**Exhibit 13**

 

**HCSBFINANCIAL CORPORATION**

 

****

 

**HORRYCOUNTY STATE BANK**

 

 

Loris, SouthCarolina

 

Annual Report

 

2009

 

 

www.hcsbaccess.com

 

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**HCSBFINANCIAL CORPORATION AND SUBSIDIARY**

 

# **Contents**

# ** **

| ** **                                                                                  | **Page** |
|---------------------------------------------------------------------------------------------|----------|
|                                                                                        |     |
| Message to Shareholders                                                                     | 2        |
|                                                                                        |     |
| Ten Year History                                                                            | 4        |
|                                                                                        |     |
| Selected Financial Data                                                                     | 5        |
|                                                                                        |     |
| Description of  Company’s Business                                                     | 6        |
|                                                                                        |     |
| Market for Common Share  and Dividends                                                      | 7        |
|                                                                                        |     |
| Management’s Discussion  and Analysis of Financial Condition and Results of Operations | 8-30     |
|                                                                                        |     |
| Report of Independent  Registered Public Accounting Firm                                    | 31       |
|                                                                                        |     |
| Consolidated Balance  Sheets                                                                | 32       |
|                                                                                        |     |
| Consolidated Statements  of Income                                                          | 33       |
|                                                                                        |     |
| Consolidated Statements  of Changes in Shareholders’ Equity and Comprehensive Income   | 34       |
|                                                                                        |     |
| Consolidated Statements  of Cash Flows                                                      | 35       |
|                                                                                        |     |
| Notes to Consolidated  Financial Statements                                                 | 36-62    |
|                                                                                        |     |
| Board of Directors                                                                          | 63       |
|                                                                                        |     |
| Corporate Officers                                                                          | 64       |
|                                                                                        |     |
| Branch Locations                                                                            | 64       |

 

# **Headquarters**

 
| 3640 Ralph Ellis  Boulevard  | Mailing Address:             |
|------------------------------|------------------------------|
| Loris, South  Carolina 29569 | Post Office Box  218         |
| (843) 756-4272               | Loris, South  Carolina 29569 |

 

Certain statements inthis annual report contain “forward-looking statements” within the meaning ofthe Private Securities Litigation Reform Act of 1995, such as statementsrelating to the future plans and expectations, and are thus prospective. Suchforward-looking statements are subject to risks, uncertainties and otherfactors that could cause actual results to differ materially from futureresults expressed or implied by such forward-looking statements.  Please see our annual report filed on Form 10-Kfor further discussion of these risks.

 

**HCSB Financial Corporation willfurnish, free of charge, copies of the Annual Report and the Company’s Reportto the Securities and Exchange Commission (Form 10-K) upon written requestto James R. Clarkson, President and C.E.O., HCSB Financial Corporation, PostOffice Box 218, Loris, South Carolina 29569.**

 

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**HCSBFINANCIAL CORPORATION AND SUBSIDIARY**

 

**MESSAGETO SHAREHOLDERS**

 

The year 2009 proved tobe the most tumultuous year for our nation’s financial system since the 1930’s.  It was marked by a stagnant economy, a realestate market that continued to sag, the near collapse of two of America’slargest automobile manufacturers, rising unemployment that reached doubledigits, over 100 bank failures nationwide and a general demise in publicconfidence that resulted from these factors.

 

The local economy inwhich Horry County State Bank operates suffered through many of these sameturmoils as our real estate market dipped substantially in activity and values,especially in the areas of condominiums and single family residentialdevelopments.  The influx of newresidents into our communities slowed dramatically as many of those who wouldhave normally moved here were unable to sell their homes elsewhere and thus notable to reinvest in new residences here.

 

Rising unemploymentacross our country caused many tourists to either cancel vacations to ourbeaches or to shorten their stays from full weeks to oftentimes three or fourdays.  It also had a negative impact onour golf industry as many Americans simply began looking in earnest last yearfor ways to reduce spending.  As a resultof all of this, our local unemployment rates also climbed into the doubledigits.

 

Going into 2009 thesingle most negative impact to Horry County State Bank was the adverse effectof low interest rates on our bank’s net interest margin, which serves as ourprimary source of revenue.  With drasticsetbacks experienced in the real estate market and the resulting impacts onmany businesses and individuals in our marketplace, however, credit qualityissues rapidly became our bank’s primary concern.

 

As with virtually everybank in America, the rates of delinquencies and defaults rose to an all-timehigh, as did our inventory of foreclosed property.  These situations were not restricted to asingle community within our market, but rather to our entire trade area.  Likewise, those who encountered financialdifficulties included people of a variety of income brackets, and some werecustomers with long standing successful track records.  And as a result, we found it necessary tosubstantially increase our Reserve for Loan Losses, which resulted in a netloss of $1.35 million, the first loss we had incurred since our bank’s openingyear in 1988.

 

In the midst of an abnormalyear, however, there were some very bright spots for HCSB.  We did utilize the TARP Capital PurchaseProgram afforded to us by the U.S. Treasury to bolster our capital positionduring the first quarter of 2009.  Thisenabled us to take advantage of a number****of excellentopportunities to attract some well-seasoned, prime customer relationships fromsome of our competitors who were forced to reduce their loan portfolios andturn away customers.  In so doing, wewere able to increase our outstanding loans by 14.0% to $484.1 million from2008, with most of this growth occurring during the first half of 2009.  Total assets also increased during the yearto close at $759.6 million, which represents a 17.9% increase from the prioryear.

 

2

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Our deposits increased by19.3% during 2009 to a level of $578.3 million. According to a report prepared annually by the Federal Deposit InsuranceCorporation, as of June 30, 2009, HCSB had risen to No. 3 in marketshare of deposits held in banks in Horry County, and we had the largest growthin deposits of any bank in the county during the twelve months ended June 30,2009.  In fact, of the banks with thefive largest deposit share ratios in Horry County, only HCSB realized anincrease in deposit market share during this period.

 

Perhaps the mostsignificant claim that we are able to continue to make at HCSB is that our bankstill meets the regulatory requirements to be considered a “well-capitalized”bank.  During these depressed economictimes in which we are currently experiencing, capital is indeed “King” in thebanking industry as it serves as a source of strength for endurance and futuregrowth.

 

Although we fully expectthe year 2010 to largely be a continuation of the economic conditions thatprevailed in 2009, we believe we have definite reasons for optimism forHCSB.  We continue to operate in a marketthat is the most desirable for people who desire to relocate specifically toSouth Carolina or generally along the Atlantic coast.  Many folks in the Carolinas, Tennessee andVirginia will still make every effort to afford some family vacation time atour beaches because the cost is significantly less than most other vacation attractions.  And, too, we have performed a very in depthreview of our expenses and determined that while some reductions may bedifficult and unpleasant to initiate, we can and already have made thedecisions to get our bank to a much leaner operational position in 2010.

 

I have no doubt that oursignificant growth in market share of deposits of late was no accident.  We have a group of outstanding employees, andwe are working diligently to provide financial services of the highest qualityin our trade area.  With the solidfactors of capital and employees on our side, we intend to bounce back andaccomplish great things as we go forward. Our local area has endured previous downturns in the economy inagriculture, tourism and development before, and we always seem to come backstronger than ever.  While this downturnmay be more significant than most others, we still have the underlyingcomponents to bring us back, and at HCSB we believe we have learned somevaluable lessons to better position us in the future.

 

On behalf of our Board ofDirectors and employees, I thank you for your continued trust and support, andI encourage you to come “Bank with Me” at HCSB!

 

Most Respectfully,

 

 

James R. Clarkson

President & CEO

 

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**HCSBFINANCIAL CORPORATION AND SUBSIDIARY**

**Ten YearHistory**

*(Dollarsin thousands)*

 
| **Year** | ** ** | **Assets** | ** ** | **Deposits** | ** ** | **Loans (net)** | ** ** | **Capital** | ** ** | **Earnings** | ** ** |
|----------|------------|------------|------------|--------------|------------|----------------------|------------|-------------|------------|--------------|------------|
|     |       |       |       |         |       |                 |       |        |       |         |       |
| 2000     |       | $          | 143,718    |         | $          | 123,500              |       | $           | 90,300     |         | $          | 9,781 |   | $ | 1,037 |   |
|     |       |       |       |         |       |                 |       |        |       |         |       |
| 2001     |       | 148,651    |       | 120,073      |       | 116,596              |       | 10,895      |       | 996          |       |
|     |       |       |       |         |       |                 |       |        |       |         |       |
| 2002     |       | 211,598    |       | 164,161      |       | 161,381              |       | 19,850      |       | 1,161        |       |
|     |       |       |       |         |       |                 |       |        |       |         |       |
| 2003     |       | 269,714    |       | 209,931      |       | 190,055              |       | 21,509      |       | 1,568        |       |
|     |       |       |       |         |       |                 |       |        |       |         |       |
| 2004     |       | 296,807    |       | 222,389      |       | 210,649              |       | 23,454      |       | 2,055        |       |
|     |       |       |       |         |       |                 |       |        |       |         |       |
| 2005     |       | 331,662    |       | 254,137      |       | 232,509              |       | 25,303      |       | 2,408        |       |
|     |       |       |       |         |       |                 |       |        |       |         |       |
| 2006     |       | 359,357    |       | 275,151      |       | 251,849              |       | 28,350      |       | 2,805        |       |
|     |       |       |       |         |       |                 |       |        |       |         |       |
| 2007     |       | 438,353    |       | 340,851      |       | 348,671              |       | 30,983      |       | 2,040        |       |
|     |       |       |       |         |       |                 |       |        |       |         |       |
| 2008     |       | 644,347    |       | 484,751      |       | 424,622              |       | 34,450      |       | 2,244        |       |
|     |       |       |       |         |       |                 |       |        |       |         |       |
| 2009     |       | 759,649    |       | 578,292      |       | 484,127              |       | 45,072      |       | (1,348       | )          |
|          |            |            |            |              |            |                      |            |             |            |              |            |  |  |  |  |  |

 

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**SelectedFinancial Data**

 

The following table setsforth certain selected financial data concerning the Company.  The selected financial data has been derivedfrom the financial statements.  Thisinformation should be read in conjunction with the financial statements of theCompany, including the accompanying notes, included elsewhere herein.

 
| **Year Ended December 31,****(Dollars in thousands, except per share)** | ** ** | **2009**   | ** ** | **2008** | ** ** | **2007**  | ** ** | **2006** | ** ** | **2005**   | ** ** |
|------------------------------------------------------------------------------|------------|------------|------------|----------|------------|-----------|------------|----------|------------|------------|------------|
| **Financial Condition:**                                                     | ** ** | ** ** |       |     |       |      |       |     |       |       |       |
| Investment  securities, available for sale                                   |       | $          | 169,463    |     | $          | 166,992   |       | $        | 49,609     |       | $          | 50,830 |   | $ | 38,233 |   |
| Allowance  for loan losses                                                   |       | 7,525      |       | 4,416    |       | 3,535     |       | 2,718    |       | 2,569      |       |
| Net  loans                                                                   |       | 484,127    |       | 424,622  |       | 348,671   |       | 251,849  |       | 232,509    |       |
| Premises  and equipment, net                                                 |       | 24,152     |       | 19,056   |       | 16,051    |       | 16,139   |       | 11,681     |       |
| Total  assets                                                                |       | 759,649    |       | 644,347  |       | 438,353   |       | 359,537  |       | 331,662    |       |
| Noninterest-bearing  deposits                                                |       | 31,661     |       | 31,285   |       | 32,407    |       | 26,428   |       | 25,418     |       |
| Interest-bearing  deposits                                                   |       | 546,631    |       | 453,466  |       | 308,444   |       | 248,723  |       | 228,719    |       |
| Total  deposits                                                              |       | 578,292    |       | 484,751  |       | 340,851   |       | 275,151  |       | 254,137    |       |
| Advances  from the Federal Home Loan Bank                                    |       | 118,800    |       | 92,000   |       | 52,300    |       | 43,390   |       | 43,390     |       |
| Total  liabilities                                                           |       | 714,577    |       | 609,897  |       | 407,370   |       | 331,187  |       | 306,359    |       |
| Total  shareholders’ equity                                             |       | 45,072     |       | 34,450   |       | 30,983    |       | 28,350   |       | 25,303     |       |
|                                                                         |       |       |       |     |       |      |       |     |       |       |       |
| **Results of Operations:**                                                   |       |       |       |     |       |      |       |     |       |       |       |
| Interest  income                                                             |       | $          | 34,101     |     | $          | 31,139    |       | $        | 28,536     |       | $          | 23,680 |   | $ | 19,164 |   |
| Interest  expense                                                            |       | 15,593     |       | 14,537   |       | 14,252    |       | 11,114   |       | 7,456      |       |
| Net  interest income                                                         |       | 18,508     |       | 16,602   |       | 14,284    |       | 12,566   |       | 11,708     |       |
| Provision  for loan losses                                                   |       | 10,361     |       | 1,754    |       | 985       |       | 770      |       | 1,070      |       |
| Net  interest income after provision for loan losses                         |       | 8,147      |       | 14,848   |       | 13,299    |       | 11,796   |       | 10,638     |       |
| Other  income                                                                |       | 7,563      |       | 3,586    |       | 2,696     |       | 2,604    |       | 1,931      |       |
| Other  expense                                                               |       | 17,898     |       | 15,086   |       | 12,903    |       | 10,308   |       | 8,903      |       |
| Income  before income taxes                                                  |       | (2,188     | )          | 3,410    |       | 3,092     |       | 4,092    |       | 3,666      |       |
| Income  tax expense                                                          |       | (840       | )          | 1,166    |       | 1,052     |       | 1,287    |       | 1,258      |       |
| Net  income                                                                  | ** ** | **$**      | **(1,348** | **)**    | **$**      | **2,244** | ** ** | **$**    | **2,040**  | ** ** | **$**      | **2,805** | ** ** | **$** | **2,408** | ** ** |
|                                                                         |       |       |       |     |       |      |       |     |       |       |       |
| **Per Share Data**(1)**:**                                                   |       |       |       |     |       |      |       |     |       |       |       |
| Net  income – basic                                                     |       | $          | 0.44       |     | $          | 0.59      |       | $        | 0.53       |       | $          | 0.75 |   | $ | 0.64 |   |
| Period  end book value                                                       |       | $          | 11.90      |     | $          | 9.09      |       | $        | 8.17       |       | $          | 7.47 |   | $ | 6.66 |   |

 

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(1)     Adjusted for 5% stock dividends declaredin February 2001, February 2002 and February 2003, and the 7.5%stock dividend declared in January 2004. Adjustments have also been made for the 3% stock dividends declared in January 2005,January 2006, February 2008 and January 2009, as well as thetwo-for-one stock split in the form of a 100% stock dividend declared in January 2007.  There was no stock dividend declared in January 2010.

 

5

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**Descriptionof Company’s Business**

 

HCSB FinancialCorporation (the Company) was incorporated on June 10, 1999 to become aholding company for Horry County State Bank. The Company’s only significant asset is its wholly owned subsidiary,Horry County State Bank (the Bank).  TheBank is a state-chartered bank incorporated on December 18, 1987 andlocated at 5201 Broad Street, Loris, South Carolina.  The Company’s primary market includes HorryCounty in South Carolina and Columbus and Brunswick Counties in NorthCarolina.  From its 14 branch locations,the Company offers a full range of deposit services, including checkingaccounts, savings accounts, certificates of deposit, money market accounts, andIRAs, as well as a broad range of non-deposit investment services.

 

The Company isprimarily engaged in the business of attracting deposits from the generalpublic and using these deposits together with other funds to make agricultural,commercial, consumer, and real estate loans. The Company’s operating results depend to a substantial extent on thedifference between interest and fees earned on loans and investments and theCompany’s interest expense, consisting principally of interest paid on depositsand borrowings.  Unlike most industrialcompanies, virtually all of the assets and liabilities of financialinstitutions are monetary.  As a result,interest rates have a greater effect on the financial institution’sperformance.  In addition to competingwith other traditional financial institutions, the Company also competes forchecking and savings dollars with nontraditional financial intermediaries, suchas mutual funds, as well as with investment opportunities available via theinternet.  This has resulted in a highlycompetitive market area.  The Companyattempts to compete in this highly competitive market by focusing on providingthe highest quality of personal service and attention to its customers.

 

In 1995, theCompany opened its first branch office in the Mt. Olive community of HorryCounty and has since expanded its branch network to 14 banking offices locatedthroughout Horry County, as well as an Operations Center in Loris, SouthCarolina which houses the Company’s support services.  This expansion of its branch system hasenabled the Company to more effectively compete for deposits and loans.  By expanding into different communities, theCompany has been able to substantially diversify its market place from one of apredominantly agricultural flavor to one which blends residential developmentsof retirees and others, tourism, major employment areas, central countygovernment and the market’s most active overall growth areas.  In so doing, the Company has reducedconsiderably the seasonality in its loan portfolio.  At the same time the coastal markets haveproven to offer primarily commercial real estate lending opportunities, andcommercial real estate has been significantly adversely impacted by the currenteconomic recession.

 

During the year2009, the Company completed the construction of its permanent branch locationin the Ocean Drive section of North Myrtle Beach.  As a result the Company closed its temporarylocation in The Plaza at Gator Hole and moved into the new facility, whichenables the Company to offer drive-up banking services.

 

Also during theyear 2009, the Company completed construction of its new Operations Center inthe Loris Commerce Center and moved its executive offices and support servicesinto this building.  The Company plans tomarket its former Operations Center for sale or lease.

 

In order tosupport this growth in its branch network, the Company has undertaken severalsecondary common stock offerings.  Priorto its reorganization from a bank into the holding company, Horry County StateBank undertook three such secondary offerings of its common stock in efforts tostrengthen the Bank’s regulatory capital position to support projected futuregrowth in assets.  Since thereorganization was consummated in 1999, the Company committed to anothersecondary offering in 2002 whereby the Company issued an additional 365,712shares of common stock at a price per share of $22.00, resulting in over$8,000,000 in added capital.

