least 8%, a
tier 1 risk-based capital ratio of at least 4% and a tier 1 leverage ratio of at
least 4%. A bank that is adequately capitalized is prohibited from directly or
indirectly accepting, renewing or rolling over any brokered deposits, absent
applying for and receiving a waiver from the applicable regulatory authorities.
Institutions that are not well capitalized are also prohibited, except in very
limited circumstances where the FDIC permits use of a higher local market rate,
from paying yields for deposits in excess of 75 basis points above a national
average rate for deposits of comparable maturity, as calculated by the FDIC. In
addition, an adequately-capitalized bank may be forced to comply with operating
restrictions similar to those placed on undercapitalized banks.




An
“undercapitalized” bank fails to meet the required minimum level for an
adequately-capitalized bank. A bank that reaches the undercapitalized level, is
likely subject to a formal agreement and other formal supervisory sanctions. An
undercapitalized bank must submit a capital restoration plan to regulatory
authorities, be closely monitored by regulatory authorities regarding its
capital restoration plan, and obtain prior regulatory approval for acquisitions,
branching, and new lines of business. In addition, federal and state regulators
may impose on an undercapitalized bank any of the following operating and
managerial restrictions, which may:




•
            
            prohibit
      capital distributions;•
            
            prohibit
      payment of management fees to a controlling person;•
            
            require
      a capital restoration plan within 45 days of becoming
      undercapitalized;•
            
            restrict
      or prohibit asset growth, or require a bank to shrink;•
            
            require
      prior approval by the primary federal regulator for acquisitions,
      branching and new lines of business;•
            
            require
      sale of securities, or, if grounds for conservatorship or receivership
      exist, direct the bank to merge or be acquired;•
            
            restrict
      affiliate transactions;•
            
            restrict
      or prohibit all activities that are determined to pose an excessive risk
      to the bank;•
            
            require
      the institution to elect new directors, dismiss directors or senior
      executive officer or employ qualified senior executive officers to improve
      management;•
            
            prohibit
      the acceptance of deposits from correspondent banks;•
            
            require
      prior approval of capital distributions by holding companies;•
            
            require
      holding company divestiture of the bank, bank divestiture of subsidiaries,
      and/or holding company divestiture of other affiliates;•
            
            require
      the bank to take any other action the federal regulator determines will
      “better achieve” prompt corrective action objectives;•
            
            prohibit
      material transactions outside the usual course of business;•
            
            prohibit
      amending the bylaws/charter of the bank;•
            
            prohibit
      any material changes in accounting methods;
and





A
“significantly undercapitalized” bank, in addition to being subject to the
restrictions applicable to undercapitalized institutions, is subject to
additional restrictions on the compensation it is able to pay to its senior
executive officers.  9
 A
“critically undercapitalized” bank, in addition to being subject to the
restrictions applicable to undercapitalized and significantly-undercapitalized
institutions, is further prohibited from doing any of the following without the
prior written approval of its primary federal regulator:





·
            entering
      into any material transaction other than in the ordinary course of
      business;





·
            extending
      credit for any highly leveraged
transaction;





·
            amending
      the institution’s charter or bylaws, except to the extent necessary to
      carry out any other requirement of any law, regulation or
      order;





·
            making
      any material change in accounting
methods;





·
            engaging
      in certain types of transactions with
  affiliates;





·
            paying
      excessive compensation or bonuses;





·
            paying
      interest on new or renewed liabilities at a rate that would increase the
      institution’s weighted average cost of funds to a level significantly
      exceeding the prevailing rates of its
  competitors;





·
            making
      any principal or interest payment on subordinated debt 60 days or more
      after becoming critically
undercapitalized;





In
addition, its primary federal regulator may impose additional restrictions on
critically undercapitalized institutions consistent with the intent of the
prompt corrective action regulations.  Once an institution has become
critically undercapitalized, subject to certain narrow exceptions such as a
material capital remediation, federal banking regulators will initiate the
resolution of the institution.




FDIC Insurance
Assessments.The Bank’s deposits are insured by the Deposit Insurance
Fund (the “DIF”) of the FDIC up to the maximum amount permitted by
law.  The Bank is thus subject to FDIC deposit premium assessments.
The FDIC uses a risk-based assessment system that assigns insured depository
institutions to one of four risk categories based on three primary sources of
information – supervisory risk ratings for all institutions, financial ratios
for most institutions, including the Bank, and long-term debt issuer ratings for
large institutions that have such ratings. In February 2009, the FDIC
issued new risk-based assessment rates that took effect on April 1, 2009.
For institutions assigned to the lowest risk category, the annual assessment
rate ranges between 7 and 16 cents per $100 of domestic deposits. For
institutions assigned to higher risk categories, the new assessment rates range
from 17 to 77.5 cents per $100 of domestic deposits.  These ranges
reflect a possible downward adjustment for unsecured debt outstanding and
possible upward adjustments for secured liabilities and, in the case of
institutions outside the lowest risk category, brokered deposits.




The FDIC
uses the DIF to protect against the loss of insured deposits if an FDIC-insured
bank or savings association fails. The FDIC must maintain the DIF within a range
between 1.15 percent and 1.50 percent of all insured deposits. In
order to keep the reserve ratio at no less than the statutorily mandated minimum
of 1.15%, the FDIC imposed an emergency special one-time assessment of an
institution’s assets minus Tier 1 capital as of June 30, 2009 that was
collected on September 30, 2009. The cost of this special assessment to the Bank
was $222,596.




On
September 29, 2009, the FDIC announced a uniform 3 basis points increase
effective January 1, 2011, and on November 12, 2009, adopted a rule requiring
nearly all FDIC-insured depository institutions, including the Bank, to prepay
their DIF assessments for the fourth quarter of 2009 and for the next three
years on December 30, 2009.  The FDIC has indicated that the
prepayment of DIF assessments is in lieu of additional special assessments,
although there can be no guarantee that continued pressures on the DIF will not
result in additional special assessments being collected by the FDIC in the
future.  10
 The FDIC
may, without further notice-and-comment rulemaking, 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
also collects a deposit-based assessment from insured financial institutions on
behalf of The Financing Corporation (“FICO”). The funds from these assessments
are used to service debt issued by FICO in its capacity as a financial vehicle
for the Federal Savings & Loan Insurance Corporation. The FICO assessment
rate is set quarterly and in 2009 ranged from 1.14 cents to 1.02 cents per $100
of assessable deposits. These assessments will continue until the debt matures
between 2017 and 2019.




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 U.S. banking system, 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 guarantees certain newly issued senior unsecured debt
issued by participating financial institutions through October 31, 2009. 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 issue any debt outstanding pursuant to the program.




The Transaction Account Guarantee
Program: Under the TLGP, the FDIC fully guarantees funds in non-interest
bearing deposit accounts held at participating FDIC-insured institutions,
regardless of dollar amount. The temporary guarantee was originally scheduled to
expire at the end of 2009, but was subsequently extended to June 30,
2010.  As a result, the new opt-out deadline was November 2,
2009.  During the original period, the FDIC imposed a 10 basis point
annual rate surcharge applied to noninterest-bearing transaction deposit amounts
over $250,000. For the extension period, this surcharge is between 15 and 25
basis points on an annualized basis.  Institutions will not be
assessed on amounts that are otherwise insured. The Bank did not opt-out of the
original or extension periods of the Transaction Account Guarantee component of
the TLGP.




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. See “Management’s Discussion and Analysis –
Critical Accounting Policies.”  11
 Commercial Real
Estate Lending.The Bank’s 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:




·
            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.




Community
Reinvestment Act.The Community Reinvestment Act requires that, in connection with
examinations of financial institutions within their respective jurisdictions,
the federal banking agencies 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, the Bank must publicly disclose the terms
of various Community Reinvestment Act-related agreements.




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. The Bank’s loan operations are also subject to federal laws applicable to
credit transactions, such as the:




·
            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;




·
            National
      Flood Insurance Act and Flood Disaster Protection Act, requiring flood
      insurance to extend or renew certain loans in flood
  plains;




·
            Real
      Estate Settlement Procedures Act, requiring certain disclosures concerning
      loan closing costs and escrows, and governing transfers of loan servicing
      and the amounts of escrows in connection with loans secured by one-to-four
      family residential properties;




·
            Soldiers’
      and Sailors’ Civil Relief Act of 1940, as amended, 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 certain types of consumer loans to military
      service members and their
dependents;




12


·
              Bank
      Secrecy Act, as amended by the Uniting and Strengthening America by
      Providing Appropriate Tools Required to Intercept and Obstruct Terrorism
      Act of 2001 (the “USA PATRIOT Act”), imposing requirements and limitations
      on specific financial transactions and account relationships, intended to
      guard against money laundering and terrorism
      financing;


·
            sections
      22(g) and 22(h) of the Federal Reserve Act which set lending restrictions
      and limitations regarding loans and other extensions of credit made to
      executive officers, directors, principal shareholders and other insiders;
      and




·
            rules
      and regulations of the various federal agencies 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 the following:




·
            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;




·
            Truth-In-Savings
      Act, requiring certain disclosures for consumer deposit
      accounts;




·
            Electronic
      Funds Transfer Act and Regulation E issued by the Federal Reserve
      Board 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 agencies charged with the
      responsibility of implementing these federal
  laws.




As part
of the overall conduct of the business, the Company and the Bank must comply
with:




·
            privacy
      and data security laws and regulations at both the federal and state
      level; and




·
            anti-money
      laundering laws, including the USA Patriot
Act.




Capital
Adequacy




The
Company and the Bank are required to comply with the capital adequacy standards
established by the Federal Reserve Board, in the case of the Company, and the
OCC, in the case of the Bank. The Federal Reserve Board has established a
risk-based and a leverage measure of capital adequacy for bank holding
companies. The Bank is also subject to risk-based and leverage capital
requirements adopted by its primary regulator, which are substantially similar
to those adopted by the Federal Reserve Board for 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.




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 management restrictions.  A bank, however, that exceeds
its capital requirements and maintains a ratio of total capital to risk-weighted
assets of 10% is classified as well 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. At December 31, 2009 our
ratio of total capital to risk-weighted assets was 15.28% and our ratio of Tier
1 Capital to risk-weighted assets was 14.03%.


13


In
addition, the Federal Reserve Board has established minimum leverage ratio
guidelines for bank holding companies, which are intended to further address
capital adequacy of the Bank. 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
Board’s 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 9.36%. 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 Board 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 or 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. See
“Prompt Corrective Action” above.




The OCC,
the Federal Reserve, and the FDIC have authority to compel or restrict certain
actions if the Bank’s capital should fall below adequate capital standards as a
result of operating losses, or if its regulators otherwise determine that it has
insufficient capital. Among other matters, the corrective actions may include,
removing officers and directors; and assessing civil monetary penalties; and
taking possession of and closing and liquidating the Bank.




The
regulatory capital framework under which the Company and the Bank operate is in
a period of change with likely legislation or regulation that will revise the
current standards and very likely increase capital requirements for the entire
banking industry, including the Company and the Bank. The resulting capital
requirements are yet to be determined. The Company and the Bank are now governed
by a set of capital rules that the Federal Reserve Board and the OCC have had in
place since 1988, with some subsequent amendments and revisions. These rules are
popularly known as “Basel I.” Before the current financial crisis began to have
a dramatic effect on the banking industry, the U.S. regulators had participated
in an effort by the Basel Committee on Banking Supervision to develop Basel II.
Basel II provides several options for determining capital requirements for
credit and operational risk. In December 2007, the agencies adopted a final rule
implementing Basel II’s “advanced approach” for “core banks” – U.S. banking
organizations with over $250 billion in banking assets or on-balance-sheet
foreign exposures of at least $10 billion. For other banking organizations,
including the Company and the Bank, the U.S. banking agencies proposed a rule in
July 2008 that would enable these organizations to adopt the Basel II
“standardized approach.” The proposed rule has not been finalized. As a result
of the financial crisis that has adversely affected global credit markets and
increases in credit, liquidity, interest rate and other risks, in September
2009, the Treasury issued principles for international regulatory reform, which
included recommendations for higher capital standards for all banking
organizations to be implemented as part of a broader reconsideration of
international risk-based capital standards developed by Basel II.




Payment
of Dividends




The
Company is a legal entity separate and distinct from the Bank. The principal
source of the Company’s cash flow, including cash flow to pay dividends to its
shareholders, are dividends that the Bank pays to the Company as the Bank’s sole
shareholder. Statutory and regulatory limitations apply to the Bank’s payment of
dividends to the Company as well as to the Company’s payment of dividends to its
shareholders. If, in the opinion of the OCC, the Bank were engaged in or about
to engage in an unsafe or unsound practice, the OCC could require that the Bank
stop or refrain from 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.




The Bank
is required by federal law to obtain prior approval of the OCC for payments of
dividends if the total of all dividends declared by the Bank in any year will
exceed (1) the total of the Bank’s net profits for that year, plus
(2) the Bank’s retained net profits of the preceding two years, less any
required transfers to surplus. 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. As of the date of this Annual
Report on Form 10-K, pursuant to a resolution adopted by our Board of Directors,
the Company is prohibited from declaring and paying cash dividends on common
shares outstanding without prior regulatory approval.




14


When the
Company received a capital investment from the United States Department of the
Treasury under the TARP CPP on December 5, 2008, 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 the TARP  CPP be paid before other dividends can be paid and
(ii) the Treasury must approve any increases in common dividends for three years
following the Treasury’s investment. The resolution adopted by our Board of
Directors is not applicable to the declaration and payment of dividends on our
preferred stock issued pursuant to the TARP CPP.




Furthermore,
earlier this year, the Federal Reserve Board clarified its guidance on dividend
policies for bank holding companies through the publication of a Supervisory
Letter, dated February 24, 2009. As part of the letter, the Federal Reserve
Board encouraged bank holding companies, particularly those that had
participated in the CPP, to consult with the Federal Reserve Board prior to
dividend declarations, and redemption and repurchase decisions even when not
explicitly required to do so by federal regulations. The Federal Reserve Board
has indicated that CPP recipients, such as the Company, should consider and
communicate in advance to regulatory staff how proposed dividends, capital
repurchases and capital redemptions are consistent with its obligation to
eventually redeem the securities held by the Treasury. This new guidance is
largely consistent with prior regulatory statements encouraging bank holding
companies to pay dividends out of net income and to avoid dividends that could
adversely affect the capital needs or minimum regulatory capital ratios of the
bank holding company and its subsidiary bank.




Any
future determination relating to our dividend policy will be made at the
discretion of the 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
Board;




·
            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. The Bank must also comply with other provisions
designed to avoid taking low-quality assets.




The
Company and the Bank are also 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.




The Bank
is also subject to restrictions on extensions of credit to its 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.  15
 Limitations
on Senior Executive Compensation




On
October 22, 2009, the Federal Reserve Board issued proposed guidance designed to
help ensure that incentive compensation policies at banking organizations do not
encourage excessive risk-taking or undermined the safety and soundness of the
organization. In connection with the proposed guidance, the Federal Reserve
Board announced that it will review incentive compensation arrangements as part
of the regular, risk-focused supervisory process. The Federal Reserve Board may
take enforcement action against a banking organization if its incentive
compensation arrangement or related risk management, control, or governance
processes pose a risk to the safety and soundness of the organization and the
organization is not taking prompt and effective measures to correct the
deficiencies.




Due to
the Company’s participation in the TARP Capital Purchase Program, it is subject
to additional executive compensation limitations. For example, the Company must
meet the following standards:




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




·
            Subject
      senior executive compensation to “clawback” if the compensation was based
      on inaccurate financial information or performance
  metrics;




·
            Prohibit
      any golden parachute payments to senior executive officers;
      and




·
            Agree
      not to deduct more than $500,000 from taxable income for a senior
      executive officer’s compensation.




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.




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 Board’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 Board 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. Neither
the Company nor the Bank can predict the nature or impact of future changes in
monetary and fiscal policies.




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, commercial
accounts, savings accounts, and other time deposits of various types, ranging
from daily money market accounts to longer-term certificates of deposit. The
transaction accounts and time certificates are tailored to our primary market
areas at rates competitive in the market area. In addition, we offer certain
retirement account services, such as IRAs. We solicit these accounts from
individuals, businesses, associations, organizations, and governmental
authorities.




Other
Banking Services




Our bank
also offers other bank services including drive up ATMs, safe deposit boxes,
traveler’s checks, direct deposit, U.S. Savings Bonds, banking by mail, and
internet banking. The bank is associated with the Plus and Star ATM networks,
which may be used by customers throughout the Bank’s primary market areas
and other regions. We believe that by being associated with a shared network of
ATMs, we are better able to serve our customers and attract customers who are
accustomed to the convenience of using ATMs. The bank does not currently
exercise trust powers, and we do not expect the Bank to offer trust services in
the near future.




Employees




As of
December 31, 2009, we had 104 full-time employees and 13 part-time
employees.  16
 ITEM 1A. RISK
FACTORS




We are subject to regulatory actions
by our primary regulatory authorities to address asset quality and
related
issues.




We
entered into a formal agreement (the "Agreement") with the Office of the
Comptroller of the Currency (the "OCC") to address asset quality and related
issues. Under the terms of the Agreement, the Bank has prepared and provided
written plans and/or reports to the regulators that address the following items:
reducing the high level of risk in the Bank, taking immediate and continuing
action to protect its interest in criticized assets, ensuring the Bank’s
adherence to its written profit plan to improve and sustain earnings, limiting
brokered deposits, excluding reciprocal CDARS, that would cause the Bank’s level
of brokered deposits to be in excess of ten percent of total deposits, and
establishing a Compliance Committee to monitor the Bank’s adherence to the
Agreement. Although management continues to address the regulatory concerns
cited in the Agreement, there is no assurance that we will be able to maintain
compliance with the Agreement in the future. If we are unable to comply, we
could be subject to other regulatory sanctions that could ultimately result in
more severe penalties.




Additionally
on January 27, 2010, pursuant to a request by the Federal Reserve Bank of
Richmond, the Board of Directors of Coastal Banking Company, Inc. adopted a
resolution which provides that the Company must obtain prior approval of the
Federal Reserve Board before incurring additional debt, purchasing or redeeming
its capital stock, or declaring or paying dividends, excluding dividends on
preferred stock related to our participation in the TARP CPP.  The
Company must also provide the Federal Reserve Board with prior notification
before using its cash assets, unless the use of such assets is related
to an investment in obligations or equity of the Bank, an investment in
short-term, liquid assets, or normal and customary expenses, including regularly
scheduled interest payments on existing debt.




Compliance
with the terms of the formal agreement, including the adoption and
implementation of the plans and policies discussed above, and the Resolution
will require significant time and attention from our management team, which may
increase our costs, impede the efficiency of our internal business processes and
adversely affect our profitability in the near-term. If we are unable to
implement our plans in a timely manner or otherwise comply with our commitments
outlined above, or if we fail to adequately resolve any other matters any of our
regulators may require us to address in the future, we could become subject to
more stringent supervisory actions. The terms of any such supervisory action
could have a material negative effect on our business, operating flexibility, or
financial condition.




We
have incurred operating losses and cannot assure you that we will be profitable
in the future.




Excluding
the nonrecurring charge of $10.4 million for impairment of Goodwill in 2009, we
have incurred a net operating loss of $4.1 million, or $1.83 per share, for the
year ended December 31, 2009 and a net loss of $4.8 million, or $1.91 per share,
for the year ended December 31, 2008, due in both cases primarily to credit
losses and associated costs, including a significant provision for loan losses.
Although we have taken steps to reduce our credit exposure, we likely will
continue to have a higher than normal level of non-performing assets and
charge-offs through 2010 and into 2011, which would continue to adversely impact
our overall financial condition and results of operations.  17
 We
may experience increased delinquencies and credit losses, which could have a
material adverse effect on our capital, financial condition and results of
operations.




Like
other lenders, we face the risk that our customers will not repay their loans. A
customer’s failure to repay us is usually preceded by missed monthly payments.
In some instances, however, a customer may declare bankruptcy prior to missing
payments, and, following a borrower filing bankruptcy, a lender’s recovery of
the credit extended is often limited. Since our loans are secured by collateral,
we may attempt to seize the collateral when and if customers default on their
loans. However, the value of the collateral may not equal the amount of the
unpaid loan, and we may be unsuccessful in recovering the remaining balance from
our customers. Rising delinquencies and rising rates of bankruptcy in our market
area generally and among our customers specifically can be precursors of future
charge-offs and may require us to increase our allowance for loan and lease
losses. Higher charge-off rates and an increase in our allowance for loan and
lease losses may hurt our overall financial performance if we are unable to
increase revenue to compensate for these losses and may also increase our cost
of funds.




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




Negative
developments since 2008 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 in 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
will continue to be negatively affected.




The impact of the
current economic environment on performance of other financial institutions in
our primary market area, actions taken by our competitors to address the current
economic downturn, and public perception of and confidence in the economy
generally, and the banking industry specifically, may present significant
challenges for us and could adversely affect our
performance.




We are
operating in a challenging and uncertain economic environment, including
generally uncertain national conditions and local conditions in our markets.
Financial institutions continue to be affected by sharp declines in the real
estate market and constrained financial markets. While we are taking steps to
decrease and limit our exposure to real estate construction loans, we
nonetheless retain direct exposure to the real estate markets, and we are
affected by these events. Continued declines in real estate values and financial
stress on borrowers as a result of the uncertain economic environment, including
job losses, could have an adverse effect on our borrowers or their customers,
which could adversely affect our financial condition and results of
operations.




The
impact of recent events relating to housing and commercial real estate markets
has not been limited to those directly involved in the real estate industry, but
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.




In
addition, 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 95% 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 continue to 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 earnings could be further adversely
affected.  18
 The
overall deterioration in economic conditions may subject us to increased
regulatory scrutiny in the current environment. In addition, further
deterioration in national and local economic conditions in our markets could
drive losses beyond that which is provided for in our allowance for loan losses,
resulting in the following other consequences:  increased loan
delinquencies, problem assets and foreclosures; decline in demand for our
products and services; decrease in deposits, adversely affecting our liquidity
position; and decline in value of collateral, reducing our customers’ borrowing
power and the value of assets and collateral associated with our existing loans.
As a community bank, we are less able to spread the risk of unfavorable 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 even if they do occur.




Continued
weakness in residential property values and mortgage loan markets could
adversely affect us.




We have a
significant number of one-to-four family residential loans, which are secured
principally by single-family residences. Loans of this type are generally
smaller in size and geographically dispersed throughout our market area. Losses
on our residential loan portfolio are difficult to predict because of a number
of variables, including interest rates, the unemployment rate, economic
conditions, and collateral values. Continued weakness in the secondary market
for residential lending could have an adverse impact upon our profitability.
Pricing may change rapidly, impacting the value of loans in our portfolio. This
weakness has been most pronounced in residential construction and development
loans; however, turmoil in the mortgage markets, combined with the ongoing
correction in real estate markets, could result in further price reductions in
single family home prices and lack of liquidity in refinancing markets. These
factors could adversely impact the quality of our residential construction and
residential mortgage portfolio in various ways, including creating discrepancies
in value between the original appraisal and the value at time of sale, and
decreasing the value of the collateral securing our mortgage loans.




We
are subject to risks in the event of certain borrower default, which could have
an adverse impact on our liquidity position and results of
operations.




We may be
required to repurchase mortgage loans or indemnify mortgage loan purchasers as a
result of certain borrower defaults, which could adversely affect our liquidity
position, results of operations, and financial condition. When we sell mortgage
loans, we are required to make customary representations and warranties to the
purchaser about the mortgage loans and the manner in which the loans were
originated. Our whole-loan sale agreements may require us to repurchase or
substitute mortgage loans in the event we breach any such representations or
warranties. In addition, we may be required to repurchase mortgage loans in the
event of early payment default of the borrower on a mortgage loan. While we have
taken steps to enhance our underwriting policies and procedures, these steps
might not be effective and might not lessen the risks associated with loans sold
in the past. If repurchase demands increase, our liquidity position, results of
operations, and financial condition could be adversely affected.




We
make and hold in our portfolio a significant number of land acquisition and
development and construction loans, which pose more credit risk than other types
of loans typically made by financial institutions.




We offer
land acquisition and development, and construction loans for builders and
developers. As of December 31, 2009, we had $42 million, or 15%, of
our total loan portfolio represented by loans for which the related property is
neither presold nor preleased. These land acquisition and development, and
construction loans are considered more risky than other types of loans. The
primary credit risks associated with land acquisition and development and
construction lending are underwriting, project risks, and market risks. Project
risks include cost overruns, borrower credit risk, project completion risk,
general contractor credit risk, and environmental and other hazard risks. Market
risks are risks associated with the sale of the completed residential units.
They include affordability risk, which means the risk that borrowers cannot
obtain affordable financing, product design risk, and risks posed by competing
projects. There can be no assurance that losses in our land acquisition and
development and construction loan portfolio will not exceed our reserves, which
could adversely impact our earnings. Given the current environment, the
non-performing loans in our land acquisition and development and construction
portfolio are likely to continue to increase in 2010, and these non-performing
loans could result in a material level of charge-offs, which will negatively
impact our capital and earnings.  19
 The
deterioration in the residential mortgage market may continue to spread to
commercial real estate credits, which may result in increased financial and
regulatory risks and greater losses and non-performing assets, each of which may
have an adverse affect on our business operations.




The
losses that were initially associated with subprime residential mortgages
rapidly spread into the residential mortgage market generally.  If the
losses in the residential mortgage market continue to spread to commercial real
estate credits, then we may be forced to take greater losses or retain more
non-performing assets.  In addition, in general commercial real
estate, or CRE, is cyclical and poses risks of possible loss due to
concentration levels and similar risks of the asset class. As of December 31,
2009, approximately 40% of our loan portfolio consisted of CRE
loans.  Our agreement with the OCC requires that we continue to adhere
to a written program to reduce the high level of credit risk at the Bank,
including instituting procedures to strengthen credit underwriting in our CRE
portfolio and, if excessive, plans to limit growth of our CRE
concentration.  We could also be required to further increase our
allowance for possible loan losses and capital levels as a result of CRE lending
exposures, which could have an adverse impact on our results of operations and
financial condition.




The
amount of other real estate owned (“OREO”) may increase significantly, resulting
in additional losses, and costs and expenses that will negatively affect our
operations.




At
December 31, 2008, we had a total of $5.8 million of OREO, and at December 31,
2009, we had a total of $18.2 million of OREO, reflecting a $12.4 million or
216% increase from year-end 2008 to year-end 2009.  These increases in
OREO are due, among other things, to the continued deterioration of the
residential real estate market and the tightening of the credit
market.  As the amount of OREO increases, our losses, and the costs
and expenses to maintain the real estate likewise increase.  Due to
the ongoing economic crisis, the amount of OREO may continue to increase
throughout 2010.  Any additional increase in losses, and maintenance
costs and expenses due to OREO may have material adverse effects on our
business, financial condition, and results of operations.  Such
effects may be particularly pronounced in a market of reduced real estate values
and excess inventory, which may make the disposition of OREO properties more
difficult, increase maintenance costs and expenses, and may reduce our ultimate
realization from any OREO sales.




Our
use of appraisals in deciding whether to make a loan on or secured by real
property or how to value such loan in the future may not accurately describe the
net value of the real property collateral that we can realize.




In
considering whether to make a loan secured by real property, we generally
require an appraisal of the property. However, an appraisal is only an estimate
of the value of the property at the time the appraisal is made, and, as real
estate values in our market area have experienced changes in value in relatively
short periods of time, this estimate might not accurately describe the net value
of the real property collateral after the loan has been closed. If the appraisal
does not reflect the amount that may be obtained upon any sale or foreclosure of
the property, we may not realize an amount equal to the indebtedness secured by
the property. The valuation of the property may negatively impact the continuing
value of such loan and could adversely affect our operating results and
financial condition.  20
 Our
allowance for loan losses may not be adequate to cover actual loan losses, which
may require us to materially increase our allowance, which would adversely
impact our financial condition and results of operations.




We
maintain an allowance for estimated loan losses that we believe is adequate for
absorbing any probable losses in our loan portfolio. Management determines the
provision for loan losses based upon an analysis of general market conditions,
credit quality of our loan portfolio, and performance of our customers relative
to their financial obligations with us. As a result of a difficult real estate
market and the deterioration of asset quality since 2008, we have increased our
allowance from 1.59% of outstanding portfolio loans as of December 31, 2008 to
2.20% as of December 31, 2009.  It may be necessary to further
increase our allowance during 2010. We employ an outside vendor specializing in
credit risk management to evaluate our loan portfolio for risk grading, which
can result in changes in our allowance for estimated loan losses. The
determination of the appropriate level of the allowance for loan and lease
losses involves a high degree of subjectivity and requires that significant
estimates of current risk be made, using existing qualitative and quantitative
information, all of which may undergo material changes. The amount of future
losses is susceptible to changes in economic, operating, and other conditions,
including changes in interest rates, that may be beyond our control, and such
losses may exceed the allowance for estimated loan losses. Additionally, federal
banking regulators, as an integral part of their supervisory function,
periodically review the allowance for estimated loan losses. If these regulatory
agencies require us to increase the allowance for estimated loan losses, it
would have a negative effect on our results of operations and financial
condition. Although management believes that the allowance for estimated loan
losses is adequate to absorb any probable losses on existing loans that may
become uncollectible, we are consistently adjusting our loan portfolio and
underwriting standards to reflect current market conditions, we can provide no
assurance that our methodology will not change and that the allowance will prove
sufficient to cover actual loan losses in the future.




Changes
in the interest rate environment could reduce our net interest income, which
could reduce our profitability.




As a
financial institution, our earnings significantly depend on 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 in the Federal Reserve Board’s fiscal and monetary policies,
affects us more than non-financial 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.




In
addition, we cannot predict whether interest rates will continue to remain at
present levels. Changes in interest rates may cause significant changes, up or
down, in our net interest income. Depending on our portfolio of loans and
investments, our results of operations may be adversely affected by changes in
interest rates. In addition, any significant increase in prevailing interest
rates could adversely affect our mortgage banking business because higher
interest rates could cause customers to request fewer refinancings and purchase
money mortgage originations.




Negative
publicity about financial institutions, generally, or about the Company or the
Bank, specifically, could damage our reputation and adversely impact its
business operations and financial results.




Reputation
risk, or the risk to our business from negative publicity, is inherent in our
business. Negative publicity can result from the actual or alleged conduct of
financial institutions, generally, or the Company or the Bank, specifically, in
any number of activities, including corporate governance and actions taken by
government regulators in response to those activities. Negative publicity can
adversely affect our ability to keep and attract customers and can expose us to
litigation and regulatory action, any of which could negatively affect our
business operations or financial results.  21
 We are subject to
liquidity risk in our operations.




Liquidity
risk is the possibility of being unable, at a reasonable cost and within
acceptable risk tolerances, to pay obligations as they come due, to capitalize
on growth opportunities as they arise, or to pay regular dividends because of an
inability to liquidate assets or obtain adequate funding on a timely basis.
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, including the resolution
adopted by our Board of Directors at the request of the Federal Reserve Bank of
Richmond, which requires us to seek prior approval before incurring any
additional debt. 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. Currently, we have access to
liquidity to meet our current anticipated needs; however, our access to
additional borrowed funds could become limited in the future, and we may be
required to pay above market rates for additional borrowed funds, if we are able
to obtain them at all, which may adversely affect our results of
operations.




As of
December 31, 2009, we had approximately $22 million in brokered deposits, which
represented approximately 6% of our total deposits. At times, the cost of
brokered deposits exceeds the cost of deposits in our local market. In addition,
the cost of brokered deposits can be volatile. In accordance with our formal
agreement, we are required to limit brokered deposits, excluding reciprocal
CDARS, that would cause the Bank’s level of brokered deposits to be in excess of
ten percent of total deposits. This limitation, coupled with potential cost
increases discussed above, could adversely affect our liquidity and ability to
support demand for loans.




The
FDIC Deposit Insurance assessments that we are required to pay may continue to
materially increase in the future, which would have an adverse effect on our
earnings.




As a
member institution of the FDIC, we are assessed a quarterly deposit insurance
premium. Failed banks nationwide have significantly depleted the insurance fund
and reduced the ratio of reserves to insured deposits. As a result, we may be
required to pay significantly higher premiums or additional special assessments
that could adversely affect our earnings.




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. Starting with the second quarter of 2009, assessment rates were
increased and currently range from 7 to 77.5 basis points
(annualized).




On
September 29, 2009, the FDIC announced a uniform 3 basis points increase
effective January 1, 2011, and on November 12, 2009, adopted a rule requiring
depository institutions to prepay, in lieu of further special assessments, their
assessments for the fourth quarter 2009 and the three years
thereafter.  Due to the recent increases in the assessment rates and
the required prepayment, we were required to pay approximately $3 million
to the DIF on December 30, 2009, which had an adverse affect on our
liquidity.




Further
increased FDIC assessment premiums, due to our risk classification, emergency
assessments, or another uniform increase, could adversely impact our
earnings.




We
may be required to raise additional capital in the future, but that capital
may not be available when it is needed and could be dilutive to our
existing shareholders, which could adversely affect our financial condition and
results of operations.




We are
required by regulatory authorities to maintain adequate levels of capital to
support our operations. To support the operations at the Bank, we may need
to raise capital in the future. Our ability to raise capital, if needed, will
depend in part on conditions in the capital markets at that time, which are
outside our control. Accordingly, we cannot assure you of our ability to raise
capital, if needed, on terms acceptable to us. If we cannot raise capital when
needed, our ability to operate or further expand our operations could be
materially impaired. In addition, if we decide to raise equity capital, the
interest of our shareholders could be diluted.  22
 We
are subject to extensive regulation that could limit or restrict our
activities.




We
operate in a highly regulated industry and are subject to examination,
supervision, and comprehensive regulation by various regulatory agencies. Our
compliance with these regulations, including compliance with our formal
agreement, is costly and restricts certain of our activities, including the
declaration and payment of cash dividends to common shareholders, mergers and
acquisitions, investments, loans and interest rates charged, interest rates paid
on deposits, and locations of offices. We are also subject to capitalization
guidelines established by our regulators, which require us to maintain adequate
capital to support our growth and operations.




The laws
and regulations applicable to the banking industry have recently changed and may
continue to change, 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 Securities and Exchange Commission, have increased the scope,
complexity, and cost of corporate governance, reporting, and disclosure
practices. We have experienced, and we expect to continue to experience as all
aspects of compliance become applicable to us in 2010, greater compliance costs,
including costs related to internal controls, as a result of the Sarbanes-Oxley
Act, which could adversely affect our results of operations.




On June
17, 2009, the Obama Administration announced a comprehensive plan for regulatory
reform of the financial services industry. The plan set forth five separate
initiatives that will be the focus of the regulatory reform, including requiring
strong supervision and appropriate regulation of all financial firms,
strengthening regulation of core markets and market infrastructure,
strengthening consumer protection, strengthening regulatory powers to
effectively manage failing institutions and improving international regulatory
standards and cooperation. The implications of this plan on our business are
unclear at this time, but the plan may adversely affect our business, results of
operations and the underlying value of our common stock.




Congress
is likely to consider additional proposals to substantially change the financial
institution regulatory system and to expand or contract the powers of banking
institutions and bank holding companies. Such legislation may change existing
banking statutes and regulations, as well as our current operating environment
significantly. If enacted, such legislation could increase or decrease the cost
of doing business, limit or expand our permissible activities, or affect the
competitive balance among banks, savings associations, credit unions, and other
financial institutions. We cannot predict whether new legislation will be
enacted and, if enacted, the effect that it, or any regulations, would have on
our business, financial condition, or results of operations.




Our
financial condition and results of operations are affected by credit policies of
monetary authorities, particularly the Federal Reserve Board. Actions by
monetary and fiscal authorities, including the Federal Reserve, could have an
adverse effect on our deposit levels, loan demand or business and
earnings.




Our
ability to pay cash dividends on common stock is limited and we may be unable to
pay future dividends.