 

In December 2004,the Company participated in the issuance of $6,000,000 of trust preferredsecurities through its non-consolidated subsidiary HCSB Financial Trust I (theTrust) to enable the company to pursue its growth goals and yet maintain a “well-capitalized”status as defined by banking regulatory agencies.

 

6

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On March 6,2009, the Company issued 12,985 shares of preferred stock, having $0.01 parvalue per share and a liquidation preference of $1,000 per share, in connectionwith the United States Treasury’s Capital Purchase Program.  The dividend rate of 5% per annum will bepayable for the first five years, increasing to 9% per annum in 2014.  The Company also issued 91,714 warrants topurchase common stock at a strike price of $21.09 per share.  The warrants expire 10 years from the issuedate.  The Company plans to redeem allshares of this series of preferred stock within five years.

 

# **Market for Common Share andDividends**

# ** **

As of December 31, 2009, there were 3,787,170 shares of our commonstock outstanding held by approximately 2,400 shareholders of record.  There is currently no established publictrading market in our common stock and trading and quotations of our commonstock have been limited and sporadic. Most of the trades of which the Company is aware have been privatelynegotiated by local buyers and sellers. In addition to these trades, the Company is aware of a number of tradesreported on Yahoo! that occurred on the OTC Bulletin Board between December 31,2008 and December 31, 2009.  Thesetrades ranged from $11.00 to $15.30.  Wehave included these trades in the following table.  Because there has not been an establishedmarket for our common stock, we may not be aware of all prices at which ourcommon stock has been traded.  We havenot determined whether the trades of which we are aware were the result of arm’s-lengthnegotiations between the parties.  Basedon information available to us, we believe transactions in our common stock canbe fairly summarized as follows for the periods indicated:

 
| **2009**        | ** ** | **Low** | ** ** | **High** | ** ** |
|-----------------|------------|---------|------------|----------|------------|
|            |       |    |       |     |       |
| Fourth  Quarter |       | $       | 11.00      |     | $          | 18.00 |   |
| Third  Quarter  |       | $       | 11.00      |     | $          | 24.00 |   |
| Second  Quarter |       | $       | 11.50      |     | $          | 25.00 |   |
| First  Quarter  |       | $       | 13.16      |     | $          | 27.00 |   |

 
| **2008**        |   |   |   |   |   |
|-----------------|--------|--------|--------|--------|--------|
|            |   |   |   |   |   |
| Fourth  Quarter |   | $      | 23.50  |   | $      | 27.00 |   |
| Third  Quarter  |   | $      | 19.00  |   | $      | 27.00 |   |
| Second  Quarter |   | $      | 19.90  |   | $      | 30.00 |   |
| First  Quarter  |   | $      | 16.50  |   | $      | 28.00 |   |

 

All share and per sharedata in this report has been adjusted to reflect all stock dividends and splitsdeclared by the Company.

 

No cash dividendshave ever been declared or paid by the Company. However, the Board of Directors approved a 10% stock dividend for eachof the five years ended December 31, 1996. The Company also paid a two-for-one stock split in the form of a 100%stock dividend in 2000, a 5% stock dividend in each of the years 2001, 2002,and 2003, a 7.5% stock dividend in 2004, a 3% stock dividend in 2005, 2006 and2008, and a two-for-one stock split in the form of a 100% stock dividend in January 2007.  The Company also paid a 3% stock dividend on February 20,2009 to shareholders of record as of close of business February 6,2009.  There was no stock dividenddeclared in January 2010 because the Company is prohibited from declaringany dividends on its common stock until March 6, 2012 without Treasury’sapproval unless the 12,985 shares of preferred stock have been repurchased fromTreasury.

 

7

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Management doesnot expect the Company to pay cash dividends in the foreseeable future.  The Company’s ability to pay dividendsdepends on the ability of its subsidiary, Horry County State Bank, to paydividends to the Company.  As a SouthCarolina state bank, the Bank may only pay dividends out of its net profits,after deducting expenses, including losses and bad debts.  In addition, the Bank is prohibited fromdeclaring a dividend on its shares of common stock until its surplus equals itsstated capital and until it receives approval from the Federal DepositInsurance Corporation (the “FDIC”) and the South Carolina Board of FinancialInstitutions.

 

# **MANAGEMENT’S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION**

# ** **

# **INTRODUCTION**

# ** **

The following discussiondescribes our results of operations for 2009 as compared to 2008 and alsoanalyzes our financial condition as of December 31, 2009 as compared to December 31,2008.  Like most community banks, wederive most of our income from interest we receive on our loans andinvestments.  Our primary source of fundsfor making these loans and investments is our deposits, both interest-bearingand noninterest-bearing.  Consequently,one of the key measures of our success is our amount of net interest income, orthe difference between the income on our interest-earning assets, such as loansand investments, and the expense on our interest-bearing liabilities, such asdeposits and borrowed funds.  In order tomaximize our net interest income, we must not only manage the volume of thesebalance sheet items, but also the yields that we earn on our interest-earningassets and the rates that we pay on interest-bearing liabilities.

 

We have included a numberof tables to assist in our description of these measures.  For example, the “Average Balances” tableshows the average balance during 2009, 2008, and 2007 of each category of ourassets and liabilities, as well as the yield we earned or the rate we paid withrespect to each category.  A review ofthis table shows that our loans typically provide higher interest yields thando other types of interest earning assets, which is why we direct a substantialpercentage of our earning assets into our loan portfolio.  Similarly, the “Rate/Volume Analysis” tablehelps demonstrate the impact of changing interest rates and changing volume ofassets and liabilities during the years shown. We also track the sensitivity of our various categories of assets andliabilities to changes in interest rates, and we have included an “InterestRate Sensitivity Analysis” table to help explain this.  Finally, we have included a number of tablesthat provide details about our investment securities, our loans, and ourdeposits and other borrowings.

 

Of course, there arerisks inherent in all loans, so we maintain an allowance for loan losses toabsorb probable losses on existing loans that may become uncollectible.  We establish and maintain this allowance bycharging a provision for loan losses against our operating earnings.  In the Loan Portfolio section we haveincluded a detailed discussion of this process, as well as several tablesdescribing our allowance for loan losses and the allocation of this allowanceamong our various categories of loans.

 

In addition toearning interest on our loans and investments, we earn income through fees thatwe charge to our customers. Likewise, we incur other operating expenses aswell.  We describe the various componentsof this noninterest income, as well as our noninterest expense, in the OtherIncome and Other Expense section.

 

8

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**GENERAL**

 

Markets in theUnited States and elsewhere have experienced extreme volatility and disruptionfor more than two years.  Thesecircumstances have exerted significant downward pressure on prices of equitysecurities and virtually all other asset classes, and have resulted insubstantially increased market volatility, severely constrained credit andcapital markets, particularly for financial institutions, and an overall lossof investor confidence.  Loan portfolioperformances have deteriorated at many institutions resulting from, among otherfactors, a weak economy and a decline in the value of the collateral supportingtheir loans.  Dramatic slowdowns in thehousing industry with falling home prices and increasing foreclosures andunemployment have created strains on financial institutions.  Across the country many borrowers are nowunable to repay their loans, and the collateral securing these loans has, insome cases, declined below the loan balance. The following discussion and analysis describes our performance in thischallenging economic environment.

 

The Companycontinued to grow throughout 2009.  Totalassets increased by $115,302,000, or 17.89%, and net loans increased by$59,505,000, or 14.01%.  Much of thisgrowth is attributable to the success of our branch network.

 

Profitabilitydecreased in 2009 by 160.07%, from net earnings of $2,244,000 in 2008 to a netloss of $1,348,000 in 2009, primarily as a result of an increase in provisionfor loan losses of $8,607,000, or 490.71%. The growth of the loan portfolio resulted in a loan to deposit ratio of85.02%.  The Company will need to attractadditional deposits, borrow more money, or a combination of the two to continueexpansion of the loan portfolio.

 

The Company isworking diligently to improve asset quality and to reduce its investment incommercial real estate loans as a percentage of Tier 1 capital.  The Company is reducing its reliance onbrokered CDs and is committed to maintaining its “well capitalized” status.

 

A more detaileddiscussion of the factors contributing to growth and challenges is presentedbelow.

 

**RESULTSOF OPERATIONS**

 

The Companyexperienced an increase of $397,000, or 1.55%, in interest income on loans andrelated fees for the year ended December 31, 2009.  The Company also experienced an increase inthe interest income on taxable securities, which increased $2,855,000 or57.62%.  This contributed to an increasein total interest income of $2,962,000 or 9.51%, over the course of 2009.  Because of the increase in growth ininterest-bearing deposits and other borrowings, total interest expenseincreased $1,056,000, or 7.26%, to $15,593,000. This resulted in a $1,906,000, or 11.48%, increase in net interestincome in 2009.  The Company alsoexperienced increases in non-interest income and expenses.  Non-interest income increased $3,977,000, or110.90%, due to gains on sale of available-for-sale securities of$3,663,000.  Non-interest expensesincreased $2,812,000, or 18.64%, during 2009 due to the acquisition ofadditional personnel in our mortgage lending and investment servicesareas.  Overall, the Company had a netloss for the year ended December 31, 2009 of $1,348,000, compared to netearnings of $2,244,000 for the year ended December 31, 2008.  This represents a decrease in net income of$3,592,000, or 160.07%.  The net loss wasdriven by the increase in provision for loan losses of $8,607,000, or 490.71%,from $1,754,000 at December 31, 2008 to $10,361,000 at December 31,2009.

 

# **ASSETS, LIABILITIES, ANDSHAREHOLDERS’ EQUITY**

# ** **

During the twelve months ended December 31, 2009, total assetsincreased $115,302,000, or 17.89%, when compared to December 31,2008.  The primary reason for theincrease in total assets was an increase in our loan portfolio of $62,614,000,or 14.59%, during 2009 from $429,038,000 at December 31, 2008.  Total deposits increased $93,541,000, or19.30%, from the December 31, 2008 amount of $484,751,000.  Interest-bearing deposits increased$93,165,000, or 20.55%, and noninterest-bearing deposits increased $376,000, or1.20%, during 2009.  The increase indeposits was primarily due to the increase in our money market savingsaccounts, which increased $58,545,000, or 62.28%, from $94,008,000 at December 31,2008 to $152,553,000 at December 31, 2009.

 

9

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# **DISTRIBUTION OF ASSETS,LIABILITIES, AND SHAREHOLDERS’ EQUITY**

 

The Company has sought tomaintain a conservative approach in determining the distribution of its assetsand liabilities. The following table presents the percentage relationships ofsignificant components of the Company’s average balance sheets for the lastthree fiscal years.

 

##### **Balance Sheet Categories as a Percent of AverageTotal Assets**

 
| ** **                                       | ** ** | **2009** | ** ** | **2008**   | ** ** | **2007** | ** ** |
|--------------------------------------------------|------------|----------|------------|------------|------------|----------|------------|
|                                             |       |     |       | ** ** |       |     |       |
| **Assets:**                                      |       |     |       |       |       |     |       |
| Interest  earning assets:                        |       |     |       |       |       |     |       |
| Federal  funds sold                              |       | 2.55     | %          | 0.88       | %          | 2.83     | %          |
| Investment  securities                           |       | 26.69    |       | 19.79      |       | 13.48    |       |
| Loans                                            |       | 64.57    |       | 72.52      |       | 76.86    |       |
| Total  interest earning assets                   |       | 93.81    |       | 93.19      |       | 93.17    |       |
| Cash  and due from banks                         |       | 1.21     |       | 1.74       |       | 2.00     |       |
| Allowance  for loan losses                       |       | (0.78    | )          | (0.72      | )          | (0.78    | )          |
| Premises  and equipment                          |       | 2.95     |       | 3.18       |       | 3.84     |       |
| Other  assets                                    |       | 2.81     |       | 2.61       |       | 1.77     |       |
| Total  assets                                    |       | 100.00   | %          | 100.00     | %          | 100.00   | %          |
|                                             |       |     |       |       |       |     |       |
| **Liabilities and shareholders’ equity:**   |       |     |       |       |       |     |       |
| Interest-bearing  liabilities:                   |       |     |       |       |       |     |       |
| Interest-bearing  deposits                       |       | 71.51    | %          | 71.17      | %          | 70.08    | %          |
| Federal  funds purchased                         |       | 0.07     |       | 0.34       |       | 0.09     |       |
| Advances  from the Federal Home Loan Bank        |       | 14.70    |       | 12.27      |       | 11.59    |       |
| Repurchase  Agreements                           |       | 1.44     |       | 1.84       |       | 0.43     |       |
| Debt  due to trust                               |       | 0.85     |       | 1.17       |       | 1.57     |       |
| Notes  Payable                                   |       | 0.15     |       | 0.14       |       | 0.00     |       |
| Total  interest-bearing liabilities              |       | 88.72    |       | 86.93      |       | 83.76    |       |
| Noninterest-bearing  deposits                    |       | 4.49     |       | 6.26       |       | 8.00     |       |
| Accrued  interest and other liabilities          |       | 0.67     |       | 0.74       |       | 0.78     |       |
| Total  liabilities                               |       | 93.88    |       | 93.93      |       | 92.54    |       |
| Shareholders’  equity                       |       | 6.12     |       | 6.07       |       | 7.46     |       |
| Total  liabilities and shareholders’ equity |       | 100.00   | %          | 100.00     | %          | 100.00   | %          |

 

**NETINTEREST INCOME**

 

Earnings are dependent toa large degree on net interest income. Net interest income represents the difference between gross interestearned on earning assets, primarily loans and investment securities, and interestpaid on deposits and borrowed funds. Net interest income is affected by theinterest rates earned or paid and by volume changes in loans, investmentsecurities, deposits, and borrowed funds. The interest rate spread and the net yield on earning assets are twosignificant elements in analyzing the Company’s net interest income.  The interest rate spread is the differencebetween the yield on average earning assets and the rate on averageinterest-bearing liabilities.  The netyield on earning assets is computed by dividing net interest income by theaverage earning assets.

 

For the year ended December 31,2009, net interest income was $18,508,000, an increase of $1,906,000, or11.48%, over net interest income of $16,602,000 in 2008.  Interest income from loans, including fees,was $25,997,000, an increase of $397,000, or 1.55%, from 2008 to 2009 asemployment of additional lenders resulted in an increase in loans.  Interest expense for the year ended December 31,2009 was $15,593,000, compared to $14,537,000 for 2008.

 

10

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This represents anincrease of $1,056,000, or 7.26%, compared to the prior year.  The interest rate spread and net yield onearning assets reflected the pressure created by the lower interest rateenvironment when compared to the previous year as our customers began to investmore of their monies into higher yielding deposit products, such as moneymarket deposit accounts and certificate of deposits, which increased$96,077,000, or 23.87%, throughout 2009. The net yield realized on earning assets was 2.77% for 2009, compared to3.35% in 2008.  The interest rate spreadwas 2.64% and 3.14% in 2009 and 2008, respectively.

 

The following table setsforth, for the periods indicated, the weighted-average yields earned, theweighted-average yields paid, the interest rate spread, and the net yield onearning assets.  The table also indicatesthe average daily balance and the interest income or expense by specificcategories.

 

**AverageBalances, Income and Expenses, and Rates**

** **
| ** **                                    | ** ** | **2009**    | ** ** | **2008**     | ** ** | **2007**   | ** ** |
|-----------------------------------------------|------------|-------------|------------|--------------|------------|------------|------------|
| **Year ended December 31,**              | ** ** | **Average** | ** ** | ** **   | ** ** | **Yield/** | ** ** | **Average** | ** ** | ** ** | ** ** | **Yield/** | ** ** | **Average** | ** ** | ** ** | ** ** | **Yield/** | ** ** |
| **(Dollars  in thousands)**                   | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate**   | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate** | ** ** |
| **ASSETS**                                    |       |        |       |         |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
|                                          |       |        |       |         |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans                                         |       | $           | 469,675    |         | $          | 25,997     |       | 5.54 | % | $ | 385,277 |   | $ | 25,600 |   | 6.64 | % | $ | 302,965 |   | $ | 25,275 |   | 8.34 | % |
| Securities,  taxable                          |       | 181,759     |       | 7,811        |       | 4.30       | %          | 93,538 |   | 4,955 |   | 5.30 | % | 42,538 |   | 2,212 |   | 5.20 | % |
| Securities,  nontaxable                       |       | 6,261       |       | 236          |       | 3.77       | %          | 7,570 |   | 295 |   | 3.90 | % | 7,571 |   | 290 |   | 3.83 | % |
| Nonmarketable  Equity Securities              |       | 6,104       |       | 32           |       | 0.52       | %          | 4,029 |   | 177 |   | 4.39 | % | 3,035 |   | 173 |   | 5.70 | % |
| Fed  funds sold and other (incl. FHLB)        |       | 18,546      |       | 26           |       | 0.14       | %          | 4,681 |   | 112 |   | 2.39 | % | 11,161 |   | 586 |   | 5.25 | % |
| Total  earning assets                         |       | 682,345     |       | 34,102       |       | 5.00       | %          | 495,095 |   | 31,139 |   | 6.29 | % | 367,270 |   | 28,536 |   | 7.77 | % |
| Cash  and due from banks                      |       | 8,810       |       |         |       |       |       | 9,252 |   |   |   |   |   | 7,869 |   |   |   |   |   |
| Allowance  for loan losses                    |       | (5,662      | )          |         |       |       |       | (3,810 | ) |   |   |   |   | (3,069 | ) |   |   |   |   |
| Premises &  equipment                |       | 21,466      |       |         |       |       |       | 16,870 |   |   |   |   |   | 15,157 |   |   |   |   |   |
| Other  assets                                 |       | 20,467      |       |         |       |       |       | 13,867 |   |   |   |   |   | 6,962 |   |   |   |   |   |
| Total  assets                                 |       | $           | 727,426    |         |       |       |       |   | $ | 531,274 |   |   |   |   |   | $ | 394,189 |   |   |   |   |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY** |       |        |       |         |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Transaction  accounts                         |       | $           | 520,167    |         | $          | 11,265     |       | 2.17 | % | $ | 378,116 |   | $ | 11,215 |   | 2.97 | % | $ | 276,269 |   | $ | 11,298 |   | 4.09 | % |
| FHLB  Advances                                |       | 125,187     |       | 3,961        |       | 3.16       | %          | 83,695 |   | 3,322 |   | 3.97 | % | 53,925 |   | 2,954 |   | 5.48 | % |
| Total  interest-bearing liabilities           |       | 645,354     |       | 15,226       |       | 2.36       | %          | 461,811 |   | 14,537 |   | 3.15 | % | 330,194 |   | 14,252 |   | 4.32 | % |
| Non-interest  deposits                        |       | 32,675      |       |         |       |       |       | 33,282 |   |   |   |   |   | 31,545 |   |   |   |   |   |
| Other  liabilities                            |       | 4,905       |       |         |       |       |       | 3,919 |   |   |   |   |   | 3,060 |   |   |   |   |   |
| Stockholders’  equity                    |       | 44,492      |       |         |       |       |       | 32,262 |   |   |   |   |   | 29,390 |   |   |   |   |   |
| Total  liabilities & equity          |       | $           | 727,426    |         |       |       |       |   | $ | 531,274 |   |   |   |   |   | $ | 394,189 |   |   |   |   |   |
|                                          |       |        |       |         |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net  interest income/ interest rate spread    |       |        |       | 18,876       |       | 2.64       | %          |   |   | 16,602 |   | 3.14 | % |   |   | 14,284 |   | 3.45 | % |
| Net  yield on earning assets                  |       |        |       |         |       | 2.77       | %          |   |   |   |   | 3.35 | % |   |   |   |   | 3.89 | % |

 

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(1)   The effects of loans in nonaccrual status andfees collected are not significant to the computations.