We make
no assurances that we will pay any dividends in the future. Any future
determination relating to dividend policy will be made at the discretion of our
Board of Directors and will depend on a number of factors, including our future
earnings, capital requirements, financial condition, future prospects,
regulatory restrictions, and other factors that our Board of Directors may deem
relevant. The holders of our common stock are entitled to receive dividends
when, and if declared by our Board of Directors out of funds legally available
for that purpose. As part of our consideration to pay cash dividends, we intend
to retain adequate funds from future earnings to support the development and
growth of our business. In addition, our ability to pay dividends is restricted
by federal policies and regulations. It is the policy of the Federal Reserve
Board that bank holding companies should pay cash dividends on common stock only
out of net income available over the past year and only if prospective earnings
retention is consistent with the organization’s expected future needs and
financial condition. Further, our principal source of funds to pay dividends is
cash dividends that we receive from the Bank. In addition, pursuant to the
resolution adopted by our Board of Directors at the request of the Federal
Reserve Bank of Richmond, we are prohibited from declaring and paying cash
dividends to holders of our common stock without prior regulatory approval from
the Federal Reserve Board.  23
 Finally,
we have participated in the United States Department of the Treasury’s TARP CPP,
our ability to pay cash dividends on common stock is further limited.
Specifically, we may not pay cash dividends on common stock unless all dividends
have been paid on the securities issued to the Treasury under the TARP CPP. The
TARP CPP also restricts our ability to increase the amount of cash dividends on
common stock, which potentially limits your opportunity for gain on your
investment.




We
are dependent on key individuals and the loss of one or more of these key
individuals could curtail our growth and adversely affect our
prospects.




The
success of our bank depends largely on the services of our chief executive
officer. Michael G. Sanchez, the president and chief executive officer of
Coastal Banking Company, Inc. and CBC National Bank, has extensive and
long-standing ties within our industry. If we lose the services of
Mr. Sanchez, our business and development could be materially and adversely
affected.




Our
success also depends, in part, on our continued ability to attract and retain
experienced loan originators, as well as other management personnel. The loss of
the services of several of such key personnel could adversely affect our growth
strategy and prospects to the extent we are unable to replace such
personnel.




Our
ability to attract and retain the best key employees may be limited by the
restrictions that we must place on the compensation of those employees due to
our participation in the United States Department of the Treasury’s Troubled
Assets Relief Program Capital Purchase Program (“TARP CPP”).




Participants
in the TARP CPP must set specified limits on the compensation to certain senior
executive officers. The limitations, which include a prohibition on any “golden
parachute” payments and a “clawback” of any bonus that was based on materially
inaccurate financial data or other performance metric, could limit our ability
to attract and retain the best executive officers because other competing
employers may not be subject to these limitations.




The
United States Department of the Treasury, as a holder of our preferred stock,
has rights that are senior to those of our common stockholders.




We have
supported our capital operations by issuing a class of preferred stock to the
United States Department of the Treasury under the TARP CPP. On December 5,
2008, we issued preferred stock to the Treasury under the TARP CPP totaling
$9.95 million. The preferred stock has dividend rights that are senior to
our common stock; therefore, we must pay dividends on the preferred stock before
we can pay any dividends on our common stock. In the event of our bankruptcy,
dissolution, or liquidation, the holders of our preferred stock must be
satisfied before we can make any distributions to our common
stockholders.




Our
agreement with the United States Department of the Treasury under the TARP CPP
is subject to unilateral change by the Treasury, which could adversely affect
our business, financial condition, and results of operations.




Under the
TARP CPP, the 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.




We
face strong competition for customers, which could prevent us from obtaining
customers and may cause us to pay higher interest rates to attract
customers and expose us to greater lending risks.




The
banking business is highly competitive, and we experience competition in our
market 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 mutual funds, as well as other super-regional, national, and
international financial institutions that operate offices in our primary market
areas and elsewhere. In addition, we compete with new entrants to our markets,
both established and de novo institutions which have aggressively sought after
market share. 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, larger financial institutions. These institutions offer
some services, such as extensive and established branch networks, that we do not
provide. There is a risk that we will not be able to compete successfully with
other financial institutions in our market, and that we may have to pay
higher interest rates to attract deposits, resulting in reduced profitability.
In addition, competitors that are not depository institutions are generally not
subject to the extensive regulations that apply to us.




24


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




We
may seek to acquire other financial institutions or parts of those
institutions in the future. We may also expand into new markets or lines of
business or offer new products or services. These activities would involve a
number of risks, including:




·
            the
      potential inaccuracy of the estimates and judgments used to evaluate
      credit, operations, management, and market risks with respect to a target
      institution;




·
            the
      time and costs of evaluating new markets, hiring or retaining 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;




·
            the
      incurrence and possible impairment of goodwill associated with an
      acquisition and possible adverse effects on our results of operations;
      and




·
            the
      risk of loss of key employees and
customers.





Environmental
liability associated with lending activities could result in
losses.




In the
course of our business, we may foreclose on and take title to properties
securing our loans. If hazardous substances are discovered on any of these
properties, we may be liable to governmental entities or third parties for the
costs of remediation of the hazard, as well as for personal injury and property
damage. Many environmental laws can impose liability regardless of whether we
knew of, or were responsible for, the contamination. In addition, if we arrange
for the disposal of hazardous or toxic substances at another site, we may be
liable for the costs of cleaning up and removing those substances from the site,
even if we neither own nor operate the disposal site. Environmental laws may
require us to incur substantial expenses and may materially limit the use of
properties that we acquire through foreclosure, reduce their value or limit our
ability to sell them in the event of a default on the loans they secure. In
addition, future laws or more stringent interpretations or enforcement policies
with respect to existing laws may increase our exposure to environmental
liability. Our loan policies require certain due diligence of high risk
industries and properties with the intention of lowering our risk of a
non-performing loan and/or foreclosed property.




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 in our market areas are affected, from time to time, by adverse weather
events, particularly hurricanes. Our market areas consists largely 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, which would adversely affect our results of operations.




ITEM 1B. UNRESOLVED STAFF
COMMENTS




Not
applicable.  25
 ITEM 2.
PROPERTIES




Our main
office is located at 1891 South 14th
Street in Fernandina Beach, Florida. The Bank owns this 6,500 square foot main
office, which is located on 1.28 acres of land. In addition, the Bank owns and
occupies the office building on property adjacent to our main office for
administrative use. In 2004, the Bank also purchased 1.16 acres of land at the
corner of Lofton Square Boulevard and State Road 200 in Yulee, Florida for a
future branch location. The Bank will be required to obtain regulatory approval
before establishing a branch at this location. We conduct our banking business
in Florida under the trade name First National Bank of Nassau
County.




We
conduct our South Carolina banking operation under the trade name “Lowcountry
National Bank” through our branch locations in Beaufort, Bluffton and Port
Royal. Our Beaufort, South Carolina branch is located at 36 Sea Island Parkway.
The Bank owns this 5,800 square foot branch office building, which is located on
2.33 acres of land.




During
2002, the Bank established a loan production office to service the Bluffton area
and in 2003 consolidated the office into a new, full-service branch at Moss
Creek Village, Bluffton, South Carolina. The Bank leases the Moss Creek office
under an agreement which will expire in 2013.




In 2007,
the Bank opened a branch in Port Royal, South Carolina, which adjoins the city
of Beaufort. The branch was completed in March 2007 and is located in the
Port Royal Center, which is a multi-unit office complex. We also occupy leased
space in the upstairs offices above the branch for executive and administrative
use. The lease is for a term of five years that will expire in 2012 with options
to renew for subsequent five year periods.




The
Meigs, Georgia branch, operated under the name “The Georgia Bank,” occupies a
storefront office in Meigs, Georgia. The branch building was acquired as part of
the acquisition of the Meigs office on October 27, 2006.




The Bank
also has loan production offices in Jacksonville, Florida and Savannah, Georgia,
as well as a wholesale mortgage office in Atlanta, Georgia. All of these
properties are leased, with the Atlanta lease expiring in 2012, and the Savannah
lease expiring in 2011. The Jacksonville location is not under a lease contract,
and may be canceled at any time with three months notice




ITEM 3. LEGAL PROCEEDINGS




None.




ITEM 4. RESERVED


26


PART
II.




ITEM 5. MARKET FOR REGISTRANT'S COMMON
EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY
SECURITIES




The
Common Stock of Coastal Banking Company, Inc. is not listed on any exchange.
However, the stock is quoted on the NASDAQ OTC Bulletin Board under the symbol
“CBCO.OB.” There were approximately 610 shareholders of record on
December 31, 2009. The following table sets forth the high and low bid
prices as quoted on the OTC Bulletin Board during the periods indicated. The
quotations reflect inter-dealer prices, without retail mark-up, mark-down, or
commissions, and may not represent actual transactions.




Years
      Ended December 31,2009
            
            
            2008High
            
            
            Low
            
            
            High
            
            
            LowFirst
      quarter
            
            $
            6.20
            
            
            $
            3.25
            
            
            $
            15.25
            
            
            $
            12.30Second
      quarter
            
            $
            6.25
            
            
            $
            3.50
            
            
            $
            13.95
            
            
            $
            9.00Third
      quarter
            
            $
            4.00
            
            
            $
            3.25
            
            
            $
            9.50
            
            
            $
            4.97Fourth
      quarter
            
            $
            3.75
            
            
            $
            2.56
            
            
            $
            7.75
            
            
            $
            5.06





Coastal
Banking Company, Inc. has never declared or paid a cash dividend and does not
expect to do so in the foreseeable future. The ability of Coastal Banking
Company, Inc. to pay cash dividends is dependent upon receiving cash dividends
from the Bank. However, federal banking regulations restrict the amount of cash
dividends that can be paid to Coastal Banking Company, Inc. from the Bank.
Further, pursuant to our issuance of 9,950 shares of the Company’s Fixed Rate
Cumulative Perpetual Preferred Stock, Series A, to the Treasury under the
TARP Capital Purchase Program, the preferred stock has dividend rights that are
senior to those of our common stock. In addition, pursuant to the terms under
which the preferred stock was issued, there are limitations on the payment of
dividends on common stock. All of our outstanding shares of common stock are
entitled to share equally in dividends from funds legally available when, and
if, declared by the board of directors. Pursuant to a resolution adopted by our
Board of Directors at the request of the Federal Reserve Bank of Richmond, the
Company is prohibited from declaring or paying dividends on its common stock
without prior regulatory approval.  This resolution, however, does not
limit the ability of the Company to declare and pay dividends on its preferred
stock issued pursuant to the TARP CPP.  Any future determination
relating to our dividend policy will be made at the discretion of the Board of
Directors.




The
Company did not sell any unregistered shares nor did it repurchase any shares of
its common stock during the fourth quarter of 2009.




ITEM 6. SELECTED FINANCIAL
DATA




Not
applicable.  27
 ITEM 7. MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS




General




Coastal
Banking Company, Inc. (in this Item 7, the “Company”) is a bank holding company
headquartered in Beaufort, South Carolina organized to own all of the common
stock of its subsidiary, CBC National Bank (in this Item 7, “Bank”). The
principal activity of the Bank is to provide banking services for its domestic
markets. The Bank’s primary markets are Beaufort County, South Carolina, Nassau
County, Florida, and Thomas County, Georgia. The Bank is primarily regulated by
the Office of the Comptroller of the Currency (“OCC”) and undergoes periodic
examinations by this regulatory agency. The holding company is regulated by the
Board of Governors of Federal Reserve System and also is subject to periodic
examinations. The Bank commenced business on May 10, 2000 as Lowcountry
National Bank at 36 Sea Island Parkway, Beaufort, South Carolina 29907. First
National opened for business July 26, 1999 and was acquired by the Company
through the merger with its holding company, First Capital Bank Holding
Corporation (“First Capital”) on October 1, 2005. On October 27, 2006
the Company acquired our Meigs, Georgia office through the merger of Cairo
Banking Company, a Georgia state bank with and into First National. On
August 10, 2008, Lowcountry National Bank and First National Bank of Nassau
County merged into one charter. Immediately after the merger, the name of the
surviving bank was changed to CBC National Bank and the main office relocated to
1891 South 14th
Street, Fernandina Beach, Nassau County, Florida. The Bank’s branches continue
to do business under the trade names “Lowcountry National Bank,” “First National
Bank of Nassau County,” and “The Georgia Bank” in their respective markets. The
Company also has an investment in Coastal Banking Company Statutory Trust I
(“Trust I”) and Coastal Banking Company Statutory Trust II (“Trust II”). Both
trusts are special purpose subsidiaries organized for the sole purpose of
issuing trust preferred securities.





The
following discussion describes our results of operations for 2009 as compared to
2008 and also analyzes our financial condition as of December 31, 2009 as
compared to December 31, 2008. Like most community banks, we derive most of
our income from interest we receive on our loans and investments. Our primary
source of funds for making these loans and investments is our deposits, on which
we pay interest. Consequently, one of the key measures of our success is our
amount of net interest income, or the difference between the income on our
interest-earning assets, such as loans and investments, and the expense on our
interest-bearing liabilities, such as deposits. Another key measure is the
spread between the yield we earn on these interest-earning assets and the rate
we pay on our interest-bearing liabilities.




We have
included a number of tables to assist in our description of these measures. For
example, the “Average Balances” table shows the average balance during 2009 and
2008 of each category of our assets and liabilities, as well as the yield we
earned or the rate we paid with respect to each category. A review of this table
shows that our loans typically provide higher interest yields than do other
types of interest earning assets, which is why we intend to continue to direct a
substantial percentage of our earning assets into our loan portfolio.
Similarly, the “Volume/Rate Analysis” table helps demonstrate the impact of
changing interest rates and changing volume of assets and liabilities during the
years shown. We also track the sensitivity of our various categories of assets
and liabilities to changes in interest rates, and to help demonstrate this
sensitivity we have included a “Sensitivity Analysis Table.” Finally, we have
included a number of tables that provide details about our investment
securities, our loans, and our deposits.




Of
course, there are risks inherent in all loans, so we maintain an allowance for
loan losses to absorb possible losses on existing loans that may become
uncollectible. We establish and maintain this allowance by charging a provision
for loan losses against our operating earnings. In the following section we have
included a detailed discussion of this process, as well as several tables
describing our allowance for loan losses. See comments in the section entitled
“Provision and Allowance for Loan Losses.”




In
addition to earning interest on our loans and investments, we earn income
through fees, gains on sales of loans and marketable securities, cash surrender
value of life insurance and other service charges to our customers. We describe
the various components of this non-interest income, as well as our non-interest
expense, in the following discussion.




The
following discussion and analysis also identifies significant factors that have
affected our financial position and operating results during the periods
included in the accompanying financial statements. We encourage you to read this
discussion and analysis in conjunction with the financial statements and the
related notes and the other statistical information also included in this
report.


28


Forward-Looking
Statements




This
report contains “forward-looking statements” relating to, without limitation,
future economic performance, plans and objectives of management for future
operations, and projections of revenues and other financial items that are based
on the beliefs of management, as well as assumptions made by and information
currently available to management. The words “may,” “will,” “anticipate,”
“should,” “would,” “believe,” “contemplate,” “expect,” “estimate,” “continue,”
“may,” and “intend,” as well as other similar words and expressions of the
future, are intended to identify forward-looking statements. Potential risks and
uncertainties include, but are not limited to, those described under the heading
“Risk Factors” in our Form 10-K for the year ended December 31,
2009.




Critical
Accounting Policies




We have
adopted various accounting policies, which govern the application of accounting
principles generally accepted in the United States of America in the preparation
of our financial statements. Our significant accounting policies are described
in Note 1 in the footnotes to the consolidated financial statements at
December 31, 2009 included elsewhere in this annual report.




We
believe that the allowance for loan losses is a critical accounting policy that
requires the most significant judgments and estimates used in preparation of our
consolidated financial statements. Please refer to the portion of management’s
discussion and analysis of financial condition and results of operations that
addresses the allowance for loan losses for a description of our processes and
methodology for determining the allowance for loan losses.




Intangible
assets include goodwill and other identifiable assets, such as core deposits,
resulting from acquisitions. Goodwill, in this context, is the excess of the
purchase price in an acquisition transaction over the fair market value of the
net assets acquired. Core deposit intangibles are amortized on a straight-line
basis over such assets’ estimated expected life. Goodwill is not amortized but
is tested annually for impairment or at any time an event occurs, or
circumstances change, that may trigger a decline in the value of the reporting
unit. Such impairment testing calculations include estimates. Furthermore, the
determination of which intangible assets have finite lives is subjective as is
the determination of the amortization period for such intangible assets. The
Company tests for goodwill impairment by determining the fair market value for
each reporting unit and comparing the fair market value to the carrying amount
of the applicable reporting unit. If the carrying amount exceeds fair market
value the potential for the impairment exists, and a second step of impairment
testing is performed. In the second step, the fair market value of the reporting
units’ goodwill is determined by allocating the reporting unit’s fair market
value to all of its assets (recognized and unrecognized) and liabilities as if
the reporting unit had been acquired in a business combination at the date of
the impairment test. If the implied fair market value of reporting unit goodwill
is less than its carrying amount, goodwill is impaired and is written-down to
its fair market value. The loss recognized is limited to the carrying amount of
goodwill. Once an impairment loss is recognized, future increases in fair market
value will not result in the reversal of previously recognized losses. The
Company performed its annual test of impairment in the fourth quarter of 2009
and determined that the entire balance of goodwill was impaired as of
December 31, 2009. The entire balance was written off against current
earnings and the carrying amount of goodwill was zero as of December 31,
2009.  It is important to note that this impairment charge was a
non-recurring expense that had no impact on current or future core operating
earnings, cash flow, liquidity or risk based regulatory capital
ratios.




Results
of Operations




Overview




Net loss
for 2009 was $14,536,000 or $5.88 per basic common share compared to net loss of
$4,838,000 or $1.91 per basic common share in 2008. The previously noted
nonrecurring charge for goodwill impairment represented $10,412,000 of the 2009
operating loss, or $4.05 per basic common share. In total, our operational
results depend to a large degree on net interest income, which is the difference
between the interest income received from our investments, such as loans,
investment securities, and federal funds sold, and interest expense, paid on
deposit liabilities and other borrowings. Net interest income was $10,944,000
for the year ended December 31, 2009 compared to net interest income of
$10,048,000 for the year ended December 31, 2008.  29
 The
provision for loan losses in 2009 was $7,771,000 compared to $7,823,000 in 2008.
The provision for loan losses is attributable to weakness in our real estate
markets, including the housing and commercial construction industries. The Bank
has a concentration in residential single-family construction loans and
residential development loans in Beaufort, South Carolina, Savannah, Georgia and
in northeast Florida, principally Nassau, Duval and St. Johns Counties. These
loan types are typically repaid as the completed lots or homes are sold;
however, the nationwide deterioration in the housing market has affected our
local markets and, as a result, caused our sources of repayment to slow and
accelerated the devaluation of the underlying collateral securing the loans. The
provision for loan losses was increased to reflect the amount calculated by our
allowance for loan losses methodology, which takes into account deteriorating
economic conditions and the underlying collateral value securing many of our
loans. Of the $7,771,000 provision expense for 2009, 56% was related to
construction loans, 18% was related to residential mortgage loans, 13% was
related to commercial mortgage loans, and 13% was related to all other loans. In
addition, of that same amount, 47% of provision expense was related to
loans secured by properties in Florida, 35% was related
to collateral properties in South Carolina, and 18% was related
to collateral properties in Georgia.




Noninterest
income for the year ended December 31, 2009 totaled $7,653,000,
representing a $4,510,000 increase from December 31, 2008. This increase
was associated with an increase in mortgage banking income of $5,530,000, offset
by a loss on Silverton Financial Services stock of $507,000, a decrease in SBA
loan income of $333,000, a decrease in gain on sale of securities of $118,000,
and a decrease in service charges on deposits and other service charges,
commissions and fees of $106,000.




Noninterest
expenses in 2009 were $27,586,000; a $14,223,000 increase compared to the 2008
amounts, primarily due to the Goodwill impairment charge of $10,412,000, the
costs associated with the wholesale mortgage division in Atlanta, Georgia, an
increase of $781,000 in FDIC premiums, and an increase of $712,000 in costs
associated with other real estate owned. The Company’s efficiency ratio, which
is a measure of total non-interest expenses as a percentage of net interest
income and non-interest income, increased to 148.33% in 2009 from 101.30% in
2008 due in large part to the previously described increase in noninterest
expenses.




In 2009,
we recognized an income tax benefit of $2,223,000 compared to an income tax
benefit of $3,156,000 in 2008. Our effective tax rate was 13.3% in 2009 and
39.5% in 2008. The fluctuation in effective tax rates reflects the impact of
permanent book-to-tax differences from tax exempt income on bank owned life
insurance and municipal securities, as well as non tax deductible losses in 2009
including the Goodwill impairment charge and the loss on Silverton Financial
Services stock.





Net
Interest Income




For the
year ended December 31, 2009, net interest income totaled $10,944,000, as
compared to $10,048,000 for the same period in 2008, an improvement of $896,000
or 8.9% on a year over year basis. Interest income from loans, including fees,
decreased $2,126,000 to $18,192,000 for the year ended December 31, 2009.
The average balance of loans was $359,541,000 in 2009 compared to $325,098,000
in 2008. The weighted average rate earned on loans was 5.06% for 2009 compared
to 6.25% in 2008. Interest income from securities decreased $474,000 on a tax
equivalent basis. The average balance of investments was $79,742,000 in 2009
compared to $82,401,000 in 2008. The weighted average rate earned on investments
was 4.82% for 2009 compared to 5.24% in 2008. This decrease in interest income
was offset by decreased interest expense, which totaled $10,812,000 for the year
ended December 31, 2009, compared to $14,388,000 in 2008. The net interest
margin realized on earning assets and the interest rate spread were 2.53% and
2.33%, respectively, for the year ended December 31, 2009. For the year
ended December 31, 2008, the net interest margin was 2.52% and the interest
rate spread was 2.12%. Yields on interest earning assets decreased during the
year by 103 basis points compared to a decrease in rates on interest bearing
liabilities of 123 basis points during the year.  30
 Average
Balances and Interest Rates




The table
below shows the average balance outstanding for each category of
interest-earning assets and interest-bearing liabilities for 2009, 2008 and
2007, and the average rate of interest earned or paid thereon. Average balances
have been derived from the daily balances throughout the period
indicated.





For
      the Years Ended December 31,2009
            
            2008
            
            2007(In
      Thousands)
            Average
              Balance
            
            
            Interest
            
            
            Yield/
              Rate
            
            Average
              Balance
            
            
            Interest
            
            
            Yield/
              Rate
            
            Average
              Balance
            
            
            Interest
            
            
            Yield/
              RateAssets:Interest-earning
      assets:Loans
      (including loan fees)
            $
            359,541
            
            
            $
            18,192
            
            
            5.06
            %
            
            $
            325,098
            
            
            $
            20,318
            
            
            6.25
            %
            
            $
            282,182
            
            
            $
            23,160
            
            
            8.21
            %Taxable
      investments
            
            65,326
            
            
            
            3,006
            
            
            4.60
            %
            
            
            65,702
            
            
            
            3,328
            
            
            5.07
            %
            
            
            79,476
            
            
            
            4,022
            
            
            5.06
            %Tax-free
      investments
            
            14,416
            
            
            
            836
            
            
            5.80
            %
            
            
            16,699
            
            
            
            988
            
            
            5.92
            %
            
            
            16,239
            
            
            
            914
            
            
            5.63
            %Interest-bearing
      deposits in
              other
      banks
            
            1,827
            
            
            
            2
            
            
            0.11
            %
            
            
            678
            
            
            
            22
            
            
            3.24
            %
            
            
            1,667
            
            
            
            89
            
            
            5.34
            %Federal
      funds sold
            
            2,137
            
            
            
            4
            
            
            0.19
            %
            
            
            4,674
            
            
            
            116
            
            
            2.48
            %
            
            
            11,719
            
            
            
            602
            
            
            5.14
            %Total
      interest-earning assets
            
            443,247
            
            
            
            22,040
            
            
            4.97
            %
            
            
            412,851
            
            
            
            24,772
            
            
            6.00
            %
            
            
            391,283
            
            
            
            28,787
            
            
            7.36
            %Other
      non-interest earning assets
            
            37,335
            
            
            
            
            
            
            
            
            
            
            30,782
            
            
            
            
            
            
            
            
            
            
            33,579Total
      assets
            $
            480,582
            
            
            
            
            
            
            
            
            
            $
            443,633
            
            
            
            
            
            
            
            
            
            $
            424,862Liabilities
      and shareholders’ equity:Interest-bearing
      liabilities:Deposits:Interest-bearing
      demand and
              savings
            $
            106,662
            
            
            $
            1,573
            
            
            1.47
            %
            
            $
            101,895
            
            
            $
            2,442
            
            
            2.40
            %
            
            $
            123,922
            
            
            $
            4,467
            
            
            3.60
            %Time
            
            248,386
            
            
            
            7,467
            
            
            3.01
            %
            
            
            228,355
            
            
            
            10,117
            
            
            4.43
            %
            
            
            194,987
            
            
            
            10,012
            
            
            5.13
            %Other
            
            53,420
            
            
            
            1,772
            
            
            3.32
            %
            
            
            40,671
            
            
            
            1,829
            
            
            4.50
            %
            
            
            34,832
            
            
            
            1,814
            
            
            5.21
            %Total
      interest-bearing liabilities
            
            408,468
            
            
            
            10,812
            
            
            2.65
            %
            
            
            370,921
            
            
            
            14,388
            
            
            3.88
            %
            
            
            353,741
            
            
            
            16,293
            
            
            4.61
            %Other
      non-interest bearing liabilities
            
            27,160
            
            
            
            
            
            
            
            
            
            
            27,055
            
            
            
            
            
            
            
            
            
            
            26,162Shareholders’
      equity
            
            44,954
            
            
            
            
            
            
            
            
            
            
            45,657
            
            
            
            
            
            
            
            
            
            
            44,959Total
      liabilities and shareholders’
              equity
            $
            480,582
            
            
            
            
            
            
            
            
            
            $
            443,633
            
            
            
            
            
            
            
            
            
            $
            424,862Excess
      of interest-earning assets
              over
      interest bearing liabilities
            $
            34,779
            
            
            
            
            
            
            
            
            
            $
            41,930
            
            
            
            
            
            
            
            
            
            $
            37,542Ratio
      of interest-earning assets to
              interest-bearing
      liabilities
            
            109
            %
            
            
            
            
            
            
            
            
            
            111
            %
            
            
            
            
            
            
            
            
            
            111
            %Tax
      equivalent adjustment
            
            
            
            
            
            (284
            )
            
            
            
            
            
            
            
            
            
            (336
            )
            
            
            
            
            
            
            
            
            
            (311
            )Net
      interest income
            
            
            
            
            $
            10,944
            
            
            
            
            
            
            
            
            
            $
            10,048
            
            
            
            
            
            
            
            
            
            $
            12,183Net
      interest spread
            
            
            
            
            
            
            
            
            2.33
            %
            
            
            
            
            
            
            
            
            
            2.12
            %
            
            
            
            
            
            
            
            
            
            2.75
            %Net
      interest margin
            
            
            
            
            
            
            
            
            2.53
            %
            
            
            
            
            
            
            
            
            
            2.52
            %
            
            
            
            
            
            
            
            
            
            3.19
            %





Non-accrual
loans and the interest income which was recorded on these loans, if any, are
included in the yield calculation for loans in all periods
reported.




Amounts
are presented on a tax equivalent basis.  31
 Volume/Rate
Analysis




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 interest-earning assets and
interest-bearing liabilities have affected our interest income and interest
expense during the periods indicated. The effect of a change in average balance
has been determined by applying the average rate in the earlier year to the
change in average balance in the later year, as compared with the earlier year.
The effect of a change in the average rate has been determined by applying the
average balance in the earlier year to the change in the average rate in the
later year, as compared with the earlier year.




2009
      Compared to 2008
              Increase
      (decrease)
              due
      to changes in
            
            
            2008
      Compared to 2007
              Increase
      (decrease)
              due
      to changes in(In
      Thousands)
            
            Volume
            
            
            Rate
            
            
            Net
      Change
            
            
            Volume
            
            
            Rate
            
            
            Net
      ChangeInterest
      income on:Loans
      (including loan fees)
            
            $
            2,006
            
            
            $
            (4,132
            )
            
            $
            (2,126
            )
            
            $
            3,195
            
            
            $
            (6,037
            )
            
            $
            (2,842
            )Taxable
      investments
            
            
            (19
            )
            
            
            (303
            )
            
            
            (322
            )
            
            
            (698
            )
            
            
            4
            
            
            
            (694
            )Non-taxable
      investments
            
            
            (133
            )
            
            
            (19
            )
            
            
            (152
            )
            
            
            26
            
            
            
            48
            
            
            
            74Interest
      bearing deposits in other banks
            
            
            14
            
            
            
            (34
            )
            
            
            (20
            )
            
            
            (40
            )
            
            
            (27
            )
            
            
            (67
            )Federal
      funds sold
            
            
            (41
            )
            
            
            (71
            )
            
            
            (112
            )
            
            
            (261
            )
            
            
            (225
            )
            
            
            (486
            )Total
      interest income (tax equivalent basis)
            
            
            1,827
            
            
            
            (4,559
            )
            
            
            (2,732
            )
            
            
            2,222
            
            
            
            (6,237
            )
            
            
            (4,015
            )Interest
      expense on:Interest-bearing
      demand and savings
            
            
            109
            
            
            
            (978
            )
            
            
            (869
            )
            
            
            (702
            )
            
            
            (1,323
            )
            
            
            (2,025
            )Time
            
            
            827
            
            
            
            (3,477
            )
            
            
            (2,650
            )
            
            
            1,583
            
            
            
            (1,478
            )
            
            
            105Other
            
            
            491
            
            
            
            (548
            )
            
            
            (57
            )
            
            
            281
            
            
            
            (266
            )
            
            
            15Total
      interest expense
            
            
            1,427
            
            
            
            (5,003
            )
            
            
            (3,576
            )
            
            
            1,162
            
            
            
            (3,067
            )
            
            
            (1,905
            )Net
      interest income (tax equivalent basis)
            
            $
            400
            
            
            $
            444
            
            
            $
            844
            
            
            $
            1,060
            
            
            $
            (3,170
            )
            
            $
            (2,110
            )





Interest
Rate Sensitivity and Asset Liability Management




Interest
rate sensitivitymeasures the timing and
magnitude of the repricing of assets compared with the repricing of liabilities
and is an important part of asset/liability management of a financial
institution.  The objective of interest rate sensitivity management is
to generate stable growth in net interest income, and to manage the risks
associated with interest rate movements.  Management constantly
reviews interest rate risk exposure and the expected interest rate environment
so that adjustments in interest rate sensitivity can be made on a timely
basis.  Since the assets and liabilities of the Company are primarily
monetary in nature (payable in fixed, determinable amounts), the performance of
the Company is affected more by changes in interest rates than by
inflation.  Interest rates generally increase as the rate of inflation
increases, but the magnitude of the change in rates may not be the
same.





Net
interest income is the primary component of net income for financial
institutions.  Net interest income is affected by the timing and
magnitude of repricing of as well as the mix of interest sensitive and
noninterest sensitive assets and liabilities. “Gap” is a static measurement of
the difference between the contractual maturities or repricing dates of interest
sensitive assets and interest sensitive liabilities within the following twelve
months.  Gap is an attempt to predict the behavior of the Company’s
net interest income in general terms during periods of movement in interest
rates.  In general, if the Company is asset sensitive, more of its
interest sensitive assets are expected to reprice within twelve months than its
interest sensitive liabilities over the same period.  In a rising
interest rate environment, assets repricing more quickly are expected to enhance
net interest income. Alternatively, decreasing interest rates would be expected
to have the opposite effect on net interest income since assets would
theoretically be repricing at lower interest rates more quickly than interest
sensitive liabilities.  Although it can be used as a general
predictor, gap as a predictor of movements in net interest income has
limitations due to the static nature of its definition and due to its inherent
assumption that all assets will reprice immediately and fully at the
contractually designated time. At December 31, 2009, the Company, as measured by
gap, and adjusted for its expectations of changes in interest bearing categories
that might not move completely in tandem with changing interest rates, is asset
sensitive when cumulatively measured at six months and liability sensitive when
cumulatively measured at one year.  Management has several tools
available to it to evaluate and affect interest rate risk, including deposit
pricing policies and changes in the mix of various types of assets and
liabilities. The Company also forecasts its sensitivity to interest rate changes
not less than quarterly using modeling software.




32


The
following table summarizes the amounts of interest-earning assets and
interest-bearing liabilities outstanding at December 31, 2009, that are
expected to mature, prepay, or reprice in each of the future time periods shown.
Except as stated below, the amount of assets or liabilities that mature or
reprice during a particular period was determined in accordance with the
contractual terms of the asset or liability. Adjustable rate loans are included
in the period in which interest rates are next scheduled to adjust rather than
in the period in which they are due, and fixed-rate loans and mortgage-backed
securities are included in the periods in which they are anticipated to be
repaid based on scheduled maturities. The Bank’s savings accounts and
interest-bearing demand accounts (NOW and money market deposit accounts) that
are not contractually tied to an adjusting index are grouped into categories
based on the Company’s historical repricing practices. Money market accounts
which are contractually tied to repricing indexes reprice monthly and are
grouped in the three month or less category. Many of these money market accounts
are tied to a Treasury index.




At
December 31, 2009


Maturing
or Repricing in





(In
      Thousands)
            
            3
      Months
              or
      Less
            
            
            4
      Months to
              12
      Months
            
            
            1
      to 5
              Years
            
            
            Over
      5
              Years
            
            
            TotalInterest-earning
      assets:Federal
      funds sold
            
            $
            539
            
            
            $
            —
            
            
            $
            —
            
            
            $
            —
            
            
            $
            539Deposits
      in other banks
            
            
            708
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            708Investment
      securities
            
            
            11,025
            
            
            
            1,269
            
            
            
            31,574
            
            
            
            23,644
            
            
            
            67,512Loans
      held for sale
            
            
            50,006
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            50,006Loans
            
            
            124,567
            
            
            
            18,081
            
            
            
            109,655
            
            
            
            37,356
            
            
            
            289,659Total
      interest-earning assets
            
            
            186,845
            
            
            
            19,350
            
            
            
            141,229
            
            
            
            61,000
            
            
            
            408,424Interest-bearing
      liabilities:Deposits:Savings
      and demand
            
            
            52
            
            
            
            51,110
            
            
            
            55,714
            
            
            
            1,817
            
            
            
            108,693Time
      deposits
            
            
            70,835
            
            
            
            133,678
            
            
            
            37,828
            
            
            
            71
            
            
            
            242,412FHLB
      advances
            
            
            17,750
            
            
            
            7,500
            
            
            
            19,987
            
            
            
            —
            
            
            
            45,237Junior
      subordinated debentures
            
            
            3,093
            
            
            
            —
            
            
            
            4,124
            
            
            
            —
            
            
            
            7,217Total
      interest-bearing liabilities
            
            
            91,730
            
            
            
            192,288
            
            
            
            117,653
            
            
            
            1,888
            
            
            
            403,559Interest
      sensitive difference per period
            
            $
            95,115
            
            
            $
            (172,938
            )
            
            $
            23,576
            
            
            $
            59,112
            
            
            $
            4,865Cumulative
      interest sensitivity difference
            
            $
            95,115
            
            
            $
            (77,823
            )
            
            $
            (54,247
            )
            
            $
            4,865Cumulative
      difference to total interest-earning assets
            
            
            23.3
            %
            
            
            (19.1
            )%
            
            
            (13.3
            )%
            
            
            1.2
            %





At
December 31, 2009, the Company had $95,115,000 more assets than liabilities
repricing or maturing within three months, which indicates that the Company is
asset sensitive over this time horizon. When extended out to one year, the
Company had $77,823,000 more liabilities than assets repricing or maturing,
indicating the Company is liability sensitive over a one-year time
period.




Certain
shortcomings are inherent in the method of analysis presented in the foregoing
table. For example, although certain assets and liabilities may have similar
maturities or periods of repricing, they may reflect changes in market interest
rates differently. Additionally, certain assets, such as adjustable-rate
mortgages, have features that restrict changes in interest rates, both on a
short-term basis and over the life of the asset. Other factors which may affect
the assumptions made in the table include options to call a security or
borrowing, pre-payment rates, early withdrawal levels, and the ability of
borrowers to service their debt. Management uses modeling techniques which
attempt to quantify the impacts of interest rates on margin changes. These
modeling techniques reflect the effects of these cited shortcomings including
the effects of maturity changes that occur as a result of changes in interest
rates. These modeling tools indicate that net interest margin would be slightly
negatively impacted at twelve months given a 1% decrease in interest rates, and
positively impacted at twelve months given a 1% increase in interest
rates.  33
 Mortgage
Banking Activities




In the
third quarter of 2007, First National Bank of Nassau County opened a wholesale
residential mortgage lending division headquartered in Atlanta, Georgia to
complement the existing retail residential mortgage lending activity conducted
through other branch locations. This division originates and funds residential
mortgage loans submitted by mortgage brokers and then sells these mortgage loans
in the secondary market. This lending channel subjects us to various risks,
including credit, liquidity and interest rate risks. We reduce unwanted credit
and liquidity risks by selling virtually all of the mortgage loans originated
through this division. From time to time, we may decide to hold loans originated
through this division as additions to our residential real estate loan
portfolio. We determine whether the loans will be held in our portfolio or sold
in the secondary market at the time of origination. We may subsequently change
our intent to hold loans in portfolio and subsequently sell some or all of these
wholesale loans from our portfolio as part of our corporate asset/liability
management strategy.




While
credit and liquidity risks have historically been relatively low for mortgage
banking activities, interest rate risk can be substantial. Changes in interest
rates will impact the value of mortgages held for sale (MHFS) as well as the
associated income and loss reflected in mortgage banking noninterest income, the
income and expense associated with instruments (economic hedges) used to hedge
changes in the value of MHFS, and the value of derivative loan commitments
extended to mortgage applicants.




Interest
rates impact the amount and timing of loan origination activity because consumer
demand for new mortgages and the level of refinancing activity are sensitive to
changes in mortgage interest rates. Typically, a decline in mortgage interest
rates will lead to an increase in mortgage origination activity. Given the time
it takes for consumer behavior to fully react to interest rate changes, as well
as the time required for processing a new application, providing the commitment,
and selling the loan, loan origination activity will lag behind interest rate
changes. The amount and timing of the impact on loan origination activity will
depend on the magnitude, speed and duration of the change in interest
rates.




As part
of our mortgage banking activities, we enter into commitments to fund
residential mortgage loans by a specified future date. A mortgage loan
commitment is an interest rate lock that binds us to lend funds to a potential
borrower at a specified interest rate and within a specified period of time,
generally up to 60 days after inception of the rate lock, subject to the
loan applicant satisfying the underwriting conditions required for approval of
their loan application. These loan commitments are derivative loan commitments
and the loans that result upon exercise of the loan commitments are held for
sale. These derivative loan commitments are recognized at fair value in the
balance sheet with changes in fair value recorded as part of mortgage banking
noninterest income. We record no value for the loan commitment at inception.
Subsequent to inception, however, we recognize the fair value of the derivative
loan commitment based upon (i) estimated changes in the fair value of the
underlying loan that would result from the exercise of that commitment and (ii)
changes in the probability that the underlying loan will fund within the terms
of the commitment (referred to as a pull through rate). The value of the
underlying loan is affected primarily by changes in interest rates and the
passage of time.




Outstanding
derivative loan commitments expose us to the risk that the value of the loans
underlying the commitments might decline due to increases in mortgage interest
rates from inception of the rate lock to the funding of the loan. To effectively
hedge this risk, we enter into forward sale contracts with secondary market
investors to sell the underlying loans by a future date at an agreed upon
price.  During 2008 and most of 2009 these forward sale contracts were
primarily on a ‘best efforts flow’ structure. Forward sales contracts are
entered into concurrently with issuance of the derivative loan commitment and
carry terms that match the terms of the underlying loan commitments. As a
result, these forward sales commitments will experience changes in fair value
that will fully offset the changes in fair value of the derivative loan
commitments.




In the
later half of 2009, we expanded our loan sales strategy from primarily best
efforts, flow delivery to add the use of mandatory flow deliveries, mini bulk
sales, and forward mortgage backed securities deliveries through assignment of
trade transactions. These alternative loan sales strategies resulted in improved
execution and thereby increased gain on sale of loans.


34


These
alternative sales strategies tend not to be as effective in hedging the interest
rate risk as the concurrent flow forward sales commitments; however, we
anticipate that the improved execution on the loan sales is expected to more
than compensate for the slight increase in interest rate risk from using less
effective hedging techniques.




Impaired
Loans




A loan is
considered to be impaired when, in management’s judgment based on current
information and events, it is probable that the loan’s principal or interest is
not collectible in accordance with the terms of the original loan agreement.
Impaired loans, when not material, will be carried in the balance sheet at a
value not to exceed their observable market price or the fair value of the
collateral if the repayment of the loan is expected to be provided solely by the
underlying collateral. The carrying values of any materially impaired loans are
measured based on the present value of expected future cash flows discounted at
the loan’s effective interest rate, which is the contractual interest rate
adjusted for any deferred loan fees or costs, premium or discount existing at
the inception or acquisition of the loan.




Loans
which management identifies as impaired generally will be non-performing loans.
Non-performing loans include non-accrual loans or loans which are 90 days or
more delinquent as to principal or interest payments. At December 31, 2009,
the Company had $8,216,000 of loans that were impaired and non-performing. At
December 31, 2008, the Company had $17,896,000 of impaired and
non-performing loans. A loan that is on nonaccrual status may not necessarily be
considered impaired if circumstances exist whereby the amount due may be
collected without foreclosure and/or liquidation of collateral.




Loans
exhibiting one or more of the following attributes are placed on a nonaccrual
status:




a.)
            Principal
      and/or interest is 90 days or more delinquent, unless the obligation is
      (i) well secured by collateral with a realizable value sufficient to
      discharge the debt including accrued interest in full, and (ii) in the
      process of collection which is reasonably expected to result in repayment
      of the debt or in its restoration to a current
  status.




b.)
            A
      borrower’s financial condition has deteriorated to such an extent or some
      condition exists that makes collection of interest and/or principal in
      full unlikely in management’s
opinion.




c.)
            Foreclosure
      or legal action has been initiated as a result of default by the borrower
      on the terms of the debt.





The
accrual of interest is discontinued on non-accrual loans and any previously
accrued interest on such loans will be reversed against current income. Any
subsequent interest income is recognized on a cash basis when received unless
collectability of a significant amount of principal is in serious doubt. In such
cases, collections are credited first to the remaining principal balance on a
cost recovery basis. An impaired loan is not returned to accrual status unless
principal and interest are current and the borrower has demonstrated the ability
to continue making payments as agreed for a reasonable period of time, typically
six months.




Potential
Problem Loans




Management
identifies and maintains a list of potential problem loans. These are loans that
are not included in non-accrual status, or loans that are past due 90 days or
more and still accruing interest. A loan is added to the potential problem list
when management becomes aware of information about possible credit problems of
borrowers that causes serious doubts as to the ability of such borrowers to
comply with the current loan repayment terms. These loans are designated as such
in order to be monitored more closely than other credits in the Bank’s
portfolio.  At December 31, 2009, the Company had $17,391,000 of
potential problem loans.  Potential problem loans at December 31, 2008
were $39,055,000.  35
 Provision
and Allowance for Loan Losses




The
provision for loan losses is the charge to operating earnings that management
believes is necessary to maintain the allowance for loan losses at an adequate
level. The provision charged to expense was $7,771,000 for the year ended
December 31, 2009 as compared to $7,823,000 for the year ended
December 31, 2008. On a year over year basis, the provision expense appears
largely unchanged, down by less than 1% or $53,000.  However, in the
fourth quarter of 2008, we incurred $6,554,000, or 84% of the total annual
provision expense in 2008.  Compared to the final quarter of 2008, the
quarterly provision expense in each of the four quarters of 2009 were
significantly lower, running from a high of $2,930,000 in the first quarter to a
low of $1,226,000 in the third quarter of 2009.  Despite the
improvement from the final quarter of 2008, the elevated levels in the provision
for loan losses is attributable to continued weakness in our real estate
markets, primarily related to the housing industry. The Bank has a concentration
in residential single-family construction loans and residential development
loans in Beaufort, South Carolina, Savannah, Georgia and in northeast Florida,
principally Nassau, Duval and St. Johns Counties These loan types are typically
repaid as the completed lots or homes are sold; however, the nationwide
deterioration in the housing market caused our sources of repayment to slow and
accelerated the devaluation of the underlying collateral securing many of our
loans. The provision for loan losses reflects the amount calculated by our
allowance for loan losses methodology, which takes into account deteriorating
economic conditions and the underlying collateral value of some of our
loans.




The loan
portfolio decreased by $14,760,000 during the year ended December 31, 2009
as compared to an increase of $23,128,000 in 2008. The allowance for loan losses
was 2.20% of gross loans at December 31, 2009 as compared to 1.59% at
December 31, 2008. There are risks inherent in making all loans, including
risks with respect to the period of time over which loans may be repaid, risks
resulting from changes in economic and industry conditions, risks inherent in
dealing with individual borrowers, and, in the case of a collateralized loan,
risks resulting from uncertainties about the future value of the
collateral.




We have
established an allowance for loan losses through a provision for loan losses
charged to expense on our statement of earnings. Additions to the allowance for
loan losses are made periodically to maintain the allowance at an appropriate
level based on management’s analysis of the potential risk in the loan
portfolio. The allowance for loan losses represents an amount, which we believe
will be adequate to absorb probable losses on existing loans that may become
uncollectible. Our judgment as to the adequacy of the allowance for loan losses
is based upon a number of assumptions about future events, which we believe to
be reasonable, but which may or may not prove to be accurate. To the extent that
the recovery of loan balances has become collateral dependent, we obtain
appraisals not less than annually, and then we reduce these appraised values for
selling and holding costs to determine the liquidated value.  Any
shortfall between the liquidated value and the loan balance is charged against
the allowance for loan losses in the month the related appraisal was received.
Our losses will undoubtedly vary from our estimates, and there is a possibility
that charge-offs can reduce this allowance. 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, commercial and residential real
estate market trends, 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/national economy, changes in volume or type of
credits, changes in volume/severity of problem loans, quality of loan review and
board of director oversight, concentrations of credit, and peer group
comparisons.  36
 We
allocate the allowance for loan losses to specific categories of loans in our
portfolio. See the table below for the allocation of loan losses and for a
history of charge-offs by loan category, which may or may not be indicative of
future charge-offs by category.




Allocation of the Allowance for Loan
Losses




December 31,2009
            
            2008
            
            2007
            
            2006
            
            2005(In
      Thousands)
            Amount
            
            %
      of
              Loans
      in
              Category
            
            Amount
            
            %
      of
              Loans
      in
              Category
            
            Amount
            
            %
      of
              Loans
      in
              Category
            
            Amount
            
            %
      of
              Loans
      in
              Category
            
            Amount
            
            %
      of
              Loans
      in
              CategoryCommercial,
      Financial andAgricultural
            $
            346
            
            4%
            
            $
            252
            
            3%
            
            $
            284
            
            4%
            
            $
            107
            
            4%
            
            $
            226
            
            5%Real
      Estate—Construction
            
            741
            
            24
            
            
            764
            
            32
            
            
            1,048
            
            46
            
            
            1,864
            
            47
            
            
            760
            
            39Real
      Estate—Mortgage
            
            4,223
            
            71
            
            
            2,566
            
            63
            
            
            1,999
            
            48
            
            
            1,350
            
            47
            
            
            342
            
            54Consumer
            
            351
            
            1
            
            
            264
            
            2
            
            
            239
            
            2
            
            
            62
            
            2
            
            
            50
            
            2Unallocated
            
            707
            
            —
            
            
            987
            
            —
            
            
            83
            
            —
            
            
            92
            
            —
            
            
            1,485
            
            —Total
            
            6,386
            
            100%
            
            $
            4,833
            
            100%
            
            $
            3,653
            
            100%
            
            
            3,475
            
            100%
            
            
            2,863
            
            100%





Our
policy has been to review the allowance for loan losses using a reserve factor
based on risk-rated categories of loans because there had been relatively little
charge-off activity prior to 2008. The overall objective is to
apply percentages to the loans based on the relative inherent risk for that
loan type and grade. Reserve factors are based on peer group data, information
from regulatory agencies, and on the experience of the Bank’s lenders. The
reserve factors will change depending on trends in national and local economic
conditions, the depth of experience of the Bank’s lenders, delinquency trends,
and other factors. Our general strategy is to maintain a minimum coverage of a
certain percentage of gross loans until we have sufficient historical data
and trends available. Periodically, we adjust the amount of the allowance based
on changing circumstances. We charge recognized losses to the allowance and add
subsequent recoveries back to the allowance for loan losses. 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. Thus,
there is a risk that substantial additional increases in the allowance for loan
losses could be required. Additions to the allowance for loan losses would
result in a decrease of our net income and, possibly, our capital.




The
following table summarizes information concerning the allowance for loan
losses:




For
      the Years Ended December 31,(In
      Thousands)
            2009
            
            
            2008
            
            
            2007
            
            2006
            
            2005Loans
      outstanding, end of year
            $
            289,659
            
            
            $
            304,419
            
            
            $
            281,291
            
            $
            291,820
            
            $
            242,369Average
      loans outstanding
            $
            301,931
            
            
            $
            302,461
            
            
            $
            282,182
            
            
            271,414
            
            
            141,989Allowance,
      beginning of year
            
            4,833
            
            
            
            3,653
            
            
            
            3,475
            
            
            2,863
            
            
            1,137Charge-offs:Commercial,
      financial and industrial
            
            599
            
            
            
            249
            
            
            
            73
            
            
            95
            
            
            —Real
      estate—construction
            
            3,831
            
            
            
            5,346
            
            
            
            1
            
            
            —
            
            
            —Real
      estate—mortgage
            
            1,828
            
            
            
            1,002
            
            
            
            54
            
            
            —
            
            
            —Consumer
            
            6
            
            
            
            66
            
            
            
            25
            
            
            27
            
            
            56Total
      charge-offs
            
            6,264
            
            
            
            6,663
            
            
            
            153
            
            
            122
            
            
            56Recoveries:Commercial,
      financial and industrial
            
            2
            
            
            
            16
            
            
            
            19
            
            
            —
            
            
            6Real
      estate—construction
            
            10
            
            
            
            —
            
            
            
            —
            
            
            —
            
            
            —Real
      estate—mortgage
            
            19
            
            
            
            —
            
            
            
            —
            
            
            —
            
            
            —Consumer
            
            15
            
            
            
            4
            
            
            
            2
            
            
            7
            
            
            —Total
      recoveries
            
            46
            
            
            
            20
            
            
            
            21
            
            
            7
            
            
            6Net
      charge-offs
            
            6,218
            
            
            
            6,643
            
            
            
            132
            
            
            115
            
            
            50Allowance
      brought forward in merger
            
            
            
            
            
            
            
            
            
            
            
            
            —
            
            
            1,396Additions
      charged to operations
            
            7,771
            
            
            
            7,823
            
            
            
            310
            
            
            727
            
            
            380Allowance,
      end of year
            $
            6,386
            
            
            $
            4,833
            
            
            $
            3,653
            
            $
            3,475
            
            $
            2,863Ratio
      of net charge-offs during the period to average loansoutstanding
      during the period
            
            2.06
            %
            
            
            2.20
            %
            
            
            0.05
            %
            
            0.04
            %
            
            0.04
            %Allowance
      for loan losses to loans, end of year
            
            2.20
            %
            
            
            1.59
            %
            
            
            1.30
            %
            
            1.19
            %
            
            1.18
            %


37
 The
following table summarizes past due and non-accrual loans, other real estate and
repossessions, and income that would have been reported on non-accrual loans as
of December 31, 2009, 2008, 2007, 2006 and 2005:




December 31,(In
      Thousands)
            
            2009
            
            
            2008
            
            
            2007
            
            
            2006
            
            
            2005Other
      real estate and repossessions
            
            $
            18,176
            
            
            $
            5,756
            
            
            $
            340
            
            
            $
            —
            
            
            $
            —Accruing
      loans 90 days or more past due
            
            
            105
            
            
            
            801
            
            
            
            69
            
            
            
            10
            
            
            
            —Non-accrual
      loans
            
            
            13,754
            
            
            
            18,213
            
            
            
            2,018
            
            
            
            86
            
            
            
            130Interest
      on non-accrual loans which would have been reported
            
            
            727
            
            
            
            602
            
            
            
            104
            
            
            
            13
            
            
            
            6





Noninterest
Income





Noninterest
income was $7,653,000 for the year ended December 31, 2009, which was an
increase of $4,510,000 or 143% from $3,143,000 earned during the year ended
December 31, 2008. The largest factor in this year over year improvement
occurred in mortgage banking income, which was $6,683,000 for the year ended
December 31, 2009 compared to $1,153,000 for the year ended
December 31, 2008. This increase to mortgage banking income was driven
almost entirely by the results of the wholesale mortgage origination business in
Atlanta, which is discussed in further detail below.




Service
charges on deposit accounts decreased by 23% or $168,000 to a level of $566,000
for the year ended December 31, 2009. SBA loan income decreased by 67% or
$333,000 to $164,000 for 2009 compared to $497,000 during 2008. This decline in
SBA loan income reflects the impact of a severe contraction in the volume and
profit margins related to SBA loan sales during 2009.




During
the first quarter of 2009, we recorded a loss on our investment in Silverton
Financial Services stock of $507,000. During the second quarter of 2009, we
recorded a gain of $99,000 on tender of one of our investment securities held to
maturity. In the third quarter of 2009, sales of securities available for sale
contributed a non-recurring gain of $1,000, compared to a non-recurring gain of
$219,000 from the sale of securities during the year ended December 31,
2008.




Noninterest
Expense




Total
noninterest expense for the year ended December 31, 2009, including a
non-recurring goodwill impairment charge of $10,412,000, was $27,586,000 as
compared to $13,363,000 for 2008.  Excluding the impact of the
goodwill impairment, total noninterest expense was $17,174,000 for the year
ended December 31, 2009 for an increase of $3,811,000 or 29% from 2008, due
largely to increased costs associated with higher wholesale lending volume,
asset quality expenses and FDIC insurance assessment expense.




Salaries
and benefits, the next largest component of non-interest expense, totaled
$8,002,000 for the year ended December 31, 2009, compared to $6,433,000 for
the same period a year ago for an increase of $1,569,000. Excluding the
wholesale mortgage banking division, the community banking division experienced
a decrease in salaries and benefits of $1,103,000 during 2009 compared to
2008.




Other
operating expenses, excluding the Goodwill impairment charge and salaries and
benefits, were $9,173,000 for the year ended December 31, 2009 as compared
to $6,930,000 for the year ended December 31, 2008. The major components of
the $2,243,000 increase in other operating expenses included an increase of
$712,000 for expenses related to other real estate owned, an increase of
$781,000 in FDIC insurance assessment premiums, and an increase of $707,000 in
loan collection related expenses.




Income
Taxes





In 2009,
we recognized an income tax benefit of $2,223,000 compared to an income tax
benefit of $3,156,000 in 2008. Our effective tax rate was 13.3% in 2009 and
39.5% in 2008. The fluctuation in effective tax rates reflects the impact of
permanent book-to-tax differences from tax exempt income on bank owned life
insurance and municipal securities, as well as non tax deductible losses in 2009
including the Goodwill impairment charge and the loss on Silverton Financial
Services stock.  38
 The
Company accounts for income taxes in accordance with income tax accounting
guidance (FASB ASC 740, Income
Taxes). On January 1, 2009, the Company adopted the recent accounting
guidance related to accounting for uncertainty in income taxes, which sets out a
consistent framework to determine the appropriate level of tax reserves to
maintain for uncertain tax positions.





The
income tax accounting guidance results in two components of income tax expense:
current and deferred.  Current income tax expense reflects taxes to be
paid or refunded for the current period by applying the provisions of the
enacted tax law to the taxable income or excess of deductions over revenues. The
Company determines deferred income taxes using the liability (or balance sheet)
method. Under this method, the net deferred tax asset or liability is based on
the tax effects of the differences between the book and tax bases of assets and
liabilities, and enacted changes in tax rates and laws are recognized in the
period in which they occur.





Deferred
income tax expense results from changes in deferred tax assets and liabilities
between periods. Deferred tax assets are recognized if it is more likely than
not, based on the technical merits, that the tax position will be realized or
sustained upon examination. The term more likely than not means a likelihood of
more than 50 percent; the terms examined and upon examination also include
resolution of the related appeals or litigation processes, if any. A tax
position that meets the more-likely-than-not recognition threshold is initially
and subsequently measured as the largest amount of tax benefit that has a
greater than 50 percent likelihood of being realized upon settlement with a
taxing authority that has full knowledge of all relevant information. The
determination of whether or not a tax position has met the more-likely-than-not
recognition threshold includes an assessment of the facts, circumstances, and
information available at the reporting date and is subject to management’s
judgment. Deferred tax assets may be reduced by deferred tax liabilities and a
valuation allowance if, based on the weight of evidence available, it is more
likely than not that some portion or all of a deferred tax asset will not be
realized.





At
December 31, 2008 the balance of the deferred tax asset was
$864,000.  The Company had sufficient tax expenses paid in prior years
that this tax asset was available to apply as a net operating loss carry back to
generate a refund of previously paid taxes in the amount of
$2,867,000.  Accordingly there was no need to record a valuation
allowance against that deferred tax asset balance as of December 31,
2008.





At
December 31, 2009 the balance of the deferred tax asset was
$3,287,000.  To the extent that the Company generates taxable income
in future periods, the balance of this account will be available to offset the
tax liability on such future taxable income.  We regularly evaluate
the deferred tax asset positions by considering both the negative and positive
indicators in assessing the likelihood that the Company will realize the
deferred tax asset through future taxable operating income.





The
cumulative loss incurred by the Company in 2008 and 2009 was the primary
negative factor considered by management.  Additionally, general
economic conditions in the Company’s primary markets and the potential for
ongoing weakening asset quality were also evaluated as potential negative
factors.





Offsetting
these negative factors were numerous positive factors considered by management
including:




·
            Prior
      to the losses in 2008 and 2009 from asset quality costs, the Company had a
      history of consistent earnings with cumulative pretax net income of
      $13,879,000 for the five year period ending December 31,
    2007.




·
            Over
      the last four fiscal quarters, asset quality indicators have stabilized
      and improved while core earnings have increased to levels last attained in
      2007, so it appears more likely than not that over the next two to five
      years taxable income will return to levels approaching those prior to
      2008.




·
            The
      Board of Directors has authorized management to liquidate all bank owned
      life insurance policies in 2010 which is expected to consume up to
      $442,000 of the deferred tax asset during the first quarter of
      2010.  Additionally, the proceeds from liquidation of these
      policies will be available to fund mortgage loans available for sale,
      shifting approximately $280,000 of annual tax exempt earnings to a like
      amount of taxable earnings available to offset the deferred tax
      asset.




·
            The
      existing portfolio of marketable securities had an unrealized mark to
      market gain as of December 31, 2009 of $1,938,000 which could consume up
      to $659,000 of the deferred tax asset if the decision was made to sell
      securities from this portfolio and replace them with current market rate
      securities.




·
            In
      January 2010 we sold approximately $3.9 million of tax exempt municipal
      bonds, generating a taxable gain of $133,000 and providing the opportunity
      to reinvest the proceeds of sale into securities that generate taxable
      income.




39


Based on
the above analysis, management believes that the positive factors outweigh the
negative factors and, as a result, we can expect that it is more likely than not
that the Company will realize the deferred tax asset over the allowable carry
forward periods through future operating income and implementation of tax
strategies as described above.  Accordingly, no deferred tax valuation
allowance has been recorded as of December 31, 2009.  However, if an
unanticipated event occurred that materially reduced pre-tax and taxable income
in future periods, the establishment of a valuation allowance may become
necessary.





Wholesale
Mortgage Banking Division





The
primary source of direct income generated by this division is mortgage banking
income which was $6,487,000 for the year ended December 31, 2009 compared to
$983,000 for 2008. Attractive mortgage rates caused a surge in mortgage loan
refinancing during the first half of 2009, leading to above average volume at
the wholesale mortgage banking division, and thus, above average gains on
sales.  The direct noninterest expenses incurred by the wholesale
division were $4,189,000 for the year ended December 31, 2009, an increase of
$3,101,000 over 2008 expenses of $1,088,000.  The largest contributor
to this increase was in salaries and benefits, which were $3,035,000 for 2009
compared to $364,000 during 2008, and largely reflect the higher commissions
paid as a result of the increased volume of loan originations in 2009 compared
to 2008.





Beyond
the impact of the noninterest income and expense from this division, the Bank
earns interest income at the respective note rates on the balance of loans
originated by the division from the time the loan is funded until it is sold to
a secondary market investor. The average outstanding daily balance of wholesale
residential mortgage loans available for sale was $56,486,000 during 2009 and
$22,149,000 during 2008. The interest income earned on these loans available for
sale was $2,880,000 and $1,310,000 during the year ended December 31, 2009 and
2008, respectively.





Financial
Condition





Total
assets decreased from $476,830,000 at December 31, 2008 to $463,097,000 at
December 31, 2009. The primary source of the decrease in assets was in our
investment portfolio which decreased $21,945,000 during 2009. Also, loans
decreased $14,760,000 during 2009, while loans held for sale increased
$18,601,000 during the year. Goodwill decreased $10,412,000 due to being fully
charged off during the fourth quarter of 2009.  Other real estate
owned increased $12,425,000, and other assets increased $5,505,000. The increase
in other assets was made up of a $2,548,000 increase in loan sales receivable
and the prepayment of $3,112,000 in FDIC insurance assessments. Total deposits
increased $6,225,000 from the December 31, 2008 balance of $362,656,000 to
$368,881,000 at December 31, 2009.





40


Interest-Earning
Assets





Loans




Gross
loans totaled $289,659,000 at December 31, 2009, a decrease of $14,760,000,
or 4.9%, since December 31, 2008. We continue to work to reduce our
exposure to higher risk loans as evidenced by the $30,578,000, or 34.69%,
decline in the balance of real estate commercial construction loans during
2009.  This decline was partially offset by growth in real estate
mortgage, residential loans, which increased $9,396,000, or 9.07%, to
$112,984,000 at December 31, 2009 and growth in real estate mortgage, commercial
loans, which increased $9,966,000, or 12.25%, to $91,326,000 at December 31,
2009.  Balances and nonaccrual levels within the major loans
receivable categories as of the last five year end periods were as
follows:







Loan
      Portfolio Mix as of December 31,(In
      Thousands)
            2009
            
            2008
            
            2007
            
            2006
            
            2005Commercial
      and financial
            $
            10,956
            
            4%
            
            $
            10,294
            
            3%
            
            $
            10,235
            
            4%
            
            $
            13,053
            
            4%
            
            $
            11,458
            
            5%Agricultural
            
            319
            
            —%
            
            
            326
            
            —%
            
            
            519
            
            —%
            
            
            55
            
            —%
            
            
            58
            
            —%Real
      estate – construction, commercial
            
            57,573
            
            20%
            
            
            88,151
            
            29%
            
            
            111,988
            
            40%
            
            
            121,791
            
            42%
            
            
            80,915
            
            33%Real
      estate – construction, residential
            
            13,063
            
            4%
            
            
            15,166
            
            5%
            
            
            17,619
            
            6%
            
            
            16,250
            
            6%
            
            
            14,542
            
            6%Real
      estate – mortgage, farmland
            
            —
            
            —%
            
            
            199
            
            —%
            
            
            94
            
            —%
            
            
            14
            
            —%
            
            
            18
            
            —%Real
      estate – mortgage, commercial
            
            91,326
            
            32%
            
            
            81,360
            
            27%
            
            
            68,281
            
            24%
            
            
            72,001
            
            25%
            
            
            63,648
            
            26%Real
      estate – mortgage, residential
            
            112,984
            
            39%
            
            
            103,588
            
            34%
            
            
            68,772
            
            25%
            
            
            64,334
            
            22%
            
            
            65,999
            
            27%Consumer
      installment loans
            
            3,293
            
            1%
            
            
            5,223
            
            2%
            
            
            2,626
            
            1%
            
            
            3,339
            
            1%
            
            
            4,386
            
            2%Other
            
            145
            
            —%
            
            
            112
            
            —%
            
            
            1,157
            
            —%
            
            
            983
            
            —%
            
            
            1,345
            
            1%$
            289,659
            
            
            
            $
            304,419
            
            
            
            $
            281,291
            
            
            
            $
            291,820
            
            
            
            $
            242,369





Loans
      on Nonaccrual as of December 31,(In
      Thousands)
            2009
            
            2008
            
            2007
            
            2006
            
            2005Commercial
      and financial
            $
            40
            
            —%
            
            $
            3
            
            —%
            
            $
            —
            
            —%
            
            $
            49
            
            57%
            
            $
            —
            
            —%Agricultural
            
            319
            
            2%
            
            
            326
            
            2%
            
            
            —
            
            —%
            
            
            —
            
            —%
            
            
            —
            
            —%Real
      estate – construction, commercial
            
            6,836
            
            50%
            
            
            14,479
            
            80%
            
            
            1,498
            
            74%
            
            
            —
            
            —%
            
            
            —
            
            —%Real
      estate – construction, residential
            
            526
            
            4%
            
            
            249
            
            1%
            
            
            —
            
            —%
            
            
            —
            
            —%
            
            
            —
            
            —%Real
      estate – mortgage, farmland
            
            —
            
            —%
            
            
            —
            
            —%
            
            
            —
            
            —%
            
            
            —
            
            —%
            
            
            —
            
            —%Real
      estate – mortgage, commercial
            
            2,831
            
            21%
            
            
            2,424
            
            13%
            
            
            502
            
            25%
            
            
            —
            
            —%
            
            
            130
            
            100%Real
      estate – mortgage, residential
            
            3,198
            
            23%
            
            
            718
            
            4%
            
            
            —
            
            —%
            
            
            —
            
            —%
            
            
            —
            
            —%Consumer
      installment loans
            
            4
            
            —%
            
            
            14
            
            —%
            
            
            18
            
            1%
            
            
            37
            
            43%
            
            
            —
            
            —%Other
            
            —
            
            —%
            
            
            —
            
            —%
            
            
            —
            
            —%
            
            
            —
            
            —%
            
            
            —
            
            —%$
            13,754
            
            
            
            $
            18,213
            
            
            
            $
            2,018
            
            
            
            $
            86
            
            
            
            $
            130





As of
December 31, 2009, maturities of loans in the indicated classifications
were as follows:





(In
      Thousands)
            
            Real
      Estate - Construction
            
            
            Real
      Estate –
              Mortgage,
              Commercial
            
            
            Real
      Estate –
              Mortgage,
              Residential
            
            
            All
      Other Loans
            
            
            TotalMaturityWithin
      1 year
            
            $
            35,631
            
            
            $
            20,375
            
            
            $
            13,427
            
            
            $
            7,937
            
            
            $
            77,3701
      to 5 years
            
            
            26,021
            
            
            
            38,066
            
            
            
            20,285
            
            
            
            4,708
            
            
            
            89,080Over
      5 years
            
            
            8,984
            
            
            
            32,885
            
            
            
            79,182
            
            
            
            2,068
            
            
            
            123,119Totals
            
            $
            70,636
            
            
            $
            91,326
            
            
            $
            112,894
            
            
            $
            14,713
            
            
            $
            289,569


41
 As of
December 31, 2009, the interest terms of loans in the indicated
classification for the indicated maturity ranges are as follows:





(In
      Thousands)
            
            Fixed
              Interest
              Rates
            
            
            Variable
              Interest
              Rates
            
            TotalReal
      estate – constructionWithin
      1 year
            
            $
            29,947
            
            
            $
            5,684
            
            $
            35,6311
      to 5 years
            
            
            19,691
            
            
            
            6,330
            
            
            26,021Over
      5 years
            
            
            2,362
            
            
            
            6,622
            
            
            8,984Real
      estate – mortgage, commercialWithin
      1 year
            
            
            18,544
            
            
            
            1,831
            
            
            20,3751
      to 5 years
            
            
            35,643
            
            
            
            2,423
            
            
            38,066Over
      5 years
            
            
            4,077
            
            
            
            28,808
            
            
            32,885Real
      estate – mortgage, residentialWithin
      1 year
            
            
            9,583
            
            
            
            3,844
            
            
            13,4271
      to 5 years
            
            
            15,135
            
            
            
            5,150
            
            
            20,285Over
      5 years
            
            
            24,277
            
            
            
            54,905
            
            
            79,182All
      other loansWithin
      1 year
            
            
            6,001
            
            
            
            1,936
            
            
            7,9371
      to 5 years
            
            
            4,349
            
            
            
            359
            
            
            4,708Over
      5 years
            
            
            1,207
            
            
            
            861
            
            
            2,068$
            170,816
            
            
            $
            118,753
            
            $
            289,569





Risk
Elements in the Loan Portfolio





As
addressed above, loans on nonaccrual status decreased by $4,459,000, or 24.5%,
from $18,213,000 at December 31, 2008 to $13,754,000 at December 31,
2009.  We believe this reduction in the level of nonaccrual loans may
be a positive sign that asset quality degradation may be approaching a point of
stabilization. In addition to the level of loans on nonaccrual status, there are
a number of other portfolio characteristics that management monitors and
evaluates to assess the risk profile of the loan portfolio.  The
following is a summary of risk elements in the loan portfolio:





Loans
      with Interest Only PaymentsDecember
      31, 2009
            
            
            
            
            
            December
      31, 2008Commercial
      and financial
            
            $
            6,330,000
            
            
            
            7
            %
            
            $
            5,058,000
            
            
            
            5
            %Real
      estate – construction, commercial
            
            
            30,230,000
            
            
            
            35
            %
            
            
            49,795,000
            
            
            
            49
            %Real
      estate – construction, residential
            
            
            6,872,000
            
            
            
            8
            %
            
            
            6,902,000
            
            
            
            7
            %Real
      estate – mortgage, commercial
            
            
            15,899,000
            
            
            
            19
            %
            
            
            11,506,000
            
            
            
            11
            %Real
      estate – mortgage, residential
            
            
            24,481,000
            
            
            
            29
            %
            
            
            25,703,000
            
            
            
            25
            %Consumer
      installment loans
            
            
            1,402,000
            
            
            
            2
            %
            
            
            2,839,000
            
            
            
            3
            %Other
            
            
            145,000
            
            
            
            ––
            %
            
            
            23,000
            
            
            
            ––
            %Gross
      loans
            
            $
            85,359,000
            
            
            
            
            
            
            $
            101,826,000





As shown
above, we have a moderate concentration of interest only loans in our portfolio,
and such loans are generally regarded as carrying a higher risk profile than
fully amortizing loans.  It is important to note that none of the
interest only loans in our portfolio allow negative amortization, nor do we have
any loans with capitalized interest reserves.  42


Geographic
      Concentration of Loan PortfolioDecember
      31, 2009Florida
            
            
            Georgia
            
            
            South
      Carolina
            
            
            OtherCommercial
      and financial
            
            $
            6,335,000
            
            
            $
            569,000
            
            
            $
            3,938,000
            
            
            $
            114,000Agricultural
            
            
            ––
            
            
            
            319,000
            
            
            
            ––
            
            
            
            ––Real
      estate – construction, commercial
            
            
            19,018,000
            
            
            
            8,775,000
            
            
            
            29,780,000
            
            
            
            ––Real
      estate – construction, residential
            
            
            3,786,000
            
            
            
            429,000
            
            
            
            8,789,000
            
            
            
            59,000Real
      estate – mortgage, farmland
            
            
            ––
            
            
            
            ––
            
            
            
            ––
            
            
            
            ––Real
      estate – mortgage, commercial
            
            
            35,505,000
            
            
            
            11,949,000
            
            
            
            43,872,000
            
            
            
            ––Real
      estate – mortgage, residential
            
            
            46,989,000
            
            
            
            21,788,000
            
            
            
            39,803,000
            
            
            
            4,404,000Consumer
      installment loans
            
            
            1,119,000
            
            
            
            602,000
            
            
            
            1,555,000
            
            
            
            17,000Other
            
            
            ––
            
            
            
            145,000
            
            
            
            ––
            
            
            
            ––Gross
      loans
            
            $
            112,752,000
            
            
            $
            44,576,000
            
            
            $
            127,737,000
            
            
            $
            4,594,000





Geographic
      Concentration of Loan PortfolioDecember
      31, 2008Florida
            
            
            Georgia
            
            
            South
      Carolina
            
            
            OtherCommercial
      and financial
            
            $
            5,732,000
            
            
            $
            535,000
            
            
            $
            3,889,000
            
            
            $
            138,000Agricultural
            
            
            ––
            
            
            
            326,000
            
            
            
            ––
            
            
            
            ––Real
      estate – construction, commercial
            
            
            31,675,000
            
            
            
            22,338,000
            
            
            
            34,138,000
            
            
            
            ––Real
      estate – construction, residential
            
            
            5,279,000
            
            
            
            1,875,000
            
            
            
            7,949,000
            
            
            
            63,000Real
      estate – mortgage, farmland
            
            
            ––
            
            
            
            ––
            
            
            
            199,000
            
            
            
            ––Real
      estate – mortgage, commercial
            
            
            31,988,000
            
            
            
            12,020,000
            
            
            
            37,352,000
            
            
            
            ––Real
      estate – mortgage, residential
            
            
            33,595,000
            
            
            
            30,500,000
            
            
            
            37,360,000
            
            
            
            2,133,000Consumer
      installment loans
            
            
            2,824,000
            
            
            
            261,000
            
            
            
            2,032,000
            
            
            
            106,000Other
            
            
            87,000
            
            
            
            2,000
            
            
            
            23,000
            
            
            
            ––Gross
      loans
            
            $
            111,180,000
            
            
            $
            67,857,000
            
            
            $
            122,942,000
            
            
            $
            2,440,000





We also
monitor and evaluate several other loan portfolio characteristics at a total
portfolio level rather than by major loan category.  These
characteristics include:





Junior Liens – Loans secured
by liens in subordinate positions tend to have a higher risk profile than loans
secured by liens in the first or senior position.  At December 31,
2009 the Company held $22,588,000 of loans secured by junior liens which
represents approximately 7.8% of the total net portfolio of
loans.  Historical loss experience as measured by net loan charge offs
was $561,000 in the year ended December 31, 2009 for all loans secured by junior
liens for an annualized loss rate of 2.5%.