 

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**RATE/VOLUMEANALYSIS**

 

Net interestincome can also be analyzed in terms of the impact of changing rates andchanging volume.  The following tabledescribes the extent to which changes in interest rates and changes in thevolume of earning assets and interest-bearing liabilities have affected theCompany’s interest income and interest expense during the periods indicated.Information on changes in each category attributable to (i) changes due tovolume (change in volume multiplied by prior period rate), (ii) changesdue to rates (changes in rates multiplied by prior period volume), and (iii) changesin rate and volume (change in rate multiplied by the change in volume) isprovided as follows:

 
| ** **                             | ** ** | **2009 compared to 2008**         | ** ** |
|----------------------------------------|------------|-----------------------------------|------------|
| ** **                             | ** ** | **Due to increase (decrease) in** | ** ** |
| **(Dollars  in thousands)**            | ** ** | **Rate**                          | ** ** | **Volume** | ** ** | **Rate/Volume** | ** ** | **Total** | ** ** |
| Interest  income:                      | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Loans                                  |       | (4,275                            | )          | 5,608 |   | (936 | ) | 397 |   |
| Securities,  taxable                   |       | (935                              | )          | 4,673 |   | (882 | ) | 2,856 |   |
| Securities,  nontaxable                |       | (10                               | )          | (51 | ) | 2 |   | (59 | ) |
| Nonmarketable  equity securities       |       | (156                              | )          | 91 |   | (80 | ) | (145 | ) |
| Fed  funds sold and other (incl. FHLB) |       | (105                              | )          | 332 |   | (312 | ) | (86 | ) |
| Total  earning assets                  |       | (5,481                            | )          | 10,653 |   | (2,208 | ) | 2,963 |   |
|                                   |       |                              |       |   |   |   |   |   |   |
| Interest  expense:                     |       |                              |       |   |   |   |   |   |   |
| Interest-bearing  deposits             |       | (3,026                            | )          | 4,213 |   | (1,137 | ) | 50 |   |
| Other  borrowings                      |       | (674                              | )          | 1,647 |   | (334 | ) | 639 |   |
|                                   |       | (3,700                            | )          | 5,860 |   | (1,471 | ) | 689 |   |
|                                   |       |                              |       |   |   |   |   |   |   |
| Net  interest income                   |       | (1,781                            | )          | 4,793 |   | (737 | ) | 2,274 |   |

 
| ** **                             | ** ** | **2008 compared to 2007**         | ** ** |
|----------------------------------------|------------|-----------------------------------|------------|
| ** **                             | ** ** | **Due to increase (decrease) in** | ** ** |
| ** **                             | ** ** | **Rate**                          | ** ** | **Volume** | ** ** | **Rate/Volume** | ** ** | **Total** | ** ** |
| Loans                                  |       | (5,144                            | )          | 6,867 |   | (1,398 | ) | 325 |   |
| Securities,  taxable                   |       | 41                                |       | 2,652 |   | 50 |   | 2,743 |   |
| Securities,  nontaxable                |       | 5                                 |       | (0 | ) | (0 | ) | 5 |   |
| Time  Deposits with other banks        |       | 0                                 |       | 0 |   | 0 |   | 0 |   |
| Nonmarketable  equity securities       |       | (40                               | )          | 57 |   | (13 | ) | 4 |   |
| Fed  funds sold and other (incl. FHLB) |       | (319                              | )          | (340 | ) | 185 |   | (474 | ) |
|                                   |       | (5,457                            | )          | 9,235 |   | (1,176 | ) | 2,603 |   |
|                                   |       |                              |       |   |   |   |   |   |   |
| Transaction  accounts                  |       | (3,104                            | )          | 4,165 |   | (1,144 | ) | (83 | ) |
| Other  borrowings                      |       | (814                              | )          | 1,631 |   | (449 | ) | 368 |   |
|                                   |       | (3,918                            | )          | 5,796 |   | (1,593 | ) | 285 |   |
|                                   |       |                              |       |   |   |   |   |   |   |
| Net  interest income                   |       | (1,539                            | )          | 3,440 |   | 417 |   | 2,318 |   |

 

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(1) Volume-rate changes have been allocated to each category based on a consistentbasis between rate and volume.

 

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**RATESENSITIVITY**

 

Interest ratespaid on deposits and borrowed funds and interest rates earned on loans andinvestments have generally followed the fluctuations in market rates in 2009and 2008.  However, fluctuations inmarket interest rates do not necessarily have a significant impact on netinterest income, depending on the Company’s interest rate sensitivity position.A rate-sensitive asset or liability is one that can be repriced either up ordown in interest rate within a certain time interval. When a proper balanceexists between rate-sensitive assets and rate-sensitive liabilities, marketinterest rate fluctuations should not have a significant impact on liquidityand earnings.  The larger the imbalance,the greater the interest rate risk assumed and the greater the positive ornegative impact of interest fluctuations on liquidity and earnings.

 

Interest rate sensitivitymanagement is concerned with the management of both the timing and themagnitude of repricing characteristics of interest-earning assets andinterest-bearing liabilities and is an important part of asset/liabilitymanagement.  The objectives of interestrate sensitivity management are to ensure the adequacy of net interest incomeand to control the risks to net interest income associated with movements ininterest rates.  The following table, “InterestRate Sensitivity Analysis,” indicates that, on a cumulative basis, after threethrough twelve months, rate-sensitive liabilities exceeded rate-sensitiveassets, resulting in a twelve-month liability sensitive position.  For a bank with a liability-sensitiveposition, or negative gap, falling interest rates would generally be expectedto have a positive effect on net interest income, and rising interest rateswould generally be expected to have the opposite effect.  The following table presents the Company’srate sensitivity at each of the time intervals indicated as of December 31,2009 and may not be indicative of the Company’s rate-sensitivity position atother points in time:

 

**Interest Rate SensitivityAnalysis**

 
| ** **                                       | ** ** | ** **      | ** **  | **After  One** | ** ** | **After  Three** | ** ** | ** **      | ** **   | **Greater**       | ** ** | ** **   | ** ** |
|--------------------------------------------------|------------|-----------------|-------------|----------------|------------|------------------|------------|-----------------|--------------|-------------------|------------|--------------|------------|
| ** **                                       | ** ** | ** **      | ** **  | **Through**    | ** ** | **Through**      | ** ** | ** **      | ** **   | **Than One**      | ** ** | ** **   | ** ** |
| **December 31, 2009**                       | ** ** | **Within  One** | ** **  | **Three**      | ** ** | **Twelve**       | ** ** | **Within  One** | ** **   | **Year or**       | ** ** | ** **   | ** ** |
| **(Dollars in thousands)**                       | ** ** | **Month**       | ** **  | **Months**     | ** ** | **Months**       | ** ** | **Year**        | ** **   | **Non-Sensitive** | ** ** | **Total**    | ** ** |
| **Assets**                                       |       |            |        |           |       |             |       |            |         |              |       |         |       |
| Interest-earning  assets                         |       |            |        |           |       |             |       |            |         |              |       |         |       |
| Federal  fund sold                               |       | $               | 1,407       |           | $          | —           |       | $               | —       |              | $          | 1,407        |       | $ | — |   | $ | 1,407 |   |
| Loans                                            |       | 245,333         |        | 14,701         |       | 70,697           |       | 330,731         |         | 162,590           |       | 493,321      |       |
| Securities                                       |       | 1,890           |        | 7,188          |       | 60,113           |       | 69,191          |         | 106,987           |       | 176,178      |       |
| Total  earning assets                            |       | 248,630         |        | 21,889         |       | 130,810          |       | 401,329         |         | 269,577           |       | 670,906      |       |
|                                             |       |            |        |           |       |             |       |            |         |              |       |         |       |
| **Liabilities**                                  |       |            |        |           |       |             |       |            |         |              |       |         |       |
| Interest-bearing  liabilities:                   |       |            |        |           |       |             |       |            |         |              |       |         |       |
| Interest-bearing  deposits:                      |       |            |        |           |       |             |       |            |         |              |       |         |       |
| Demand  deposits                                 |       | 41,354          |        | —         |       | —           |       | 41,354          |         | —            |       | 41,354       |       |
| Savings  deposits                                |       | 159,176         |        | —         |       | —           |       | 159,176         |         | —            |       | 159,176      |       |
| Time  deposits                                   |       | 46,929          |        | 67,235         |       | 180,412          |       | 294,576         |         | 51,525            |       | 346,101      |       |
| Total  interest-bearing deposits                 |       | 247,459         |        | 67,235         |       | 180,412          |       | 495,106         |         | 51,525            |       | 546,631      |       |
| Other  borrowings                                |       | 18,031          |        | 20,600         |       | 10,000           |       | 48,631          |         | 78,200            |       | 126,831      |       |
| Junior  subordinated debentures                  |       | —          |        | 6,186          |       | —           |       | 6,186           |         | —            |       | 6,186        |       |
| Total  interest-bearing liabilities              |       | 265,490         |        | 94,021         |       | 190,412          |       | 549,923         |         | 129,725           |       | 679,648      |       |
| Period  gap                                      | ** ** | **$**           | **(16,860** | **)**          | **$**      | **(72,132**      | **)**      | **$**           | **(59,602**  | **)**             | **$**      | **(148,594** | **)**      | **$** | **139,852** |   |   |   |
| Cumulative  gap                                  | ** ** | **$**           | **(16,860** | **)**          | **$**      | **(88,992**      | **)**      | **$**           | **(148,594** | **)**             | **$**      | **(148,594** | **)**      | **$** | **(8,742** | **)** |   |   |
| Ratio  of cumulative gap to total earning assets |       | (2.51           | )%          | (13.26         | )%         | (22.15           | )%         | (22.15          | )%           | (1.30             | )%         |         |       |
|                                                  |            |                 |             |                |            |                  |            |                 |              |                   |            |              |            |  |  |  |  |  |  |

 

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**PROVISIONFOR LOAN LOSSES**

 

The provision for loanlosses is charged to earnings based upon management’s evaluation of specificloans in its portfolio and general economic conditions and trends in themarketplace.  The 2009 and 2008provisions for loan losses and their related effect of increasing the allowancefor loan losses are related to growth in the loan portfolio.  Please refer to the section “Loan Portfolio”for a discussion of management’s evaluation of the adequacy of the allowancesfor loan losses. In 2009 and 2008, the provisions for loan losses were$10,361,000 and $1,754,000, respectively.

 

# **NONINTEREST INCOME**

# ** **

Noninterest income was$7,563,000 for the year ended December 31, 2009, an increase of$3,977,000, or 110.90%, when compared with the year ended December 31,2008.  The increase is primarily a resultof net gains on sale of securities of $4,102,000 for the year ended December 31,2009 as compared to $439,000 for the same period in 2008, an increase of$3,663,000, or 834.40%.  Due to theincrease in pre-payments of principal on our mortgage-backed securities,management began to realize gains within the portfolio to help improve theprofitability of the bank.  This increasein noninterest income is also a result of an increase of $167,000, or 53.35%,in income from cash value of life insurance from $313,000 for the year ended December 31,2008 to $480,000 for the year ended December 31, 2009.  This increase is due to the Bank’s investmentin bank-owned life insurance policies of $600,000 during 2009.  In addition, gains on sale of residentialmortgages in the secondary market increased $100,000, 18.73%, from $534,000 forthe year ended December 31, 2008 to $634,000 for the year ended December 31,2009.  This increase is due to additionalpersonnel hired in this area, as well as, the various tax advantages availableto the homebuyer during 2009.  Also,brokerage commission fees increased $89,000, or 61.38%, from $145,000 for theyear ended December 31, 2008 to $234,000 for the year ended December 31,2009.  This increase is due to twoadditional personnel hired in this area. We also experienced decreases in noninterest income.  We incurred a decrease in service charges ondeposit accounts of $90,000, or 5.29%, from $1,700,000 for the year ended 2008compared to $1,610,000 for the year ended 2009, due to the increase in growthin our money market and certificate of deposits, which generates minimalservice charge fee income.

 

# **NONINTEREST EXPENSES**

# ** **

Most categories ofnoninterest expenses increased during 2009 due to continued growth of theCompany.  Salaries and employee benefitsincreased $902,000, or 10.15%, due to the employment of additional personnel inour mortgage lending and investment brokerage services.  Also, FDIC insurance premiums increased$801,000, or 183.72%, from $436,000 for the year ended December 31, 2008to $1,237,000 for the comparable period in 2009.  Also, other operating expenses increased$578,000, or 21.44%, from $2,696,000 for the year ended December 31, 2008to $3,274,000 for the year ended December 31, 2009, which was a result ofincreased legal and repossession expenses relating to our impaired loans.  In addition, losses incurred in the sale ofassets increased $186,000 to $171,000 for the period ended December 31,2009 due to the sale of our repossessions and foreclosed property.  There were also losses experienced on stockin Silverton Bank due to its insolvency of $122,000 during 2009.  There were also increases in net occupancyexpense during 2009 of $78,000, or 7.01%, to $1,190,000 for the year ended December 31,2009 due to the construction of an Operations Center, which became operationalin November 2009 and the movement of our Ocean Drive branch from a storefront location to a permanent location.

 

## **INCOME TAXES**

## ** **

The Company’s income taxbenefit for 2009 was $840,000, a decrease of $1,944,000 from the 2008 expenseof $1,104,000. The decrease in the expense results from the decrease in incomebefore taxes in 2009 compared to 2008. The Company’s effective tax rates for the years ended December 31,2009 and 2008 were 38.39% and 32.97%, respectively.

 

14

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# **LIQUIDITY**

# ** **

Liquidity is the abilityto meet current and future obligations through liquidation or maturity ofexisting assets or the acquisition of additional liabilities.  The Company manages both assets andliabilities to achieve appropriate levels of liquidity.  Cash and federal funds sold are the Company’sprimary sources of asset liquidity. These funds provide a cushion against short-term fluctuations in cashflow from both deposits and loans.  Theinvestment securities portfolio is the Company’s principal source of secondaryasset liquidity.  However, theavailability of this source of funds is influenced by market conditions.  Individual and commercial deposits are theCompany’s primary source of funds for credit activities.  Although not historically used as principalsources of liquidity, federal funds purchased from correspondent banks andadvances from the Federal Home Loan Bank are other options available tomanagement.

 

As of December 31,2009, the Company had unused lines of credit to purchase federal funds fromunrelated banks totaling $21,000,000. These lines of credit are available on a one to fourteen day basis forgeneral corporate purposes.  The lendershave reserved the right not to renew their respective lines.  Unpledged securities available-for-sale,which totaled $25,720,000 at December 31, 2009, also serve as a readysource of liquidity. Management believes that the Company’s liquidity sourcesare adequate to meet its operating needs. The level of liquidity is measured by the loans-to-total borrowed fundsratio, which was at 69.12% and 71.00% at December 31, 2009 and 2008,respectively.

 

# **IMPACT OF OFF-BALANCE-SHEETINSTRUMENTS**

# ** **

The Company is aparty to financial instruments with off-balance-sheet risk in the normal courseof business to meet the financing needs of its customers.  These financial instruments consist ofcommitments to extend credit and standby letters of credit.  Commitments to extend credit are legallybinding agreements to lend to a customer at predetermined interest rates aslong as there is no violation of any condition established in thecontract.  Commitments generally havefixed expiration dates or other termination clauses and may require payment ofa fee.  A commitment involves, to varyingdegrees, elements of credit and interest rate risk in excess of the amountrecognized in the balance sheets.  TheCompany’s exposure to credit loss in the event of nonperformance by the otherparty to the instrument is represented by the contractual notional amount ofthe instrument.  Since certaincommitments are expected to expire without being drawn upon, the totalcommitment amounts do not necessarily represent future cash requirements.  Letters of credit are conditional commitmentsissued to guarantee a customer’s performance to a third party and haveessentially the same credit risk as other lending facilities.  Standby letters of credit often expirewithout being used.  Management believesthat through various sources of liquidity, the Company has the necessaryresources to meet obligations arising from these financial instruments.

 

The Company usesthe same credit underwriting procedures for commitments to extend credit andstandby letters of credit as for on-balance-sheet instruments.  The credit worthiness of each borrower isevaluated and the amount of collateral, if deemed necessary, is based on thecredit evaluation.  Collateral held forcommitments to extend credit and standby letters of credit varies but mayinclude accounts receivable, inventory, property, plant, equipment, andincome-producing commercial properties, as well as liquid assets such as timedeposit accounts, brokerage accounts, and cash value of life insurance.

 

The Company is notinvolved in off-balance-sheet contractual relationships, other than thosedisclosed in this report, which it believes could result in liquidity needs orother commitments or that could significantly impact earnings.

 

As of December 31, 2009, commitments to extend credit totaled$53,840,000 and standby letters of credit totaled $1,137,000.

 

15

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# ** **

The following table sets forth the length of time until maturity forunused commitments to extend credit and standby letters of credit at December 31,2009.

 
| ** **                           | ** ** | ** ** | ** ** | **After  One** | ** ** | **After  Three** | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
|--------------------------------------|------------|------------|------------|----------------|------------|------------------|------------|------------|------------|--------------|------------|------------|------------|
| ** **                           | ** ** | **Within** | ** ** | **Through**    | ** ** | **Through**      | ** ** | **Within** | ** ** | **Greater**  | ** ** | ** ** | ** ** |
| ** **                           | ** ** | **One**    | ** ** | **Three**      | ** ** | **Twelve**       | ** ** | **One**    | ** ** | **Than**     | ** ** | ** ** | ** ** |
| **(Dollars in thousands)**           | ** ** | **Month**  | ** ** | **Months**     | ** ** | **Months**       | ** ** | **Year**   | ** ** | **One Year** | ** ** | **Total**  | ** ** |
| Unused  commitments to extend credit |       | $          | 1,450      |           | $          | 5,990            |       | $          | 24,175     |         | $          | 31,615     |       | $ | 22,225 |   | $ | 53,840 |   |
| Standby  letters of credit           |       | 31         |       | 55             |       | 918              |       | 1,004      |       | 133          |       | 1,137      |       |
|                                 | ** ** | ** ** | ** ** | ** **     | ** ** | ** **       | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| Totals                               | ** ** | **$**      | **1,481**  | ** **     | **$**      | **6,045**        | ** ** | **$**      | **25,093** | ** **   | **$**      | **32,619** | ** ** | **$** | **22,358** | ** ** | **$** | **54,977** | ** ** |

 

The Company entered into interest rate swap agreements associated withFederal Home Loan Bank advances during the third quarter of 2003.  The interest rate swaps effectively convertedthe fixed interest rates on the advances to a variable rate. The notionalamount of advances involved in this transaction totaled $14,600,000.  In May 2009 management decided to unwindthe swaps, which produced a gain of $82,000. Management currently does not utilize swaps to hedge interest rate risk.

 

# **IMPACT OF INFLATION ANDCHANGING PRICES**

# ** **

The financial statementsand related financial data presented herein have been prepared in accordancewith generally accepted accounting principles which require the measurement offinancial position and operating results in terms of historical dollars withoutconsidering changes in relative purchasing power over time due toinflation.  Unlike most industrialcompanies, virtually all of the assets and liabilities of a financialinstitution are monetary in nature.  As aresult, interest rates generally have a more significant impact on a financialinstitution’s performance than does the effect of inflation.

 

While the effect ofinflation on a bank is normally not as significant as its influence on thosebusinesses that have large investments in plant and inventories, it does havean effect.  Interest rates generallyincrease as the rate of inflation increases, but the magnitude of the change inrates may not be the same.  Whileinterest rates have traditionally moved with inflation, the effect on income isdiminished because both interest earned on assets and interest paid onliabilities vary directly with each other unless the Company is in a highliability sensitive position.  Also,general increases in the price of goods and services will result in increasedoperating expenses.

 

16

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# **CAPITAL RESOURCES**

# ** **

The Company usesseveral indicators of capital strength. The most commonly used measure is average common equity to averageassets, which was 6.12% in 2009 compared to 6.07% in 2008.  The change in this ratio reflects an increasein the Company’s equity as a percentage of assets in 2009 as compared to 2008.

 

The Company and the Bankare subject to various regulatory capital requirements administered by thefederal banking agencies.  Failure tomeet minimum capital requirements can initiate certain mandatory and possiblyadditional discretionary actions by regulators that, if undertaken, could havea material effect on the Company’s financial statements. Under capital adequacyguidelines and the regulatory framework for prompt corrective action, theCompany and the Bank must meet specific capital guidelines that involvequantitative measures of their assets, liabilities, and certainoff-balance-sheet items as calculated under regulatory accountingpractices.  The capital amounts andclassifications are also subject to qualitative judgments by the regulatorsabout components, risk weightings, and other factors.

 

Quantitative measuresestablished by regulation to ensure capital adequacy require the Company andthe Bank to maintain minimum ratios of Tier 1 and total capital as a percentageof assets and off-balance-sheet exposures, adjusted for risk weights rangingfrom 0% to 100%.  Tier 1 capital consistsof common shareholders’ equity, excluding the unrealized gain or loss onsecurities available-for-sale, minus certain intangible assets.  Tier 2 capital consists of the allowance forloan losses subject to certain limitations. Total capital for purposes of computing the capital ratios consists ofthe sum of Tier 1 and Tier 2 capital. The regulatory minimum requirements are 4% for Tier 1 and 8% for totalrisk-based capital.

 

The Company and the Bankare also required to maintain capital at a minimum level based on quarterlyaverage assets, which is known as the leverage ratio.  Only the strongest banks are allowed tomaintain capital at the minimum requirement of 3%.  All others are subject to maintaining ratios1% to 2% above the minimum.

 

As of December 31,2009, the most recent notifications from the Bank’s primary regulatorcategorized the Bank as “well-capitalized” under the regulatory framework forprompt corrective action.  Due to theimpact of the current economic environment on the Bank, we have developed acapital plan through which we intend to retain our “well-capitalized”designation and continue our growth.  Ourcapital plan outlines how we intend to remain “well-capitalized” by raisingadditional capital.  We are currentlyexploring a number of financing alternatives to strengthen the capital levelsof the Bank.

 

17

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# ** **

# **The Company and the Bank are required to maintain certain risk-basedand leverage ratios.  The Company and theBank exceeded these regulatory capital ratios at December 31, 2009, 2008,and 2007 as set forth in the following tables.**

** **
| **December 31,****(Dollars in thousands)** | ** ** | **2009** | ** **  | **2008**   | ** ** | **2007**    | ** ** |
|-------------------------------------------------|------------|----------|-------------|------------|------------|-------------|------------|
| **The Company**                                 |       |     |        |       |       |        |       |
| Tier  1 capital                                 |       | $        | 50,514      |       | $          | 39,352      |       | $ | 36,989 |   |
| Tier  2 capital                                 |       | 6,658    |        | 4,416      |       | 3,534       |       |
| Total  qualifying capital                       | ** ** | **$**    | **57,172**  | ** ** | **$**      | **43,768**  | ** ** | **$** | **40,523** | ** ** |
|                                            |       |     |        |       |       |        |       |
| Risk-adjusted  total assets                     |       |     |        |       |       |        |       |
| (including  off-balance-sheet exposures)        | ** ** | **$**    | **531,759** | ** ** | **$**      | **458,154** | ** ** | **$** | **361,051** | ** ** |
|                                            |       |     |        |       |       |        |       |
| Tier  1 risk-based capital ratio                |       | 9.50     | %           | 8.59       | %          | 10.24       | %          |
| Total  risk-based capital ratio                 |       | 10.75    | %           | 9.55       | %          | 11.22       | %          |
| Tier  1 leverage ratio                          |       | 6.94     | %           | 7.41       | %          | 9.38        | %          |
|                                            |       |     |        |       |       |        |       |
| **The Bank**                                    |       |     |        |       |       |        |       |
| Tier  1 capital                                 |       | $        | 49,959      |       | $          | 42,714      |       | $ | 36,100 |   |
| Tier  2 capital                                 |       | 6,658    |        | 4,416      |       | 3,534       |       |
| Total  qualifying capital                       | ** ** | **$**    | **56,617**  | ** ** | **$**      | **47,130**  | ** ** | **$** | **39,634** | ** ** |
|                                            |       |     |        |       |       |        |       |
| Risk-adjusted  total assets                     |       |     |        |       |       |        |       |
| (including  off-balance-sheet exposures)        | ** ** | **$**    | **531,795** | ** ** | **$**      | **457,174** | ** ** | **$** | **360,346** | ** ** |
|                                            |       |     |        |       |       |        |       |
| Tier  1 risk-based capital ratio                |       | 9.39     | %           | 9.35       | %          | 10.02       | %          |
| Total  risk-based capital ratio                 |       | 10.65    | %           | 10.31      | %          | 11.00       | %          |
| Tier  1 leverage ratio                          |       | 6.47     | %           | 6.86       | %          | 8.55        | %          |

 

The Company did not paycash dividends to shareholders during 2009 and the Company is prohibited fromdeclaring any dividends on its common stock until March 6, 2012 withTreasury’s approval unless the 12,985 shares of preferred stock have beenrepurchased from Treasury.

 

# **INVESTMENT PORTFOLIO**

# ** **

Management classifiesinvestment securities as either held-to-maturity or available-for-sale based ontheir intentions and the Company’s ability to hold them until maturity.  In determining such classifications, securitiesthat management has the positive intent and the Company has the ability to holduntil maturity are classified as held-to-maturity and carried at amortizedcost.  All other securities aredesignated as available-for-sale and carried at estimated fair value withunrealized gains and losses included in shareholders’ equity on an after-taxbasis.  As of December 31, 2009 and2008, all securities were classified as available-for-sale.

 

During 2009management began to grow the investment portfolio as a means to help buildliquidity and capital.  As principalpaydowns in our mortgage-backed securities increased, management decided torealize gains within the securities portfolio. There were $4,102,000 of gains realized in noninterest income for theCompany as of December 31, 2009.

 

18

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# ** **

The followingtables summarize the carrying value of investment securities as of theindicated dates and the weighted-average yields of those securities at December 31,2009.

 

**Investment Securities Portfolio Composition**

 
| **December 31,****(Dollars in thousands)** | ** ** | **2009** | ** **  | **2008**   | ** ** | **2007**    | ** ** |
|-------------------------------------------------|------------|----------|-------------|------------|------------|-------------|------------|
| Government-Sponsored  Enterprises               |       | $        | 27,511      |       | $          | 19,316      |       | $ | 20,447 |   |
| Obligations  of state and local governments     |       | 5,697    |        | 7,668      |       | 7,730       |       |
| Mortgage-backed  securities                     |       | 136,255  |        | 140,008    |       | 21,432      |       |
| Nonmarketable  equity securities                |       | 6,715    |        | 5,261      |       | 3,327       |       |
|                                            |       |     |        |       |       |        |       |
| **Total securities**                            | ** ** | **$**    | **176,178** | ** ** | **$**      | **172,253** | ** ** | **$** | **52,936** | ** ** |

 

**InvestmentSecurities Portfolio Maturity Schedule**

 
| ** **                                       | ** ** | **Available-for-Sale** | ** ** |
|--------------------------------------------------|------------|------------------------|------------|
| **December 31, 2009**                       | ** ** | **Carrying**           | ** ** | ** ** | ** ** |
| **(Dollars  in thousands)**                      | ** ** | **Amount**             | ** ** | **Yield** | ** ** |
| Government-Sponsored  Enterprises due:           |       |                   |       |   |   |
| After  one year but within five years            |       | 2,978                  |       | 2.84 | % |
| After  five years but within ten years           |       | 10,100                 |       | 4.77 | % |
| After  ten years                                 |       | 14,433                 |       | 5.06 | % |
|                                             |       |                   |       |   |   |
| Obligations  of states and local government due: |       |                   |       |   |   |
| One  year or less                                |       | 300                    |       | 3.23 | % |
| After  one year but within five years            |       | 2,112                  |       | 3.59 | % |
| After  five years but within ten years           |       | 2,649                  |       | 3.62 | % |
| After  ten years                                 |       | 636                    |       | 4.34 | % |
|                                             |       | 5,697                  |       | 3.67 | % |
|                                             |       |                   |       |   |   |
| Mortgage-backed  securities                      |       | 78,228                 |       | 3.76 | % |
|                                             |       |                   |       |   |   |
| Collateralized  Mortgage Obligation (CMOs)       |       | 58,027                 |       | 4.83 | % |
|                                             |       |                   |       |   |   |
| Nonmarketable  equity securities                 |       | 6,715                  |       |   |   |
|                                             |       |                   |       |   |   |
|                                             |       | $                      | 176,178    |   | 4.28 | % |
|                                                  |            |                        |            |  |  |  |

# ** **

# **LOAN PORTFOLIO**

# ** **

The Company hasexperienced continued growth of its loan portfolio throughout 2009 and 2008,resulting in increases of $62,614,000 and $76,832,000, respectively.  Management has concentrated on seeking tomaintain quality in the loan portfolio. The loan-to-deposit ratio is used tomonitor a financial institution’s potential profitability and efficiency ofasset distribution and utilization. Generally, a higher loan-to-deposit ratio is indicative of higherinterest income since loans typically yield a higher return than otherinterest-earning assets.  Theloan-to-deposit ratios were 85.02% and 88.51% at December 31, 2009 and2008, respectively.  The Company wantedto

 

19

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improve itsliquidity position by investing more in its securities portfolio, which notonly provides cash flow but also improves our capital position.  The loans-to-total borrowed funds ratio was69.12% and 71.00% at December 31, 2009 and 2008, respectively.  Management intends to deploy available fundsto loans to the extent it deems prudent to achieve its targeted ratio of loansto deposits; however, there can be no assurance that management will be able toexecute its strategy or that loan demand will continue to support growth.

 

The followingtable sets forth the composition of the loan portfolio by category for the fiveyears ended December 31, 2009 and highlights the Company’s generalemphasis on mortgage lending.

 
| **December 31,**                                 | ** ** | **Loan Portfolio Composition** | ** **  |
|--------------------------------------------------|------------|--------------------------------|-------------|
| **(Dollars in thousands)**                       | ** ** | **2009**                       | ** **  | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
| Real  estate - construction and land development |       | $                              | 95,788      |   | $ | 60,643 |   | $ | 59,084 |   | $ | 28,124 |   | $ | 18,686 |   |
| Real  estate - mortgage and commercial           |       | 305,561                        |        | 253,450 |   | 201,448 |   | 147,156 |   | 133,527 |   |
| Agricultural                                     |       | 10,338                         |        | 7,613 |   | 7,221 |   | 6,099 |   | 5,141 |   |
| Commercial  and industrial                       |       | 60,914                         |        | 84,568 |   | 64,019 |   | 54,313 |   | 55,909 |   |
| Consumer                                         |       | 15,871                         |        | 19,655 |   | 18,535 |   | 18,267 |   | 21,168 |   |
| All  other loans (including overdrafts)          |       | 3,180                          |        | 3,109 |   | 1,899 |   | 608 |   | 647 |   |
| **Total gross loans**                            | ** ** | **$**                          | **491,652** | ** ** | **$** | **429,038** | ** ** | **$** | **352,206** | ** ** | **$** | **254,567** | ** ** | **$** | **235,078** | ** ** |

 

The primary component ofour loan portfolio is loans collateralized by real estate, which made upapproximately 62.3% of our loan portfolio at December 31, 2009.  These loans are secured generally by first orsecond mortgages on residential, agricultural or commercial property.  These loans consist of commercial real estateloans, which as of December 31, 2009 totaled $251,617,000, or 62.44% ofour real estate loans.  We anticipatedecreasing our amount of commercial real estate loans in 2010.  There are no foreign loans, and agriculturalloans, as of December 31, 2009, are limited.  There are no significant concentrations ofloans in any particular individuals or industry or group of related individualsor industries.

 

## **Credit Risk Management**

## ** **

Credit risk entails bothgeneral risk, which is inherent in the process of lending, and risk that isspecific to individual borrowers.  Themanagement of credit risk involves the processes of loan underwriting and loanadministration.  The Company seeks tomanage credit risk through a strategy of making loans within the Company’sprimary marketplace and within the Company’s limits of expertise.  Although management seeks to avoidconcentrations of credit by loan type or industry through diversification, asubstantial portion of the borrowers’ ability to honor the terms of their loansis dependent on the business and economic conditions in Horry County in SouthCarolina and Columbus and Brunswick Counties in North Carolina.  A continuation of the economic downturn orprolonged recession could result in the deterioration of the quality of ourloan portfolio and reduce our level of deposits, which in turn would have anegative impact on our business. Additionally, since real estate is considered by the Company as the mostdesirable nonmonetary collateral, a significant portion of the Company’s loansare collateralized by real estate; however, the cash flow of the borrower orthe business enterprise is generally considered as the primary source ofrepayment.  Generally, the value of realestate is not considered by the Company as the primary source of repayment forperforming loans.  The Company also seeksto limit total exposure to individual and affiliated borrowers.  The Company seeks to manage risk specific toindividual borrowers through the loan underwriting process and through anongoing analysis of the borrower’s ability to service the debt as well as thevalue of the pledged collateral.

 

The Company’s loanofficers and loan administration staff are charged with monitoring the Company’sloan portfolio and identifying changes in the economy or in a borrower’scircumstances which may affect the ability to repay the

 

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debt or the value of thepledged collateral.  In order to assessand monitor the degree of risk in the Company’s loan portfolio, several creditrisk identification and monitoring processes are utilized.  The Company assesses credit risk initiallythrough the assignment of a risk grade to each loan based upon an assessment ofthe borrower’s financial capacity to service the debt and the presence andvalue of any collateral.

 

Credit grading isadjusted during the life of the loan to reflect economic and individual changeshaving an impact on the borrowers’ abilities to honor the terms of theircommitments.  Management uses the riskgrades as a tool for identifying known and inherent losses in the loanportfolio and for determining the adequacy of the allowance for loan losses.