High Loan to Value Ratios –
Typically the Company will not originate a new loan with a loan to value (LTV)
ratio in excess of 100%.  However declines in collateral values can
result in the case of an existing loan renewal with an LTV in excess of 100%
based on the current appraised value of the collateral.  In such cases
the borrower may be asked to pledge additional collateral or to renew the loan
for a lesser amount.  If the borrower lacks the ability to pay down
the loan or provide additional collateral, but has the ability to continue to
service the debt, the loan will be renewed with an LTV in excess of
100%.  At December 31, 2009 the loan portfolio included 22 loans with
a balance of $10,244,000, or 3.5% of the net loan portfolio with current loan to
value ratios in excess of 100%.





Restructured Loans – The
Company has followed a conservative approach by classifying any loan as
restructured whenever the terms of a loan were adjusted to the benefit of any
borrower in financial distress, regardless of the status of the loan at the time
of restructuring.  There are two primary categories of restructured
loans based on the status and condition of the loan at the time of any such
restructure, and these categories present very different risk
profiles.  43
 The first
category is identified as performing restructured loans, which includes loans
that are on accrual status because they were current or less than 90 days past
due at the time of restructure.  In many cases the borrower has never
been delinquent, but for various reasons is experiencing financial distress that
raises a doubt about the borrower’s continued ability to make payments under
current terms. By adjusting the terms of the loan to better fit the borrower’s
current financial condition, expectations are that this loan will avoid a future
default.  For regulatory purposes, these loans are only reported as
restructured during the fiscal year in which the restructure occurred, after
which the designation as a restructured loan is removed provided the borrower is
paying in accordance with the restructured loan terms.





The
second category is identified as nonperforming restructured loans, which is made
up of loans that were in default at the time the loan terms were
restructured.  The expectation is that by adjusting the terms of such
loans, the borrower may begin to make payments again based on the improved loan
terms.  These loans will stay on nonaccrual status as restructured
loans until the borrower has demonstrated a willingness and ability to make
payments in accordance with the new loan terms for a reasonable length of time,
typically six months.  Once these loans are returned to accrual
status, they will be reported as performing restructured loans until the end of
the fiscal year in which they were returned to accrual status after which the
designation as a restructured loan is removed.





Although
we have limited experience with respect to restructured loans, it appears that
performing restructured loans perform better than non performing restructured
loans, as evidenced by a lower delinquency recidivism rate. At December 31,
2009, the Company had 28 performing restructured loans with a balance of
$16,041,000, of which 100 percent are current and paying in accordance with
restructured terms, and 7 nonperforming restructured loans with a balance of
$3,701,000, of which 100 percent are current and paying in accordance with the
restructured terms.  In total, as of December 31, 2009, these 35
restructured loans with a total balance of $19,742,000 represented 6.8% of the
net loan portfolio balance.





Criticized or Classified Loans
– Management evaluates all loan relationships periodically in order to assess
the financial strength of the borrower and the value of any underlying
collateral.  Loans that are found to have a potential or actual
weakness are identified as criticized or classified and subject to increased
monitoring by management.  This typically includes frequent contact
with the borrower to actively manage the borrowing relationship as needed to
rehabilitate or mitigate the weakness identified.  At December 31,
2009 the Company had $52,808,000 in loans that were internally criticized or
classified of which $40,739,000 or 77% were either current or less than 30 days
past due.





Loan
Portfolio Performance Trends





Management
monitors and evaluates several key metrics that provide indications of the risk
profile within the loan portfolio.  By following the trends in these
key metrics we are able to establish patterns of improving or worsening
performance in order to adjust our portfolio management and loss mitigation
actions as needed.  A discussion of the metrics tracked and recent
trends follows:





(in
      thousands)
            
            December
      31,2009
            
            
            September
      30,2009
            
            
            June
      30,2009
            
            
            March
      31,2009
            
            
            December
      31, 2008
            
            
            September
      30, 2008
            
            
            June
      30,2008
            
            
            March
      31, 2008Portfolio
      loans, gross
            
            $
            289,659
            
            
            $
            299,270
            
            
            $
            305,669
            
            
            $
            305,240
            
            
            $
            304,419
            
            
            $
            310,869
            
            
            $
            307,861
            
            
            $
            296,497Loans
      past due > 30 days and still accruing interest
            
            $
            2,032
            
            
            $
            2,832
            
            
            $
            3,345
            
            
            $
            2,782
            
            
            $
            9,765
            
            
            $
            7,322
            
            
            $
            3,417
            
            
            $
            3,841Loans
      on nonaccrual
            
            $
            13,754
            
            
            $
            23,903
            
            
            $
            25,925
            
            
            $
            24,336
            
            
            $
            18,213
            
            
            $
            9,639
            
            
            $
            5,005
            
            
            $
            1,929(as
      a % of loans, gross)
            
            
            4.75
            %
            
            
            7.99
            %
            
            
            8.48
            %
            
            
            7.97
            %
            
            
            5.98
            %
            
            
            3.10
            %
            
            
            1.63
            %
            
            
            0.65
            %Net
      loan charge offs (recoveries)
            
            $
            2,072
            
            
            $
            1,485
            
            
            $
            473
            
            
            $
            2,188
            
            
            $
            6,195
            
            
            $
            279
            
            
            $
            (1
            )
            
            $
            170(as
      a % of loans, gross)
            
            
            0.72
            %
            
            
            0.50
            %
            
            
            0.15
            %
            
            
            0.72
            %
            
            
            2.04
            %
            
            
            0.09
            %
            
            
            0.00
            %
            
            
            0.06
            %


44
 Loans past due
> 30 days and still accruing interesthas proven to be a useful
leading indicator of directional trends in future loan losses. As the level of
this metric rises, expectations are for a comparable increase in loans moving
into a nonaccrual status and ultimately foreclosure resulting in increased
losses. This pattern can be observed in the schedule above where increases in
loans past due > 30 days and still accruing are followed in future quarters
with the same directional changes in the level of loans on
nonaccrual.  The Company realized a 79% decline in loans past due >
30 days and still accruing interest from $9,765,000 at December 31, 2008 to
$2,032,000 at December 31, 2009. While management does not expect to see a
decline in loans on nonaccrual of a similar magnitude in the immediate future,
we believe this metric may indicate that the weakening trend in loan quality
experienced during 2008 and 2009 may be reaching a point of stabilization and
possible improvement.





Loans on
nonaccrualhas been another leading indicator of potential future losses
from loans. We typically place loans on nonaccrual status when they become 90
days past due. In addition to the interest lost when a loan is placed on
nonaccrual status, there is an increased probability of a loan on nonaccrual
moving into foreclosure with a potential loss outcome. As shown in the table
above, the level of loans on nonaccrual was approximately $2 million at the end
of the first quarter of 2008. Beginning with the quarter ended June 30, 2008
this metric began to increase significantly, approximately doubling in each of
the remaining three fiscal quarters of 2008.  At June 30, 2009 the
level of loans on nonaccrual reached a peak of $25,925,000, an increase of 42%
from $18,213,000 at December 31, 2008. The quarterly rate of increase of loans
on nonaccrual since March 31, 2008 was 159%, 93% and 89% at the end of the
second, third and fourth fiscal quarters of 2008, respectively. The rate of
increase in the first quarter of 2009 was only 34%, followed by a rate of
increase of 7% in the second quarter of 2009, and then decreases of 8% and 42%
in the third and fourth quarters of 2009, respectively.  Management is
encouraged by two consecutive quarters of a decline in the level of nonaccrual
loans after five consecutive fiscal quarters of increasing nonaccrual loans. We
believe this linked quarter decrease in the level of loans on nonaccrual is
another positive sign that asset quality degradation may be approaching a point
of stabilization.





Net Loan Charge
offs or recoveriesreflect our practice of charging recognized losses to
the allowance and adding subsequent recoveries back to the allowance. During the
three months ended December 31, 2009, we recorded charge offs net of recoveries
of $2,072,000. Although this amount was an increase from the $1,485,000 in net
charge offs recorded during the prior quarter ended September 30, 2009, it
represents a significant reduction of 67% from the $6,195,000 net charge offs
during the same quarter in the prior year.





Prior to
the fourth fiscal quarter of 2008, we had very little charge off activity, and
therefore, have little historical information upon which to base our current
estimates. Accordingly, we continue to assess the implications of trends in
recent charge off activity on potential future losses. The recent volatility in
the level of quarterly net loan charge offs or recoveries makes it difficult to
identify a specific trend or establish reliable future expectations. As a
result, there can be no assurance that charge offs of loans in future periods
will not increase or 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. Thus, there is a risk that substantial additional
increases in the allowance for loan losses could be required, which would result
in a decrease in our net income and possibly our capital.





In
addition to considering the metrics described above, we evaluate the
collectability of individual loans, the balance of impaired loans, economic
conditions that may affect the borrower’s ability to repay, the amount and
quality of collateral securing the loans and a review of specific problem loans.
Based on this process and as shown below, the provision charged to expense was
$2,125,000 for the three months ended December 31, 2009, as compared to
$6,554,000 for the three months ended December 31, 2008. On a consecutive
quarter basis, this provision level was $859,000, or 68%, higher than the
$1,266,000 provision charged to expense during the quarter ended September 30,
2009.





(in
      thousands)
            
            December
      31,2009
            
            
            September
      30,2009
            
            
            June
      30,2009
            
            
            March
      31,2009
            
            
            December
      31, 2008
            
            
            September
      30, 2008
            
            
            June
      30,2008
            
            
            March
      31, 2008Provision
      during quarter ended
            
            $
            2,125
            
            
            $
            1,266
            
            
            $
            1,450
            
            
            $
            2,930
            
            
            $
            6,554
            
            
            $
            250
            
            
            $
            896
            
            
            $
            123Provision
      added in excess of net charge offs
            
            $
            53
            
            
            $
            (219
            )
            
            $
            977
            
            
            $
            742
            
            
            $
            359
            
            
            $
            (29
            )
            
            $
            897
            
            
            $
            (47
            )Allowance
      for loan losses
            
            $
            6,386
            
            
            $
            6,306
            
            
            $
            6,525
            
            
            $
            5,575
            
            
            $
            4,833
            
            
            $
            4,474
            
            
            $
            4,503
            
            
            $
            3,606(as
      a % of loans, gross)
            
            
            2.20
            %
            
            
            2.11
            %
            
            
            2.13
            %
            
            
            1.83
            %
            
            
            1.59
            %
            
            
            1.44
            %
            
            
            1.46
            %
            
            
            1.22
            %





45


The
difference between the amount of the provision for loan losses and net loan
charge offs will result in expansion or shrinkage to the level of the allowance
for loan losses. As shown above, during the three months ended December 31, 2009
the current provision for loan losses of $2,125,000 was more than net charge
offs against the allowance of $2,072,000 by $53,000.  The result was
an increase to the allowance for loan losses by $80,000 to a level of
$6,386,000, or 2.20% of gross loans outstanding at December 31, 2009, as
compared to $4,833,000, or 1.59% of gross loans outstanding at December 31,
2008.





From a
historical perspective, through the first quarter of 2008, while the level of
loans on nonaccrual was relatively stable, the allowance for loan losses was
maintained in the range of 1.2% to 1.3%. However, with the uptick in loans on
nonaccrual during the quarter ended June 30, 2008, it was determined that an
increase to the allowance level was appropriate given the projected increased
risk of loss, and the allowance was increased to a range of 1.4% to 1.5% for the
second and third fiscal quarters of 2008. The weakening of the loan portfolio
performance continued into the final quarter of 2008 and first quarter of 2009
with actual loss levels that exceeded projections from earlier in 2008,
resulting in the decision to increase the allowance level further, to the range
of 1.6% to 1.8%. The most recent three quarters reflect further analysis and
projections of potential loan losses in the Bank’s existing portfolio, and as a
result, represents a further increase in the allowance level to in excess of 2%
of gross loans outstanding.





Management
is encouraged by the recent trends in the asset quality metrics discussed above,
as these seem to be pointing to the possibility that the asset quality
deterioration over the last two years may be reaching a point of stabilization
and improvement.  Despite these recent favorable trends, management
acknowledges that future asset quality results may vary from our estimates and
expectations, resulting in negative asset quality metrics which could have a
material adverse effect on our results of operations and financial
condition.





Other
Real Estate Owned





Other
real estate owned represents collateral property taken back from borrowers in
partial or full satisfaction of their defaulted debt obligation to the
Company.  We track our historical experience of loans that ultimately
convert to other real estate owned by major loan category and by geographic
exposure as shown on the following tables:





December
      31, 2009Florida
            
            
            Georgia
            
            
            South
      Carolina
            
            
            TotalReal
      estate – construction, commercial
            
            $
            997,000
            
            
            $
            ––
            
            
            $
            208,000
            
            
            $
            1,205,000Real
      estate – construction, residential
            
            
            7,266,000
            
            
            
            5,370,000
            
            
            
            1,492,000
            
            
            
            14,128,000Real
      estate – mortgage, commercial
            
            
            567,000
            
            
            
            ––
            
            
            
            808,000
            
            
            
            1,375,000Real
      estate – mortgage, residential
            
            
            305,000
            
            
            
            391,000
            
            
            
            772,000
            
            
            
            1,468,000$
            9,135,000
            
            
            $
            5,761,000
            
            
            $
            3,280,000
            
            
            $
            18,176,000





December
      31, 2008Florida
            
            
            Georgia
            
            
            South
      Carolina
            
            
            TotalReal
      estate – construction, commercial
            
            $
            1,308,000
            
            
            $
            1,482,000
            
            
            $
            922,000
            
            
            $
            3,712,000Real
      estate – construction, residential
            
            
            55,000
            
            
            
            ––
            
            
            
            ––
            
            
            
            55,000Real
      estate – mortgage, commercial
            
            
            ––
            
            
            
            ––
            
            
            
            422,000
            
            
            
            422,000Real
      estate – mortgage, residential
            
            
            ––
            
            
            
            ––
            
            
            
            1,562,000
            
            
            
            1,562,000$
            1,363,000
            
            
            $
            1,482,000
            
            
            $
            2,906,000
            
            
            $
            5,751,000





December
      31, 2007Florida
            
            
            Georgia
            
            
            South
      Carolina
            
            
            TotalReal
      estate – construction, commercial
            
            $
            ––
            
            
            $
            ––
            
            
            $
            ––
            
            
            $
            ––Real
      estate – construction, residential
            
            
            ––
            
            
            
            ––
            
            
            
            ––
            
            
            
            ––Real
      estate – mortgage, commercial
            
            
            209,000
            
            
            
            110,000
            
            
            
            ––
            
            
            
            319,000Real
      estate – mortgage, residential
            
            
            ––
            
            
            
            ––
            
            
            
            ––
            
            
            
            ––$
            209,000
            
            
            $
            110,000
            
            
            $
            ––
            
            
            $
            319,000





46


During
the year ended December 31, 2009 we sold a total of 31 other real estate owned
properties with a total book value of $6,872,000.  The net proceeds
from these sales were $6,675,000, which resulted in a net recovery of
approximately 73.4% of the original loan amounts and 97.1% of the book value of
the other real estate sold.





The
Bank’s special asset group is charged with the administration and liquidation of
other real estate owned.  Our approach has been to manage each
property individually in such a way as to maximize our net proceeds upon
sale.  Management is evaluating other methods to liquidate these
properties more quickly, but such methods typically result in a much lower
recovery relative to the original loan amount.  Management believes
that it may be in the best interest of the Company to aggressively drive down
the level of nonperforming assets, and such actions may result in significant
charges to future earnings from recovery levels much lower than historic
results.





Investment
Securities




Investment
securities decreased to $62,515,000 at December 31, 2009 from $84,461,000
at December 31, 2008.




The
following table presents the investments by category:




December
      31,2009
            
            2008
            
            2007(In
      Thousands)
            Amortized
              Cost
            
            Estimated
              Fair
      Value
            
            Amortized
              Cost
            
            Estimated
              Fair
      Value
            
            Amortized
              Cost
            
            Estimated
              Fair
      ValueAvailable
      for saleU.S.
      Government and federal agencies
            $
            —
            
            $
            —
            
            $
            —
            
            $
            —
            
            $
            2,998
            
            $
            2,995Government
      sponsored enterprises
            
            —
            
            
            —
            
            
            500
            
            
            502
            
            
            6,496
            
            
            6,507State
      and municipal securities
            
            10,185
            
            
            10,370
            
            
            16,956
            
            
            16,573
            
            
            16,786
            
            
            16,618Mortgage-backed
      securities
            
            48,558
            
            
            50,145
            
            
            63,494
            
            
            64,363
            
            
            60,925
            
            
            61,051$
            58,743
            
            $
            60,515
            
            $
            80,950
            
            $
            81,438
            
            $
            87,205
            
            $
            87,171Held
      to MaturityCorporate
      debt securities
            $
            2,000
            
            $
            2,095
            
            $
            3,023
            
            $
            3,024
            
            $
            —
            
            $
            —$
            2,000
            
            $
            2,095
            
            $
            3,023
            
            $
            3,024
            
            $
            —
            
            $
            —





The
following table presents the maturities of investment securities at carrying
value and the weighted average yields for each range of maturities presented.
Yields are based on amortized cost of securities.





Maturities
      at
              December 31,
      2009
              (In
      Thousands)
            
            State
      and
              Municipal
              Securities
            
            
            Weighted
              Average
              Yields
            
            
            Mortgage-
              backed
              Securities
            
            
            Weighted
              Average
              Yields
            
            
            Corporate
              debt
              Securities
            
            
            Weighted
              Average
              YieldsWithin
      1 year
            
            $
            544
            
            
            
            3.11
            %
            
            $
            10,610
            
            
            
            5.08
            %
            
            $
            —
            
            
            
            —After
      1 through 5 years
            
            
            5,893
            
            
            
            3.68
            %
            
            
            27,664
            
            
            
            4.71
            %
            
            
            2,000
            
            
            
            6.05
            %After
      5 through 10 years
            
            
            2,940
            
            
            
            3.88
            %
            
            
            4,406
            
            
            
            4.44
            %
            
            
            —
            
            
            
            —After
      10 years
            
            
            993
            
            
            
            4.21
            %
            
            
            7,465
            
            
            
            5.14
            %
            
            
            —
            
            
            
            —Totals
            
            $
            10,370
            
            
            
            3.76
            %
            
            $
            50,145
            
            
            
            4.83
            %
            
            $
            2,000
            
            
            
            6.05
            %





Mortgage-backed
securities are included in the maturities categories in which they are
anticipated to be repaid based on scheduled maturities.  47
 Deposits




Total
deposits increased by $6,225,000, or 2%, to a total of $368,881,000 at
December 31, 2009 from $362,656,000 at December 31, 2008.
Non-interest-bearing demand deposits decreased $863,000, or 5%, while
interest-bearing deposits increased $7,088,000, or 2%. The Company has continued
its use of a modest level of brokered deposits, which carry substantially lower
interest rates than comparable term core retail deposits.  Brokered
deposits are issued in individual’s names and in the names of trustees with
balances participated out to others.  Core retail deposits are
deposits which are gathered in the normal course of business, without the use of
a broker.  Core reciprocal deposits are gathered in the same manner as
core retail deposits, but the funds are participated out to other banks through
use of the CDARS reciprocal transactions program.  In June 2009 we
placed $13.5 million of core deposits in the CDARS program.  The CDARS
program allows depositors to obtain FDIC insurance for deposits up to $50
million by exchanging the portions of their deposits in excess of FDIC insurance
limitations with other financial institutions participating in the CDARS
program.  In return, we receive an equal amount of deposits back from
other CDARS participating financial institutions, such that there is no net
change in the level of total deposits on our balance sheet. Pursuant to the
formal agreement entered into with the OCC, the Bank is required to limit its
level of brokered deposits to no more than ten percent of total deposits, such
requirement does not include reciprocal CDARS.





Balances
and percentages within the major deposit categories are as
follows:





December
      31, 2009(In
      thousands)
            
            Core
      Retail Deposits
            
            
            Core
      Reciprocal Deposits
            
            
            Brokered
      Deposits
            
            
            Total
      DepositsNoninterest-bearing
      demand deposits
            
            $
            17,776
            
            
            $
            ––
            
            
            $
            ––
            
            
            $
            17,776Interest-bearing
      demand deposits
            
            
            105,734
            
            
            
            ––
            
            
            
            ––
            
            
            
            105,734Savings
      deposits
            
            
            2,959
            
            
            
            ––
            
            
            
            ––
            
            
            
            2,959Certificates
      of deposit $100,000 and over
            
            
            118,684
            
            
            
            12,763
            
            
            
            ––
            
            
            
            131,447Other
      time deposits
            
            
            88,029
            
            
            
            858
            
            
            
            22,078
            
            
            
            110,965$
            333,182
            
            
            $
            13,621
            
            
            $
            22,078
            
            
            $
            368,881





December
      31, 2008(In
      thousands)
            
            Core
      Retail Deposits
            
            
            Core
      Reciprocal Deposits
            
            
            Brokered
      Deposits
            
            
            Total
      DepositsNoninterest-bearing
      demand deposits
            
            $
            18,639
            
            
            $
            ––
            
            
            $
            ––
            
            
            $
            18,639Interest-bearing
      demand deposits
            
            
            95,687
            
            
            
            ––
            
            
            
            ––
            
            
            
            95,687Savings
      deposits
            
            
            3,027
            
            
            
            ––
            
            
            
            ––
            
            
            
            3,027Certificates
      of deposit $100,000 and over
            
            
            130,837
            
            
            
            ––
            
            
            
            ––
            
            
            
            130,837Other
      time deposits
            
            
            85,455
            
            
            
            ––
            
            
            
            29,011
            
            
            
            114,466$
            333,645
            
            
            $
            ––
            
            
            $
            29,011
            
            
            $
            362,656





December
      31, 2007(In
      thousands)
            
            Core
      Retail Deposits
            
            
            Core
      Reciprocal Deposits
            
            
            Brokered
      Deposits
            
            
            Total
      DepositsNoninterest-bearing
      demand deposits
            
            $
            25,147
            
            
            $
            ––
            
            
            $
            ––
            
            
            $
            25,147Interest-bearing
      demand deposits
            
            
            102,674
            
            
            
            ––
            
            
            
            ––
            
            
            
            102,674Savings
      deposits
            
            
            2,952
            
            
            
            ––
            
            
            
            ––
            
            
            
            2,952Certificates
      of deposit $100,000 and over
            
            
            104,891
            
            
            
            ––
            
            
            
            ––
            
            
            
            104,891Other
      time deposits
            
            
            86,035
            
            
            
            ––
            
            
            
            24,148
            
            
            
            110,183$
            321,699
            
            
            $
            ––
            
            
            $
            24,148
            
            
            $
            345,847


48
 The
average balance of deposits and the average rates paid on such deposits are
summarized as follows:





December 31,2009
            
            
            2008
            
            
            2007(In
      Thousands)
            
            Amount
            
            
            Rate
            
            
            Amount
            
            
            Rate
            
            
            Amount
            
            
            RateNon-interest-bearing
      demand
            
            $
            19,216
            
            
            —
            %
            
            $
            23,134
            
            
            
            —
            %
            
            $
            24,791
            
            
            
            —
            %Interest-bearing
      demand
            
            
            103,640
            
            
            1.50
            %
            
            
            98,889
            
            
            
            2.49
            %
            
            
            120,934
            
            
            
            3.58
            %Savings
            
            
            3,022
            
            
            0.50
            %
            
            
            3,006
            
            
            
            0.52
            %
            
            
            2,988
            
            
            
            0.71
            %Time
            
            
            248,386
            
            
            3.01
            %
            
            
            228,355
            
            
            
            4.43
            %
            
            
            194,987
            
            
            
            5.13
            %Total
            
            $
            374,264
            
            
            
            
            
            $
            353,384
            
            
            
            
            
            
            $
            343,700




Maturities
of time certificates of deposit of $100,000 or more outstanding at
December 31, 2009 are summarized as follows:




(In
      Thousands)Within
      3 months
            
            $
            39,906After
      3 through 12 months
            
            77,7341
      through 3 years
            
            16,221After
      3 years
            
            586Total
            
            $
            131,447





Other
Borrowings





Other
Borrowings of $45,237,000 at December 31, 2009 are composed of advances
from the Federal Home Loan Bank of Atlanta (FHLB), and represent a decrease from
$51,693,000 at December 31, 2008. At December 31, 2009 the Bank has
pledged $110,223,000 of its portfolio loans to FHLB and can borrow up to
$60,271,000 on such collateral.  The Bank has also pledged $55,240,000
of its portfolio loans to Federal Reserve Bank of Atlanta and can borrow up to
$28,256,000 on such collateral at the Discount Window.




Junior
Subordinated Debentures




In
May 2004, Coastal Banking Company Statutory Trust I issued
$3.0 million of trust preferred securities with a maturity of July 23,
2034. The proceeds from the issuance of the trust preferred securities were used
by the Trust to purchase $3,093,000 of the Company’s junior subordinated
debentures, which pay interest at a floating rate equal to 3 month LIBOR plus
275 basis points. The Company used the proceeds from the sale of the junior
subordinated debentures for general purposes, primarily to provide capital to
the Bank. The debentures represent the sole asset of the Trust.




In
June 2006, Coastal Banking Company Statutory Trust II issued
$4.0 million of trust preferred securities with a maturity of
September 30, 2036. The proceeds from the issuance of the trust preferred
securities were used by the Trust to purchase $4,124,000 million of the
Company’s junior subordinated debentures, which pay interest at a fixed rate of
7.18% until September 30, 2011 and a variable rate thereafter equal to 3
month LIBOR plus 160 basis points. The Company used the proceeds from the sale
of the junior subordinated debentures for general purposes, primarily to provide
capital to the Bank. The debentures represent the sole asset of the
Trust.  49
 Capital
Resources




Total
shareholders’ equity decreased from $52,005,000 at December 31, 2008 to
$37,902,000 at December 31, 2009. Net loss for the period reduced equity by
$14,536,000, while comprehensive income of $847,000 resulted from an increase in
fair market value of investment securities available for sale during 2009, net
of tax.  Included in this net loss for the period was a charge of
$10,412,000 for the write off of the intangible asset, goodwill.  As a
result, only $4,124,000 of the net loss for the period reduced tangible
equity.  Regulatory capital ratios exclude intangibles such as
goodwill from inclusion in regulatory capital, so the impact on our regulatory
capital ratios was limited to the reduction to tangible equity.




Bank
holding companies, including the Company, and their banking subsidiaries are
required by banking regulators to meet particular minimum levels of capital
adequacy, which are expressed in the form of certain ratios. Capital is
separated into Tier 1 capital (essentially common shareholders’ equity and a
limited amount of trust preferred securities less intangible assets) and Tier 2
capital (essentially the allowance for loan losses limited to 1.25% of
risk-weighted assets). The first two ratios, which are based on the degree of
credit risk in our assets, provide the weighting of assets based on assigned
risk factors and include off-balance sheet items such as loan commitments and
stand-by letters of credit. The ratio of Tier 1 capital to risk-weighted assets
must be at least 4.0% and the ratio of total capital (Tier 1 capital plus Tier 2
capital) to risk-weighted assets must be at least 8.0% to be adequately
capitalized. The capital leverage ratio supplements the risk-based capital
guidelines. Banks and bank holding companies are required to maintain a minimum
ratio of Tier 1 capital to adjusted quarterly average total assets of 4.0% to be
adequately capitalized.




The
following table summarizes the Company’s capital ratios at December 31,
2009 and 2008, respectively:




December
      31, 2009
            
            
            December 31,
      2008Tier
      1 capital (to risk-weighted assets)
            
            
            14.03
            %
            
            
            14.85
            %Total
      capital (to risk-weighted assets)
            
            
            15.28
            %
            
            
            16.10
            %Tier
      1 capital (to total average assets)
            
            
            9.36
            %
            
            
            11.14
            %





See note
17 of notes to consolidated financial statements for a detail of the Bank and
Company.




Liquidity




The Bank
must maintain, on a daily basis, sufficient funds to cover the withdrawals from
depositors’ accounts and to supply new borrowers with funds. To meet these
obligations, the Bank keeps cash on hand, maintains account balances with its
correspondent banks, and purchases and sells federal funds and other short-term
investments. Asset and liability maturities are monitored in an attempt to match
the maturities to meet liquidity needs. It is the policy of the Bank to monitor
its liquidity to meet regulatory requirements and local funding
requirements.




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, standby letters of credit
and loans sold with representations and warranties. 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. Standby letters of credit are written
conditional commitments issued by the Bank to guarantee the performance of a
customer to a third party. 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. Our exposure to credit
loss in the event of non-performance 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. We use
the same credit policies in making commitments to extend credit as we do for
on-balance sheet instruments. Collateral held for commitments to extend credit
varies but may include accounts receivable, inventory, property, plant,
equipment, and income-producing commercial properties.  50
 Loans on
one-to-four family residential mortgages originated by us are sold to various
other financial institutions with representations and warranties that are usual
and customary for the industry. These representations and warranties give the
purchaser of the loan the right to require that we repurchase a loan if the
borrower fails to make any one of the first four loan payments within 30 days of
the due date, which is termed an Early Payment Default (“EPD”). Our maximum
liquidity need in the event of an EPD claim would be the unpaid principal
balance of the loan to be repurchased along with any premium paid by the
investor when the loan was purchased and other minor collection cost
reimbursements. The Bank has received notification from purchasers of three EPD
claims in 2008 and seven EPD claims in 2009, but has not yet had to repurchase a
single loan. Beyond the initial payments to the purchasers of $58,100 upon
receipt of the claims, the maximum remaining exposure under these claims would
be the difference between the total loan amounts of $2,020,000 and the
liquidated value of the underlying collateral consisting of ten single family
residences. Original loan to value ratios ranged from 75% to 97% while all loans
with a loan to value ratio over 80% have a mortgage insurance policy in place.
If repurchase was required, management believes that the potential amount of
loss would not be material and that sufficient reserves exist to fully absorb
any loss. Management does not anticipate any material credit risk related to
potential EPD claims on loans that have been previously sold and are no longer
on the Bank’s balance sheet.




In
addition to EPD claims, the representations and warranties in our loan sale
agreements also provide that we will indemnify the investors for losses or costs
on loans we sell under certain limited conditions. Some of these conditions
include underwriting errors or omissions, fraud or material misstatements by the
borrower in the loan application or invalid market value on the collateral
property due to deficiencies in the appraisal. In connection with the start up
of the wholesale lending division, the Bank has established a reserve for costs
related to potential indemnification costs and EPD claims. The balance in this
indemnification reserve was $500,000 at December 31, 2009 and there have
been no claims or charges against this reserve since it was established in
September 2007. Accordingly, management does not anticipate any material
exposure in connection with loan sale indemnification or EPD
claims.




The
following table summarizes our off-balance sheet financial instruments whose
contract amounts represent credit risk as of December 31,
2009:




Commitments
      to extend credit
            
            $
            24,488,000Standby
      letters of credit
            
            $
            23,000Loans
      sold with representations and warranties
            
            $
            310,945,000





Management
is not aware of any significant concentrations of loans to classes of borrowers
or industries that would be affected similarly by economic conditions. Although
the Bank’s loan portfolio is diversified, a substantial portion of our
borrowers’ ability to honor the terms of their loans is dependent on the
economic conditions in Beaufort County, South Carolina; Nassau County, Florida;
and Fulton and Thomas Counties, Georgia as well as the surrounding areas. In
addition, a substantial portion of our loan portfolio is collateralized by
improved and unimproved real estate and is therefore dependent on the local real
estate markets.




The Bank
maintains relationships with correspondent banks that can provide funds on short
notice, if needed. Presently, the Bank has arrangements with commercial banks
for short term unsecured advances up to $7,000,000, from which up to $4,000,000
is available for daylight overdraft and $3,000,000 for overnight borrowing. The
Bank also has reverse repurchase accommodations with a term of up to one month
for a maximum advance of $50 million, limited by the amount of eligible
securities pledged, which was $21 million at December 31, 2009. The reverse
repurchase agreements are committed borrowing facilities granted by other
commercial banks and are secured by securities in the Bank’s investment
portfolio.




The
amount due from commercial banks on loan sales is another source of short term
liquidity available to the Bank.  When residential mortgage loans are
shipped to other commercial banks for sale under the terms of forward sale
commitments, the gain or loss on sale is immediately recognized under trade date
accounting rules, and a loan sales receivable balance is established in other
assets.  At December 31, 2009, the balance of the loan sales
receivable was $14.8 million, of which approximately 56% was received as cash
payments within 10 business days.  As such, these funds represent
another source of quickly available liquidity to either fund new residential
loan originations or repay borrowings.  51
 Cash and
due from banks as of December 31, 2009 totaled $2,679,000, a decrease of
$2,112,000 from December 31, 2008. Cash used by operating activities
totaled $12,007,000 in 2009, while inflows from investing activities totaled
$10,141,000, which was attributable to sales, calls and maturities of investment
securities totaling $25,399,000, offset by a net increase in loans of
$11,610,000.




During
2009, we had net cash used of $246,000 in financing activities. Financing
activities included net increase in deposits of $6,225,000, offset by repayments
of borrowings of $6,470,000.




Contractual
Obligations





Summarized
below are our contractual obligations as of December 31, 2009.





Total
            
            
            Less than 1 year
            
            
            1
      to 3 years
            
            
            3
      to 5 years
            
            
            More
      than 5 yearsOther
      borrowings
            
            $
            45,237,000
            
            
            $
            16,750,000
            
            
            $
            11,500,000
            
            
            $
            10,000,000
            
            
            $
            6,987,000Operating
      Lease Obligations
            
            
            769,000
            
            
            
            282,000
            
            
            
            460,000
            
            
            
            27,000
            
            
            
            ––Junior
      Subordinated Debentures
            
            
            7,217,000
            
            
            
            ––
            
            
            
            ––
            
            
            
            ––
            
            
            
            7,217,000$
            53,223,000
            
            
            $
            17,032,000
            
            
            $
            11,960,000
            
            
            $
            10,027,000
            
            
            $
            14,204,000





Inflation




Inflation
impacts the growth in total assets in the banking industry and causes a need to
increase equity capital at higher than normal rates to meet capital adequacy
requirements. We cope with the effects of inflation through the management of
interest rate sensitivity, by periodically reviewing and adjusting our pricing
of services to consider current costs.




Selected
Ratios




The
following table sets out certain ratios:





For
      the Years Ended December 31,2009
            
            
            2008
            
            
            2007Net
      income (loss) to:Average
      shareholders’ equity (tangible)
            
            (42.28
            )
      %
            
            
            (13.86
            )
      %
            
            
            7.72
            %Average
      assets (tangible)
            
            (3.18
            )
      %
            
            
            (1.12
            )
      %
            
            
            0.64
            %Dividends
      to net income
            
            —
            %
            
            
            —
            %
            
            
            —
            %Average
      equity to average assets (tangible)
            
            7.51
            %
            
            
            8.06
            %
            
            
            8.24
            %





ITEM 7A. QUANTITATIVE AND QUANTITATIVE
DISCLOSURES ABOUT MARKET RISKS




Not
applicable.