 

**Maturities and Sensitivity ofLoans to Changes in Interest Rates:**

 

The following tablesummarizes the loan maturity distribution, by type, at December 31, 2009and related interest rate characteristics:

 
| ** **                                       | ** ** | ** **   | ** **  | **Over**        | ** ** | ** **     | ** ** | ** ** | ** **  |
|--------------------------------------------------|------------|--------------|-------------|-----------------|------------|----------------|------------|------------|-------------|
| ** **                                       | ** ** | ** **   | ** **  | **One Year**    | ** ** | ** **     | ** ** | ** ** | ** **  |
| **December 31, 2009**                       | ** ** | **One Year** | ** **  | **Through**     | ** ** | **Over  Five** | ** ** | ** ** | ** **  |
| **(Dollars in thousands)**                       | ** ** | **or Less**  | ** **  | **Five  Years** | ** ** | **Years**      | ** ** | **Total**  | ** **  |
| Real  estate - construction and land development |       | $            | 72,977      |            | $          | 21,541         |       | $          | 1,270       |   | $ | 95,788 |   |
| Real  estate - other                             |       | 128,112      |        | 147,210         |       | 30,239         |       | 305,561    |        |
| Agricultural                                     |       | 1,649        |        | 4,583           |       | 4,106          |       | 10,338     |        |
| Commercial  and industrial                       |       | 44,066       |        | 16,098          |       | 750            |       | 60,914     |        |
| Consumer                                         |       | 5,425        |        | 10,137          |       | 309            |       | 15,871     |        |
| All  other loans (including overdrafts)          |       | 2,937        |        | 243             |       | —         |       | 3,180      |        |
| ** **                                       | ** ** | ** **   | ** **  | ** **      | ** ** | ** **     | ** ** | ** ** |        |
| ** **                                       | ** ** | **$**        | **255,166** | ** **      | **$**      | **199,812**    | ** ** | **$**      | **36,674**  | ** ** | **$** | **491,652** |   |
| Loans  maturing after one year with:             |       |         |        |            |       |           |       |       |        |
| Fixed  interest rates                            |       |         |        |            |       |           |       | $          | 159,889     |   |
| Floating  interest rates                         |       |         |        |            |       |           |       | 74,292     |        |
|                                             |       |         |        |            |       |           |       |       |        |
| ** **                                       | ** ** |         |        |            |       |           |       | **$**      | **234,181** |   |

 

## **Risk Elements**

## ** **

Loans are defined asimpaired when it is probable that a creditor will be unable to collect allamounts due according to the contractual terms of the loan agreement.  Impairment of a loan is based on the presentvalue of the expected future cash flows discounted at the loan’s effectiveinterest rate or at the fair value of the collateral if the loan is collateraldependent.

 

Loans on the Company’sproblem loan watch list are considered potentially impaired loans.  These loans are evaluated in determiningwhether all outstanding principal and interest are expected to be collected.  Loans are not considered impaired if aminimal delay occurs and all amounts due, including accrued interest at thecontractual interest rate for the period of delay, are expected to becollected.

 

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# ** **

The following table setsforth our nonperforming assets for the dates indicated.

 
| **Nonperforming Assets**                                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| **(Dollars in thousands)**                                  | ** ** | **2009**   | ** ** | **2008**   | ** ** | **2007**   | ** ** | **2006**   | ** ** | **2005**   | ** ** |
| Nonaccrual  loans (includes impaired loans)                 |       | $          | 23,138     |       | $          | 9,040      |       | $          | 2,696      |       | $          | 760 |   | $ | 2,044 |   |
| Total  nonperforming loans                                  |       | 23,138     |       | 9,040      |       | 2,696      |       | 760        |       | 2,044      |       |
|                                                        |       |       |       |       |       |       |       |       |       |       |       |
| Other  real estate owned                                    |       | 6,432      |       | 2,965      |       | 338        |       | 95         |       | 485        |       |
|                                                        |       |       |       |       |       |       |       |       |       |       |       |
| Total  nonperforming assets                                 |       | $          | 29,570     |       | $          | 12,005     |       | $          | 3,034      |       | $          | 855 |   | $ | 2,529 |   |
| Loans  90 days or more past due and still accruing interest |       | —     |       | —     |       | —     |       | $          | 1,714      |       | 843        |   |
| Nonperforming  assets to period end loans                   |       | 6.01       | %          | 2.80       | %          | 0.86       | %          | 0.33       | %          | 1.08       | %          |

 

For loans to be inexcess of 90 days delinquent and still accruing interest, the borrowers must beeither remitting payments although not able to get current, liquidation onloans deemed to be well secured must be near completion, or the Company musthave a reason to believe that correction of the delinquency status by theborrower is near.  The amount of bothnonaccrual loans and loans past due 90 days or more were considered incomputing the allowance for loan losses as of December 31, 2009.  Generally, the Company places loans which arein excess of 90 days delinquent on nonaccrual status.  If the borrower is able to bring the accountcurrent, the loan is then placed back on regular accrual status.

 

22

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**Summaryof Loan Loss Experience**

 
| **(Dollars in thousands)**                                   | ** ** | **2009**   | ** ** | **2008**   | ** ** | **2007**   | ** ** | **2006**   | ** ** | **2005**   | ** ** |
|--------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| Total  loans outstanding at end of period                    |       | $          | 491,652    |       | $          | 429,038    |       | $          | 354,214    |       | $          | 256,800 |   | $ | 235,669 |   |
| Average  loans outstanding                                   |       | $          | 469,675    |       | $          | 385,277    |       | $          | 302,965    |       | $          | 247,614 |   | $ | 226,528 |   |
|                                                         |       |       |       |       |       |       |       |       |       |       |       |
| Balance  of allowance for loan losses at beginning of period |       | $          | 4,416      |       | $          | 3,535      |       | $          | 2,718      |       | $          | 2,569 |   | $ | 2,155 |   |
|                                                         |       |       |       |       |       |       |       |       |       |       |       |
| Charge-offs:                                                 |       |       |       |       |       |       |       |       |       |       |       |
| Real  estate                                                 |       | 8,056      |       | 385        |       | —     |       | 4          |       | 122        |       |
| Commercial                                                   |       | 1,448      |       | 550        |       | 54         |       | 418        |       | 382        |       |
| Consumer  and credit card                                    |       | 248        |       | 294        |       | 165        |       | 289        |       | 287        |       |
| Other  Loans                                                 |       | 56         |       | 23         |       | —     |       | —     |       | —     |       |
| **Total charge-offs**                                        | ** ** | **9,808**  | ** ** | **1,252**  | ** ** | **219**    | ** ** | **711**    | ** ** | **791**    | ** ** |
|                                                         |       |       |       |       |       |       |       |       |       |       |       |
| Recoveries  of loans previous charge-off                     |       | 2,556      |       | 379        |       | 51         |       | 90         |       | 135        |       |
| **Net charge-offs**                                          | ** ** | **7,252**  | ** ** | **873**    | ** ** | **168**    | ** ** | **621**    | ** ** | **656**    | ** ** |
|                                                         |       |       |       |       |       |       |       |       |       |       |       |
| Provision  charged to operations                             |       | 10,361     |       | 1,754      |       | 985        |       | 770        |       | 1,070      |       |
|                                                         |       |       |       |       |       |       |       |       |       |       |       |
| **Balance of allowance for loan losses at end of period**    | ** ** | $          | 7,525      | ** ** | $          | 4,416      | ** ** | $          | 3,535      | ** ** | $          | 2,718 | ** ** | $ | 2,569 | ** ** |
| **Ratios:**                                                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net  charge-offs to average loans outstanding                |       | 1.54       | %          | 0.23       | %          | 0.06       | %          | 0.25       | %          | 0.29       | %          |
| Net  charge-offs to loans at end of year                     |       | 1.48       | %          | 0.20       | %          | 0.05       | %          | 0.24       | %          | 0.28       | %          |
| Allowance  for loan losses to average loans                  |       | 1.60       | %          | 1.15       | %          | 1.17       | %          | 1.10       | %          | 1.13       | %          |
| Allowance  for loan losses to loans at end of year           |       | 1.53       | %          | 1.03       | %          | 1.00       | %          | 1.06       | %          | 1.09       | %          |
| Net  charge-offs to allowance for loan losses                |       | 96.37      | %          | 19.77      | %          | 4.75       | %          | 22.85      | %          | 25.54      | %          |
| Net  charge-offs to provisions for loan losses               |       | 69.99      | %          | 49.77      | %          | 17.06      | %          | 80.65      | %          | 61.31      | %          |

 

Management hasestablished an allowance for loan losses through a provision for loan lossescharged to expense on our statements of income.  The allowance represents an amount whichmanagement believes will be adequate to absorb probable losses on existingloans that may become uncollectible. Management does not allocate specific percentages of our allowance forloan losses to the various categories of loans but evaluates the adequacy on anoverall portfolio basis utilizing several factors.  The primary factor considered is the creditrisk grading system, which is applied to each loan.  The amount of both nonaccrual loans and loanspast due 90 days or more is also considered. The historical loan loss experience, the size of our lending portfolio,changes in the lending policies and

 

23

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procedures, changes in volume or type of credits, changes involume/severity of problem loans, quality of loan review and board of directoroversight, concentrations of credit, and peer group comparisons, andcurrent and anticipated economic conditions are also considered in determiningthe provision for loan losses. The amount of the allowance is adjustedperiodically based on changing circumstances. Recognized losses are charged to theallowance for loan losses, while subsequent recoveries are added to theallowance.

 

Management regularlymonitors past due and classified loans. However, it should be noted that no assurances can be made that futurecharges to the allowance for loan losses or provisions for loan losses may notbe significant to a particular accounting period.  At December 31, 2009 and 2008,management considered the allowances for loan losses adequate based on itsjudgments, evaluations, and analysis of the loan portfolio.

 

Management’s judgment asto the adequacy of the allowance is based upon a number of assumptions aboutfuture events which it believes to be reasonable, but which may or may notprove to be accurate.  Because of theinherent uncertainty of assumptions made during the evaluation process, therecan be no assurance that loan losses in future periods will not exceed theallowance for loan losses or that additional allocations will not berequired.  Our losses will undoubtedlyvary from our estimates, and there is a possibility that charge-offs in futureperiods will exceed the allowance for loan losses as estimated at any point intime.

 

At December 31,2009, the nonperforming assets to period end loans increased to 6.01% from2.80% and 0.86% at December 31, 2008 and 2007, respectively.  The increase in nonperforming assets havewarranted an increase in the allowance for loan losses as a percentage ofperiod ending loans of 1.53% at December 31, 2009 compared with 1.15% at December 31,2008.  As of December 31, 2009 and2008, the Company had nonaccrual loans of approximately $23,138,000 and$9,040,000, respectively.  These loanscomprise a substantial majority of loans classified as impaired.  A significant portion, or 96.18%, ofnonperforming loans at December 31, 2009 were secured by real estate.  Our real estate loans consist of commercialreal estate loans, which as of December 31, 2009 constituted 78.26% of ournonperforming loans.  We have evaluatedthe underlying collateral on these loans and believe that the collateral onthese loans is sufficient to minimize future losses.  However, therecent downturn in the real estate market has resulted in increased loandelinquencies, defaults and foreclosures, and we believe that these trends arelikely to continue.  In some cases, thisdownturn has resulted in a significant impairment to the value of thecollateral used to secure these loans and the ability to sell the collateralupon foreclosure.  These conditions haveadversely affected our loan portfolio. The real estate collateral in each case provides an alternate source ofrepayment in the event of default by the borrower and may deteriorate in valueduring the time the credit is extended. If real estate values continue to decline, it is also more likely thatwe would be required to increase our allowance for loan losses.  If during a period of reduced real estatevalues we are required to liquidate the property collateralizing a loan tosatisfy the debt or to increase the allowance for loan losses, this couldmaterially reduce our profitability and adversely affect our financialcondition.

 

24

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# **AVERAGE DAILY DEPOSITS**

# ** **

The followingtable summarizes the Company’s average daily deposits during the years ended December 31,2009, 2008, and 2007.  These totalsinclude time deposits $100,000 and over, which at December 31, 2009totaled $115,762,000.  Of this total,scheduled maturities within three months were $22,010,000; over three throughtwelve months were $75,515,000; and over twelve months were $18,237,000.

 

The adverseeconomic environment has also placed greater pressure on our deposits, and wehave taken steps to decrease our reliance on brokered deposits, while at thesame time the competition for local deposits among banks in our market has beenincreasing.  We generally obtainout-of-market time deposits of $100,000 or more through brokers with whom wemaintain ongoing relationships.  As of December 31,2009, we had brokered deposits of $104 million, representing 18% of our totaldeposits as compared to $122 million, representing 25.2% of our total depositsas of December 31, 2008.

 
| ** **                            | ** ** | **2009**    | ** **  | **2008**    | ** ** | **2007**    | ** ** |
|---------------------------------------|------------|-------------|-------------|-------------|------------|-------------|------------|
| ** **                            | ** ** | ** **  | ** **  | **Average** | ** ** | ** **  | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                            | ** ** | **Average** | ** **  | **Rate**    | ** ** | **Average** | ** ** | **Rate** | ** ** | **Average** | ** ** | **Rate** | ** ** |
| ** **                            | ** ** | **Amount**  | ** **  | **Paid**    | ** ** | **Amount**  | ** ** | **Paid** | ** ** | **Amount** | ** ** | **Paid** | ** ** |
| Noninterest-bearing demand            |       | $           | 32,675      |        | 0.00       | %           | $          | 33,282 |   | 0.00 | % | $ | 31,545 |   | 0.00 | % |
| Interest-bearing transaction accounts |       | 41,533      |        | 0.23        |       | 46,376      |       | 0.56 |   | 47,171 |   | 1.19 |   |
| Money market savings account          |       | 125,770     |        | 2.02        |       | 93,125      |       | 2.19 |   | 102,532 |   | 4.54 |   |
| Other savings accounts                |       | 6,568       |        | 2.34        |       | 5,602       |       | 1.34 |   | 5,402 |   | 1.22 |   |
| Time deposits                         |       | 346,296     |        | 2.48        |       | 233,013     |       | 3.79 |   | 121,164 |   | 4.94 |   |
| Total deposits                        |       | $           | **552,842** |        |       | ** **  | **$**      | **411,398** |   |   | ** ** | **$** | **307,814** |   |   |   |

 

**ADVANCESFROM THE FEDERAL HOME LOAN BANK**

 

The followingtable summarizes the Company’s short-term borrowings for the years ended December 31,2009, 2008 and 2007.

 
| ** **                            | ** ** | **Maximum**     | ** ** | ** **  | ** ** | **Weighted** | ** ** | ** **           | ** ** |
|---------------------------------------|------------|-----------------|------------|-------------|------------|--------------|------------|----------------------|------------|
| ** **                            | ** ** | **Outstanding** | ** ** | ** **  | ** ** | **Average**  | ** ** | ** **           | ** ** |
| ** **                            | ** ** | **at any**      | ** ** | **Average** | ** ** | **Interest** | ** ** | **Balance**          | ** ** |
| **(Dollars in thousands)**            | ** ** | **Month  End**  | ** ** | **Balance** | ** ** | **Rate**     | ** ** | **December 31** | ** ** |
| **2009**                              |       |            |       |        |       |         |       |                 |       |
| Advances  from Federal Home Loan Bank |       | $               | 118,800    |        | $          | 106,946      |       | 3.33                 | %          | $ | 118,800 |   |
| **2008**                              |       |            |       |        |       |         |       |                 |       |
| Advances  from Federal Home Loan Bank |       | $               | 92,500     |        | $          | 65,195       |       | 3.37                 | %          | $ | 92,000 |   |
| **2007**                              |       |            |       |        |       |         |       |                 |       |
| Advances  from Federal Home Loan Bank |       | $               | 52,300     |        | $          | 45,674       |       | 4.46                 | %          | $ | 52,300 |   |

 

Advances from the FederalHome Loan Bank are collateralized by one-to-four family residential mortgageloans, certain commercial real estate loans, certain securities in the Bank’sinvestment portfolio and the Company’s investment in Federal Home Loan Bankstock.  Although we expect to continueusing Federal Home Loan Bank advances as a secondary funding source, coredeposits will continue to be our primary funding source.  Of the $118,800,000 advances from FederalHome Loan Bank outstanding at December 31, 2009, $14,600,000 havescheduled principal reductions in 2010, $5,500,000 in 2011, $17,500,000 in 2012and the remainder after five years.

 

25

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# **Asdiscussed in the notes to the financial statements, the Company entered into interestrate swap agreements associated with Federal Home Loan Bank advances maturingon March 1, 2010, May 24, 2010 and March 22, 2011.  The interest rate swaps effectively convertedthe fixed interest rates on the advances to a variable rate.  In May 2009, management decided toterminate the interest rate swaps on these FHLB advances.  The unwinding of these swaps resulted in again of $82,000.**

# ** **

**JUNIORSUBORDINATED DEBENTURES**

 

On December 21,2004, HCSB Financial Trust I (the “Trust”), a non-consolidated subsidiary ofthe Company, issued and sold a total of 6,000 trust preferred securities, with$1,000 liquidation amount per capital security (the “Capital Securities”), toinstitutional buyers in a pooled trust preferred issue.  The Capital Securities, which are reported onthe consolidated balance sheet as junior subordinated debentures, generatedproceeds of $6 million.  The Trust loanedthese proceeds to the Company to use for general corporate purposes.  The junior subordinated debentures qualify asTier 1 capital under Federal Reserve Board guidelines, subject tolimitations.  See Note 11 to theconsolidated financial statements for more information about the terms of thejunior subordinated debentures.

 

Debt issuancecosts, net of accumulated amortization, from junior subordinated debenturestotaled $91,361 and $95,028 at December 31, 2009 and 2008, respectively,and are included in other assets on the consolidated balance sheet.  Amortization of debt issuance costs fromjunior subordinated debentures totaled $3,667 for the years ended December 31,2009, and December 31, 2008, and are reported in other expenses on theconsolidated income statement for the years ended December 31, 2009, and December 31,2008.

 

# **RETURN ON EQUITY AND ASSETS**

# ** **

The following table showsthe return on average assets (net income divided by average total assets),return on average equity (net income divided by average daily equity), andequity to assets ratio (average daily equity divided by average total assets)for the period indicated.  Since itsinception, the Company has not paid cash dividends.

 
| ** **                | ** ** | **2009** | ** ** | **2008** | ** ** | **2007** | ** ** |
|---------------------------|------------|----------|------------|----------|------------|----------|------------|
| Return on average  assets |       | (0.19    | )%         | 0.42     | %          | 0.52     | %          |
| Return on average  equity |       | (3.03    | )%         | 6.96     | %          | 6.94     | %          |
| Equity to assets ratio    |       | 6.12     | %          | 6.07     | %          | 7.46     | %          |

 

# **ACCOUNTING AND FINANCIALREPORTING ISSUES**

# ** **

We have adopted various accounting policies, which govern theapplication of accounting principles generally accepted in the United States inthe preparation of our financial statements. Our significant accounting policies are described in the footnotes tothe consolidated financial statements at December 31, 2009, as filed onour annual report on Form 10-K. Certain accounting policies involvesignificant judgments and assumptions by us which have a material impact on thecarrying value of certain assets and liabilities.  We consider these accounting policies to becritical accounting policies. The judgments and assumptions we use are based onhistorical experience and other factors, which we believe to be reasonableunder the circumstances.  Because of thenature of the judgments and assumptions we make, actual results could differfrom these judgments and estimates which could have a material impact on ourcarrying values of assets and liabilities and our results of operations.

 

We believe the allowancefor loan losses is a critical accounting policy that requires the mostsignificant judgments and estimates used in preparation of our consolidatedfinancial statements.  Refer to theportion of this discussion that addresses our allowance for loan losses for adescription of our processes and methodology for determining our allowance forloan losses.

 

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# **INDUSTRY DEVELOPMENTS**

# ** **

**Sarbanes-OxleyAct of 2002**

 

The Congress of theUnited States of America passed the Sarbanes-Oxley Act in 2002 in the aftermathof corporate scandals among several major publicly traded corporations.  The intent of the Act was to legislatecorporate governance and better ascertain the accuracy of financial reportingby companies regulated by the Securities and Exchange Commission.

 

Section 404 of theSarbanes-Oxley Act, which became effective for the Company in 2008, requiresthat the Company adopt and maintain effective internal controls that will,among other things, permit the preparation of financial statements inconformity with accounting principles generally accepted in the United Statesof America.

 

Management of the Companyhas the responsibility to adopt sound accounting policies, maintain an adequateand efficient accounting system, safeguard assets and devise policies to ensurethat the Company complies with applicable laws and regulations.

 

From time to time,various bills are introduced in the United States Congress with respect to theregulation of financial institutions. Certain of these proposals, if adopted, could significantly change theregulation of banks and the financial services industry.  The Company cannot predict whether any ofthese proposals will be adopted or, if adopted, how these proposals wouldaffect the Company.

 

**Recent Legislative and RegulatoryInitiatives to Address Financial and Economic Crises**

 

The Congress, TreasuryDepartment and the federal banking regulators, including the FDIC, have takenbroad action since early September 2008 to address volatility in the U.S.banking system.

 

In October 2008, theEmergency Economic Stabilization Act of 2008 (“EESA”) wasenacted. The EESA authorizes the Treasury Department to purchase fromfinancial institutions and their holding companies up to $700 billion inmortgage loans, mortgage-related securities and certain other financialinstruments, including debt and equity securities issued by financialinstitutions and their holding companies in a troubled asset relief program (“TARP”).  Thepurpose of TARP is to restore confidence and stability to the U.S. bankingsystem and to encourage financial institutions to increase their lending tocustomers and to each other.  The Treasury Department has allocated$250 billion towards the TARP Capital Purchase Program (“CPP”).  Underthe CPP, Treasury will purchase debt or equity securities from participatinginstitutions.  The TARP also will include direct purchases orguarantees of troubled assets of financial institutions. Participants inthe CPP are subject to executive compensation limits and are encouraged toexpand their lending and mortgage loan modifications.

 

On March 6, 2009, aspart of the TARP CPP, the Company entered into a Letter Agreement andSecurities Purchase Agreement (collectively, the “CPP Purchase Agreement”) withthe Treasury Department, pursuant to which the Company sold (i) 12,895shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series T(the “Series T Preferred Stock”) and (ii) a warrant (the “CPP Warrant”)to purchase 91,714 shares of the Company’s common stock for an aggregatepurchase price of $12,895,000 in cash.

 

The Series TPreferred Stock will qualify as Tier 1 capital and will be entitled tocumulative dividends at a rate of 5% per annum for the first five years, and 9%per annum thereafter.  The Company mustconsult with the FDIC before it may redeem the Series T Preferred Stockbut, contrary to the original restrictions in the EESA, will not necessarily berequired to raise additional equity capital in order to redeem this stock.  The Warrant has a 10-year term and isimmediately exercisable upon its issuance, with an exercise price, subject toanti-dilution adjustments, equal to $21.09 per share of the common stock.Please see the Form 8-K we filed with the SEC on March 6, 2009, foradditional information about the Series T Preferred Stock and the Warrant.

 

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Pursuant to the terms ofthe certificate of designations creating the Series T Preferred Stock, wemay only redeem the Series T Preferred Stock at par after May 15,2012. Prior to this date, we may redeem the Series T Preferred Stock atpar if (i) we have raised aggregate gross proceeds in one or moreQualified Equity Offerings (as defined in the Purchase Agreement) in excess ofapproximately $3.2 million, and (ii) the aggregate redemption price doesnot exceed the aggregate net proceeds from such Qualified Equity Offerings. Anyredemption is subject to the consent of the Board of Governors of the FederalReserve System.  However, pursuant to theterms of American Recovery and Reinvestment Act (the “Recovery Act”) whichmodified EESA, we may, upon consultation with our primary federal regulator,repay the amount received for the Series T Preferred Stock at any time,without regard to whether we have replaced such funds from any source or to anywaiting period. Upon repayment of the amount received for the Series TPreferred Stock, the Treasury Department will also liquidate the associatedWarrant in accordance with the Recovery Act and any rules and regulationsthereunder.

 

EESA also increased FDICdeposit insurance on most accounts from $100,000 to $250,000.  This increase is in place until the end of2013 and is not covered by deposit insurance premiums paid by the bankingindustry.

 

On October 14, 2008,the FDIC established the Temporary Liquidity Guarantee Program (“TLGP”).  TLGP includes the Transaction AccountGuarantee Program (“TAGP”), which provides unlimited deposit insurance coveragethrough June 30, 2010 for noninterest-bearing transaction accounts(typically business checking accounts) and certain funds swept intononinterest-bearing savings accounts. Institutions participating in TLGP pay a 10 basis points fee(annualized) on the balance of each covered account in excess of $250,000,while the extra deposit insurance is in place. TLGP also includes the Debt Guarantee Program (“DGP”), under which theFDIC guarantees certain newly-issued senior unsecured debt.  The guarantee applied to new debt issued onor before October 31, 2009 and provides protection until December 31,2012.  Participants in DGP pay a 75 basispoint fee for the guarantee.  TAGP andDGP are in effect for all eligible entities, unless the entity opted out on orbefore December 5, 2008.  We areparticipating in the TAGP and opted out of the DGP.

 

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

 

·                                          A capital assistance program that invested inmandatory convertible preferred stock of certain qualifying institutionsdetermined on a basis and through a process similar to the CPP;

 

·                                          A consumer and business lending initiative to fund newconsumer loans, small business loans and commercial mortgage asset-backedsecurities issuances;

 

·                                          A public-private investment fund program that isintended to leverage public and private capital with public financing topurchase up to $500 billion to $1 trillion of legacy “toxic assets” fromfinancial institutions; and

 

·                                          Assistance for homeowners by providing up to $75billion to reduce mortgage payments and interest rates and establishing loanmodification guidelines for government and private programs.

 

On February 17,2009, the Recovery Act was signed into law in an effort to, among other things,create jobs and stimulate growth in the United States economy.  The Recovery Act specifies appropriations ofapproximately $787 billion for a wide range of Federal programs and willincrease or extend certain benefits payable under the Medicaid, unemploymentcompensation, and nutrition assistance programs.  The Recovery Act also reduces individual andcorporate income tax collections and makes a variety of other changes to taxlaws.  The Recovery Act also imposescertain limitations on compensation paid by participants in TARP.

 

On March 23, 2009,Treasury, in conjunction with the FDIC and the Federal Reserve, announced thePublic-Private Partnership Investment Program for Legacy Assets which consistsof two separate plans, addressing two distinct asset groups:

 

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·                                          The first plan is the Legacy Loan Program, which has aprimary purpose to facilitate the sale of troubled mortgage loans by eligibleinstitutions, including FDIC-insured federal or state banks and savingsassociations. Eligible assets are not strictly limited to loans; however, whatconstitutes an eligible asset will be determined by participating banks, theirprimary regulators, the FDIC and the Treasury. Under the Legacy Loan Program,the FDIC has sold certain troubled assets out of an FDIC receivership in twoseparate transactions relating to the failed Illinois bank, Corus Bank, NA, andthe failed Texas bank, Franklin Bank, S.S.B. These transactions were completedin September 2009 and October 2009, respectively.

 

·                                          The second plan is the Securities Program, which isadministered by the Treasury and involves the creation of public-private investmentfunds to target investments in eligible residential mortgage-backed securitiesand commercial mortgage-backed securities issued before 2009 that originallywere rated AAA or the equivalent by two or more nationally recognizedstatistical rating organizations, without regard to rating enhancements(collectively, “Legacy Securities”). Legacy Securities must be directly securedby actual mortgage loans, leases or other assets, and may be purchased onlyfrom financial institutions that meet TARP eligibility requirements. Treasuryreceived over 100 unique applications to participate in the Legacy SecuritiesPPIP and in July 2009 selected nine public-private investment fundmanagers.  As of December 31, 2009,public-private investment funds have completed initial and subsequent closingson approximately $6.2 billion of private sector equity capital, which wasmatched 100% by Treasury, representing $12.4 billion of total equity capital.Treasury has also provided $12.4 billion of debt capital, representing $24.8billion of total purchasing power. As of December 31, 2009, public-privateinvestment funds have drawn-down approximately $4.3 billion of total capitalwhich has been invested in certain non-agency residential mortgage backedsecurities and commercial mortgage backed securities and cash equivalentspending investment.

 

**Insuranceof Accounts and Regulation by the FDIC**

 

Our deposits are insuredup to applicable limits by the Deposit Insurance Fund of theFDIC.  The Deposit Insurance Fund is the successor to the BankInsurance Fund and the Savings Association Insurance Fund, which were mergedeffective March 31, 2006.  As insurer, the FDIC imposes depositinsurance premiums and is authorized to conduct examinations of and to requirereporting by FDIC insured institutions.  It also may prohibit anyFDIC insured institution from engaging in any activity the FDIC determines byregulation or order to pose a serious risk to the insurancefund.  The FDIC also has the authority to initiate enforcementactions against savings institutions, after giving the Office of ThriftSupervision an opportunity to take such action, and may terminate the depositinsurance if it determines that the institution has engaged in unsafe orunsound practices or is in an unsafe or unsound condition.

 

Under regulationseffective January 1, 2007, the FDIC adopted a new risk-based premiumsystem that provides for quarterly assessments based on an insured institution’sranking in one of four risk categories based upon supervisory and capital evaluations. Institutions are assessed at annual rates ranging from 5 to 43 basis points,respectively, depending on each institution’s risk of default as measured byregulatory capital ratios and other supervisory measures.  In May 2009,the FDIC issued a final rule which levied a special assessment applicableto all insured depository institutions totaling 5 basis points of eachinstitution’s total assets less Tier 1 capital as of June 30, 2009, not toexceed 10 basis points of domestic deposits. This special assessment was part of the FDIC’s efforts to rebuild theDeposit Insurance Fund.  We paid thisone-time special assessment in the amount of $326,158 to the FDIC at the end ofthe third quarter 2009.

 

In November 2009,the FDIC issued a rule that required all insured depository institutions,with limited exceptions, to prepay their estimated quarterly risk-basedassessments for the fourth quarter of 2009 and for all of 2010, 2011 and2012.  The FDIC also adopted a uniformthree-basis point increase in assessment rates effective on January 1,2011.  In December 2009, we paid $3,746,273 in prepaid risk-based assessments, which included $238,939 related tothe fourth quarter of 2009 that would have been otherwise payable in the firstquarter of 2010.

 

29

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This amount is includedin deposit insurance expense for 2009. The remaining $3,507,334 in prepaid deposit insurance is included inprepaid expenses in our other assets category for 2009.  As a result, we incurred increased insurancecosts during 2009 than in previous periods.

 

FDIC insured institutionsare required to pay a Financing Corporation assessment, in order to fund theinterest on bonds issued to resolve thrift failures in the 1980s.  For thequarterly period ended December 31, 2008, the Financing Corporationassessment equaled 1.61 basis points for each $100 in domesticdeposits.    These assessments, which may be revised basedupon the level of deposits, will continue until the bonds mature in the years2017 through 2019.

 

The FDIC may terminatethe deposit insurance of any insured depository institution, including thebank, if it determines after a hearing that the institution has engaged inunsafe or unsound practices, is in an unsafe or unsound condition to continueoperations or has violated any applicable law, regulation, rule, order orcondition imposed by the FDIC or the OCC.  It also may suspenddeposit insurance temporarily during the hearing process for the permanenttermination of insurance, if the institution has no tangible capital.  Ifinsurance of accounts is terminated, the accounts at the institution at thetime of the termination, less subsequent withdrawals, shall continue to beinsured for a period of six months to two years, as determined by theFDIC.  Management of the bank is not aware of any practice, conditionor violation that might lead to termination of the bank’s deposit insurance.

 

# **MANAGEMENT’S ANNUAL REPORTON INTERNAL CONTROL OVER FINANCIAL REPORTING**

# ** **

Management of HCSBFinancial Corporation and its subsidiary Horry County State Bank is responsiblefor establishing and maintaining adequate internal control over financialreporting. The Company’s internal control system was designed to providereasonable assurance to management and the Board of Directors regarding thepreparation and fair presentation of published financial statements.

 

Because of its inherentlimitations, internal control over financial reporting may not prevent ordetect misstatements. Also, projections of any evaluation of effectiveness tofuture periods are subject to the risk that controls may become inadequatebecause of changes in conditions, or that the degree of compliance with thepolicies or procedures may deteriorate.

 

The Company’s management assessedthe effectiveness of the Company’s internal control over financial reporting asof December 31, 2009. Based on this assessment management believes that asof December 31, 2009, the Company’s internal control over financialreporting was effective.  Managementbased this assessment on criteria for effective internal control over financialreporting described in *“Internal Control —Integrated Framework issued by the Committee of Sponsoring Organizations of theTreadway Commission.”* Management’s assessment included an evaluation of the design of ourinternal control over financial reporting and testing of the operationaleffectiveness of its internal control over financial reporting.  Management reviewed the results of itsassessment with the Audit Committee of the Board of Directors.  Based on this assessment, management believesthat HCSB Financial Corporation maintained effective internal control overfinancial reporting as of December 31, 2009.

 

This annual report doesnot include an attestation report of the Company’s registered public accountingfirm regarding internal control over financial reporting. Management’s reportwas not subject to attestation by the Company’s registered public accountingfirm pursuant to temporary rules of the Securities and Exchange Commissionthat permit the Company to provide only management’s report in this annualreport.

 

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## **REPORT OF INDEPENDENT REGISTERED PUBLICACCOUNTING FIRM**

## ** **

The Board of Directors

HCSB Financial Corporationand Subsidiary

Loris, South Carolina

 

We have audited theaccompanying consolidated balance sheets of HCSB Financial Corporation and itssubsidiary as of December 31, 2009 and 2008, and the related consolidatedstatements of operations, changes in shareholders’ equity and comprehensiveincome, and cash flows for the years then ended.  These consolidated financial statements arethe responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statementsbased on our audits.

 

We conducted our auditsin accordance with the standards of the Public Company Accounting OversightBoard (United States). Those standards require that we plan and perform theaudit to obtain reasonable assurance about whether the financial statements arefree of material misstatement.  An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements. An audit also includes assessing the accounting principles used and thesignificant estimates made by management as well as evaluating the overallfinancial statement presentation.  Webelieve that our audits provide a reasonable basis for our opinion.

 

In our opinion, theconsolidated financial statements referred to above present fairly, in allmaterial respects, the financial position of HCSB Financial Corporation and itssubsidiary as of December 31, 2009 and 2008, and the results of theiroperations and their cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles.