52


ITEM 8. FINANCIAL STATEMENTS AND
SUPPLEMENTARY DATA




REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM




To
the Board of Directors


and
Stockholders of


Coastal
Banking Company




We have
audited the accompanying balance sheets of Coastal Banking Company of
December 31, 2009 and 2008, and the related statements of operations,
comprehensive loss, changes in shareholders' equity, and cash flows for each of
the years in the two-year period ended December 31, 2009. Coastal Banking
Company’s management is responsible for these financial statements. Our
responsibility is to express an opinion on these 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. The Company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audit included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company’s internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, 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 financial statements referred to above present fairly, in all
material respects, the financial position of Coastal Banking Company as of
December 31, 2009 and 2008, and the results of its operations and its cash
flows for each of the years in the two-year period ended December 31, 2009
in conformity with accounting principles generally accepted in the United States
of America.

















Albany,
Georgia


March 17,
2010  53


COASTAL
BANKING COMPANY, INC. AND SUBSIDIARIES


Consolidated
Balance Sheets





December 31,2009
            
            
            2008AssetsCash
      and due from banks
            
            $
            2,679,003
            
            
            $
            4,790,625Interest-bearing
      deposits in banks
            
            
            707,593
            
            
            
            110,748Federal
      funds sold
            
            
            539,326
            
            
            
            464,724Securities
      available for sale, at fair value
            
            
            60,515,592
            
            
            
            81,438,389Securities
      held to maturity, at cost
            
            
            2,000,000
            
            
            
            3,022,621Restricted
      equity securities, at cost
            
            
            4,996,250
            
            
            
            4,793,916Loans
      held for sale
            
            
            50,005,901
            
            
            
            31,404,990Loans,
      net of unearned income
            
            
            289,658,956
            
            
            
            304,418,704Less
      allowance for loan losses
            
            
            6,386,409
            
            
            
            4,833,491Loans,
      net
            
            
            283,272,547
            
            
            
            299,585,213Premises
      and equipment, net
            
            
            7,599,170
            
            
            
            7,849,316Cash
      surrender value of life insurance
            
            
            7,394,114
            
            
            
            7,107,522Intangible
      assets
            
            
            136,480
            
            
            
            260,641Goodwill
            
            
            —
            
            
            
            10,411,914Other
      real estate owned
            
            
            18,176,169
            
            
            
            5,750,973Other
      assets
            
            
            25,075,253
            
            
            
            19,838,157Total
      assets
            
            $
            463,097,398
            
            
            $
            476,829,749Liabilities
      and Shareholders’ EquityDeposits:Noninterest-bearing
            
            $
            17,775,762
            
            
            $
            18,639,212Interest-bearing
            
            
            351,104,768
            
            
            
            344,017,033Total
      deposits
            
            
            368,880,530
            
            
            
            362,656,245Other
      borrowings
            
            
            45,237,158
            
            
            
            51,692,588Junior
      subordinated debentures
            
            
            7,217,000
            
            
            
            7,217,000Other
      liabilities
            
            
            3,860,284
            
            
            
            3,259,236Total
      liabilities
            
            
            425,194,972
            
            
            
            424,825,069Commitments
      and contingencies (Note 15)Shareholders’
      Equity:Preferred
      stock, par value $.01; 10,000,000 shares authorized; 9,950 shares issued
      and outstanding in 2009 and 2008
            
            
            9,515,758
            
            
            
            9,453,569Common
      stock, par value $.01; 10,000,000 shares authorized; 2,568,707 shares
      issued and outstanding in 2009 and 2008
            
            
            25,687
            
            
            
            25,687Additional
      paid-in capital
            
            
            41,121,636
            
            
            
            41,037,403Retained
      earnings (deficit)
            
            
            (13,930,443
            )
            
            
            1,165,630Accumulated
      other comprehensive income
            
            
            1,169,788
            
            
            
            322,391Total
      shareholders’ equity
            
            
            37,902,426
            
            
            
            52,004,680Total
      liabilities and shareholders’ equity
            
            $
            463,097,398
            
            
            $
            476,829,749




54
 COASTAL
BANKING COMPANY, INC. AND SUBSIDIARIES


Consolidated
Statements of Operations





For
      the years ended December 31,2009
            
            
            
            2008Interest
      income:Interest
      and fees on loans
            
            $
            18,191,733
            
            
            $
            20,317,870Interest
      on taxable securities
            
            
            3,006,007
            
            
            
            3,328,239Interest
      on nontaxable securities
            
            
            551,813
            
            
            
            652,413Interest
      on deposits in other banks
            
            
            2,703
            
            
            
            21,944Interest
      on federal funds sold
            
            
            3,990
            
            
            
            115,933Total
      interest income
            
            
            21,756,246
            
            
            
            24,436,399Interest
      expense:Interest
      on deposits
            
            
            9,039,805
            
            
            
            12,558,859Interest
      on junior subordinated debentures
            
            
            417,071
            
            
            
            493,512Interest
      on other borrowings
            
            
            1,354,983
            
            
            
            1,335,699Total
      interest expense
            
            
            10,811,859
            
            
            
            14,388,070Net
      interest income
            
            
            10,944,387
            
            
            
            10,048,329Provision
      for loan losses
            
            
            7,771,000
            
            
            
            7,823,235Net
      interest income after provision for loan losses
            
            
            3,173,387
            
            
            
            2,225,094Non-interest
      income:Service
      charges on deposit accounts
            
            
            565,858
            
            
            
            734,019Other
      service charges, commissions and fees
            
            
            306,059
            
            
            
            243,905SBA
      loan income
            
            
            163,792
            
            
            
            496,767Mortgage
      banking income
            
            
            6,682,665
            
            
            
            1,153,075Gain
      on sale of securities available for sale
            
            
            1,065
            
            
            
            218,505Gain
      on tender of securities held to maturity
            
            
            98,996
            
            
            
            —Loss
      on Silverton Financial Services stock
            
            
            (507,366
            )
            
            
            —Income
      from investment in life insurance contracts
            
            
            288,714
            
            
            
            288,933Other
      income
            
            
            53,445
            
            
            
            8,191Total
      other income
            
            
            7,653,228
            
            
            
            3,143,395Non-interest
      expenses:Salaries
      and employee benefits
            
            
            8,001,701
            
            
            
            6,433,108Occupancy
      and equipment expense
            
            
            1,210,033
            
            
            
            1,223,767Advertising
      fees
            
            
            140,470
            
            
            
            232,689Amortization
      of intangible assets
            
            
            124,161
            
            
            
            198,503Audit
      fees
            
            
            390,531
            
            
            
            240,228Data
      processing fees
            
            
            921,893
            
            
            
            924,200Director
      fees
            
            
            159,200
            
            
            
            245,502FDIC
      insurance expense
            
            
            1,017,378
            
            
            
            236,507Goodwill
      impairment
            
            
            10,411,914
            
            
            
            —Legal
      and other professional fees
            
            
            728,450
            
            
            
            698,524Loan
      collection expense
            
            
            777,315
            
            
            
            69,677Mortgage
      loan expense
            
            
            470,771
            
            
            
            332,705OCC
      examination fees
            
            
            124,492
            
            
            
            170,443Other
      real estate expenses
            
            
            1,918,990
            
            
            
            1,207,435Other
      operating
            
            
            1,189,064
            
            
            
            1,149,790Total
      other expenses
            
            
            27,586,363
            
            
            
            13,363,078Loss
      before income taxes
            
            
            (16,759,748
            )
            
            
            (7,994,589
            )Income
      tax benefit
            
            
            (2,223,360
            )
            
            
            (3,156,288
            )Net
      loss
            
            $
            (14,536,388
            )
            
            $
            (4,838,301
            )Preferred
      stock dividends
            
            
            559,685
            
            
            
            46,502Net
      loss available to common shareholders
            
            $
            (15,096,073
            )
            
            $
            (4,884,803
            )Basic
      and diluted loss per share available to common
shareholders
            
            $
            (5.88
            )
            
            $
            (1.91
            )


See
accompanying notes to consolidated financial statements.
 55


COASTAL
BANKING COMPANY, INC. AND SUBSIDIARIES


Consolidated
Statements of Comprehensive Loss




For
      the years ended
              December 31,2009
            
            
            2008Net
      loss
            
            $
            (14,536,388
            )
            
            $
            (4,838,301
            )Other
      comprehensive income, net of tax:Net
      unrealized holding gains arising during period,  net of tax of
      $436,900 and $251,930
            
            
            848,100
            
            
            
            489,042Reclassification
      adjustment for gains included  in net loss, net of tax of $362 and
      $74,292
            
            
            (703
            )
            
            
            (144,213
            )Total
      other comprehensive income
            
            
            847,397
            
            
            
            344,829Comprehensive
      loss
            
            $
            (13,688,991
            )
            
            $
            (4,493,472
            )


See
accompanying notes to consolidated financial statements.
 56
 COASTAL
BANKING COMPANY, INC. AND SUBSIDIARIES


Consolidated
Statements of Changes in Shareholders’ Equity


For
the Years Ended December 31, 2009 and 2008





Preferred
      Stock
            
            
            Common
      Stock
            
            
            AdditionalPaid-inCapital
            
            
            RetainedEarnings(Deficit)
            
            
            AccumulatedOther
      Comprehensive
      Income
      (Loss)Shares
            
            
            Amount
            
            
            Shares
            
            
            Amount
            
            
            
            
            
            
            
            
            TotalBalance,
      December 31, 2007
            
            
            —
            
            
            $
            —
            
            
            
            2,570,560
            
            
            $
            25,708
            
            
            $
            40,280,395
            
            
            $
            6,463,087
            
            
            $
            (22,438
            )
            
            $
            46,746,752Net
      loss
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            ––
            
            
            
            (4,838,301
            )
            
            
            —
            
            
            
            (4,838,301
            )Proceeds
      from exercise of
              stock
      options
            
            
            —
            
            
            
            —
            
            
            
            43,311
            
            
            
            433
            
            
            
            374,207
            
            
            
            —
            
            
            
            —
            
            
            
            374,640Restricted
      stock grant
            
            
            —
            
            
            
            —
            
            
            
            5,000
            
            
            
            50
            
            
            
            (50
            )
            
            
            —
            
            
            
            —
            
            
            
            ––Stock
      repurchase
            
            
            —
            
            
            
            —
            
            
            
            (50,164
            )
            
            
            (504
            )
            
            
            (279,111
            )
            
            
            (412,654
            )
            
            
            —
            
            
            
            (692,269
            )Preferred
      stock issuance
            
            
            9,950
            
            
            
            9,448,525
            
            
            
            —
            
            
            
            —
            
            
            
            501,475
            
            
            
            —
            
            
            
            —
            
            
            
            9,950,000Preferred
      stock dividend
            
            
            —
            
            
            
            5,044
            
            
            
            —
            
            
            
            —
            
            
            
            ––
            
            
            
            (46,502
            )
            
            
            —
            
            
            
            (41,458
            )Stock-based
      compensation
              expense
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            160,487
            
            
            
            —
            
            
            
            —
            
            
            
            160,487Other
      comprehensive
              income
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            
            
            
            
            —
            
            
            
            —
            
            
            
            344,829
            
            
            
            344,829Balance,
      December 31, 2008
            
            
            9,950
            
            
            
            9,453,569
            
            
            
            2,568,707
            
            
            
            25,687
            
            
            
            41,037,403
            
            
            
            1,165,630
            
            
            
            322,391
            
            
            
            52,004,680Net
      loss
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            ––
            
            
            
            (14,536,388
            )
            
            
            —
            
            
            
            (14,536,388
            )Preferred
      stock dividend
            
            
            —
            
            
            
            62,189
            
            
            
            —
            
            
            
            —
            
            
            
            ––
            
            
            
            (559,685
            )
            
            
            —
            
            
            
            (497,496
            )Stock-based
      compensation
              expense
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            84,233
            
            
            
            —
            
            
            
            —
            
            
            
            84,223Other
      comprehensive
              income
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            
            
            
            
            —
            
            
            
            —
            
            
            
            847,397
            
            
            
            847,397Balance,
      December 31, 2009
            
            
            9,950
            
            
            $
            9,515,758
            
            
            
            2,568,707
            
            
            $
            25,687
            
            
            $
            41,121,636
            
            
            $
            (13,930,443
            )
            
            $
            1,169,788
            
            
            $
            37,902,426


See
accompanying notes to consolidated financial statements.
 57
 COASTAL
BANKING COMPANY, INC. AND SUBSIDIARIES


Consolidated
Statements of Cash Flows





For
      the years ended December 31,2009
            
            
            2008Cash
      flows from operating activities:Net
      loss
            
            $
            (14,536,388
            )
            
            $
            (4,838,301
            )Adjustments
      to reconcile net loss to net cash used by operating
      activities:Depreciation,
      amortization and accretion
            
            
            462,202
            
            
            
            457,149Amortization
      of intangible assets
            
            
            124,161
            
            
            
            198,503Goodwill
      impairment
            
            
            10,411,914
            
            
            
            —Stock-based
      compensation expense
            
            
            84,233
            
            
            
            160,487Provision
      for loan losses
            
            
            7,771,000
            
            
            
            7,823,235Provision
      for deferred income taxes
            
            
            (2,860,351
            )
            
            
            (23,598
            )Gain
      on sale of securities available for sale
            
            
            (1,065
            )
            
            
            (218,505
            )Gain
      on tender of securities held to maturity
            
            
            (98,996
            )
            
            
            —Loss
      on Silverton Financial Services stock
            
            
            507,366
            
            
            
            —Loss
      on sale or disposal of premises and equipment
            
            
            —
            
            
            
            35,736Loss
      on sale of other real estate owned
            
            
            1,054,759
            
            
            
            607,041Proceeds
      from sales of other real estate owned
            
            
            6,671,738
            
            
            
            558,573Increase
      in cash value of life insurance
            
            
            (288,714
            )
            
            
            (288,933
            )Originations
      of mortgage loans held for sale
            
            
            (946,928,854
            )
            
            
            (487,892,332
            )Proceeds
      from sales of mortgage loans held for sale
            
            
            928,327,943
            
            
            
            470,941,051Net
      decrease in interest receivable
            
            
            267,809
            
            
            
            610,401Net
      decrease in interest payable
            
            
            (192,474
            )
            
            
            (105,252
            )SBA
      loan income
            
            
            (163,792
            )
            
            
            (496,767
            )Mortgage
      banking income
            
            
            (6,682,665
            )
            
            
            (3,148,375
            )Net
      other operating activities
            
            
            4,063,513
            
            
            
            (5,954,203
            )Net
      cash used by operating activities
            
            
            (12,006,661
            )
            
            
            (21,574,090
            )Cash
      flows from investing activities:Net
      (increase) decrease in interest-bearing deposits in banks
            
            
            (596,845
            )
            
            
            1,953,065Net
      (increase) decrease in federal funds sold
            
            
            (74,602
            )
            
            
            4,245,673Proceeds
      from maturities of securities available for sale
            
            
            14,373,147
            
            
            
            14,037,395Proceeds
      from sale of securities available for sale
            
            
            9,906,198
            
            
            
            22,742,519Purchases
      of securities available for sale
            
            
            (2,107,227
            )
            
            
            (30,305,914
            )Proceeds
      from maturities of securities held to maturity
            
            
            1,120,000
            
            
            
            —Purchases
      of securities held to maturity
            
            
            —
            
            
            
            (3,022,621
            )Net
      change in restricted equity securities
            
            
            (709,700
            )
            
            
            (1,110,500
            )Net
      increase in loans
            
            
            (11,610,027
            )
            
            
            (36,368,407
            )Purchase
      of premises and equipment
            
            
            (160,190
            )
            
            
            (165,923
            )Net
      cash provided (used) by investing activities
            
            
            10,140,754
            
            
            
            (27,994,713
            )Cash
      flows from financing activities:Net
      increase in deposits
            
            
            6,224,285
            
            
            
            16,809,129Decrease
      in securities sold under agreements to repurchase
            
            
            —
            
            
            
            (2,000,000
            )Proceeds
      from other borrowings
            
            
            —
            
            
            
            27,220,000Repayment
      of other borrowings
            
            
            (6,470,000
            )
            
            
            (2,300,000
            )Proceeds
      from issuance of preferred stock
            
            
            —
            
            
            
            9,950,000Purchase
      and retirement of treasury shares
            
            
            —
            
            
            
            (692,269
            )Proceeds
      from exercise of stock options
            
            
            —
            
            
            
            374,640Net
      cash provided (used) by financing activities
            
            
            (245,715
            )
            
            
            49,361,500Net
      change in cash and due from banks
            
            
            (2,111,622
            )
            
            
            (207,303
            )Cash
      and due from banks at beginning of year
            
            
            4,790,625
            
            
            
            4,997,928Cash
      and due from banks at end of year
            
            $
            2,679,003
            
            
            $
            4,790,625Supplemental
      disclosures of cash flow information:Cash
      paid during the year for interest
            
            $
            11,004,333
            
            
            $
            14,493,322Cash
      paid during the year for income taxes
            
            $
            13,637
            
            
            $
            391,809Noncash
      Transactions:Principal
      balances of loans transferred to other real estate owned
            
            $
            20,151,693
            
            
            $
            6,597,587


See
accompanying notes to consolidated financial statements.
 58


COASTAL
BANKING COMPANY, INC. AND SUBSIDIARIES


Notes
to Consolidated Financial Statements




Note
      1.
            Summary
      of Significant Accounting Policies




Basis
of Presentation and Nature of Operations




Coastal
Banking Company, Inc. (the “Company”) is organized under the laws of the
State of South Carolina for the purpose of operating as a bank holding company
for CBC National Bank (the “Bank”). The Bank commenced business on May 10,
2000 as Lowcountry National Bank. The Company acquired First National Bank of
Nassau County, which began its operations in 1999, through its merger with First
Capital Bank Holding Corporation on October 1, 2005. On October 27,
2006, the Company acquired the Meigs, Georgia office of the Bank through merger
of Cairo Banking Co. with and into the Bank. On August 10, 2008, Lowcountry
National Bank and First National Bank of Nassau County merged into one charter.
Immediately after the merger, the name of the surviving bank was changed to CBC
National Bank and the main office relocated to 1891 South 14th
Street, Fernandina Beach, Nassau County, Florida. The Bank’s branches continue
to do business under the trade names “Lowcountry National Bank,” “First National
Bank of Nassau County,” and “The Georgia Bank” in their respective markets. The
Bank provides full commercial banking services to customers throughout Beaufort
County, South Carolina; Nassau County, Florida; and Thomas County, Georgia and
is subject to regulation by the Office of the Comptroller of the Currency (the
“OCC”) and the Federal Deposit Insurance Corporation (the “FDIC”). The Bank also
has loan production offices in Savannah, Georgia and Jacksonville, Florida, as
well as a wholesale mortgage office in Atlanta, Georgia. The Company is subject
to regulation by the Federal Reserve Board of Governors. The Company also has an
investment in Coastal Banking Company Statutory Trust I (“Trust I”) and Coastal
Banking Company Statutory Trust II (“Trust II”). Both trusts are special purpose
subsidiaries organized for the sole purpose of issuing trust preferred
securities.




The
consolidated financial statements include the accounts of the Company and the
Bank. All significant intercompany transactions have been eliminated in
consolidation. The accounting and reporting policies of the Company conform to
accounting principles generally accepted in the United States of America and to
general practices in the banking industry.




Accounting
Estimates




The
preparation of consolidated financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities as of
the date of the consolidated financial statements and the reported amount of
income and expenses during the reporting periods. Actual results could differ
from those estimates.




Cash,
Due from Banks and Cash Flows




For
purposes of reporting cash flows, cash and due from banks includes cash on hand,
cash items in process of collection and amounts due from banks. Cash flows from
loans, federal funds sold, deposits, interest-bearing deposits in banks,
restricted equity securities and securities sold under agreements to repurchase
are reported net.




The Bank
is required to maintain reserve balances in cash or on deposit with the Federal
Reserve Bank. The total of those reserve requirements was approximately $100,000
and $270,000 at December 31, 2009 and 2008, respectively.




Securities




The
Company classifies its securities as available for sale or held to maturity.
Held to maturity securities are those securities for which the Company has the
ability and intent to hold until maturity. All securities not included in held
to maturity are classified as available for sale.




Available
for sale securities are recorded at fair value. Held to maturity securities are
recorded at cost, adjusted for the amortization or accretion of premiums or
discounts. Unrealized holding gains and losses on securities available for sale,
net of the related tax effect, are excluded from earnings and are reported as a
separate component of shareholders’ equity until realized.  59
 The
Financial Accounting Standards Board (“FASB”) recently issued accounting
guidance related to the recognition and presentation of other-than-temporary
impairment (FASB ASC 320-10).  See the “Recent Accounting
Pronouncement” section for additional information.




Prior to
the adoption of the recent accounting guidance on April 1, 2009, management
considered, in determining whether other-than-temporary impairment exists, (1)
the length of time and the extent to which the fair value has been less than
cost, (2) the financial condition and near-term prospects of the issuer, and (3)
the intent and ability of the Company to retain its investment in the issuer for
a period of time sufficient to allow for any anticipated recovery in fair
value.




A decline
in the market value of securities below cost that is deemed other than temporary
is charged to earnings and establishes a new cost basis for the
security.




Premiums
and discounts are amortized or accreted over the life of the related securities
as adjustments to the yield. Realized gains and losses for securities classified
as available for sale and held to maturity are included in earnings and are
derived using the specific identification method for determining the cost of
securities sold.




Restricted
Equity Securities




The
Company is required to maintain an investment in capital stock of the Federal
Home Loan Bank of Atlanta (“FHLB”) and the Federal Reserve Bank of Atlanta
(“FRB”).  The stock is generally pledged as collateral against any
borrowings from these institutions.  Based on redemption provisions of
these entities, the stock has no quoted market value and is carried at
cost.  At their discretion, these entities may declare dividends on
the stock.  Management reviews for impairment based on the ultimate
recoverability of the cost basis in these stocks.  At December 31,
2009 the balance of FHLB stock was $3,612,900 and the balance of FRB stock was
$1,383,350




Loans
Held for Sale




Loans
originated and intended for sale in the secondary market are carried at the
lower of cost or market (LOCOM) or fair value under the fair value option
accounting guidance for financial instruments.  For loans carried at
LOCOM, gains and losses on loan sales (sales proceeds minus carrying value) are
recorded in noninterest income, and direct loan origination costs and fees are
deferred at origination of the loan and are recognized in noninterest income
upon sale of the loan.




The Bank
also originates SBA loans, which in some cases are sold on the secondary market.
Origination fees associated with these loans are amortized over the life of the
loan or until a decision is made to sell. Once the decision is made to sell,
adjustments to reflect fair value and realized gains and losses upon ultimate
sale of the loans are classified as noninterest income in the Consolidated
Statements of Operations.




Loans
and Allowance for Loan Losses




Loans are
stated at the principal amount outstanding, net of deferred loan origination
fees and costs and the allowance for loan losses. Interest on loans is
calculated by using the interest method based upon the principal amount
outstanding. Loan origination and commitment fees and direct loan origination
costs are deferred and amortized over the contractual or expected economic life
of the related loan or commitments as an adjustment of the related loan
yields.




A loan is
considered impaired when, based on current information and events, it is
probable that all amounts due according to the contractual terms of the loan
agreement will not be collected. Impaired loans are measured based on the
present value of expected future cash flows discounted at the loan’s effective
interest rate, at the loan’s observable market price, or at the fair value of
the collateral of the loan if the loan is collateral dependent.




To the
extent that the recovery of loan balances has become collateral dependent, we
obtain appraisals not less than annually, and then we reduce these appraised
values for selling and holding costs to determine the liquidated
value.  Any shortfall between the liquidated value and the loan
balance is charged against the Allowance for Loan Losses in the month the
related appraisal was received. In the ordinary course of managing and
monitoring non performing loans, information may come to our attention that
indicates the collateral value has declined further from the value established
in the most recent appraisal.  Such other information may include
prices on recent comparable property sales or internet based property valuation
estimates.  In cases where this other information is deemed reliable,
and the impact of a further reduction in collateral value would result in a
further loss to the Company, we will record an increase to the allowance to
reflect the additional estimated collateral shortfall.


60


Accrual
of interest is discontinued on a loan when management believes, after
considering economic and business conditions and collection efforts that the
borrower’s financial condition is such that collection of interest is doubtful.
When the ultimate collectability of an impaired loan’s principal is in doubt,
wholly or partially, all cash receipts are applied to principal.




The
allowance for loan losses is established through a provision for loan losses
charged to expense. Loans are charged against the allowance for loan losses when
management believes that the collectability of the principal is unlikely. The
allowance represents an amount, which, in management’s judgment, will be
adequate to absorb probable losses on existing loans that may become
uncollectible.




Management’s
judgment in determining the adequacy of the allowance is based on evaluations of
the collectability of loans. These evaluations take into consideration such
factors as changes in the nature and volume of the loan portfolio, historical
losses, high loan concentrations, trends in past dues and non-accrual loans,
loan risk ratings, economic conditions, market conditions and other internal and
external factors that influence each portfolio segment and review of specific
impaired loans. The combination of these results are compared monthly to the
recorded allowance for loan losses for reasonableness and material differences
are adjusted by increasing or decreasing the provision for loan losses.
Management uses an external loan review program to challenge and corroborate the
internal loan grading system and provide additional analysis in determining the
adequacy of the allowance and the future provisions for estimated loan
losses.




Management
believes that the allowance for loan losses is adequate. While management uses
available information to recognize losses on loans, future additions to the
allowance may be necessary based on changes in economic conditions. In addition,
various regulatory agencies, as an integral part of their examination process,
periodically review the Bank’s allowance for loan losses. Such agencies may
require the Bank to recognize additions to the allowance based on judgments
different than those of management.




Non-performing
Assets




Loans are
placed in a non-accrual status when, in the opinion of management, the
collection of additional interest is questionable. Thereafter, no interest is
taken into income unless received in cash or until such time as the borrower
demonstrates the ability to pay principal and interest.




Premises
and Equipment




Premises
and equipment are stated at cost less accumulated depreciation. Costs incurred
for maintenance and repairs that do not extend the useful life of the asset are
expensed as incurred.




Depreciation
expense is computed using the straight-line method over the following estimated
useful lives:




Building
      and improvements
            
            10
      - 40 yearsFurniture
      and equipment
            
            3 -
      10 years




Goodwill
and Intangible Assets




Goodwill
represents the excess of cost over the fair value of the net assets purchased in
business combinations. Goodwill is required to be tested annually for impairment
or whenever events occur that may indicate that the recoverability of the
carrying amount is not probable. In the event of an impairment, the amount by
which the carrying amount exceeds the fair value is charged to earnings. The
Company performed its annual test of impairment in the fourth quarter and
determined that the entire balance of goodwill was impaired as of
December 31, 2009. The entire balance was written off against current
earnings and the carrying amount of goodwill was zero as of December 31,
2009.  It is important to note that this impairment charge was a
non-recurring expense that has no current or future impact on core operating
earnings, cash flow, liquidity or risk based regulatory capital
ratios.




Intangible
assets consist of core deposit premiums acquired in connection with business
combinations. The core deposit premiums were initially recognized based on
valuations performed as of the consummation date. The core deposit premiums are
amortized over the average remaining life of the acquired customer deposits.
Amortization periods are reviewed annually in connection with the annual
impairment testing of goodwill.




61


Included
in the consolidated statements of operations for December 31, 2009,
and 2008 were charges for amortization of identifiable intangible assets in the
amounts of $124,000 and $199,000, respectively.




Other
real estate owned




Other
real estate owned acquired through or in lieu of loan foreclosure are held for
sale and are initially recorded at fair value less selling costs. Any write-down
to fair value at the time of transfer to other real estate owned is charged to
the allowance for loan losses. Subsequent to foreclosure, valuations are
periodically performed by management and the assets are carried at the lower of
carrying amount or fair value less costs to sell. Costs of improvements are
capitalized, whereas costs relating to holding other real estate owned and
subsequent adjustments to the value are expensed.  The carrying amount
of other real estate owned at December 31, 2009 and 2008 was $18,176,169 and
$5,750,973, respectively.






Derivatives




Derivatives
are recognized as assets and liabilities on the consolidated balance sheet and
measured at fair value.  For exchange-traded contracts, fair value is
based on quotable market prices.  For nonexchange traded contracts,
fair value is based on dealer quotes, pricing models, discounted cash flow
methodologies, or similar techniques for which the determination of fair value
may require significant management judgment or estimation.




Cash
flows resulting from the derivative financial instruments that are accounted for
as hedges of assets and liabilities are classified in the cash flow statement in
the same category as the cash flows of the items being hedged.




Derivative
Loan Commitments




Mortgage
loan commitments that relate to the origination of a mortgage that will be held
for sale upon funding are considered derivative instruments under the
derivatives and hedging accounting guidance (FASB ASC 815, Derivatives and
Hedging).  Loan commitments that are derivatives are recognized
at fair value on the consolidated balance sheet in other assets and other
liabilities with changes in their fair values recorded in noninterest
income.




Effective
January 1, 2008, the Company adopted the Securities and Exchange Commission’s
(SEC’s) Staff Accounting Bulletin (SAB) No. 109, “Written Loan Commitments
Recorded at Fair Value Through Earnings” and began including the value
associated with servicing of loans in the measurement of all written loan
commitments issued after that date.  SAB No. 109 requires that the
expected net future cash flows related to servicing of a loan be included in the
measurement of all written loan commitments that are accounted for at fair value
through earnings.  In estimating fair value, the Company assigns a
probability to a loan commitment based on an expectation that it will be
exercised and the loan will be funded.  The adoption of SAB No. 109
generally has resulted in higher fair values being recorded upon initial
recognition of derivative loan commitments.




Forward
Loan Sale Commitments




The
Company carefully evaluates all loan sales agreements to determine whether they
meet the definition of a derivative under the derivatives and hedging accounting
guidance (FASB ASC 815) as facts and circumstances may differ
significantly.  If agreements qualify, to protect against the price
risk inherent in derivative loan commitments, the Company uses both “mandatory
delivery” and “best efforts” forward loan sale commitments to mitigate the risk
of potential decreases in the values of loans that would result from the
exercise of the derivative loan commitments.  Mandatory delivery
contracts are accounted for as derivative instruments.  Accordingly,
forward loan sale commitments are recognized at fair value on the consolidated
balance sheet in other assets and liabilities with changes in their fair values
recorded in other noninterest income.




The
Company estimates the fair value of its forward loan sales commitments using a
methodology similar to that used for derivative loan commitments.  62
 Income
Taxes




The
Company accounts for income taxes in accordance with income tax accounting
guidance (FASB ASC 740, Income
Taxes).  On January 1, 2009, the Company adopted the recent
accounting guidance related to accounting for uncertainty in income taxes, which
sets out a consistent framework to determine the appropriate level of tax
reserves to maintain for uncertain tax positions.




The
income tax accounting guidance results in two components of income tax expense:
current and deferred.  Current income tax expense reflects taxes to be
paid or refunded for the current period by applying the provisions of the
enacted tax law to the taxable income or excess of deductions over
revenues.  The Company determines deferred income taxes using the
liability (or balance sheet) method.  Under this method, the net
deferred tax asset or liability is based on the tax effects of the differences
between the book and tax bases of assets and liabilities, and enacted changes in
tax rates and laws are recognized in the period in which they
occur.




Deferred
income tax expense results from changes in deferred tax assets and liabilities
between periods.  Deferred tax assets are recognized if it is more
likely than not, based on the technical merits, that the tax position will be
realized or sustained upon examination.  The term more likely than not
means a likelihood of more than 50 percent; the terms examined and upon
examination also include resolution of the related appeals or litigation
processes, if any.  A tax position that meets the more-likely-than-not
recognition threshold is initially and subsequently measured as the largest
amount of tax benefit that has a greater than 50 percent likelihood of being
realized upon settlement with a taxing authority that has full knowledge of all
relevant information.  The determination of whether or not a tax
position has met the more-likely-than-not recognition threshold considers the
facts, circumstances, and information available at the reporting date and is
subject to management’s judgment.  Deferred tax assets may be reduced
by deferred tax liabilities and a valuation allowance if, based on the weight of
evidence available, it is more likely than not that some portion or all of a
deferred tax asset will not be realized.




Stock
Compensation Plans




Stock
compensation accounting guidance (FASB ASC 718, Compensation - Stock
Compensation) requires that the compensation cost relating to share-based
payment transactions be recognized in financial statements.  That cost
will be measured based on the grant date fair value of the equity or liability
instruments issued.  The stock compensation accounting guidance covers
a wide range of share-based compensation arrangements including stock options,
restricted share plans, performance-based awards, share appreciation rights, and
employee share purchase plans.




The stock
compensation accounting guidance requires that compensation cost for all stock
awards be calculated and recognized over the employees’ service period,
generally defined as the vesting period.  For awards with
graded-vesting, compensation cost is recognized on a straight-line basis over
the requisite service period for the entire award.  A Black-Scholes
model is used to estimate the fair value of stock options, while the market
price of the Company’s common stock at the date of grant is used for restricted
stock awards and stock grants.




Losses
Per Share




The
Company is required to report losses per common share with and without the
dilutive effects of potential common stock issuances from instruments such as
options, convertible securities and warrants on the face of the statements of
operations. Basic losses per common share are based on the weighted average
number of common shares outstanding during the period, which was 2,568,707 in
2009 and 2,560,866 in 2008, while the effects of potential common shares
outstanding during the period are included in diluted earnings per share.
Additionally, the Company must reconcile the amounts used in the computation of
both “basic earnings per share” and “diluted earnings per share”. At
December 31, 2009, potential common shares of 325,779 were not included in
the calculation of diluted losses per share because the exercise of such shares
would be anti-dilutive. There were 77,156 anti-dilutive potential common shares
at December 31, 2008. Losses per common share amounts are as
follows:  63


For
      the year ended December 31,2009
            
            
            2008Net
      loss
            
            $
            (14,536,388
            )
            
            $
            (4,838,301
            )Preferred
      stock dividends
            
            
            (559,685
            )
            
            
            (46,502
            )Net
      loss available to common shareholders
            
            $
            (15,096,073
            )
            
            $
            (4,884,803
            )Weighted
      average common shares
            
            
            2,568,707
            
            
            
            2,560,866Effect
      of dilutive securities
            
            
            ––
            
            
            
            ––Diluted
      average common shares
            
            
            2,568,707
            
            
            
            2,560,866Losses
      per common share
            
            $
            (5.88
            )
            
            $
            (1.91
            )Diluted
      losses per common share
            
            $
            (5.88
            )
            
            $
            (1.91
            )





Recent
Accounting Pronouncements and Accounting Changes




Effective
July 1, 2009, the Company adopted new accounting guidance related to U.S. GAAP
(FASB ASC 105, Generally Accepted Accounting Principles).  This
guidance establishes FASB ASC as the source of authoritative U.S. GAAP
recognized by FASB to be applied by nongovernmental entities.  Rules
and interpretive releases of the SEC under authority of federal securities laws
are also sources of authoritative U.S. GAAP for SEC registrants.  FASB
ASC supersedes all existing non-SEC accounting and reporting
standards.  All other nongrandfathered, non-SEC accounting literature
not included in FASB ASC has become nonauthoritative.  FASB will no
longer issue new standards in the form of Statements, FASB Staff Positions, or
Emerging Issues Task Force Abstracts.  Instead, it will issue
Accounting Standards Updates (ASUs), which will serve to update FASB ASC,
provide background information about the guidance, and provide the basis for
conclusions on the changes to FASB ASC.  FASB ASC is not intended to
change U.S. GAAP or any requirements of the SEC.  This guidance is
effective for the Company as of December 31, 2009.