 

We were not engaged toexamine management’s assertion of the effectiveness of HCSB FinancialCorporation’s internal control over financial reporting as of December 31,2009, included in Management’s Annual Report on Internal Control over FinancialReporting and, accordingly, we do not express an opinion thereon.

 
| /s/ Elliott Davis, LLC    |   |
|---------------------------|--------|
| Elliott Davis, LLC        |   |
| Columbia, South  Carolina |   |
| March 10, 2010            |   |

 

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** **

**HCSB FINANCIAL CORPORATION ANDSUBSIDIARY**

** **

**ConsolidatedBalance Sheets**

** **
| ** **                                                                                                                                                            | ** ** | **December 31,** | ** **  |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|-------------|
| **(Dollars in thousands except share amounts)**                                                                                                                       | ** ** | **2009**              | ** **  | **2008** | ** ** |
| **Assets:**                                                                                                                                                           |       |                  |        |   |   |
| Cash and cash equivalents:                                                                                                                                            |       |                  |        |   |   |
| Cash and due from banks                                                                                                                                               |       | $                     | 44,902      |   | $ | 10,423 |   |
| Federal funds sold                                                                                                                                                    |       | 1,407                 |        | — |   |
| Total cash and cash equivalents                                                                                                                                       |       | 46,309                |        | 10,423 |   |
| Investment securities:                                                                                                                                                |       |                  |        |   |   |
| Securities available-for-sale                                                                                                                                         |       | 169,463               |        | 166,992 |   |
| Nonmarketable equity securities                                                                                                                                       |       | 6,715                 |        | 5,261 |   |
| Total investment securities                                                                                                                                           |       | 176,178               |        | 172,253 |   |
|                                                                                                                                                                  |       |                  |        |   |   |
| Loans held for sale                                                                                                                                                   |       | 1,669                 |        | 70 |   |
|                                                                                                                                                                  |       |                  |        |   |   |
| Loans receivable                                                                                                                                                      |       | 491,652               |        | 429,038 |   |
| Less allowance for loan losses                                                                                                                                        |       | (7,525                | )           | (4,416 | ) |
| Loans, net                                                                                                                                                            |       | 484,127               |        | 424,622 |   |
|                                                                                                                                                                  |       |                  |        |   |   |
| Premises, furniture and equipment, net                                                                                                                                |       | 24,152                |        | 19,056 |   |
| Accrued interest receivable                                                                                                                                           |       | 4,120                 |        | 3,625 |   |
| Cash value of life insurance                                                                                                                                          |       | 9,492                 |        | 8,465 |   |
| Other assets                                                                                                                                                          |       | 13,602                |        | 5,833 |   |
| Total assets                                                                                                                                                          | ** ** | **$**                 | **759,649** | ** ** | **$** | **644,347** | ** ** |
|                                                                                                                                                                  | ** ** | ** **            | ** **  | ** ** | ** ** |
| **Liabilities:**                                                                                                                                                      |       |                  |        |   |   |
| Deposits:                                                                                                                                                             |       |                  |        |   |   |
| Noninterest-bearing transaction accounts                                                                                                                              |       | $                     | 31,661      |   | $ | 31,285 |   |
| Interest-bearing transaction accounts                                                                                                                                 |       | 41,354                |        | 45,228 |   |
| Money market savings accounts                                                                                                                                         |       | 152,553               |        | 94,008 |   |
| Other savings accounts                                                                                                                                                |       | 6,623                 |        | 5,661 |   |
| Time deposits $100 and over                                                                                                                                           |       | 115,762               |        | 81,082 |   |
| Other time deposits                                                                                                                                                   |       | 230,339               |        | 227,487 |   |
| Total deposits                                                                                                                                                        |       | 578,292               |        | 484,751 |   |
|                                                                                                                                                                  |       |                  |        |   |   |
| Federal Funds purchased                                                                                                                                               |       | —                |        | 7,653 |   |
| Repurchase agreements                                                                                                                                                 |       | 8,031                 |        | 9,172 |   |
| Advances from the Federal Home Loan Bank                                                                                                                              |       | 118,800               |        | 92,000 |   |
| Notes payable                                                                                                                                                         |       | —                |        | 4,500 |   |
| Junior subordinated debentures                                                                                                                                        |       | 6,186                 |        | 6,186 |   |
| Accrued interest payable                                                                                                                                              |       | 1,444                 |        | 2,105 |   |
| Other liabilities                                                                                                                                                     |       | 1,824                 |        | 3,530 |   |
| Total liabilities                                                                                                                                                     |       | 714,577               |        | 609,897 |   |
|                                                                                                                                                                  |       |                  |        |   |   |
| **Commitments and Contingencies  (Notes 4, 12 and 13)**                                                                                                               |       |                  |        |   |   |
| ** **                                                                                                                                                            |       |                  |        |   |   |
| **Shareholders’ Equity:**                                                                                                                                        |       |                  |        |   |   |
| Preferred stock, $1,000 par value; Authorized  5,000,000 shares; Issued and outstanding 12,895 and 0 shares at December 31,  2009 And 2008, respectively         |       | 11,962                |        | — |   |
| Common stock, $0.01 par value, 10,000,000 shares  authorized; 3,787,170 and 3,788,293 shares issued and outstanding at  December 31, 2009 and 2008, respectively |       | 38                    |        | 38 |   |
| Capital surplus                                                                                                                                                       |       | 30,856                |        | 30,728 |   |
| Common stock warrants                                                                                                                                                 |       | 1,012                 |        | — |   |
| Nonvested restricted stock                                                                                                                                            |       | (645                  | )           | (645 | ) |
| Retained earnings                                                                                                                                                     |       | 1,291                 |        | 3,231 |   |
| Accumulated other comprehensive income                                                                                                                                |       | 558                   |        | 1,098 |   |
| Total shareholders’ equity                                                                                                                                       |       | 45,072                |        | 34,450 |   |
| Total liabilities and shareholders’ equity                                                                                                                       | ** ** | **$**                 | **759,649** | ** ** | **$** | **644,347** | ** ** |

 

The accompanying notes are an integral part of the consolidatedfinancial statements.

 

32

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**HCSBFINANCIAL CORPORATION AND SUBSIDIARY**

 

**Consolidated Statements of Operations**

 
| ** **                                               | ** ** | **Years ended December 31,** | ** ** |
|----------------------------------------------------------|------------|-----------------------------------|------------|
| **(Dollars in thousands except share amounts)**          | ** ** | **2009**                          | ** ** | **2008** | ** ** |
| **Interest income:**                                     |       |                              |       |   |   |
| Loans, including fees                                    |       | $                                 | 25,997     |   | $ | 25,600 |   |
| Investment securities:                                   |       |                              |       |   |   |
| Taxable                                                  |       | 7,810                             |       | 4,955 |   |
| Tax-exempt                                               |       | 236                               |       | 295 |   |
| Nonmarketable equity securities                          |       | 32                                |       | 177 |   |
| Federal funds sold and other                             |       | 26                                |       | 112 |   |
| Total                                                    |       | 34,101                            |       | 31,139 |   |
|                                                     |       |                              |       |   |   |
| **Interest expense:**                                    |       |                              |       |   |   |
| Deposits                                                 |       | 11,632                            |       | 11,215 |   |
| Borrowings                                               |       | 3,961                             |       | 3,322 |   |
| Total                                                    |       | 15,593                            |       | 14,537 |   |
|                                                     |       |                              |       |   |   |
| **Net interest income**                                  | ** ** | **18,508**                        | ** ** | **16,602** | ** ** |
|                                                     |       |                              |       |   |   |
| Provision for loan losses                                |       | 10,361                            |       | 1,754 |   |
|                                                     |       |                              |       |   |   |
| **Net interest income after  provision for loan losses** | ** ** | **8,147**                         | ** ** | **14,848** | ** ** |
|                                                     |       |                              |       |   |   |
| **Noninterest income:**                                  |       |                              |       |   |   |
| Service charges on deposit accounts                      |       | 1,610                             |       | 1,700 |   |
| Credit life insurance commissions                        |       | 46                                |       | 52 |   |
| Gain on sale of residential mortgage loans               |       | 634                               |       | 534 |   |
| Brokerage commissions                                    |       | 234                               |       | 145 |   |
| Other fees and commissions                               |       | 319                               |       | 281 |   |
| Gain (Losses) on sales of securities                     |       | 4,102                             |       | 439 |   |
| Income from cash value life insurance                    |       | 480                               |       | 313 |   |
| Other                                                    |       | 138                               |       | 122 |   |
| Total                                                    |       | 7,563                             |       | 3,586 |   |
|                                                     |       |                              |       |   |   |
| **Noninterest expenses:**                                |       |                              |       |   |   |
| Salaries and employee benefits                           |       | 9,791                             |       | 8,889 |   |
| Net occupancy                                            |       | 1,190                             |       | 1,112 |   |
| Marketing and advertising                                |       | 457                               |       | 450 |   |
| Loss on sale of assets                                   |       | 171                               |       | (15 | ) |
| Provision for losses on OREO                             |       | 336                               |       | 259 |   |
| Furniture and equipment                                  |       | 1,320                             |       | 1,259 |   |
| Loss on other than temporary impairment                  |       | 122                               |       | — |   |
| FDIC insurance premiums                                  |       | 1,237                             |       | 436 |   |
| Other operating                                          |       | 3,274                             |       | 2,696 |   |
| Total                                                    |       | 17,898                            |       | 15,086 |   |
|                                                     |       |                              |       |   |   |
| **Income (loss) before income taxes**                    | ** ** | **(2,188**                        | **)**      | **3,348** | ** ** |
| Income tax provision (benefit)                           |       | (840                              | )          | 1,104 |   |
| **Net income (loss)**                                    | ** ** | **$**                             | **(1,348** | **)** | **$** | **2,244** | ** ** |
|                                                     |       |                              |       |   |   |
| Accretion of preferred stock to redemption value         |       | (146                              | )          | — |   |
| Preferred dividends accrued                              |       | (163                              | )          | — |   |
|                                                     |       |                              |       |   |   |
| **Net income (loss) available to  common shareholders**  | ** ** | **(1,657**                        | **)**      | **$** | **2,244** | ** ** |
|                                                     |       |                              |       |   |   |
| **Net income per common share**                          |       |                              |       |   |   |
| Basic                                                    | ** ** | **$**                             | **(0.44**  | **)** | **$** | **0.59** | ** ** |
| Diluted                                                  | ** ** | **$**                             | **(0.44**  | **)** | **$** | **0.59** | ** ** |
| **Average common shares  outstanding**                   |       |                              |       |   |   |
| Basic                                                    | ** ** | **3,787,327**                     | ** ** | **3,788,296** | ** ** |
| Diluted                                                  | ** ** | **3,787,327**                     | ** ** | **3,829,061** | ** ** |

 

The accompanying notesare an integral part of the consolidated financial statements.

 

33

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**HCSBFINANCIAL CORPORATION AND SUBSIDIARY**

 

**Consolidated Statements of Shareholders’ Equityand Comprehensive Income**

**Years ended December 31, 2009 and 2008**

** **
| ** **                                                    | ** ** | ** **        | ** ** | ** ** | ** ** | ** **           | ** ** | ** **     | ** ** | ** **  | ** ** | ** **    | ** ** | ** **        | ** ** | ** **    | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
|---------------------------------------------------------------|------------|-------------------|------------|------------|------------|----------------------|------------|----------------|------------|-------------|------------|---------------|------------|-------------------|------------|---------------|------------|-----------------|------------|------------|------------|
| ** **                                                    | ** ** | ** **        | ** ** | ** ** | ** ** | **Common**           | ** ** | ** **     | ** ** | ** **  | ** ** | **Nonvested** | ** ** | ** **        | ** ** | **Retained**  | ** ** | **other**       | ** ** | ** ** | ** ** |
| **(Dollars in thousands except**                              | ** ** | **Common  Stock** | ** ** | **Stock**  | ** ** | **Preferred  Stock** | ** ** | **Restricted** | ** ** | **Capital** | ** ** | **Earnings**  | ** ** | **comprehensive** | ** ** | ** **    | ** ** |
| **share data)**                                               | ** ** | **Shares**        | ** ** | **Amount** | ** ** | **Warrants**         | ** ** | **Shares**     | ** ** | **Amount**  | ** ** | **Stock**     | ** ** | **Surplus**       | ** ** | **(deficit)** | ** ** | **income**      | ** ** | **Total**  | ** ** |
| **Balance, December 31, 2007**                           | ** ** | **3,677,974**     | ** ** | **37**     | ** ** | **$**                | **—** | ** **     | **—** | ** **  | **$**      | **—**    | ** ** | **(645**          | **)**      | **28,689**    | ** ** | **2,908**       | ** ** | **(6**     | **)**      | **30,983** | ** ** |
| Net income for the  period                                    |       |              |       |       |       |                 |       |           |       |        |       |          |       |              |       | 2,244         |       |            |       | 2,244      |       |
| Other comprehensive  income, net of tax                       |       |              |       |       |       |                 |       |           |       |        |       |          |       |              |       |          |       | 1,104           |       | 1,104      |       |
| Comprehensive income                                          |       |              |       |       |       |                 |       |           |       |        |       |          |       |              |       |          |       |            |       | 3,348      |       |
| Payment of fractional  shares                                 |       | (19               | )          |       |       |                 |       |           |       |        |       |          |       |              |       | (28           | )          |            |       | (28        | )          |
| Declaration of 3% stock  dividend on January 22, 2009    |       | 110,338           |       | 1          |       |                 |       |           |       |        |       |          |       | 1,892             |       | 1,893         |       |            |       | —     |       |
| Stock compensation  expense                                   |       |              |       |       |       |                 |       |           |       |        |       |          |       | 147               |       |          |       |            |       | 147        |       |
| **Balance, December 31, 2008**                           | ** ** | **3,788,293**     | ** ** | **$**      | **38**     | ** **           | **$**      | **—**     | ** ** | **—**  | ** ** | **$**         | **—** | ** **        | **$**      | **(645**      | **)**      | **$**           | **30,728** | ** ** | **$**      | **3,231** | ** ** | **$** | **1,098** | ** ** | **$** | **34,450** | ** ** |
| Adjustment due to 3%  stock dividend of January 22, 2009 |       | (1,123            | )          |       |       |                 |       |           |       |        |       |          |       | (19               | )          | 19            | ** ** | ** **      | ** ** | **—** | ** ** |
| Net loss for the period                                       |       |              |       |       |       |                 |       |           |       |        |       |          |       |              |       | (1,348        | )          |            |       | (1,348     | )          |
| Other comprehensive  income, net of tax                       |       |              |       |       |       |                 |       |           |       |        |       |          |       |              |       |          |       | (540            | )          | (540       | )          |
| Comprehensive loss                                            |       |              |       |       |       |                 |       |           |       |        |       |          |       |              |       |          |       |            |       | (1,888     | )          |
| Issuance of preferred  stock                                  |       |              |       |       |       |                 |       | 12,895         |       | 11,816      |       |          |       |              |       |          |       |            |       | 11,816     |       |
| Issuance of common  stock warrants                            |       |              |       |       |       | 1,012                |       |           |       |        |       |          |       |              |       |          |       |            |       | 1,012      |       |
| Accretion of preferred  stock to redemption value             |       |              |       |       |       |                 |       |           |       | 146         |       |          |       |              |       | (146          | )          |            |       | —     |       |
| Stock compensation  expense                                   | ** ** | ** **        |       |       | ** ** | ** **           | ** ** | ** **     |       |        |       |          |       | 147               |       |          |       |            |       | 147        |       |
| Payment of dividend on  preferred stock                       | ** ** | ** **        |       |       | ** ** | ** **           | ** ** | ** **     |       |        |       |          |       |              |       | (446          | )          |            |       | (446       | )          |
| Payment of fractional  shares                                 |       |              |       |       |       |                 |       |           |       |        |       |          |       |              |       | (19           | )          |            |       | (19        | )          |
| **Balance, December 31, 2010**                           | ** ** | **3,787,170**     | ** ** | **$**      | **38**     | ** **           | **$**      | **1,012**      | ** ** | **12,895**  | ** ** | **$**         | **11,962** | ** **        | **$**      | **(645**      | **)**      | **$**           | **30,856** | ** ** | **$**      | **1,291** | ** ** | **$** | **558** | ** ** | **$** | **45,072** | ** ** |

 

34

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**HCSB FINANCIAL CORPORATION AND SUBSIDIARY**

 

**Consolidated Statements of Cash Flows**

 
| ** **                                                                                              | ** ** | **Years ended December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| **(Dollars in thousands)**                                                                              | ** ** | **2009**                          | ** ** | **2008** | ** ** |
| **Cash flows from operating  activities:**                                                              |       |                              |       |   |   |
| Net income                                                                                              |       | $                                 | (1,348     | ) | $ | 2,244 |   |
| Adjustments to reconcile net income to net cash  provided (used) by operating activities:               |       |                              |       |   |   |
| Provision for loan losses                                                                               |       | 10,361                            |       | 1,754 |   |
| (Increase) decrease on deferred income tax benefit                                                      |       | 909                               |       | (207 | ) |
| Depreciation expense                                                                                    |       | 944                               |       | 874 |   |
| Premium amortization less discount accretion                                                            |       | 673                               |       | 105 |   |
| Amortization of net deferred loan costs                                                                 |       | 41                                |       | 14 |   |
| Gain on sale of securities available-for-sale                                                           |       | (4,102                            | )          | (439 | ) |
| Loss on sale of other real estate owned                                                                 |       | 520                               |       | 271 |   |
| Gain on disposal of premises and equipment                                                              |       | —                            |       | (18 | ) |
| (Increase) decrease in loans held for sale                                                              |       | (1,599                            | )          | 1,938 |   |
| Increase in interest receivable                                                                         |       | (495                              | )          | (152 | ) |
| Increase (decrease) in interest payable                                                                 |       | (661                              | )          | 1,123 |   |
| Increase in other assets                                                                                |       | (5,638                            | )          | (363 | ) |
| Loss on other than temporary impairment investment                                                      |       | 122                               |       | — |   |
| Stock compensation expense                                                                              |       | 147                               |       | 147 |   |
| Increase (decrease) in other liabilities                                                                |       | (1,388                            | )          | 834 |   |
|                                                                                                    |       |                              |       |   |   |
| Net cash provided (used) by operating activities                                                        |       | (1,514                            | )          | 8,125 |   |
|                                                                                                    |       |                              |       |   |   |
| **Cash flows from investing  activities:**                                                              |       |                              |       |   |   |
| Purchases of securities available-for-sale                                                              |       | (193,140                          | )          | (145,348 | ) |
| Maturities of securities available-for-sale                                                             |       | 90,213                            |       | 15,370 |   |
| Proceeds from sales of securities  available-for-sale                                                   |       | 103,027                           |       | 14,681 |   |
| Net increase in loans to customers                                                                      |       | (76,397                           | )          | (81,858 | ) |
| Purchase of premises, furniture and equipment                                                           |       | (6,040                            | )          | (3,880 | ) |
| Proceeds from sale of premises, furniture and  equipment                                                |       | —                            |       | 19 |   |
| Proceeds from sale of other real estate owned                                                           |       | 2,503                             |       | 1,241 |   |
| Purchase of life insurance contracts                                                                    |       | (600                              | )          | (7,503 | ) |
| Purchase of nonmarketable equity securities                                                             |       | (1,576                            | )          | (1,934 | ) |
|                                                                                                    |       |                              |       |   |   |
| Net cash used by investing activities                                                                   |       | (82,010                           | )          | (209,212 | ) |
|                                                                                                    |       |                              |       |   |   |
| **Cash flows from financing  activities:**                                                              |       |                              |       |   |   |
| Net increase (decrease) in demand deposits,  interest-bearing transaction accounts and savings accounts |       | 56,009                            |       | (12,667 | ) |
| Net increase in time deposits                                                                           |       | 37,532                            |       | 156,567 |   |
| Net increase (decrease) in notes payable                                                                |       | (4,500                            | )          | 4,500 |   |
| Net increase in FHLB borrowings                                                                         |       | 26,800                            |       | 39,700 |   |
| Dividend paid on preferred stock                                                                        |       | (446                              | )          | — |   |
| Net increase in preferred stock                                                                         |       | 12,828                            |       | — |   |
| Net increase in repurchase agreements                                                                   |       | (1,141                            | )          | 4,172 |   |
| Increase in federal funds purchased                                                                     |       | (7,653                            | )          | 7,653 |   |
| Cash paid for fractional shares                                                                         |       | (19                               | )          | (28 | ) |
|                                                                                                    |       |                              |       |   |   |
| Net cash provided by financing activities                                                               |       | 119,410                           |       | 199,897 |   |
|                                                                                                    |       |                              |       |   |   |
| **Net increase (decrease) in cash  and cash equivalents**                                               |       | 35,886                            |       | (1,190 | ) |
| ** **                                                                                              |       |                              |       |   |   |
| **Cash and cash equivalents,  beginning of year**                                                       |       | 10,423                            |       | 11,613 |   |
| ** **                                                                                              |       |                              |       |   |   |
| **Cash and cash equivalents, end of  year**                                                             | ** ** | **$**                             | **46,309** | ** ** | **$** | **10,423** | ** ** |

 

35

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**HCSB FINANCIAL CORPORATION AND SUBSIDIARY**

 

**NOTE 1 - ORGANIZATION ANDSIGNIFICANT ACCOUNTING POLICIES**

 

**Basisof Presentation and Consolidation** - The accompanyingconsolidated financial statements include the accounts of HCSB FinancialCorporation which was incorporated on June 10, 1999 (the Company) to serveas a bank holding company for its subsidiary and its wholly owned subsidiary,Horry County State Bank (the Bank).  TheCompany was incorporated on June 10, 1999. The Bank was incorporated onDecember 18, 1987, and opened for operations on January 4, 1988.  The principal business activity of theCompany is to provide commercial banking services in Horry County, SouthCarolina, and in Columbus and Brunswick Counties, North Carolina.  The Bank is a state-chartered bank, and itsdeposits are insured by the Federal Deposit Insurance Corporation.  HCSB Financial Trust I (The Trust) is aspecial purpose subsidiary organized for the sole purpose of issuing trustpreferred securities.  The operations ofthe Trust have not been consolidated in these financial statements.