Effective
April 1, 2009, the Company adopted new accounting guidance related to
recognition and presentation of other-than-temporary impairment (FASB ASC
320-10).  This recent accounting guidance amends the recognition
guidance for other-than-temporary impairments of debt securities and expands the
financial statement disclosures for other-than-temporary impairment losses on
debt and equity securities.  The recent guidance replaced the “intent
and ability” indication in current guidance by specifying that (a) if a company
does not have the intent to sell a debt security prior to recovery and (b) it is
more likely than not that it will not have to sell the debt security prior to
recovery, the security would not be considered other-than-temporarily impaired
unless there is a credit loss.  When an entity does not intend to sell
the security, and it is more likely than not, the entity will not have to sell
the security before recovery of its cost basis, it will recognize the credit
component of an other-than-temporary impairment of a debt security in earnings
and the remaining portion in other comprehensive income.  For
held-to-maturity debt securities, the amount of an other-than-temporary
impairment recorded in other comprehensive income for the noncredit portion of a
previous other-than-temporary impairment should be amortized prospectively over
the remaining life of the security on the basis of the timing of future
estimated cash flows of the security. The effect of adoption was not
material.




The
Company adopted accounting guidance related to fair value measurements and
disclosures (FASB ASC 820, Fair Value Measurements and
Disclosures).  This guidance defines fair value, establishes a
framework for measuring fair value, and expands disclosures about fair value
measurements.  This guidance establishes a fair value hierarchy about
the assumptions used to measure fair value and clarifies assumptions about risk
and the effect of a restriction on the sale or use of an asset.  The
effect of adoption was not material.  64
 FASB
issued ASU 2009-05 (FASB ASC 820) which describes the valuation techniques
companies should use to measure the fair value of liabilities for which there is
limited observable market data.  If a quoted price in an active market
is not available for an identical liability, an entity should use one of the
following approaches: (1) the quoted price of the identical liability when
traded as an asset, (2) quoted prices for similar liabilities or similar
liabilities when traded as an asset, or (3) another valuation technique that is
consistent with the accounting guidance in FASB ASC for fair value measurements
and disclosures.  When measuring the fair value of liabilities, this
guidance reiterates that companies should apply valuation techniques that
maximize the use of relevant observable inputs, which is consistent with
existing accounting provisions for fair value measurements. In addition, this
guidance clarifies when an entity should adjust quoted prices of identical or
similar assets that are used to estimate the fair value of
liabilities.  This guidance is effective for the Company as of
December 31, 2009 with adoption applied prospectively.




In
addition, the following accounting pronouncement was issued by FASB, but is not
yet effective:




FASB
issued accounting guidance (FASB Statement No. 166) which modifies certain
guidance contained in the Transfers and Servicing topic of FASB ASC (FASB ASC
860).  This standard eliminates the concept of qualifying special
purpose entities, provides guidance as to when a portion of a transferred
financial asset can be evaluated for sale accounting, provides additional
guidance with regard to accounting for transfers of financial assets, and
requires additional disclosures.  This guidance is effective for the
Company as of January 1, 2010, with adoption applied prospectively for transfers
that occur on or after the effective date.




Transfers
of Financial Assets




Transfers
of financial assets are accounted for as sales, when control over the assets has
been surrendered.  Control over transferred assets is deemed to be
surrendered when (1) the assets have been isolated from the Company - put
presumptively beyond the reach of the transferor and its creditors, even in
bankruptcy or other receivership, (2) the transferee obtains the right (free of
conditions that constrain it from taking advantage of that right) to pledge or
exchange the transferred assets, and (3) the Company does not maintain effective
control over the transferred assets through an agreement to repurchase them
before their maturity or the ability to unilaterally cause the holder to return
specific assets.




Fair
Value of Financial Instruments




Fair
values of financial instruments are estimates using relevant market information
and other assumptions, as more fully disclosed in Note 18.  Fair value
estimates involve uncertainties and matters of significant
judgment.  Changes in assumptions or in market conditions could
significantly affect the estimates.




Comprehensive
Loss





Accounting
principles generally require that recognized revenue, expenses, gains and losses
be included in net loss.  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 loss, are components of comprehensive
loss.




Risks
and Uncertainties




In the
normal course of its business, the Company encounters two significant types of
risk: 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 bases, than its interest-earning
assets. Credit risk is the risk of default on the Company’s loan portfolio that
results from borrowers’ inability or unwillingness to make contractually
required payments. Market risk reflects changes in the value of collateral
underlying loans receivable, the valuation of real estate held by the Company,
and the valuation of loans held for sale and mortgage-backed securities
available for sale.




The
Company is subject to the regulations of various government 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, resulting from the
regulators’ judgments based on information available to them at the time of
their examination.




65


Concentrations
of Credit Risk




The
Company, through its subsidiary, makes loans to individuals and businesses in
and around Beaufort County, South Carolina; in and around Fulton, Chatham and
Thomas Counties in Georgia; and in and around Duval and Nassau Counties in
Florida for various personal and commercial purposes.




The
Company makes loans to individuals and small businesses for various personal and
commercial purposes primarily through our full-service offices in Beaufort
County, South Carolina and Nassau County, Florida and through our loan
production offices in Jacksonville, Florida and Savannah, Georgia. The Company’s
loan portfolio is not concentrated in loans to any single borrower or in a
relatively small number of borrowers. Our loan portfolio has a significant
number of construction loans that have been subjected to a real estate market
down-turn which has adversely affected the earnings of the Company.




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 that could arise from potential concentrations of
lending products and practices such as loans that subject borrowers to
substantial payment increases (e.g. principal deferral period, loans with
initial interest-only payments, etc), and loans with high loan-to-value ratios.
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.




The
Company’s investment portfolio consists principally of obligations of the United
States, its agencies or its corporations and general obligation municipal
securities. In the opinion of management, there is no concentration of credit
risk in this 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.




Reclassification
of Certain Items




Certain
items in the consolidated financial statements as of and for the year ended
December 31, 2008 have been reclassified, with no effect on net loss, to be
consistent with the classifications adopted for the year ended December 31,
2009.




Note
      2.
            Regulatory
      Oversight, Capital Adequacy, Operating Losses, Liquidity and Management’s
      Plans




Regulatory
Oversight





The Bank
entered into a formal agreement with the OCC on August 26, 2009 that imposes
certain operational and financial directives on the Bank.  The
specific directives of this agreement addressed the current level of credit risk
in the Bank’s loan portfolio, action required to protect the Bank’s interest in
criticized assets, adherence to its written profit plan to improve and sustain
earnings, limitations on increasing the existing level of brokered deposits,
excluding reciprocal CDARS deposits, and the establishment of a board level
Compliance Committee to monitor the Bank’s adherence to the
Agreement.





Additionally,
in response to a request by the Federal Reserve Bank of Richmond, the Board of
Directors of Coastal Banking Company, Inc. adopted a resolution on January 27,
2010.  This resolution requires that the Company obtain prior approval
of the Federal Reserve Board before incurring additional debt, purchasing or
redeeming its capital stock, or declaring or paying cash dividends to common
shareholders. The Company has not in the past, and does not plan in the future
to conduct such transactions; as a result, the Company expects that the prior
approval requirements will have limited impact on its operations.  The
resolution also requires that the Company provide the Federal Reserve Board with
prior notification before using its cash assets for purposes other than
investments in obligations or equity of the Bank, investments in short-term,
liquid assets, or payment of normal and customary expenses, including regularly
scheduled interest payments on existing debt.  It is important to note
that this resolution does not prohibit payment of cash dividends on preferred
stock issued pursuant to the TARP CPP or interest expense on our Trust Preferred
Securities.


66


As a
result of the aforementioned formal agreement and board resolution, the Bank and
the Company are now operating under heightened regulatory scrutiny and
monitoring.  Management has taken aggressive steps to address the
components of the formal agreement and has frequent contact with the OCC as we
work to improve our financial condition and comply with all the directives of
the formal agreement.  Monitoring of our progress by the OCC is much
more frequent and includes interim on-site visits as well as ongoing telephone
consultations.  Management recognizes that failure to adequately
address the formal agreement could result in additional actions by the banking
regulators with the potential for more severe operating restrictions and
oversight requirements.





Capital
Adequacy





As of
December 31, 2009, the Bank exceeded all of the regulatory capital ratio levels
to be categorized as “well capitalized.”  It is noteworthy that the
OCC did not include a capital directive, or minimum capital maintenance
requirement, in the formal agreement; however, management is intent on
maintaining the Bank’s existing capital adequacy. To that end, we have
established internal policy minimums on capital ratios at levels that exceed the
“well capitalized” regulatory minimums by 200 basis points. In effect, if our
key regulatory capital ratios fall within 200 basis points of the “well
capitalized” limits, management will implement strategic action plans to restore
capital ratios above this 200 basis point threshold.





Key to
our efforts to maintain existing capital adequacy is the need for the Bank to
return to profitability through a focus on increasing core earnings and
decreasing the levels of adversely classified and nonperforming assets.
Management is pursuing a number of strategic alternatives to improve the core
earnings of the Bank and to reduce the level of classified assets. Current
market conditions for banking institutions, the overall uncertainty in financial
markets and the Bank’s high level of non-performing assets are potential
barriers to the success of these strategies. If current adverse market factors
continue for a prolonged period of time, new adverse market factors emerge,
and/or the Bank is unable to successfully execute its plans or adequately
address regulatory concerns in a sufficient and timely manner, it could have a
material adverse effect on the Bank’s business, results of operations and
financial position.





Operating
Losses





During
the year ended December 31, 2009, the Company recorded an impairment charge to
fully write off Goodwill in the amount of $10.4 million.  Excluding
the impact of this nonrecurring intangible impairment charge, the Company
recorded a net loss from recurring operations of $4.1 million for the year ended
December 31, 2009.  This loss was largely the result of an excessive
level of non-performing assets, which caused the Company to record increased
provisions for loan losses, carrying costs on foreclosed properties and losses
on the sale of foreclosed properties. Carrying costs on foreclosed assets are
expected to remain elevated during 2010 as the Company works towards liquidation
of these non-performing assets.  This current year loss represents a
modest improvement from the loss of $4.9 million for the year ended December 31,
2008.





Management
has implemented a number of actions in an effort to improve earnings, including
significant reductions to the cost of interest bearing liabilities and strict
controls over other operating expenses.  These actions have been
effective in improving core earnings in 2009; however, asset quality charges
throughout the year continued to negatively impact earnings.  Recent
trends appear to indicate a possible stabilization of asset quality; however,
existing negative economic conditions may reverse these trends resulting in
continued losses that will hinder our ability to return to profitability and
further erode capital levels.





Liquidity





Management
monitors liquidity on a daily basis and forecasts liquidity needs over a 90 day
horizon in order to anticipate and provide for future needs.  We also
utilize a comprehensive contingency funding policy that uses several key
liquidity ratios or metrics to define different stages of the Company’s overall
liquidity position.  This policy defines actions or strategies that
are employed based on the liquidity position of the Company to reduce the risk
of a future liquidity shortfall.  67
 The
primary sources of liquidity are cash and cash equivalents, deposits, scheduled
repayments of loans, unpledged investment securities and available borrowing
facilities.  Within deposits we utilize retail deposits from our
branch locations, a modest level of brokered deposits, CDARS reciprocal deposits
and deposits from other insured depository institutions.  The
previously mentioned formal agreement with the OCC includes a limitation that
our brokered deposits, excluding reciprocal CDARs, not exceed 10% of our total
deposits, which is consistent with our existing internal liquidity
policy.  As a result of our existing internal liquidity policy, we
have been and anticipate continuing to be in compliance with the brokered
deposit limitation provision of the formal agreement.  Although the
FDIC Call Report defines CDARS reciprocal deposits as brokered deposits, our
ability to raise CDARS reciprocal deposits is not constrained by the terms of
the formal agreement.  Our borrowing facilities include collateralized
repurchase agreements and unsecured federal funds lines with correspondent
banks, as well as borrowing agreements with the Federal Home Loan Bank of
Atlanta and the Federal Reserve Bank collateralized by pledged loans and
securities.





As of
December 31, 2009, the Company had $114.3 million in total borrowing capacity,
of which we had utilized $45.2 million or 39.6%, leaving remaining available
liquidity of $69.1 million. Approximately $15 million of the borrowings
outstanding were on an overnight basis to fund a temporary bulge in liquidity
needs from a year end spike in fundings of loans available for
sale.  Loans available for sale are also considered by management as a
key source of liquidity as a result of the speed with which these loans are sold
and settled for cash.  Management expects that loans originated for
sale will be sold and converted to cash within 18 to 20 calendar days after the
loan is originated.  The balance of loans available for sale averaged
just over $59 million in 2009.  Accordingly, in the event of a
liquidity crisis, we anticipate having the ability to slow or stop loan
origination activity to allow the loans available for sale to convert into cash.
Based on current and expected liquidity needs and sources, management expects
the Company to be able to meet all obligations as they become due.





Note
      3.
            Investment
      Securities




Investment
securities are as follows:





December 31,
      2009Amortized
              Cost
            
            
            Gross
              Unrealized
              Gains
            
            
            Gross
              Unrealized
              Losses
            
            
            Fair
              ValueAvailable
      for saleState
      and municipal securities
            
            $
            10,185,270
            
            
            $
            218,293
            
            
            $
            (33,354
            )
            
            $
            10,370,209Mortgage-backed
      securities
            
            
            48,557,915
            
            
            
            1,624,517
            
            
            
            (37,049
            )
            
            
            50,145,383$
            58,743,185
            
            
            $
            1,842,810
            
            
            $
            (70,403
            )
            
            $
            60,515,592Held
      to maturityCorporate
      debt securities
            
            $
            2,000,000
            
            
            $
            94,717
            
            
            $
            —
            
            
            $
            2,094,717$
            2,000,000
            
            
            $
            94,717
            
            
            $
            —
            
            
            $
            2,094,717


68


December 31,
      2008Amortized
              Cost
            
            
            Gross
              Unrealized
              Gains
            
            
            Gross
              Unrealized
              Losses
            
            
            Fair
              ValueAvailable
      for saleGovernment-sponsored
      enterprises
            
            $
            500,000
            
            
            $
            1,570
            
            
            $
            —
            
            
            $
            501,570State
      and municipal securities
            
            
            16,956,227
            
            
            
            123,448
            
            
            
            (506,367
            )
            
            
            16,573,308Mortgage-backed
      securities
            
            
            63,493,691
            
            
            
            911,117
            
            
            
            (41,297
            )
            
            
            64,363,511$
            80,949,918
            
            
            $
            1,036,135
            
            
            $
            (547,664
            )
            
            $
            81,438,389Held
      to maturityCorporate
      debt securities
            
            $
            3,022,621
            
            
            $
            64,829
            
            
            $
            (63,740
            )
            
            $
            3,023,710$
            3,022,621
            
            
            $
            64,829
            
            
            $
            (63,740
            )
            
            $
            3,023,710





The
following table shows gross unrealized losses and fair value of securities,
aggregated by category and length of time that securities have been in a
continuous unrealized loss position, at December 31, 2009.




Investment
securities available for sale:





Less
      than 12 Months
            
            
            12
      Months or More
            
            
            TotalFair
              Value
            
            
            Unrealized
              Losses
            
            
            Fair
              Value
            
            
            Unrealized
              Losses
            
            
            Fair
              Value
            
            
            Unrealized
              LossesState
      and municipalsecurities
            
            $
            2,334,400
            
            
            $
            (33,354
            )
            
            $
            —
            
            
            $
            —
            
            
            $
            2,334,400
            
            
            $
            (33,354
            )Mortgage-backedsecurities
            
            
            2,031,756
            
            
            
            (37,049
            )
            
            
            —
            
            
            
            —
            
            
            
            2,031,756
            
            
            
            (37,049
            )Total
            
            $
            4,366,156
            
            
            $
            (70,403
            )
            
            $
            —
            
            
            $
            —
            
            
            $
            4,366,156
            
            
            $
            (70,403
            )





Management
evaluates securities for other-than-temporary impairment at least on a quarterly
basis, and more frequently when economic or market concerns warrant such
evaluation. No individual securities available for sale were in a continuous
loss position for twelve months or more. No securities held to maturity were in
a loss position. 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 not in the credit quality of the issuer. The
unrealized losses are considered temporary because each security carries an
acceptable investment grade and the repayment sources of principal and interest
are government backed. The Company has the ability and intent to hold these
securities until such time as the value recovers or the securities
mature.




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




Investment
securities available for sale:





Less
      than 12 Months
            
            
            12
      Months or More
            
            
            TotalFair
              Value
            
            
            Unrealized
              Losses
            
            
            Fair
              Value
            
            
            Unrealized
              Losses
            
            
            Fair
              Value
            
            
            Unrealized
              LossesState
      and municipalsecurities
            
            $
            8,203,258
            
            
            $
            (506,367
            )
            
            $
            —
            
            
            $
            —
            
            
            $
            8,203,258
            
            
            $
            (506,367
            )Mortgage-backedsecurities
            
            
            13,296,745
            
            
            
            (41,044
            )
            
            
            167,472
            
            
            
            (253
            )
            
            
            13,464,217
            
            
            
            (41,297
            )Total
            
            $
            21,500,003
            
            
            $
            (547,411
            )
            
            $
            167,472
            
            
            $
            (253
            )
            
            $
            21,667,475
            
            
            $
            (547,664
            )


69
 Investment
securities held to maturity:





Less
      than 12 Months
            
            
            12
      Months or More
            
            
            TotalFair
              Value
            
            
            Unrealized
              Losses
            
            
            Fair
              Value
            
            
            Unrealized
              Losses
            
            
            Fair
              Value
            
            
            Unrealized
              LossesCorporate
      debtsecurities
            
            $
            1,936,260
            
            
            $
            (63,740
            )
            
            $
            —
            
            
            $
            —
            
            
            $
            1,936,260
            
            
            $
            (63,740
            )Total
            
            $
            1,936,260
            
            
            $
            (63,740
            )
            
            $
            —
            
            
            $
            —
            
            
            $
            1,936,260
            
            
            $
            (63,740
            )





At
December 31, 2008 one (1) individual security available for sale was in a
continuous loss position for twelve months or more. No securities held to
maturity were in a continuous loss position for twelve months or more. The
Company has the ability and intent to hold these securities until such time as
the value recovers or the securities mature. The Company believes, based on
industry analyst reports and credit ratings, that the deterioration in value is
attributable to changes in market interest rates and not in the credit quality
of the issuer and therefore, these losses are not considered
other-than-temporary.




The
amortized cost and estimated fair value of investment securities at
December 31, 2009, by contractual maturity, are shown below. Expected
maturities will differ from contractual maturities because borrowers have the
right to call or prepay obligations with or without call or prepayment
penalties.





Amortized
      Cost
            
            Fair
      ValueAvailable
      for saleDue
      in one year or less
            
            $
            286,284
            
            $
            291,504Due
      from one year to five years
            
            2,039,645
            
            
            2,120,210Due
      from five to ten years
            
            4,971,399
            
            
            5,102,110Due
      after ten years
            
            2,887,942
            
            
            2,856,385Mortgage-backed
      securities
            
            48,557,915
            
            
            50,145,383$
            58,743,185
            
            $
            60,515,592Held
      to maturityDue
      in one year or less
            
            $
            —
            
            $
            —Due
      from one year to five years
            
            2,000,000
            
            
            2,094,717Due
      from five to ten years
            
            —
            
            
            —Due
      after ten years
            
            —
            
            
            —$
            2,000,000
            
            $
            2,094,717





Securities
with an amortized cost and fair value of $39,748,000 and $41,048,000,
respectively as of December 31, 2009 and $48,053,000 and $48,035,000,
respectively as of December 31, 2008 were pledged to secure public deposits and
Federal Home Loan Bank borrowings.  Pledged securities may not be sold
without first pledging replacement securities and obtaining consent of the party
to whom the securities are pledged.





Gains and
losses on sales of securities available for sale consist of the
following:





For
      the Years Ended December 31,2009
            
            
            2008Gross
      gains on sales of securities
            
            $
            173,790
            
            
            $
            296,122Gross
      losses on sales of securities
            
            
            (172,725
            )
            
            
            (77,617
            )Net
      realized gains on sales of securities available for sale
            
            $
            1,065
            
            
            $
            218,505





On April
9, 2009, one security classified as held-to-maturity with an amortized cost
basis of $1,021,121 was subject to an early tender offer by the
issuer.  The Company accepted the early tender offer which generated a
gain on early tender of $98,996.  The Company had the ability and
intent to hold this security until maturity on May 15, 2012; however the terms
of the tender offer were isolated, nonrecurring and unusual for the Company, and
as such could not have been reasonably anticipated in establishing the original
held-to-maturity classification of this security.  70


Note
      4.
            Loans
      and allowance for loan losses




The
composition of loans is summarized as follows:





December 31,2009
            
            
            2008Commercial
      and financial
            
            $
            10,955,636
            
            
            $
            10,293,990Agricultural
            
            
            319,311
            
            
            
            326,000Real
      estate – construction, commercial
            
            
            57,573,184
            
            
            
            88,150,871Real
      estate – construction, residential
            
            
            13,063,354
            
            
            
            15,165,313Real
      estate – mortgage, farmland
            
            
            —
            
            
            
            199,000Real
      estate – mortgage, commercial
            
            
            91,325,597
            
            
            
            81,359,921Real
      estate – mortgage, residential
            
            
            112,984,042
            
            
            
            103,588,614Consumer
      installment loans
            
            
            3,293,317
            
            
            
            5,222,995Other
            
            
            144,515
            
            
            
            112,000Gross
      loans
            
            
            289,658,956
            
            
            
            304,418,704Less:
      Allowance for loan losses
            
            
            6,386,409
            
            
            
            4,833,491Net
      loans
            
            $
            283,272,547
            
            
            $
            299,585,213





The Bank
grants loans and extensions of credit to individuals and a variety of businesses
and corporations located in its general trade areas of Beaufort County,
South Carolina and adjoining counties, Nassau County, Florida and Thomas County,
Georgia. Although the Bank has a diversified loan portfolio, a substantial
portion of the loan portfolio is collateralized by improved and unimproved real
estate and is dependent upon the real estate market.




A loan is
considered impaired, in accordance with the impairment accounting guidance (FASB
ASC 310-10-35-16), when based on current information and events, it is probable
that the Company will be unable to collect all amounts due from the borrower in
accordance with the contractual term of the loan.  Impaired loans at
December 31, 2009 were $8,215,542.  At December 31, 2008, impaired
loans totaled $17,895,836.  During the years ended December 31, 2009
and December 31, 2008, the Company charged off all of its specific reserve on
impaired loans, therefore there was no valuation allowance recorded on impaired
loans at either reporting date.





Loans
which management identifies as impaired generally will be non-performing loans.
Non-performing loans include non-accrual loans or loans which are 90 days or
more delinquent as to principal or interest payments. A loan that is on
nonaccrual status may not necessarily be considered impaired if circumstances
exist whereby the amount due may be collected without foreclosure and/or
liquidation of collateral.




Loans
exhibiting one or more of the following attributes are placed on a nonaccrual
status:




a.)
            Principal
      and/or interest is 90 days or more delinquent, unless the obligation is
      (i) well secured by collateral with a realizable value sufficient to
      discharge the debt including accrued interest in full, and (ii) in the
      process of collection which is reasonably expected to result in repayment
      of the debt or in its restoration to a current
  status.




b.)
            A
      borrower’s financial condition has deteriorated to such an extent or some
      condition exists that makes collection of interest and/or principal in
      full unlikely in management’s
opinion.




c.)
            Foreclosure
      or legal action has been initiated as a result of default by the borrower
      on the terms of the debt.





The
following is a summary of information pertaining to nonaccrual
loans:





For
      the Years Ended December 31,2009
            
            
            2008Total
      nonaccrual loans
            
            $
            13,753,718
            
            
            $
            18,212,579Total
      loans past due ninety days or more and still accruing
            
            
            105,000
            
            
            
            801,405Average
      investment in nonaccrual loans
            
            
            22,080,000
            
            
            
            14,673,000Interest
      income recognized on nonaccrual loans
            
            
            157,049
            
            
            
            59,528Forgone
      interest income on nonaccrual loans
            
            
            726,785
            
            
            
            601,470


71
 The
Company has followed a conservative approach by classifying any loan as
restructured whenever the terms of a loan were adjusted to the benefit of any
borrower in financial distress, regardless of the status of the loan at the time
of restructuring.  Performing restructured loans includes loans that are on
accrual status because they were current or less than 90 days past due at the
time of restructure.  In many cases the borrower has never been delinquent,
but for various reasons is experiencing financial distress that raises a doubt
about the borrower’s continued ability to make payments under current terms. By
adjusting the terms of the loan to better fit the borrower’s current financial
condition, expectations are that this loan will avoid a future
default.  Nonperforming restructured loans are made up of loans that
were in default at the time the loan terms were restructured.  The
expectation is that by adjusting the terms of such loans, the borrower may begin
to make payments again based on the improved loan terms.  These loans will
stay on nonaccrual status as restructured loans until the borrower has
demonstrated a willingness and ability to make payments in accordance with the
new loan terms for a reasonable length of time, typically six
months.  At December 31, 2009, the Company had 28 performing
restructured loans with a balance of $16,041,000, of which 100 percent are
current and paying in accordance with restructured terms, and 7 nonperforming
restructured loans with a balance of $3,701,000, of which 100 percent are
current and paying in accordance with the restructured terms.  In total, as
of December 31, 2009, these 35 restructured loans with a total balance of
$19,742,000 represented 6.8% of the net loan portfolio balance.





Management
evaluates all loan relationships periodically in order to assess the financial
strength of the borrower and the value of any underlying collateral.  Loans
that are found to have a potential or actual weakness are identified as
criticized or classified and subject to increased monitoring by
management.  This typically includes frequent contact with the borrower to
actively manage the borrowing relationship as needed to rehabilitate or mitigate
the weakness identified.  At December 31, 2009 the Company had $52,808,000
in loans that were internally criticized or classified of which $40,739,000 or
77% were either current or less than 30 days past due.





An
analysis of the activity in the allowance for loan losses is presented
below:





For
      the Years Ended December 31,2009
            
            
            2008Balance,
      beginning of year
            
            $
            4,833,491
            
            
            $
            3,653,017Provision
      for loan losses
            
            
            7,771,000
            
            
            
            7,823,235Loans
      charged off
            
            
            (6,264,399
            )
            
            
            (6,663,858
            )Recoveries
      of loans previously charged off
            
            
            46,317
            
            
            
            21,097Balance,
      end of year
            
            $
            6,386,409
            
            
            $
            4,833,491





In the
ordinary course of business, the Company has granted loans to certain directors,
executive officers and their affiliates. The interest rates on these loans were
substantially the same as rates prevailing at the time of the transaction and
repayment terms are customary for the type of loan. Changes in related-party
loans are summarized as follows:





For
      the Years Ended December 31,2009
            
            
            2008Balance,
      beginning of year
            
            $
            6,619,170
            
            
            $
            6,939,997Advances
            
            
            1,039,923
            
            
            
            294,163Repayments
            
            
            (880,314
            )
            
            
            (614,990
            )Transactions
      due to changes in related parties
            
            
            —
            
            
            
            —Balance,
      end of year
            
            $
            6,778,779
            
            
            $
            6,619,170


72




Note
      5.
            Premises
      and Equipment




Premises
and equipment are summarized as follows:





December 31,2009
            
            
            2008Land
            
            $
            3,648,350
            
            
            $
            3,648,350Building
            
            
            4,339,645
            
            
            
            4,313,882Furniture
      and equipment
            
            
            2,945,681
            
            
            
            2,811,25410,933,676
            
            
            
            10,773,486Less
      accumulated depreciation
            
            
            (3,334,506
            )
            
            
            (2,924,170
            )$
            7,599,170
            
            
            $
            7,849,316





The Bank
has entered into a non-cancelable operating lease related to land and buildings
at its Bluffton branch, which expires in 2013 with options to
renew.




In 2007,
the Bank entered into a non-cancelable lease for office space above the branch
building in Port Royal, South Carolina. The lease is for a term of five years
that will expire in 2012 with options to renew for subsequent five year
periods.




In 2008,
the Bank entered into a three-year lease for rental space for a loan production
office in Savannah, Georgia. It also has an operating lease for rental space for
a loan production office in Jacksonville, Florida. This lease is cancelable at
any time with four months notice.




In 2009,
the Bank entered into a three-year lease for rental space for a wholesale
mortgage office in Atlanta, Georgia.




At
December 31, 2009, future minimum lease payments under the non-cancelable
operating leases with initial or remaining terms of one year or more are as
follows:





2010
            
            $
            274,7792011
            
            283,6052012
            
            175,9072013
            
            27,426$
            761,717





Total
rental expense amounted to $323,990 and $350,035 for the years ended
December 31, 2009 and 2008, respectively, under these operating
leases.




Note
      6.
            Other
      real estate owned




A summary
of other real estate owned is presented as follows:





Years
      Ended December 31,2009
            
            
            2008Balance,
      beginning of year
            
            $
            5,750,973
            
            
            $
            319,000Additions
            
            
            20,151,693
            
            
            
            6,597,587Disposals
            
            
            (6,671,738
            )
            
            
            (558,573
            )Valuation
      write downs and losses on sales
            
            
            (1,054,759
            )
            
            
            (607,041
            )Balance,
      end of year
            
            $
            18,176,169
            
            
            $
            5,750,973





During
2009, sales of other real estate totaling $543,646 were financed by the
Bank.  73
 Expenses
applicable to other real estate owned include the following:





Years
      Ended December 31,2009
            
            
            2008Net
      (gain) loss on sales of real estate
            
            $
            200,600
            
            
            $
            470Valuation
      write downs
            
            
            854,159
            
            
            
            606,571Operating
      expenses, net of rental income
            
            
            864,231
            
            
            
            600,394$
            1,918,990
            
            
            $
            1,207,435





Note
      7.
            Goodwill
      and Other Intangible Assets




Following
is a summary of information related to acquired intangible assets:





December 31,2009
            
            
            2008Core
      deposit premiumsGross
      carrying amount
            
            $
            1,212,435
            
            
            $
            1,212,435Accumulated
      amortization
            
            $
            1,075,955
            
            
            $
            951,794





The
aggregate amortization expense for intangible assets was $124,000 and $199,000
for the years ended December 31, 2009 and 2008, respectively.




The
estimated remaining amortization expense is as follows:





2010
            
            74,0262011
            
            39,8042012
            
            17,5552013
            
            5,095$
            136,480





Changes
in the carrying amount of goodwill are as follows:





For
      the years ended December 31,2009
            
            
            2008Beginning
      balance
            
            $
            10,411,914
            
            
            $
            10,411,914Impairment
      charge
            
            
            (10,411,914
            )
            
            
            —Ending
      balance
            
            $
            —
            
            
            $
            10,411,914





Note
      8.
            Deposits




The
aggregate amount of time deposits in denominations of $100,000 or more at
December 31, 2009 and 2008 was $131,446,464 and $130,837,381, respectively.
The Company had $22,077,572 and $29,361,353 in brokered deposits included in
time deposits as of December 31, 2009 and 2008, respectively. The scheduled
maturities of time deposits at December 31, 2009 are as
follows:





2010
            
            $
            204,512,8572011
            
            28,369,1902012
            
            4,379,5072013
            
            4,059,2492014
      and later
            
            
            1,090,742$
            242,411,545


At
December 31, 2009 and 2008, overdraft demand deposits reclassified to loans
totaled $60,093 and $44,042, respectively.  74


Note
      9.
              Employee
      Benefit Plans





The
Company sponsors the Coastal Banking Company Inc. 401(k) Profit Sharing Plan
& Trust (the “Plan”) for the benefit of all eligible employees. All
full-time and part-time employees are eligible to participate in the Plan
provided they have met the eligibility requirements. Contributions may
begin after 30 days of employment. Part-time employees must work
a minimum of 1,000 hours per year to be eligible. The Plan allows a participant
to defer a portion of his compensation and provides that the Company will match
a portion of the deferred compensation. Company matched contributions are vested
over a five year period. The Company contributes to the Plan annually upon
approval by the Board of Directors. Contributions made to the Plan in 2009 and
2008 amounted to $172,524 and $109,742, respectively.




Note
      10.
            Deferred
      Compensation Plans




The
Company adopted a Director and Executive Officer Deferred Compensation Plan in
2004 that allows directors and executive officers to defer compensation.
Interest accrues quarterly on deferred amounts at a rate, which is equal to 75%
of the previous quarter’s return on equity, not to exceed 12%. Accrued deferred
compensation of $19,215 at December 31, 2009 and 2008 is included in other
liabilities. Accrued director compensation of $300,046 was included in other
liabilities at December 31, 2008. The deferred director compensation
outstanding at December 31, 2008 was paid out in full during
January 2009.




Note
      11.
            Other
      Borrowings




Other
borrowings consist of the following FHLB advances.





FHLB
      Advances Outstanding
              December 31,
      2009Type
      advance
            
            Balance
            
            
            Interest
      rate
            
            Maturity
      date
            
            Convertible
      dateFixed
      rate
            
            
            2,500,000
            
            
            
            2.69
            %
            April 8,
      2010Fixed
      rate
            
            
            2,500,000
            
            
            
            3.00
            %
            April 8,
      2011Fixed
      rate
            
            
            5,000,000
            
            
            
            5.65
            %
            June 1,
      2011Fixed
      rate
            
            
            2,500,000
            
            
            
            3.30
            %
            April 8,
      2012Convertible
      fixed rate advance
            
            
            1,500,000
            
            
            
            4.05
            %
            September 7,
      2012
            
            March 8,
      2010Fixed
      rate
            
            
            10,000,000
            
            
            
            4.25
            %
            May 21,
      2014Convertible
      fixed rate advance
            
            
            5,000,000
            
            
            
            3.71
            %
            June 24,
      2015
            
            June 24,
      2010Convertible
      fixed rate advance
            
            
            2,000,000
            
            
            
            3.69
            %
            September 7,
      2017
            
            March 8,
      2010Variable
      rate
            
            
            14,250,000
            
            
            
            0.36
            %Less
      purchase accounting adjustments
            
            
            (12,842
            )Total
            
            $
            45,237,158
            
            
            
            2.88
            %





FHLB
      Advances Outstanding
              December 31,
      2008Type
      advance
            
            Balance
            
            
            Interest
      rate
            
            Maturity
      date
            
            Convertible
      dateFixed
      rate
            
            $
            1,000,000
            
            
            
            5.02
            %
            February 17,
      2009Fixed
      rate
            
            
            2,500,000
            
            
            
            2.69
            %
            April 8,
      2010Fixed
      rate
            
            
            2,500,000
            
            
            
            3.00
            %
            April 8,
      2011Fixed
      rate
            
            
            5,000,000
            
            
            
            5.65
            %
            June 1,
      2011Fixed
      rate
            
            
            2,500,000
            
            
            
            3.30
            %
            April 8,
      2012Convertible
      fixed rate advance
            
            
            1,500,000
            
            
            
            4.05
            %
            September 7,
      2012
            
            March 9,
      2009Convertible
      fixed rate advance
            
            
            10,000,000
            
            
            
            4.25
            %
            May 21,
      2014
            
            May 21,
      2009Convertible
      fixed rate advance
            
            
            5,000,000
            
            
            
            3.71
            %
            June 24,
      2015
            
            June 24,
      2010Convertible
      fixed rate advance
            
            
            2,000,000
            
            
            
            3.69
            %
            September 7,
      2017
            
            March 9,
      2009Variable
      rate
            
            
            19,720,000
            
            
            
            0.46
            %Less
      purchase accounting adjustments
            
            
            (27,412
            )Total
            
            $
            51,692,588
            
            
            
            2.69
            %


75
 The Bank
maintains relationships with correspondent banks that can provide funds on short
notice, if needed. Presently, the Bank has arrangements with commercial banks
for short term unsecured advances up to $7,000,000, from which up to $4,000,000
is available for day light overdraft and $3,000,000 for overnight borrowing. The
Bank also has reverse repurchase accommodations with a term of up to one month
for a maximum advance of $50 million, limited by the amount of eligible
securities pledged which was $21 million at December 31, 2009. The reverse
repurchase agreements are committed borrowing facilities granted by other
commercial banks and are secured by securities in the Bank’s investment
portfolio.




Note
    12.
            Income
      Taxes




The
components of income tax benefits are as follows:




For
      the Years Ended December 31,2009
            
            
            2008Currently
      payable
            
            $
            636,991
            
            
            $
            (3,132,690
            )Deferred
      tax benefit
            
            
            (2,860,351
            )
            
            
            (23,598
            )$
            (2,223,360
            )
            
            $
            (3,156,288
            )





The
Company’s income tax benefits differ from the amounts computed by applying the
federal income tax statutory rates to income before income taxes. A
reconciliation of the differences is as follows:





For
      the Years Ended December 31,2009
            
            
            2008Tax
      at federal income tax rate
            
            $
            (5,698,314
            )
            
            $
            (2,718,160
            )Increase
      (decrease) resulting from:Goodwill
      impairment
            
            
            3,540,051
            
            
            
            —State
      income taxes, net of federal benefit
            
            
            —
            
            
            
            (164,077
            )Tax
      exempt interest
            
            
            (166,771
            )
            
            
            (190,769
            )Other
            
            
            101,674
            
            
            
            (83,282
            )$
            (2,223,360
            )
            
            $
            (3,156,288
            )





Net
deferred tax assets are included in other assets. The components of deferred
income taxes are as follows:





December 31,2009
            
            
            2008Deferred
      income tax assets:Net
      operating losses
            
            $
            2,299,909
            
            
            $
            —Loan
      loss reserves
            
            
            1,304,683
            
            
            
            1,137,555Unrealized
      loss on securities available for sale
            
            
            —
            
            
            
            —Other
            
            
            1,139,319
            
            
            
            381,046Total
      deferred tax assets
            
            
            4,743,911
            
            
            
            1,518,601Deferred
      income tax liabilities:Depreciation
      and amortization
            
            
            164,298
            
            
            
            184,418Intangible
      assets
            
            
            184,559
            
            
            
            254,835Unrealized
      gain on securities available for sale
            
            
            602,618
            
            
            
            166,080Other
            
            
            505,022
            
            
            
            49,667Total
      deferred tax liabilities
            
            
            1,456,497
            
            
            
            655,000Net
      deferred tax asset
            
            $
            3,287,414
            
            
            $
            863,601


76




Note
      13.
            Junior
      Subordinated Debentures




In
May 2004, Coastal Banking Company Statutory Trust I (the “Trust”) (a
non-consolidated subsidiary) issued $3,000,000 of floating rate trust preferred
securities with a maturity of July 23, 2034. The Company received from the
Trust the $3,000,000 million proceeds from the issuance of securities and
the $93,000 initial proceeds from the capital investment in the Trust, and
accordingly has shown the funds due to the Trust as $3,093,000 junior
subordinated debentures.




All of
the common securities of the Trust are owned by the Company. The proceeds from
the issuance of the trust preferred securities were used by the Trust to
purchase $3,093,000 of junior subordinated debentures of the Company, which
carry a floating rate equal to the 3-month LIBOR plus 2.75%. At
December 31, 2009, this rate was 3.03%. The proceeds received by the
Company from the sale of the junior subordinated debentures were used to
strengthen the capital position of the Bank and to accommodate current and
future growth. The current regulatory rules allow certain amounts of junior
subordinated debentures to be included in the calculation of regulatory capital,
and have been included in the Tier I calculation accordingly. The debentures and
related accrued interest represent the sole assets of the Trust.




The trust
preferred securities accrue and pay distributions quarterly, equal to 3-month
LIBOR plus 2.75% per annum of the stated liquidation value of $1,000 per capital
security. The Company has entered into contractual arrangements which, taken
collectively, fully and unconditionally guarantee payment of: (i) accrued and
unpaid distributions required to be paid on the trust preferred securities; (ii)
the redemption price with respect to any trust preferred securities called for
redemption by the Trust, and (iii) payments due upon a voluntary or involuntary
dissolution, winding up, or liquidation of the Trust.




The trust
preferred securities must be redeemed upon maturity of the debentures on
July 23, 2034, or upon earlier redemption as provided in the indenture. The
Company has the right to redeem the debentures purchased by the Trust in whole
or in part, on or after July 23, 2009. As specified in the indenture, if
the debentures are redeemed prior to maturity, the redemption price will be the
unpaid principal amount, plus any accrued unpaid interest.




In
June 2006, Coastal Banking Company Statutory Trust II (the “Trust”) (a
non-consolidated subsidiary) issued $4,000,000 of fixed rate trust preferred
securities with a maturity of September 30, 2036. The Company received from
the Trust the $4,000,000 proceeds from the issuance of securities and the
$124,000 initial proceeds from the capital investment in the Trust, and
accordingly has shown the funds due to the Trust as $4,124,000 junior
subordinated debentures.




All of
the common securities of the Trust are owned by the Company. The proceeds from
the issuance of the trust preferred securities were used by the Trust to
purchase $4,124,000 of junior subordinated debentures of the Company, which
carry a fixed rate of 7.18% until September 30, 2011 and a floating rate
equal to the 3-month LIBOR plus 1.60%, adjusted quarterly thereafter. The
proceeds received by the Company from the sale of the junior subordinated
debentures were used to strengthen the capital position of the Bank and to
accommodate current and future growth. The current regulatory rules allow
certain amounts of junior subordinated debentures to be included in the
calculation of regulatory capital, and have been included in the Tier I
calculation accordingly. The debentures and related accrued interest represent
the sole assets of the Trust.




The trust
preferred securities accrue and pay distributions quarterly at a rate of 7.18%
per annum of the stated liquidation value of $1,000 per capital security. The
Company has entered into contractual arrangements which, taken collectively,
fully and unconditionally guarantee payment of: (i) accrued and unpaid
distributions required to be paid on the trust preferred securities; (ii) the
redemption price with respect to any trust preferred securities called for
redemption by the Trust, and (iii) payments due upon a voluntary or involuntary
dissolution, winding up, or liquidation of the Trust.




The trust
preferred securities must be redeemed upon maturity of the debentures on
September 30, 2036, or upon earlier redemption as provided in the
indenture. The Company has the right to redeem the debentures purchased by the
Trust in whole or in part, on or after September 30, 2011. As specified in
the indenture, if the debentures are redeemed prior to maturity, the redemption
price will be the unpaid principal amount, plus any accrued unpaid
interest.  77




Note
      14.
            Stock
      Based Compensation





The
Company adopted a Stock Incentive Plan in 2000 which currently authorizes
385,306 shares of the Company’s common stock for issuance under the
Plan.  The Plan provides for the total number of shares authorized for
issuance under the Plan to be increased upon the issuance of new shares by the
Company by an amount equal to the difference between 15% of the total
outstanding shares after the issuance of the new shares and the number of shares
authorized for issuance prior to the issuance of the new shares.  The
Plan is administered by the Board of Directors and provides for the granting of
options to purchase shares of common stock to officers, directors, employees or
consultants of the Company and Bank. The exercise price of each option granted
under the Plan will not be less than the fair market value of the shares of
common stock subject to the option on the date of grant as determined by the
Board of Directors. Options are exercisable in whole or in part upon such terms
as may be determined by the Board of Directors, and are exercisable no later
than ten years after the date of grant. Options granted under the Plan generally
vest over a five-year vesting period. Pursuant to the Plan, no Incentive Stock
Option may be granted more than ten years after February 15, 2000, the effective
date of the Plan. As of December 31, 2009, 177,516 shares were available for
grant under this Plan.





Additionally,
the Company assumed the outstanding options under the 1999 First Capital Bank
Holding Corporation Stock Option Plan (the “First Capital Plan”) in connection
with the merger of First Capital Bank Holding Company with and into the Company
on October 1, 2005.  As a result of the merger, each outstanding
option under the First Capital Plan was converted into an option to purchase
Coastal Banking Company, Inc. common stock.  Coastal assumed and
maintains the First Capital Plan solely to administer the options that were
outstanding as of the effective time of the merger.  As of the
effective time of the merger, the Company elected to discontinue the issuance of
options under the First Capital Plan.





On March
21, 2008, the Company granted a restricted stock award to Gary Horn, Regional
President of Lowcountry National Bank, for 5,000 shares of the Company’s common
stock.  The restricted stock vests in five equal annual increments on
the anniversary date of the grant date of the restricted stock.  The
restricted stock was granted to Mr. Horn as compensation for his service to the
Bank.





On
August 15, 2008, the Board of Directors of Coastal Banking Company approved
a reduction in the exercise price of 42,603 incentive stock options that were
previously issued and outstanding. The options had been issued to 14
officers and employees of the Company with an average exercise price of
$19.26 per share. The new exercise price was $7.50 per share, the market
value of the Company's common stock on the day the lower exercise price
was set by the Board action. The ultimate cost to the Company from this
exercise price reduction will be impacted by future option forfeitures, but
in any case will not exceed $86,875 between August 15, 2008 and the latest
vesting date of August 15, 2012.




The fair
value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted average
assumptions for grants in 2009 and 2008. Expected volatilities are based on
historical volatility of the Company’s stock. The Company has not and does
not expect to pay a dividend to common shareholders in the near
future. Historical data is used to estimate option exercises and employee
terminations within the valuation model. The risk-free rate for periods
within the contractual life of the option is based on the U.S. Treasury yield
curve in effect at the time of grant.





For
      the Years Ended December 31,2009
            
            
            2008Weighted
      average grant date fair value of options granted during the
      year
            
            $
            1.56
            
            
            $
            1.80Assumptions
      used to estimate fair value:Risk-free
      interest rate
            
            
            3.449
            %
            
            
            2.200
            %Dividend
      yield
            
            
            0
            %
            
            
            0
            %Expected
      volatility
            
            
            34
            %
            
            
            27
            %Expected
      life
            
            7
      years
            
            
            7
      years


78
 Information
pertaining to options outstanding at December 31, 2009 is as
follows:





Options
      Outstanding
            
            
            Options
      Fully Vested and Exercisable
            
            
            Options
      Expected to VestOptionShares
              Outstanding
            
            
            AverageRemaining
              Life(In
      Years)
            
            
            WeightedAverage
              ExercisePrice
            
            
            Number
              Exercisable
            
            
            WeightedAverage
              ExercisePrice
            
            
            NumberExpected
              To
      Vest
            
            
            WeightedAverage
              ExercisePrice11,576
            
            
            
            0.4
            
            
            
            8.65
            
            
            
            11,576
            
            
            
            8.65
            
            
            
            —
            
            
            $
            —6,972
            
            
            
            1.4
            
            
            
            9.04
            
            
            
            6,972
            
            
            
            9.04
            
            
            
            —
            
            
            
            —11,576
            
            
            
            2.0
            
            
            
            8.65
            
            
            
            11,576
            
            
            
            8.65
            
            
            
            —
            
            
            
            —4,880
            
            
            
            2.4
            
            
            
            10.76
            
            
            
            4,880
            
            
            
            10.76
            
            
            
            —
            
            
            
            —15,015
            
            
            
            3.1
            
            
            
            7.86
            
            
            
            15,015
            
            
            
            7.86
            
            
            
            —
            
            
            
            —2,323
            
            
            
            3.2
            
            
            
            11.83
            
            
            
            2,323
            
            
            
            11.83
            
            
            
            —
            
            
            
            —11,575
            
            
            
            3.4
            
            
            
            10.65
            
            
            
            11,575
            
            
            
            10.65
            
            
            
            —
            
            
            
            —1,653
            
            
            
            5.6
            
            
            
            7.50
            
            
            
            1,653
            
            
            
            7.50
            
            
            
            —
            
            
            
            —12,780
            
            
            
            4.5
            
            
            
            19.05
            
            
            
            12,780
            
            
            
            19.05
            
            
            
            —
            
            
            
            —4,200
            
            
            
            6.6
            
            
            
            7.50
            
            
            
            2,520
            
            
            
            7.50
            
            
            
            1,680
            
            
            
            7.5013,650
            
            
            
            6.9
            
            
            
            7.50
            
            
            
            8,190
            
            
            
            7.50
            
            
            
            5,460
            
            
            
            7.5021,000
            
            
            
            7.8
            
            
            
            7.50
            
            
            
            8,400
            
            
            
            7.50
            
            
            
            12,600
            
            
            
            7.503,000
            
            
            
            9.0
            
            
            
            5.31
            
            
            
            600
            
            
            
            5.31
            
            
            
            2,400
            
            
            
            5.3115,332
            
            
            
            10.0
            
            
            
            3.63
            
            
            
            —
            
            
            
            —
            
            
            
            15,332
            
            
            
            3.63135,532
            
            
            
            5.0
            
            
            $
            8.88
            
            
            
            98,060
            
            
            $
            10.06
            
            
            
            37,472
            
            
            $
            5.16





A summary
status of the Company’s stock option plan as of December 31, 2009 and
changes during the year is presented below:





Shares
            
            WeightedAverage
              ExercisePrice
            
            WeightedAverage
              Remaining
              ContractualTerm
      (years)
            
            Aggregate
              IntrinsicValueOutstanding,
      beginning of year
            179,795
            
            $
            9.82
            
            4.2
            
            $
            —Granted
      during the year
            15,332
            
            
            3.63Exercised
      during the year
            —
            
            
            —Forfeited
      or expired during the year
            (59,595
            )
            
            10.37Outstanding,
      end of year
            135,532
            
            
            8.88
            
            4.2
            
            
            —Options
      exercisable at year end
            98,060
            
            
            10.06
            
            3.6
            
            
            —





The
weighted-average grant-date fair value of options granted during the years 2009
and 2008 was $1.56 and $1.80, respectively. No options were exercised in 2009.
The total intrinsic value of options exercised during the year ended
December 31, 2008 was $186,237.




It is the
Company’s policy to issue new shares for stock option exercises and restricted
stock rather than issue treasury shares. The Company recognizes stock-based
compensation expense on a straight-line basis over the options’ related vesting
term. As of December 31, 2009, there was $201,610 of total unrecognized
compensation cost related to nonvested stock-based compensation arrangements
granted under the Plan. That cost is expected to be recognized over a
weighted-average period of 2.6 years. The total fair value of shares vested
during the years ended December 31, 2009 and 2008 was $84,233 and $160,487,
respectively.




On
October 1, 2005, the Company acquired First Capital Bank Holding
Corporation, the holding company for First National Bank of Nassau County,
Florida. First Capital had a Phantom Stock Appreciation Rights (“PSARs”) plan.
As a result of the merger, the Company acquired a PSARs plan in which the
participants were fully vested as a result of the merger. The PSARs Plan
authorized 31,955 rights to be granted to certain officers and key employees at
the discretion of the Board of Directors of First Capital. The Company does not
plan to grant additional PSARs. On June 29, 2007 the PSAR Plan was frozen
at current market price of $19.05. The total amount in accrued expenses was
approximately $94,000 at December 31, 2008. At December 31, 2008,
there were 21,027 PSARS outstanding with a weighted-average exercise price of
$15.35. The PSARs outstanding at December 31, 2008 were paid out in full
during January 2009. The balance of PSARs outstanding was $83,000 at
December 31, 2008.




79




Note
      15.
            Commitments
      and Contingent Liabilities




Loan
Commitments




The Bank
is 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 include commitments to extend credit, standby letters of credit and
loans sold with representations and warranties. These instruments involve, to
varying degrees, elements of credit risk in excess of the amount recognized in
the consolidated balance sheet. The contractual amounts of those instruments
reflect the extent of involvement the Bank has in particular classes of
financial instruments.




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. Since many of the commitments are expected to expire without being
drawn upon, the total commitment amounts do not necessarily represent future
cash requirements. The Bank evaluates each customer’s creditworthiness on a
case-by-case basis. The amount of collateral obtained, if deemed necessary by
the Bank upon extension of credit, is based on management’s credit evaluation of
the counterparty. The Bank’s loans are primarily collateralized by residential
and other real properties, automobiles, savings deposits, accounts receivable,
inventory and equipment.




Standby
letters of credit are written conditional commitments issued by the Bank to
guarantee the performance of a customer to a third party. Those guarantees are
primarily issued to support public and private borrowing arrangements. Most
letters of credit extend for less than one year. The credit risk involved in
issuing letters of credit is essentially the same as that involved in extending
loan facilities to customers.




Loans on
one-to-four family residential mortgages originated by us are sold to various
other financial institutions with representations and warranties that are usual
and customary for the industry. These representations and warranties give the
purchaser of the loan the right to require that we repurchase a loan if the
borrower fails to make any one of the first four loan payments within 30 days of
the due date, which is termed an Early Payment Default (“EPD”). Our maximum
exposure to credit loss in the event of an EPD claim would be the unpaid
principal balance of the loan to be repurchased along with any premium paid by
the investor when the loan was purchased and other minor collection cost
reimbursements. The Bank has received notification from purchasers of three EPD
claims in 2008 and seven EPD claims in 2009, but has not yet had to repurchase a
loan. Beyond the initial payments to the purchasers of $58,100 upon receipt of
the claims, the maximum remaining exposure under these claims would be the
difference between the total loan amounts of $2,020,000 and the liquidated value
of the underlying collateral consisting of ten single family residences.
Original loan to value ratios ranged from 75% to 97% while all loans with a loan
to value ratio over 80% have a mortgage insurance policy in place. If repurchase
was required, management believes that the potential amount of loss would not be
material and that sufficient reserves exist to fully absorb any loss. Management
does not anticipate any material credit risk related to potential EPD claims on
loans that have been previously sold and are no longer on the Bank’s balance
sheet.




In
addition to EPD claims, the representations and warranties in our loan sale
agreements also provide that we will indemnify the investors for losses or costs
on loans we sell under certain limited conditions. Some of these conditions
include underwriting errors or omissions, fraud or material misstatements by the
borrower in the loan application or invalid market value on the collateral
property due to deficiencies in the appraisal. In connection with the start up
of the wholesale lending division, the Bank has established a reserve for costs
related to potential indemnification costs and EPD claims. The balance in this
indemnification reserve was $500,000 at December 31, 2009 and there have
been no claims or charges against this reserve since establishment of the
reserve in September 2007, accordingly management does not anticipate any
material exposure in connection with loan sale indemnification or EPD
claims.




The
Bank’s exposure to credit loss in the event of non-performance by the other
party to the financial instrument for commitments to extend credit, standby
letters of credit and loans sold with representations and warranties is
represented by the contractual amount of those instruments. The Bank uses the
same credit policies in making commitments and conditional obligations as it
does for on-balance-sheet instruments. In most cases, the Bank requires
collateral to support financial instruments with credit risk.  80


December 31,2009
            
            
            2008Commitments
      to extend credit
            
            $
            24,488,000
            
            
            $
            34,294,000Standby
      letters of credit
            
            $
            23,000
            
            
            $
            366,000Loans
      sold with representations and warranties
            
            $
            310,945,000
            
            
            $
            153,231,000





Contingencies




The
Company has, from time to time, various lawsuits and claims arising from the
conduct of its business. Such items are not expected to have any material
adverse effect on the financial position or results of operations of the
Company.




Note
      16.
            Concentrations
      of Credit




The Bank
makes commercial, residential, construction, agricultural, agribusiness and
consumer loans to customers in South Carolina, Florida, and Georgia. A
substantial portion of the Company's customers' abilities to honor their
contracts is dependent on the business economy in the geographical area served
by the Bank.




A
substantial portion of the Company's loans are secured by real estate in the
Company's primary market area. Accordingly, the ultimate collectability of a
substantial portion of the Company's loan portfolio is susceptible to changes in
real estate conditions in the Company's primary market area.




Note
      17.
            Shareholders’
      Equity and 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 direct
material effect on the financial statements. Under certain adequacy guidelines
and the regulatory framework for prompt corrective action, specific capital
guidelines that involve quantitative measures of the assets, liabilities, and
certain off-balance-sheet items as calculated under regulatory accounting
practices must be met. The capital amounts and classification 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 amounts and ratios (set forth in the
table below) of Total and Tier 1 Capital (as defined in the regulations) to
risk-weighted assets (as defined), and of Tier 1 Capital (as defined) to average
assets (as defined). Management believes, as of December 31, 2009 and 2008,
that the Company and the Bank exceed all capital adequacy requirements to which
they are subject.




As of
December 31, 2009, the most recent notification from the Federal Deposit
Insurance Corporation categorized the Bank as well capitalized under the
regulatory framework for prompt corrective action. To be categorized as well
capitalized the Bank must maintain minimum total risk-based, Tier 1 risk-based
and Tier 1 leverage ratios as set forth in the table. There are no conditions or
events since that notification that management believes have changed the Bank’s
category. Prompt corrective action provisions are not applicable to bank holding
companies.  81
 The
actual capital amounts and ratios are also presented in the table
below.





Actual
            
            
            For
      Capital
              Adequacy
      Purposes
            
            
            To
      Be Well
              Capitalized
      Under
              Prompt
      Corrective
              Action
      ProvisionsAmount
            
            
            Ratio
            
            
            Amount
            
            
            Ratio
            
            
            Amount
            
            
            RatioAs
      of December 31, 2009:Total
      Capital to Risk Weighted AssetsConsolidated
            
            $
            46,682,567
            
            
            
            15.28
            %
            
            $
            24,444,117
            
            
            
            8.00
            %
            
            
            ---N/A---CBC
      National Bank
            
            $
            42,171,341
            
            
            
            13.92
            %
            
            $
            24,240,880
            
            
            
            8.00
            %
            
            $
            30,301,100
            
            
            
            10.00
            %Tier
      I Capital to Risk Weighted AssetsConsolidated
            
            $
            42,856,158
            
            
            
            14.03
            %
            
            $
            12,222,058
            
            
            
            4.00
            %
            
            
            ---N/A---CBC
      National Bank
            
            $
            38,344,932
            
            
            
            12.65
            %
            
            $
            12,120,440
            
            
            
            4.00
            %
            
            $
            18,180,660
            
            
            
            6.00
            %Tier
      I Capital to Average AssetsConsolidated
            
            $
            42,856,158
            
            
            
            9.36
            %
            
            $
            18,306,029
            
            
            
            4.00
            %
            
            
            ---N/A---CBC
      National Bank
            
            $
            38,344,932
            
            
            
            8.40
            %
            
            $
            18,266,120
            
            
            
            4.00
            %
            
            $
            22,832,650
            
            
            
            5.00
            %





Actual
            
            
            For
      Capital
              Adequacy
      Purposes
            
            
            To
      Be Well
              Capitalized
      Under
              Prompt
      Corrective
              Action
      ProvisionsAmount
            
            
            Ratio
            
            
            Amount
            
            
            Ratio
            
            
            Amount
            
            
            RatioAs
      of December 31, 2008:Total
      Capital to Risk Weighted AssetsConsolidated
            
            $
            52,271,225
            
            
            
            16.10
            %
            
            $
            25,973,099
            
            
            
            8.00
            %
            
            
            ---N/A---CBC
      National Bank
            
            $
            46,061,231
            
            
            
            14.28
            %
            
            $
            25,798,480
            
            
            
            8.00
            %
            
            $
            32,248,100
            
            
            
            10.00
            %Tier
      I Capital to Risk Weighted AssetsConsolidated
            
            $
            48,226,734
            
            
            
            14.85
            %
            
            $
            12,986,550
            
            
            
            4.00
            %
            
            
            ---N/A---CBC
      National Bank
            
            $
            42,016,740
            
            
            
            13.03
            %
            
            $
            12,899,240
            
            
            
            4.00
            %
            
            $
            19,348,860
            
            
            
            6.00
            %Tier
      I Capital to Average AssetsConsolidated
            
            $
            48,226,734
            
            
            
            11.14
            %
            
            $
            17,315,055
            
            
            
            4.00
            %
            
            
            ---N/A---CBC
      National Bank
            
            $
            42,016,740
            
            
            
            9.62
            %
            
            $
            17,475,045
            
            
            
            4.00
            %
            
            $
            21,843,807
            
            
            
            5.00
            %





There are
no current plans to initiate payment of cash dividends and future dividend
policy will depend on the Bank’s and the Company’s earnings, capital
requirements, financial condition and other factors considered relevant by the
Company’s Board of Directors. The Bank is restricted in its ability to pay
dividends under national banking laws and regulations of the OCC. Generally,
these restrictions require the Bank to pay dividends derived solely from net
profits. Moreover, the OCC’s prior approval is required if dividends declared by
the Bank in any calendar year exceed the Bank’s net profit for that year
combined with its retained net profits for the preceding two years.  82
 On
December 5, 2008, Coastal issued and sold 9,950 preferred shares of Fixed
Rate Cumulative Perpetual Preferred Stock, Series A, along with a Warrant
to purchase common stock to the U.S. Treasury as part of the Capital Purchase
Program (“CPP”). The U.S. Treasury’s investment in Coastal is part of the
government’s program to provide capital to the healthy financial institutions
that are the core of the nation’s economy in order to increase the flow of
credit to consumers and businesses and provide additional assistance to
distressed homeowners facing foreclosure. The Preferred Shares have an annual 5%
cumulative preferred dividend rate, payable quarterly. The dividend rate
increases to 9% after five years. Dividends compound if they accrue in arrears.
The Board has approved and Coastal paid all dividends on the CPP preferred
through the Form 10-k filing date. Preferred Shares have a liquidation
preference of $1,000 per share plus accrued dividends. The Preferred Shares have
no redemption date and are not subject to any sinking fund. The Preferred Shares
carry certain restrictions. The Preferred Shares rank senior to our common stock
and also provide certain limitations on compensation arrangements of executive
officers. During the first three years, Coastal may not reinstate a cash
dividend on its common shares nor purchase equity shares without the approval of
the U.S. Treasury, subject to certain limited exceptions. Coastal may not
reinstate a cash dividend on its common shares to the extent preferred dividends
remain unpaid. Generally, the Preferred Shares are non-voting. However, should
Coastal fail to pay six quarterly dividends, the holder may elect two directors
to the Company’s Board of Directors until such dividends are paid. In connection
with the issuance of the Preferred Shares, a Warrant to purchase 205,579 common
shares was issued with an exercise price of $7.26 per share, which was
calculated based upon the average closing prices of our common stock on the 20
trading days ending on the last trading day prior to the date that our
application was approved to participate in the TARP Capital Purchase Program.
The Warrant is immediately exercisable and expires in ten years. The Warrant is
subject to a proportionate anti-dilution adjustment in the event of stock
dividends or splits, among other events.




The fair
value of the warrant grant was estimated on the date of grant using the
Black-Scholes option pricing model with the following assumptions. Expected
volatilities are based on historical volatility of the Company’s stock. The
Company has not and does not expect to pay a dividend to common shareholders in
the near future. The risk-free rate for periods within the contractual life
of the option was based on the U.S. Treasury yield curve in effect at the time
of grant.





Fair
      value of warrants
            
            $
            1.90Assumptions
      used to estimate fair value:Risk-free
      interest rate
            
            
            2.20
            %Dividend
      yield
            
            
            0
            %Expected
      volatility
            
            
            27
            %Expected
      life
            
            10
      years





The
Preferred Shares and Warrant qualify as Tier 1 capital and are presented in
permanent equity on the Consolidated Statement of Condition in the amounts of
$9,515,758 and $501,475, respectively. Proceeds were allocated between Preferred
Shares and Warrants based on the proportional fair value of each.  The
fair value of the Preferred Shares was calculated using a discounted cash flow
model assuming a five year life, a 5% dividend rate and a comparable discount
interest rate of 12%. The Preferred Share discount is being amortized over five
years.




On August
26, 2009, the Bank entered into a formal agreement with the OCC.  The
Agreement contains certain operational and financial restrictions, which address
the following items: reducing the high level of credit risk in the Bank; taking
immediate and continuing action to protect the Bank’s interest in criticized
assets; ensuring the Bank’s adherence to its written profit plan to improve and
sustain earnings; limiting brokered deposits, excluding reciprocal CDARS, that
would cause the Bank’s level of brokered deposits to be in excess of ten percent
of total deposits; and establishing a Compliance Committee to monitor the Bank’s
adherence to the Agreement.




Additionally
on January 27, 2010, pursuant to a request by the Federal Reserve Bank of
Richmond, the Board of Directors of Coastal Banking Company, Inc. adopted a
resolution, which provides that the Company must obtain prior approval of the
Federal Reserve Board before incurring additional debt, purchasing or redeeming
its capital stock, or declaring or paying dividends, excluding dividends on
preferred stock related to our participation in the TARP CPP.  The
Company must also provide the Federal Reserve Board with prior notification
before using its cash assets, unless the use of such assets is related
to an investment in obligations or equity of the Bank, an investment in
short-term, liquid assets, or normal and customary expenses, including regularly
scheduled interest payments on existing debt.




83




Note
      18.
            Fair
      Value




Determination
of Fair Value




The
Company uses fair value measurements to record fair value adjustments to certain
assets and liabilities and to determine fair value disclosures.  In
accordance with the Fair Value Measurements and Disclosures topic (FASB ASC
820), the fair value of a financial instrument is the price that would be
received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date.  Fair
value is best determined based upon quoted market prices.  However, in
many instances, there are no quoted market prices for the Company’s various
financial instruments.  In cases where quoted market prices are not
available, fair values are based on estimates using present value or other
valuation techniques.  Those techniques are significantly affected by
the assumptions used, including the discount rate and estimates of future cash
flows.  Accordingly, the fair value estimates may not be realized in
an immediate settlement of the instrument.




The
recent fair value guidance provides a consistent definition of fair value, which
focuses on exit price in an orderly transaction (that is, not a forced
liquidation or distressed sale) between market participants at the measurement
date under current market conditions.  If there has been a significant
decrease in the volume and level of activity for the asset or liability, a
change in valuation technique or the use of multiple valuation techniques may be
appropriate.  In such instances, determining the price at which
willing market participants would transact at the measurement date under current
market conditions depends on the facts and circumstances and requires the use of
significant judgment.  The fair value is a reasonable point within the
range that is most representative of fair value under current market
conditions.




Fair
Value Hierarchy




In
accordance with this guidance, the Company groups its financial assets and
financial liabilities generally measured at fair value in three levels, based on
the markets in which the assets and liabilities are traded and the reliability
of the assumptions used to determine fair value.




Level 1 -
Valuation is based on quoted prices in active markets for identical assets or
liabilities that the reporting entity has the ability to access at the
measurement date.  Level 1 assets and liabilities generally include
debt and equity securities that are traded in an active exchange
market.  Valuations are obtained from readily available pricing
sources for market transactions involving identical assets or
liabilities.




Level 2 -
Valuation is based on inputs other than quoted prices included within level 1
that are observable for the asset or liability, either directly or
indirectly.  The valuation may be based on quoted prices for similar
assets or liabilities; quoted prices in markets that are not active; or other
inputs that are observable or can be corroborated by observable market data for
substantially the full term of the asset or liability.




Level 3 -
Valuation is based on unobservable inputs that are supported by little or no
market activity and that are significant to the fair value of the assets or
liabilities.  Level 3 assets and liabilities include financial
instruments whose value is determined using pricing models, discounted cash flow
methodologies, or similar techniques, as well as instruments for which
determination of fair value requires significant management judgment or
estimation.




A
financial instrument’s categorization within the valuation hierarchy is based
upon the lowest level of input that is significant to the fair value
measurement.




Assets
Measured at Fair Value on a Recurring Basis




The
following is a description of the valuation methodologies used for instruments
measured at fair value on a recurring basis and recognized in the accompanying
balance sheet, as well as the general classification of such instruments
pursuant to the valuation hierarchy.




Where
quoted market prices are available in an active market, securities are
classified within Level 1 of the valuation hierarchy. Level 1 securities would
include highly liquid government bonds, mortgage products and exchange traded
equities. If quoted market prices are not available, then fair values are
estimated by using pricing models, quoted prices of securities with similar
characteristics or discounted cash flows. Level 2 securities include U.S. agency
securities, mortgage-backed agency securities, obligations of states and
political subdivisions and certain corporate, asset backed and other securities.
In certain cases where Level 1 or Level 2 inputs are not available, securities
are classified within Level 3 of the hierarchy.  84


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





Carrying
              Value
            
            
            Quoted
      Prices
              in
      Active
              Markets
      for
              Identical
      Assets
              (Level
      1)
            
            
            Significant
      Other
              Observable
              Inputs
              (Level
      2)
            
            
            Significant
              Unobservable
              Inputs
              (Level
      3)Assets:Investment
      securities available for sale
            
            $
            60,515,592
            
            
            $
            ––
            
            
            $
            60,515,592
            
            
            $
            ––Loans
      held for sale
            
            
            50,005,901
            
            
            
            ––
            
            
            
            49,463,110
            
            
            
            542,791Derivative
      asset positions
            
            
            837,005
            
            
            
            ––
            
            
            
            837,005
            
            
            
            ––Total
      fair value of assets measured on a
              recurring
      basis
            
            $
            111,358,498
            
            
            $
            ––
            
            
            $
            110,815,707
            
            
            $
            542,791Liabilities:Derivative
      liability positions
            
            $
            1,234,024
            
            
            $
            ––
            
            
            $
            1,234,024
            
            
            $
            ––Total
      fair value of liabilities measured on a
              recurring
      basis
            
            $
            1,234,024
            
            
            $
            ––
            
            
            $
            1,234,024
            
            
            $
            ––





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





Carrying
              Value
            
            
            Quoted
      Prices
              in
      Active
              Markets
      for
              Identical
      Assets
              (Level
      1)
            
            
            Significant
      Other
              Observable
              Inputs
              (Level
      2)
            
            
            Significant
              Unobservable
              Inputs
              (Level
      3)Assets:Investment
      securities available for sale
            
            $
            81,438,389
            
            
            $
            ––
            
            
            $
            81,438,389
            
            
            $
            ––Loans
      held for sale
            
            
            31,404,990
            
            
            
            ––
            
            
            
            29,881,658
            
            
            
            1,523,332Derivative
      asset positions
            
            
            793,456
            
            
            
            ––
            
            
            
            793,456
            
            
            
            ––Total
      fair value of assets measured on a
              recurring
      basis
            
            $
            113,636,835
            
            
            $
            ––
            
            
            $
            112,113,503
            
            
            $
            1,523,332Liabilities:Derivative
      liability positions
            
            $
            596,879
            
            
            $
            ––
            
            
            $
            596,879
            
            
            $
            ––Total
      fair value of liabilities measured on a
              recurring
      basis
            
            $
            596,879
            
            
            $
            ––
            
            
            $
            596,879
            
            
            $
            ––





The table
below presents a reconciliation of level 3 assets as of December 31, 2009 and
2008.





Loans
      held for sale2009
            
            
            2008Balance,
      beginning of year
            
            $
            1,523,332
            
            
            $
            1,001,436Total
      gains/(losses) included in net income
            
            
            171,518
            
            
            
            124,734Purchases,
      sales, issuances and settlements, net
            
            
            (1,152,059
            )
            
            
            397,162Transfers
      in or out of Level 3
            
            
            ––
            
            
            
            ––Balance,
      end of year
            
            $
            542,791
            
            
            $
            1,523,332


85
 Assets
Measured at Fair Value on a Nonrecurring Basis




The
following is a description of the valuation methodologies used for instruments
measured at fair value on a nonrecurring basis and recognized in the
accompanying balance sheet, as well as the general classification of such
instruments pursuant to the valuation hierarchy.




Loan
impairment is reported when full payment under the loan terms is not expected.
Impaired loans are carried at the present value of estimated future cash flows
using the loan's existing rate, or the fair value of collateral if the loan is
collateral dependent. A portion of the allowance for loan losses is allocated to
impaired loans if the value of such loans is deemed to be less than the unpaid
balance. If these allocations cause the allowance for loan losses to require an
increase, such increase is reported as a component of the provision for loan
losses. Loan losses are charged against the allowance when management believes
the uncollectability of a loan is confirmed. When the fair value of the
collateral is based on an observable market price or a current appraised value,
the Company records the loan impairment 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 loan impairment as nonrecurring
Level 3.




Other
real estate owned is adjusted to fair value upon transfer of ownership of the
loan collateral 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 OREO or management’s estimation of the value of the
OREO. When the fair value of the OREO is based on an observable market price or
a current appraised value, the Company records the OREO as nonrecurring Level 2.
When an appraised value is not available or management determines the fair value
of the OREO is further impaired below the appraised value and there is no
observable market price, the Company records the OREO as nonrecurring Level
3.





The table
below presents the Company’s assets and liabilities for which a nonrecurring
change in fair value has been recorded during the year ended December 31,
2009, aggregated by the level in the fair value hierarchy within which those
measurements fall.





Carrying
              Value
            
            
            Quoted
      Prices
              in
      Active
              Markets
      for
              Identical
              Assets
              (Level
      1)
            
            
            Significant
              Other
              Observable
              Inputs
              (Level
      2)
            
            
            Significant
              Unobservable
              Inputs
              (Level
      3)
            
            
            Total
      gains
              (losses)
      for the
              year
      ended
              December 31,
              2009Assets:Impaired
      loans
            
            $
            8,215,542
            
            
            $
            ––
            
            
            $
            ––
            
            
            $
            8,215,542
            
            
            $
            ––Foreclosed
      assets
            
            
            18,176,169
            
            
            
            ––
            
            
            
            ––
            
            
            
            18,176,169
            
            
            
            (1,054,759
            )Total
      fair value of assets measured
              on
      a nonrecurring basis
            
            $
            26,391,711
            
            
            $
            ––
            
            
            $
            ––
            
            
            $
            26,391,711
            
            
            $
            (1,054,759
            )





The table
below presents the Company’s assets and liabilities for which a nonrecurring
change in fair value has been recorded during the year ended December 31,
2008, aggregated by the level in the fair value hierarchy within which those
measurements fall.





Carrying
              Value
            
            
            Quoted
      Prices
              in
      Active
              Markets
      for
              Identical
              Assets
              (Level
      1)
            
            
            Significant
              Other
              Observable
              Inputs
              (Level
      2)
            
            
            Significant
              Unobservable
              Inputs
              (Level
      3)
            
            
            Total
      gains
              (losses)
      for the
              year
      ended
              December 31,
              2008Assets:Impaired
      loans
            
            $
            17,895,836
            
            
            $
            ––
            
            
            $
            ––
            
            
            $
            17,895,836
            
            
            $
            ––Foreclosed
      assets
            
            
            5,750,973
            
            
            
            ––
            
            
            
            ––
            
            
            
            5,750,973
            
            
            
            (607,041
            )Total
      fair value of assets measured
              on
      a nonrecurring basis
            
            $
            23,646,809
            
            
            $
            ––
            
            
            $
            ––
            
            
            $
            23,646,809
            
            
            $
            (607,041
            )


86
 Fair
Value of Financial Instruments




The fair
value of a financial instrument is the current amount that would be exchanged
between willing parties. Fair value is best determined based upon quoted market
prices. However, in many instances, there are no quoted market prices for the
Company’s various financial instruments. Where quoted prices are not available,
fair values are based on estimates using discounted cash flows and other
valuation techniques. The use of discounted cash flows can be significantly
affected by the assumptions used, including the discount rate and estimates of
future cash flows. The following disclosures should not be considered as
representative of the liquidation value of the Bank, but rather represent a
good-faith estimate of the increase or decrease in value of financial
instruments held by the Bank since purchase, origination, or
issuance.




The
following methods and assumptions were used in this analysis in estimating the
fair value of financial instruments:




·
            Cash, due
      from banks, interest-bearing deposits in banks: The carrying amount
      of cash, due from banks and interest-bearing deposits in banks
      approximates fair value.




·
            Securities:
      The fair values of securities available for sale are determined by an
      independent securities accounting service provider using quoted prices on
      nationally recognized securities exchanges or matrix pricing, which is a
      mathematical technique used widely in the industry to value debt
      securities without relying exclusively on quoted prices for the specific
      securities but rather by relying on the securities’ relationship to other
      benchmark quoted securities. The carrying amount of equity securities with
      no readily determinable fair value approximates fair
  value.




·
            Loans:
      The carrying amount of variable-rate loans that reprice frequently and
      have no significant change in credit risk approximates fair value. The
      fair value of fixed-rate loans is estimated based on discounted
      contractual cash flows, using interest rates currently being offered for
      loans with similar terms to borrowers with similar credit quality. The
      fair value of impaired loans is estimated based on discounted contractual
      cash flows or underlying collateral values, where
    applicable.




·
            Loans Held
      for Sale (LHFS): Residential mortgage loans originated for sale as
      whole loans in the secondary market. These loans are carried at fair
      value, with changes in the fair value of these loans recognized in
      mortgage banking noninterest income. Direct loan origination costs and
      fees are deferred at origination, and then recognized in the gain or loss
      on loan sales when the loans are sold. Gains and losses on loan sales
      (sales proceeds minus the carrying value of the loan sold) are recorded as
      noninterest income.




·
            Derivative
      asset and liability positions: The fair value of derivative asset
      and liability positions is based on available quoted market
      prices.




·
            Deposits:
      The carrying amount of demand deposits, savings deposits and variable-rate
      certificates of deposits approximates fair value. The fair value of
      fixed-rate certificates of deposit is estimated based on discounted
      contractual cash flows using interest rates currently being offered for
      certificates of similar maturities.




·
            Other
      Borrowings: The carrying amount of variable rate borrowings and
      federal funds sold approximates fair value. The fair value of fixed rate
      other borrowings is estimated based on discounted contractual cash flows
      using the current incremental borrowing rates for similar type borrowing
      arrangements.




·
            Junior
      Subordinated Debentures:The fair value of the
      Company’s trust preferred securities is based on discounted contractual
      cash flows using the current incremental borrowing rates for similar type
      borrowing arrangements.




·
            Accrued
      Interest:The carrying amount of accrued interest approximates fair
      value.




·
            Off-Balance-Sheet
      Instruments: The carrying amount of commitments to extend credit
      and standby letters of credit approximates fair value. The carrying amount
      of the off-balance-sheet financial instruments is based on fees charged to
      enter into such agreements.




The
carrying amount and estimated fair value of the Company’s financial instruments
are as follows:





December 31,2009
            
            
            2008Carrying
              Amount
            
            
            Fair
              Value
            
            
            Carrying
              Amount
            
            
            Fair
              ValueFinancial
      assets:Cash,
      due from banks, and interest-bearing deposits in banks
            
            $
            3,386,596
            
            
            
            3,386,596
            
            
            $
            4,901,373
            
            
            
            4,901,373Federal
      funds sold
            
            
            539,326
            
            
            
            539,326
            
            
            
            464,724
            
            
            
            464,724Securities
      available for sale
            
            
            60,515,592
            
            
            
            60,515,592
            
            
            
            81,438,389
            
            
            
            81,438,389Securities
      held to maturity
            
            
            2,000,000
            
            
            
            2,094,717
            
            
            
            3,022,621
            
            
            
            3,023,710Restricted
      equity securities
            
            
            4,996,250
            
            
            
            4,996,250
            
            
            
            4,793,916
            
            
            
            4,793,916Loans
      held for sale
            
            
            50,005,901
            
            
            
            50,005,901
            
            
            
            31,404,990
            
            
            
            31,404,990Loans,
      net
            
            
            283,272,547
            
            
            
            288,500,101
            
            
            
            299,585,213
            
            
            
            314,512,482Derivative
      asset positions
            
            
            837,005
            
            
            
            837,005
            
            
            
            793,456
            
            
            
            793,456Accrued
      interest receivable
            
            
            1,444,702
            
            
            
            1,444,702
            
            
            
            1,712,511
            
            
            
            1,712,511Financial
      liabilities:Deposits
            
            
            368,880,530
            
            
            
            371,290,169
            
            
            
            362,656,245
            
            
            
            365,446,726Other
      borrowings
            
            
            45,237,158
            
            
            
            49,777,577
            
            
            
            51,692,588
            
            
            
            57,226,061Junior
      subordinated debentures
            
            
            7,217,000
            
            
            
            7,195,664
            
            
            
            7,217,000
            
            
            
            7,347,077Derivative
      liability positions
            
            
            1,234,024
            
            
            
            1,234,024
            
            
            
            596,879
            
            
            
            596,879Accrued
      interest payable
            
            
            406,064
            
            
            
            406,064
            
            
            
            598,538
            
            
            
            598,538




Note
      19.
              Derivative
      Financial Instruments
  Mortgage
banking derivatives used in the ordinary course of business consist of best
efforts and mandatory forward sales contracts and interest rate lock commitments
on residential mortgage loan applications. Forward sales contracts represent
future commitments to deliver loans at a specified price and date and are used
to manage interest rate risk on loan commitments and mortgage loans held for
sale. Rate lock commitments represent commitments to fund loans at a specific
rate and by a specified expiration date. These derivatives involve underlying
items, such as interest rates, and are designed to mitigate risk. Substantially
all of these instruments expire within 60 days from the date of issuance.
Notional amounts are amounts on which calculations and payments are based, but
which do not represent credit exposure, as credit exposure is limited to the
amounts required to be received or paid.




The
Company adopted FASB ASC 815-10, “Disclosures about Derivative
Instruments and Hedging Activities” at the beginning of the first quarter
of 2009, and has included here the expanded disclosures required by that
statement.  87
 The
following tables include the notional amounts and realized gain (loss) for
mortgage banking derivatives recognized in mortgage banking income for the
periods ending December 31, 2009 and December 31, 2008:





Derivatives
      not designated as hedging instruments
            
            December
      31, 2009
            
            
            December
      31, 2008(in
      thousands)Mandatory
      forward sales contractsNotional
      amount
            
            $
            95,593
            
            
            $
            900Gain
      (loss) on change in market value of mandatory
              forward
      sales contracts
            
            $
            300
            
            
            $
            (10
            )Derivative
      asset balance included in other assets
            
            $
            791
            
            
            $
            ––Derivative
      liability balance included in other liabilities
            
            $
            489
            
            
            $
            10Best
      efforts forward sales contractsNotional
      amount
            
            $
            5,030
            
            
            $
            100,429Gain
      (loss) on change in market value of best efforts
              forward
      sales contracts
            
            $
            4
            
            
            $
            679Derivative
      asset balance included in other assets
            
            $
            29
            
            
            $
            755Derivative
      liability balance included in other liabilities
            
            $
            24
            
            
            $
            76Rate
      lock loan commitmentsNotional
      amount
            
            $
            63,802
            
            
            $
            69,526Gain
      (loss) on change in market value of rate lock
              commitments
            
            $
            (704
            )
            
            $
            (473
            )Derivative
      asset balance included in other assets
            
            $
            17
            
            
            $
            38Derivative
      liability balance included in other liabilities
            
            $
            721
            
            
            $
            512





Forward
sales contracts also contain an element of risk in that the counterparties may
be unable to meet the terms of such agreements. In the event the parties to
deliver commitments are unable to fulfill their obligations, the Company could
potentially incur significant additional costs by replacing the positions at
then current market rates. The Company manages its risk of exposure by limiting
counterparties to those banks and institutions deemed appropriate by management
and the Board of Directors. The Company does not expect any counterparty to
default on their obligations and therefore, the Company does not expect to incur
any cost related to counterparty default.





The
Company is exposed to interest rate risk on loans held for sale and rate lock
loan commitments. As market interest rates increase or decrease, the fair value
of mortgage loans held for sale and rate lock commitments will decline or
increase accordingly. To offset this interest rate risk, the Company enters into
derivatives such as forward contracts to sell loans. The fair value of these
forward sales contracts will change as market interest rates change, and the
change in the value of these instruments is expected to largely, though not
entirely, offset the change in fair value of loans held for sale and rate lock
commitments. The objective of this activity is to minimize the exposure to
losses on rate lock commitments and loans held for sale due to market interest
rate fluctuations. The net effect of derivatives on earnings will depend on risk
management activities and a variety of other factors, including market interest
rate volatility, the amount of rate lock commitments that close, the ability to
fill the forward contracts before expiration, and the time period required to
close and sell loans.




Note
      20.
              Supplemental
      Segment Information


The Bank
has two reportable segments: community banking and wholesale mortgage banking
operations. The community banking segment provides traditional banking services
offered through the Bank’s branch locations, including a modest level of retail
residential mortgage banking origination activity at the Ladys Island, South
Carolina branch location. The wholesale mortgage banking loan origination
segment originates residential mortgage loans submitted through a network of
independent mortgage brokers and then sells these loans to various investors on
the secondary market. All wholesale mortgage banking activity is conducted in
the Bank’s single wholesale mortgage banking office in Atlanta,
Georgia.




The
accounting policies of the segments are the same as those described in the
summary of significant accounting policies. The Company evaluates performance
based on profit and loss from operations before income taxes not including
nonrecurring gains and losses.




88


All
direct costs and revenues generated by each segment are allocated to the
segment, however there is no allocation of indirect corporate overhead costs to
the wholesale mortgage banking segment. The Company accounts for intersegment
revenues and expenses as if the revenue/expense transactions were to third
parties, that is, at current market prices.




The
Company’s reportable segments are strategic business units that offer different
products and services to a different customer base. They are managed separately
because each segment has different types and levels of credit and interest rate
risk.




(In
      thousands)
            
            Community
      Banking
            
            
            Wholesale
      Mortgage
              Banking
            
            
            Consolidated
      CompanyYear
      ended December 31,
            
            2009
            
            
            2008
            
            
            2009
            
            
            2008
            
            
            2009
            
            
            2008Interest
      income
            
            $
            18,452
            
            
            $
            22,092
            
            
            $
            3,304
            
            
            $
            2,344
            
            
            $
            21,756
            
            
            $
            24,436Interest
      expense
            
            
            8,928
            
            
            
            12,911
            
            
            
            1,884
            
            
            
            1,477
            
            
            
            10,812
            
            
            
            14,388Net
      interest income
            
            
            9,524
            
            
            
            9,181
            
            
            
            1,420
            
            
            
            867
            
            
            
            10,944
            
            
            
            10,048Provision
      for loan losses
            
            
            7,705
            
            
            
            7,823
            
            
            
            66
            
            
            
            ––
            
            
            
            7,771
            
            
            
            7,823Net
      interest income after provision
            
            
            1,819
            
            
            
            1,358
            
            
            
            1,354
            
            
            
            867
            
            
            
            3,173
            
            
            
            2,225Non
      interest income
            
            
            1,109
            
            
            
            2,146
            
            
            
            6,545
            
            
            
            998
            
            
            
            7,654
            
            
            
            3,144Non
      interest expense
            
            
            23,397
            
            
            
            12,275
            
            
            
            4,189
            
            
            
            1,088
            
            
            
            27,586
            
            
            
            13,363Net
      income (loss) before tax expense (benefit)
            
            
            (20,469
            )
            
            
            (8,771
            )
            
            
            3,710
            
            
            
            777
            
            
            
            (16,759
            )
            
            
            (7,994
            )Income
      tax expense (benefit)
            
            
            (3,320
            )
            
            
            (3,389
            )
            
            
            1,097
            
            
            
            233
            
            
            
            (2,223
            )
            
            
            (3,156
            )Net
      income (loss) after taxes
            
            $
            (17,149
            )
            
            $
            (5,382
            )
            
            $
            2,613
            
            
            $
            544
            
            
            $
            (14,536
            )
            
            $
            (4,838
            )Average
      portfolio loans, net
            
            
            293,886
            
            
            
            286,654
            
            
            
            8,045
            
            
            
            15,807
            
            
            
            301,931
            
            
            
            302,461Average
      loans available for sale
            
            
            1,124
            
            
            
            488
            
            
            
            56,486
            
            
            
            22,149
            
            
            
            57,610
            
            
            
            22,637Average
      total assets
            
            
            415,194
            
            
            
            405,406
            
            
            
            65,388
            
            
            
            38,227
            
            
            
            480,582
            
            
            
            443,633Average
      deposits
            
            
            374,264
            
            
            
            353,384
            
            
            
            ––
            
            
            
            ––
            
            
            
            374,264
            
            
            
            353,384Average
      other borrowings
            
            
            ––
            
            
            
            3,885
            
            
            
            53,420
            
            
            
            36,786
            
            
            
            53,420
            
            
            
            40,671




Note
      21.
            Condensed
      Financial Information of Coastal Banking Company (Parent Company
      Only)




Condensed
Balance Sheets





December 31,2009
            
            
            2008AssetsCash
      and due from banks
            
            $
            2,604,811
            
            
            $
            4,164,061Investment
      in Coastal Banking Company Statutory Trust I & II
            
            
            217,000
            
            
            
            217,000Investment
      in subsidiary bank
            
            
            40,608,200
            
            
            
            53,011,686Premises
      and equipment
            
            
            1,193,486
            
            
            
            1,226,184Other
      assets
            
            
            604,844
            
            
            
            739,558Total
      assets
            
            $
            45,228,341
            
            
            $
            59,358,489LiabilitiesJunior
      subordinated debentures
            
            $
            7,217,000
            
            
            $
            7,217,000Other
      liabilities
            
            
            108,915
            
            
            
            136,809Total
      liabilities
            
            
            7,325,915
            
            
            
            7,353,809Shareholders’
      EquityShareholders’
      equity
            
            
            37,902,426
            
            
            
            52,004,680Total
      liabilities and shareholders’ equity
            
            $
            45,228,341
            
            
            $
            59,358,489




89


Condensed
Statements of Operations




For
      the years ended
              December
      31,2009
            
            
            2008IncomeInterest
      income
            
            $
            75,570
            
            
            $
            48,398Dividend
      income
            
            
            —
            
            
            
            300,000Other
      income
            
            
            63,227
            
            
            
            63,713Total
      income
            
            
            138,797
            
            
            
            412,111ExpensesInterest
      expense
            
            
            417,071
            
            
            
            493,512Other
      operating expenses
            
            
            803,426
            
            
            
            1,414,001Total
      expense
            
            
            1,220,497
            
            
            
            1,907,513Loss
      before income tax benefits and equity in undistributed loss of
      subsidiary
            
            
            (1,081,700
            )
            
            
            (1,495,402
            )Income
      tax benefits
            
            
            396,195
            
            
            
            580,604Loss
      before equity in undistributed loss of subsidiary
            
            
            (685,505
            )
            
            
            (914,798
            )Equity
      in undistributed loss of subsidiary
            
            
            (13,850,883
            )
            
            
            (3,923,503
            )Net
      loss
            
            $
            (14,536,388
            )
            
            $
            (4,838,301
            )




Condensed
Statements of Cash Flows




For
      the years ended
              December 31,2009
            
            
            2008Cash
      flows from operating activities:Net
      loss
            
            $
            (14,536,388
            )
            
            $
            (4,838,301
            )Adjustments
      to reconcile net loss to net cash used by operating
      activities:Equity
      in undistributed loss of Bank
            
            
            13,850,883
            
            
            
            3,923,503Depreciation
      and amortization
            
            
            32,698
            
            
            
            57,671Stock-based
      compensation expense
            
            
            84,233
            
            
            
            160,487Change
      in other assets and liabilities
            
            
            (390,676
            )
            
            
            (443,127
            )Net
      cash used by operating activities
            
            
            (959,250
            )
            
            
            (1,139,767
            )Cash
      flows from investing activities:Contribution
      of capital to subsidiary bank
            
            
            (600,000
            )
            
            
            (6,000,000
            )Net
      cash used by investing activities
            
            
            (600,000
            )
            
            
            (6,000,000
            )Cash
      flows from financing activities:Issuance
      of preferred stock
            
            
            —
            
            
            
            9,950,000Purchase
      and retirement of treasury shares
            
            
            —
            
            
            
            (692,269
            )Proceeds
      from exercise of stock options
            
            
            —
            
            
            
            374,640Net
      cash provided by financing activities
            
            
            —
            
            
            
            9,632,371Net
      change in cash and due from banks
            
            
            (1,559,250
            )
            
            
            2,492,604Cash
      and due from banks at beginning of year
            
            
            4,164,061
            
            
            
            1,671,457Cash
      and due from banks at end of year
            
            $
            2,604,811
            
            
            $
            4,164,061


90




ITEM 9. CHANGES IN AND DISAGREEMENTS WITH
ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE




None.




ITEM 9A. CONTROLS AND
PROCEDURES




Evaluation
of Disclosure Controls and Procedures




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 Securities
Exchange Act of 1934, as amended (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 Securities and Exchange Commission’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 and chief financial officer, as appropriate to allow
timely decisions regarding required disclosure.




Our
management, including the chief executive officer and chief financial officer,
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 chief executive officer and chief financial
officer 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 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
our Board of Directors.




Based on
this assessment, management believes that Coastal Banking Company, 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 Securities and
Exchange Commission that permit the Company to provide only management’s report
in this annual report.  91


There
have been no significant changes in our internal controls over financial
reporting during the fourth fiscal quarter ended December 31, 2009 that
have materially affected, or are reasonably likely to materially affect, our
internal controls over financial reporting.




ITEM 9B. OTHER INFORMATION




None.





92
 PART III




ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, AND
CORPORATE GOVERNANCE.




The
information for this Item is included in the Company’s Proxy Statement for the
Annual Meeting of Shareholders to be held on May 26, 2010, under the
headings “Proposal: Election of Directors”, “Code of Ethics,” “Executive
Officers” and “Section 16(a) Beneficial Ownership Reporting
Compliance” and are incorporated herein by reference.




ITEM 11. 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 May 26, 2010, under the
heading “Compensation” and are incorporated herein by reference.




ITEM 12. SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.




The
responses to this Item are included, in part, in the Company’s Proxy Statement
for the Annual Meeting of Shareholders to be held on May 26, 2010, under
the heading “Security Ownership of Certain Beneficial Owners and Management” and
are incorporated herein by reference.




Equity
Compensation Plans




The table
below sets forth information regarding shares of the Company’s common stock
authorized for issuance under the following equity compensation plans and
agreements:




·
            Coastal
      Banking Company, Inc. 2000 Stock Incentive Plan (the “Coastal
      Plan”)




·
            First
      Capital Bank Holding Corporation 1999 Stock Option Plan (the “First
      Capital Plan’)




·
            Coastal
      Banking Company, Inc. Stock Warrant
Agreements




Equity
Compensation Plan Information




Plan
            
            Number of
              Securities tobe
      IssuedUpon
      Exerciseof
      OutstandingOptions,Warrantsand Rights
            
            
            WeightedAverageExercise
      Priceof OutstandingOptions
            
            
            Number
      ofSecuritiesRemainingfor FutureIssuanceEquity
      Plans Approved by Security Holders
            
            
            135,532
            (1)
            
            $
            8.88
            
            
            
            177,516
            (2)Equity
      Compensation Plans Not Approved by Security Holders
            
            
            205,579
            
            
            
            7.26
            
            
            
            ––Total
            
            
            341,111
            
            
            
            7.90
            
            
            
            162,516





———————


(1)
            Includes
      121,357 shares subject to options issued under the Coastal Plan and 14,175
      shares subject to options issued under the First Capital
    Plan.




(2)
            Reflects
      shares available for issuance under the Coastal Plan. No shares are
      available for issuance under the First Capital Plan. The total number of
      shares authorized for issuance under the Coastal Plan automatically
      increases each time the Company issues additional shares of common stock,
      so that the aggregate number of shares authorized for issuance continues
      to equal 15% of the total number of outstanding shares of the Company’s
      common stock. The total number of shares authorized for issuance under the
      Coastal Plan as of December 31, 2009 was
  385,306.




Stock
Option Plans




The
Coastal Plan was approved by shareholders on May 23, 2000. Coastal Banking
Company, Inc. assumed the First Capital Plan in connection with the merger of
First Capital Bank Holding Company with and into Coastal Banking Company, Inc.
on October 1, 2005. As a result of the merger, each outstanding option
under the First Capital Plan was converted into an option to purchase Coastal
Banking Company, Inc. common stock. Coastal assumed and maintains the First
Capital Plan solely to administer the options that were outstanding as of the
effective time of the merger. As of the effective time of the merger, the
Company elected to discontinue the issuance of options under the First Capital
Plan.  93
 Stock
Warrants




In
conjunction with our participation in the TARP Capital Purchase Program, the
U.S. Treasury Department received an immediately exercisable Warrant to purchase
205,579 shares of the Company’s commons stock with an exercise price of $7.26
per share. The Warrant is fully vested as of execution of the TARP agreement on
December 5, 2008. The Warrant expires December 5, 2018.




ITEM 13. 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 May 26, 2010, under the headings
“Related Party Transactions” and “Compensation” and are incorporated herein by
reference.




ITEM 14. PRINCIPAL ACCOUNTANT FEES AND
SERVICES




The
responses to this Item are included in the Company’s Proxy Statement for the
Annual Meeting of Shareholders to be held on May 26, 2010, under the
heading “Independent Registered Public Accounting Firm” and are incorporated
herein by reference.




ITEM 15. EXHIBITS




3.1
            
            Amended
      and Restated Articles of Incorporation (incorporated by reference to
      Exhibit 3.1 of the Registration Statement on Form SB-2, File
      No. 333-86371).3.2
            
            Articles
      of Amendment to Articles of Incorporation (incorporated by reference to
      Exhibit 3.1 of the Current Report on Form 8-K, filed on
      December 5, 2008, File No. 000-28333)3.3
            
            Bylaws
      (incorporated by reference to Exhibit 3.3 of the Registration
      Statement on Form SB-2, File No. 333-86371).4.1
            
            See
      Exhibits 3.1, 3.2, and 3.3 for provisions in the Company’s Articles of
      Incorporation and Bylaws defining the rights of holders’ of the common
      stock (incorporated by reference to Exhibits 3.1 and 3.2 of the
      Registration Statement on Form SB-2, File
      No. 333-86371).4.2
            
            Form of
      certificate of common stock (incorporated by reference to Exhibit 4.2
      of the Registration Statement on Form SB-2, File
      No. 333-86371).4.3
            
            Coastal
      Banking Company, Inc. Indenture dated May 18, 2004 (incorporated by
      reference to Exhibit 4.3 of the Form 10-K for the period ended
      December 31, 2007, File No. 000-28333)4.4
            
            Amended
      and Restated Declaration of Trust dated May 18, 2004 (incorporated by
      reference to Exhibit 4.4 of the Form 10-K for the period ended
      December 31, 2007, File No. 000-28333)4.5
            
            Guarantee
      Agreement, Coastal Banking Company, Inc. dated May 18, 2004
      (incorporated by reference to Exhibit 4.5 of the Form 10-K for
      the period ended December 31, 2007, File
      No. 000-28333)4.6
            
            Coastal
      Banking Company, Inc. Junior Subordinated Indenture dated June 30,
      2006 (incorporated by reference to Exhibit 4.6 of the Form 10-K
      for the period ended December 31, 2007, File
      No. 000-28333)4.7
            
            Coastal
      Banking Company, Inc. Amended and Restated Trust Agreement dated
      June 30, 2006 (incorporated by reference to Exhibit 4.7 of the
      Form 10-K for the period ended December 31, 2007, File
      No. 000-28333)4.8
            
            Guarantee
      Agreement between Coastal Banking Company, Inc., as Guarantor and
      Wilmington Trust Company, as Guarantee Trustee, dated June 30, 2006
      (incorporated by reference to Exhibit 4.8 of the Form 10-K for
      the period ended December 31, 2007, File
      No. 000-28333)4.9.
            
            Form of
      Certificate for the Series A Preferred Shares (incorporated by
      reference to Exhibit 4.1 of the Current Report on Form 8-K,
      filed on December 5, 2008, File
No. 000-28333)4.10.
            
            Warrant
      to purchase up to 205,579 shares of common stock, dated December 5,
      2008 (incorporated by reference to Exhibit 4.2 of the Current Report
      on Form 8-K, filed on December 5, 2008, File
      No. 000-28333)


94





10.1.
            
            Form of
      Stock Warrant Agreement (incorporated by reference to Exhibit 10.8 of
      the Registration Statement on Form SB-2, File
      No. 333-86371).*10.1.1
            
            First
      Amendment to the Coastal Banking Co. Inc Form of Stock Warrant
      Agreement (incorporated by Reference to Exhibit 10.10 to the
      Registration Statement on Form S-4, File No. 333-125318, filed
      May 27, 2005).*10.2
            
            Coastal
      Banking Company, Inc. 2000 Stock Incentive Plan and Form of
      Stock Option Agreement (incorporated by reference to Exhibit 10.6 of
      the Form 10-K for the period ended December 31, 2002, File
      No. 000-28333).*10.3
            
            Lease
      Agreement between Lowcountry National Bank and Bright O’Hare Moss Creek
      Partnership, dated January 14, 2003 (incorporated by reference to
      Exhibit 10.7 of the Form 10-K for the period ended
      December 31, 2002, File No. 000-28333).10.4
            
            Form of
      Lowcountry National Bank Director Deferred Fee Agreement. (incorporated by
      reference to Exhibit 10.5 of the Form 10-K for the period ended
      December 31, 2004, File No. 000-28333)*10.4.1
            
            Form
      of Second Amendment to Lowcountry National Bank Director Deferred Fee
      Agreement (incorporated by reference to Exhibit 10.13 to the Form 10-K for
      the period ended December 31, 2006, File No.
000-28333)*10.4.2
            
            Form
      of Third Amendment to Lowcountry National Bank Director Deferred Fee
      Agreement with Dennis O. Green and James W. Holden, Jr. (incorporated by
      reference to Exhibit 10.4.2 to the Form 10-K for the period ended December
      31, 2008, File No. 000-28333)*10.4.3
            
            Form
      of Third Amendment to Lowcountry National Bank Director Deferred Fee
      Agreement with Ladson F. Howell, James C. Key, and Robert B. Pinkerton
      (incorporated by reference to Exhibit 10.4.3 to the Form 10-K for the
      period ended December 31, 2008, File No. 000-28333)*10.4.4
            
            Form
      of First Amendment to the Lowcountry National Bank Director Deferred Fee
      Agreement(incorporated by reference to Exhibit 10.4.4 to the Form 10-K for
      the period ended December 31, 2008, File No.
000-28333)*10.5
            
            Form of
      Lowcountry National Bank Executive Deferred Compensation
      Agreement.(incorporated by reference to Exhibit 10.5 of the
      Form 10-K for the period ended December 31, 2004, File
      No. 000-28333)*10.5.1
            
            Form
      of Second Amendment to Lowcountry National Bank Executive Deferred
      Compensation Agreement (incorporated by reference to Exhibit 10.14 to the
      Form 10-K for the period ended December 31, 2006, file No.
      000-28333)*10.5.2
            
            Amendment
      to the Lowcountry National Bank Executive Deferred Compensation Agreement
      for Gary Horn (incorporated by reference to Exhibit 10.5.2 to the Form
      10-K for the period ended December 31, 2008, File No.
      000-28333)*10.5.3
            
            Form
      of First Amendment to the Lowcountry National Bank Executive Deferred
      Compensation Agreement (incorporated by reference to Exhibit 10.5.3 to the
      Form 10-K for the period ended December 31, 2008, File No.
      000-28333)*10.6
            
            Amended
      and Restated Employment Agreement dated December 31, 2008 between the
      Company and Michael Sanchez (incorporated by reference to
      Exhibit 10.1 of the Current Report on Form 8-K, filed
      January 7, 2009, File No. 000-28333).*10.6.1
            
            First
      Amendment to the Restated Employment Agreement between Coastal Banking
      Company, Inc., CBC National Bank and Michael Sanchez, dated March 20, 2009
      (incorporated by reference to Exhibit 10.1 of Current Report on form 8-K,
      filed on March 20, 2009)*10.7
            
            Salary
      Continuation Agreement dated April 6, 2005 between the Company and
      Gary Horn (incorporated by reference to Exhibit 10.4 of the Current
      Report on Form 8-K, File No. 000-28333).*10.7.1
            
            First
      Amendment to Salary Continuation Agreement dated December 17, 2008 between
      the Company, CBC National Bank and Gary Horn (incorporated by reference to
      Exhibit 10.7.1 to the Form 10-K for the period ended December 31, 2008,
      File No. 000-28333)*10.8
            
            Employment
      Agreement dated September 10, 2007 between the Company and Paul R.
      Garrigues (incorporated by reference to Exhibit 10.12 to Amendment No. 1
      to the Form 10-K for the period ended December 31, 2008, File No.
      000-28333)*10.8.1
            
            First
      Amendment to Employment Agreement dated December 17, 2008 between the
      Company and Paul R. Garrigues (incorporated by reference to Exhibit
      10.12.1 to the Form 10-K for the period ended December 31, 2008, File No.
      000-28333)*10.9
            
            Letter
      Agreement, dated December 5, 2008, including Securities Purchase
      Agreement –– Standard Terms, incorporated by reference therein, between
      the Company and the United States Department of the Treasury (incorporated
      by reference to Exhibit 10.1 of the Current Report on Form 8-K,
      filed on December 5, 2008, File
No. 000-28333)10.10
            
            Form of
      Waiver (incorporated by reference to Exhibit 10.2 of the Current
      Report on Form 8-K, filed on December 5, 2008, File
      No. 000-28333)*10.11
            
            Form of
      Senior Executive Officer Agreement(incorporated by reference to
      Exhibit 10.3 of the Current Report on Form 8-K, filed on
      December 5, 2008, File
No. 000-28333)*  95
 10.12
            
            Executive
      Supplemental Retirement Income Agreement for Michael Sanchez (incorporated
      by reference to Exhibit 10.1 to the Form 10-QSB for the period ended
      September 30, 2004 filed by First Capital Bank Holding Corporation, File
      No. 000-30297)*10.13
            
            Phantom
      Stock Appreciation Rights Plan (incorporated by reference to Exhibit 10.2
      to the Form 10-QSB for the period ended September 30, 2004 filed by First
      Capital Bank Holding Corporation, File No. 000-30297)*10.13.1
            
            Form
      of First Amendment to the Phantom Stock Appreciation Rights Plan
      (incorporated by reference to Exhibit 10.17.1 to the Form 10-K for the
      period ended December 31, 2008, File No. 000-28333)*10.13.2
            
            Form
      of Second Amendment to the Phantom Stock Appreciation Rights Plan
      (incorporated by reference to Exhibit 10.17.2 to the Form 10-K for the
      period ended December 31, 2008, File No. 000-28333)*10.13.3
            
            Form
      of Third Amendment to the Phantom Stock Appreciation Rights Plan
      (incorporated by reference to Exhibit 10.17.3 to the Form 10-K for the
      period ended December 31, 2008, File No. 000-28333)*10.14
            
            Form
      Phantom Stock Appreciation Rights Agreement (incorporated by reference to
      Exhibit 10.3 to the
              Form
      10-QSB for the period ended September 30, 2004 filed by First Capital Bank
      Holding Corporation,
              File
      No. 000-30297)*10.15
            
            Formal
      Agreement with Comptroller of the Currency, dated August 26, 2009
      (incorporated by reference to Exhibit 10.1 to the Form 10-Q for the period
      ended September 30, 2009, File No. 000-28333)21.1
            
            Subsidiaries
      of the Company23.1
            
            Consent
      of Certified Public Accountants.24.1
            
            Power
      of Attorney (contained as part of the signature
      pages herewith)31.1
            
            Rule 13a-14(a) Certification
      of the Chief Executive Officer31.2
            
            Rule 13a-14(a) Certification
      of the Chief Financial Officer32.1
            
            Section 1350
      Certifications99.1
            
            Certification
      of Compliance with EESA Section 111 by Chief Executive
    Officer99.2
            
            Certification
      of Compliance with EESA Section 111 by Chief Financial
    Officer


———————


*
            Management
      contract or compensatory plan or arrangement required to be filed as an
      Exhibit to this Annual Report on
  Form 10-K.  96
  SIGNATURES





Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, Coastal Banking Company, Inc. has duly caused this Report to
be signed on its behalf by the undersigned, thereunto duly
authorized.





COASTAL
      BANKING COMPANY, INC.By:
            /s/
      Michael G.
      SanchezMichael
      G. SanchezPresident
      and Chief Executive OfficerDate:
            March
      17, 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 Paul R. Garrigues and Michael
G. Sanchez 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 Coastal Banking
Company, Inc. and in the capacities and on the dates
indicated.





Signature
            
            Title
            
            Date/s/
      CHRISTINA H. BRYAN
            
            Director
            
            March
      17, 2010Christina
      H. Bryan/s/
      Suellen
      Rodeffer
      Garner
            
            Chairman
      of the Board of
            
            March
      17, 2010Suellen
      Rodeffer Garner
            
            Directors/s/
      Paul R.
      Garrigues
            
            Chief
      Financial Officer
            
            March
      17, 2010Paul
      R. Garrigues **/s/
      Dennis O.
      Green
            
            Director
            
            March
      17, 2010Dennis
      O. Green/s/
      MARK B. HELES
            
            Director
            
            March
      17, 2010Mark
      B. Heles/s/
      JAMES W. HOLDEN, JR.
            
            Director
            
            March
      17, 2010James
      W. Holden, Jr.





97





Signature
            
            Title
            
            Date/s/
      Ladson F.
      Howell
            
            Vice
      Chairman of the Board of
            
            March
      17, 2010Ladson
      F. Howell
            
            Directors/s/
      JAMES C. KEY
            
            Director
            
            March
      17, 2010James
      C. Key/s/
      Robert B.
      Pinkerton
            
            Director
            
            March
      17, 2010Robert
      B. Pinkerton/s/
      Michael G.
      Sanchez
            
            President,
      Chief Executive Officer
            
            March
      17, 2010Michael
      G. Sanchez*
            
            And
      DirectorDirector
            
            March
      17, 2010Edward
      E. Wilson/s/
      Marshall E.
      Wood
            
            Director
            
            March
      17, 2010Marshall
      E. Wood





*      Principal
Executive Officer


**    Principal
Financial and Accounting Officer  98