 

**Management’sEstimates** - In preparing the consolidated financialstatements, management is required to make estimates and assumptions thataffect the reported amounts of assets and liabilities as of the balance sheetdate and income and expenses for the period. Actual results could differ significantly from those estimates.

 

Materialestimates that are particularly susceptible to significant change relate to thedetermination of the allowance for loan losses, including valuation allowancesfor impaired loans, and the carrying amount of real estate acquired inconnection with foreclosures or in satisfaction of loans.  Management must also make estimates in determiningthe estimated useful lives and methods for depreciating premises and equipment.

 

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

 

**InvestmentSecurities** - Investment securities available-for-sale by theCompany are carried at amortized cost and adjusted to their estimated fairvalue.  The unrealized gain or loss isrecorded in shareholders’ equity net of the deferred tax effects.  Management does not actively trade securitiesclassified as available-for-sale, but intends to hold these securities for anindefinite period of time and may sell them prior to maturity to achievecertain objectives.  Reductions in fairvalue considered by management to be other than temporary are reported as arealized loss and a reduction in the cost basis in the security.  The adjusted cost basis of securitiesavailable-for-sale is determined by specific identification and is used incomputing the realized gain or loss from a sales transaction.

 

**NonmarketableEquity Securities** - Nonmarketable equity securities includethe Company’s investments in the stock of the Federal Home Loan Bank atDecember 31, 2009 and 2008 and Silverton Bank at December 31,2008.  The stocks are carried at costbecause they have no quoted market value and no ready market exists.  Investment in Federal Home Loan Bank stock isa condition of borrowing from the Federal Home Loan Bank, and the stock is pledgedto collateralize the borrowings.  Dividends received on Federal Home Loan Bankstock and Silverton Bank stock are included as a separate component in interestincome.

 

At December 31, 2009 and 2008, theinvestment in Federal Home Loan Bank stock was $6,504,000 and $4,928,000,respectively.  The investment inSilverton Bank stock was $122,000 at December 31, 2008 and this amount wasrecorded as a realized loss on other-than-temporary impairment of value in 2009due to Silverton’s closure by the FDIC. The Company also had a $25,000 investment in the holding company of acommunity bank at December 31, 2009 and 2008.  Also included in nonmarketable equities isinvestment in the Trust, which totaled $186,000 at December 31, 2009 and2008.

 

36

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**HCSBFINANCIAL CORPORATION AND SUBSIDIARY**

 

**NOTE 1 - ORGANIZATION ANDSIGNIFICANT ACCOUNTING POLICIES** - *continued*

 

**Loansheld for Sale** - Loans held for sale consist of residentialmortgage loans the Company originates for sale to secondary market investors.  They are carried at the lower of aggregatecost or market value.  Net unrealizedlosses, if any, are recognized through a valuation allowance by charges toincome.  Fees collected in conjunctionwith origination activities are deferred as part of the cost basis of the loanand recognized when the loan is sold. Gains or losses on sales are recognized when the loans are sold and aredetermined as the difference between the sales price and the carrying value ofthe loans.

 

TheCompany issues rate lock commitments to borrowers based on prices quoted bysecondary market investors.  When ratesare locked with borrowers, a sales commitment is immediately entered (on a bestefforts basis) at a specified price with a secondary market investor.  Accordingly, any potential liabilitiesassociated with rate lock commitments are offset by sales commitments toinvestors.

 

**LoansReceivable** - Loans receivable are stated at their unpaidprincipal balance.  Interest income onloans is computed based upon the unpaid principal balance.  Interest income is recorded in the periodearned.

 

Theaccrual of interest income is generally discontinued when a loan becomescontractually 90 days past due as to principal or interest.  Management may elect to continue the accrualof interest when the estimated net realizable value of collateral exceeds theprincipal balance and accrued interest.

 

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

 

Loans are defined as impaired when it isprobable that a creditor will be unable to collect all amounts due according tothe contractual terms of the loan agreement. All loans are subject to this criteria except for smaller balancehomogeneous loans that are collectively evaluated for impairment and loansmeasured at fair value or at the lower of cost or fair value.  The Company considers its consumerinstallment portfolio, credit card loans, and home equity lines as suchexceptions.  Therefore, loans within thereal estate and commercial loan portfolios are reviewed individually.

 

Impairmentof a loan is measured based on the present value of expected future cash flowsdiscounted at the loan’s effective interest rate or the fair value of thecollateral if the loan is collateral dependent. When management determines that a loan is impaired, the differencebetween the Company’s investment in the related loan and the present value ofthe expected future cash flows, or the fair value of the collateral, is chargedoff with a corresponding entry to the allowance for loan losses.  The accrual of interest is discontinued on animpaired loan when management determines the borrower may be unable to meetpayments as they become due.  Asdiscussed in Note 4, nonaccrual loans comprise a substantial majority of loansclassified as impaired at December 31, 2009 and 2008.

 

**Concentrations of Credit Risk** - Financialinstruments, which potentially subject the Company to concentrations of creditrisk, consist principally of loans receivable, investment securities, federalfunds sold and amounts due from banks.

 

TheCompany makes loans to individuals and small businesses for various personaland commercial purposes primarily throughout Horry County in South Carolina andColumbus and Brunswick counties of North Carolina.  The Company’s loan portfolio is not concentratedin loans to any single borrower or a relatively small number of borrowers.Additionally, management is not aware of any concentrations of loans to classesof borrowers or industries that would be similarly affected by economicconditions except for loans secured by residential and commercial real estateand commercial and industrial non-real estate loans.  These concentrations of residential andcommercial real estate loans and commercial and industrial non-real estateloans totaled $266,751,000 and $60,915,000, respectively, at December 31,2009, representing 591.84% and 135.15%, respectively, of total equity and55.10% and 12.58%, respectively, of net loans receivable.

 

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**HCSBFINANCIAL CORPORATION AND SUBSIDIARY**

 

**NOTE 1 - ORGANIZATION ANDSIGNIFICANT ACCOUNTING POLICIES** - *continued*

 

**Concentrations of Credit Risk***(continued)* - In addition to monitoring potentialconcentrations of loans to particular borrowers or groups of borrowers,industries and geographic regions, management monitors exposure to credit riskfrom concentrations of lending products and practices such as loans thatsubject borrowers to substantial payment increases (e.g. principal deferralperiods, loans with initial interest-only periods, etc.), and loans with high loan-to-valueratios. Management has determined that there is no concentration of credit riskassociated with its lending policies or practices. Additionally, there areindustry practices that could subject the Company to increased credit riskshould economic conditions change over the course of a loan’s life.  For example, the Company makes variable rateloans and fixed rate principal-amortizing loans with maturities prior to theloan being fully paid (i.e. balloon payment loans).  These loans are underwritten and monitored tomanage the associated risks.  Therefore,management believes that these particular practices do not subject the Companyto unusual credit risk.

 

TheCompany’s investment portfolio consists principally of obligations of theUnited States, its agencies or its corporations and general obligationmunicipal securities.  In the opinion ofmanagement, there is no concentration of credit risk in its investmentportfolio.  The Company places itsdeposits and correspondent accounts with and sells its federal funds to highquality institutions.  Managementbelieves credit risk associated with correspondent accounts is not significant.

 

**Allowancefor Loan Losses** - Management believes that the allowance isadequate to absorb inherent losses in the loan portfolio; however, assessingthe adequacy of the allowance is a process that requires considerablejudgment.  Management’s judgments arebased on numerous assumptions about current events, which management believesto be reasonable, but which may or may not be valid.  Thus there can be no assurance that loanlosses in future periods will not exceed the current allowance amount or thatfuture increases in the allowance will not be required.  No assurance can be given that management’songoing evaluation of the loan portfolio in light of changing economicconditions and other relevant circumstances will not require significant futureadditions to the allowance, thus adversely affecting the operating results ofthe Company.

 

Theallowance is subject to examination by regulatory agencies, which may considersuch factors as the methodology used to determine adequacy and the size of theallowance relative to that of peer institutions, and other adequacy tests.  In addition, such regulatory agencies couldrequire the Company to adjust its allowance based on information available tothem at their examination.

 

Themethodology used to determine the reserve for unfunded lending commitments,which is included in other liabilities, is inherently similar to that used to determinethe allowance for loan losses adjusted for factors specific to bindingcommitments, including the probability of funding and historical loss ratio.

 

**Premises,Furniture and Equipment** - Premises, furniture andequipment are stated at cost less accumulated depreciation.  The provision for depreciation is computed bythe straight-line method.  Rates ofdepreciation are generally based on the following estimated useful lives:  buildings - 40 years; furniture and equipment- 3 to 25 years.  The cost of assets soldor otherwise disposed of and the related accumulated depreciation is eliminatedfrom the accounts, and the resulting gains or losses are reflected in theincome statement.

 

Maintenanceand repairs are charged to current expense as incurred, and the costs of majorrenewals and improvements are capitalized.

 

**OtherReal Estate Owned** - Other real estate owned includes realestate acquired through foreclosure. Other real estate owned is initially recorded at the lower of cost(principal balance of the former loan plus costs of improvements) or fairvalue, less estimated costs to sell.

 

Anywrite-downs at the dates of acquisition are charged to the allowance for loanlosses.  Expenses to maintain suchassets, subsequent write-downs, and gains and losses on disposal are includedin other expenses.

 

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**HCSBFINANCIAL CORPORATION AND SUBSIDIARY**

 

**NOTE 1 - ORGANIZATION ANDSIGNIFICANT ACCOUNTING POLICIES** - *continued*

 

**DerivativeFinancial Instruments** - The Company has entered into certaininterest rate swap agreements which are derivative financial instruments(“derivatives”).  The derivatives arerecognized as other assets on the balance sheet at their fair value. On thedate the derivative contract is entered into, the Company designates thederivative as a hedge of fair value of a recognized asset or liability (“fairvalue hedge”).  Changes in the fair valueof a derivative that is highly effective as - and that is designated andqualifies - as a fair value hedge, along with the loss or gain on the hedgedasset or liability that is attributable to the hedged risk, are recorded incurrent-period earnings.

 

TheCompany formally documents all relationships between hedging instruments andhedged items, as well as its risk-management objective and strategy forundertaking hedged transactions.  Thisprocess includes linking all derivatives that are designated as fair valuehedges to specific assets and liabilities on the balance sheet.  The derivatives in which the Company is acounterparty qualify for the “shortcut” method of assessing the ongoingeffectiveness of its hedging relationship with the underlying hedged item.  The Company discontinues hedge accountingprospectively when (1) the derivative expires or is sold, terminated, orexercised; (2) management determines that designation of the derivative asa hedge instrument is no longer appropriate; or (3) the underlying hedgeditem is liquidated.  When hedge accountingis discontinued, the derivative is carried at its fair value on the balancesheet, with changes in its fair value recognized in current-period earnings.

 

**Incomeand Expense Recognition** - The accrual method ofaccounting is used for all significant categories of income and expense.  Immaterial amounts of insurance commissionsand other miscellaneous fees are reported when received.

 

**IncomeTaxes** - Amounts provided for income taxes are based onincome reported for financial statement purposes. Deferred income taxes areprovided for the temporary differences between the financial reporting basisand the tax basis of the Company’s assets and liabilities.  Deferred tax assets are reduced by avaluation allowance when, in the opinion of management, it is more likely thannot that some portion or all of the deferred tax assets will not be realized.Management has determined that it is more likely than not that the entiredeferred tax asset at December 31, 2009, will not be realized, andaccordingly, has established a valuation allowance.  Deferred tax assets and liabilities areadjusted for the effects of changes in tax laws and rates on the date ofenactment.

 

TheCompany believes that its income tax filing positions taken or expected to betaken in its tax returns will more likely than not be sustained upon audit bythe taxing authorities and does not anticipate any adjustments that will resultin a material adverse impact on the Company’s financial condition, results ofoperations, or cash flow.  Therefore noreserves for uncertain income tax positions have been recorded.

 

**AdvertisingExpense** - Advertising and public relations costs aregenerally expensed as incurred.  Externalcosts incurred in producing media advertising are expensed the first time theadvertising takes place.  External costsrelating to direct mailing costs are expensed in the period in which the directmailings are sent.  Advertising andpublic relations costs of $457,000 and $450,000 were included in the Company’sresults of operations for 2009 and 2008, respectively.

 

**NetIncome (Loss) Per Share** - Basic income (loss) pershare is calculated by dividing net income (loss) by the weighted-averagenumber of shares outstanding during the year. Diluted net income per share is computed based on net income divided bythe weighted average number of common and potential common shares.  Retroactive recognition has been given forthe effects of all stock dividends and splits in computing the weighted-averagenumber of shares.  The only potentialcommon share equivalents are those related to stock options and restrictedstock awards.  Stock options which areanti-dilutive are excluded from the calculation of diluted net income pershare.

 

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**HCSBFINANCIAL CORPORATION AND SUBSIDIARY**

 

**NOTE 1 - ORGANIZATION ANDSIGNIFICANT ACCOUNTING POLICIES** - *continued*

 

**ComprehensiveIncome** - Accounting principles generally requirerecognized income, expenses, gains, and losses to be included in netincome.  Although certain changes inassets and liabilities, such as unrealized gains and losses onavailable-for-sale securities, are reported as a separate component of theequity section of the balance sheet, such items, along with net income, arecomponents of comprehensive income.

 

Thecomponents of other comprehensive income and related tax effects are asfollows:

 
| ** **                                                             | ** ** | **Years  Ended December 31,** | ** ** |
|------------------------------------------------------------------------|------------|------------------------------------|------------|
| **(Dollars in thousands)**                                             | ** ** | **2009**                           | ** ** | **2008** | ** ** |
| Unrealized  gains on securities available-for-sale                     |       | $                                  | 3,245      |   | $ | 2,191 |   |
| Reclassification  adjustment for (gains) losses realized in net income |       | (4,102                             | )          | (439 | ) |
|                                                                   |       |                               |       |   |   |
| Net  unrealized losses on securities                                   |       | (857                               | )          | 1,752 |   |
|                                                                   |       |                               |       |   |   |
| Tax  effect                                                            |       | 317                                |       | (648 | ) |
|                                                                   |       |                               |       |   |   |
| Net-of-tax  amount                                                     | ** ** | **$**                              | **(540**   | **)** | **$** | **1,104** | ** ** |

 

**Statementsof Cash Flows******- For purposes of reportingcash flows, the Company considers certain highly liquid debt instrumentspurchased with a maturity of three months or less to be cash equivalents.  Cash equivalents include amounts due frombanks, federal funds sold, and time deposits with other banks with maturities ofthree months or less.

 

Thefollowing summarizes supplemental cash flow information:

 
| ** **                                                | ** ** | **Years  ended December 31,** | ** ** |
|-----------------------------------------------------------|------------|------------------------------------|------------|
| **(Dollars in thousands)**                                | ** ** | **2009**                           | ** ** | **2008** | ** ** |
|                                                      |       |                               |       |   |   |
| Cash  paid for interest                                   |       | $                                  | 16,254     |   | $ | 13,414 |   |
|                                                      |       |                               |       |   |   |
| Cash  paid for income taxes                               |       | 831                                |       | 1,344 |   |
|                                                      |       |                               |       |   |   |
| Supplemental  noncash investing and financing activities: |       |                               |       |   |   |
| Transfers  of loans to other real estate owned            |       | 6,490                              |       | 2,639 |   |
|                                                           |            |                                    |            |  |  |  |  |

 

**Off-Balance-SheetFinancial Instruments** - In the ordinary course of business, theCompany enters into off-balance-sheet financial instruments consisting ofcommitments to extend credit and letters of credit.  These financial instruments are recorded inthe financial statements when they become payable by the customer.

 

**RecentlyIssued Accounting Pronouncements** — The following is asummary of recent authoritative pronouncements.

 

In June 2009, the Financial AccountingStandards Board (“FASB”) issued guidance which restructured generally acceptedaccounting principles (“GAAP”) and simplified access to all authoritativeliterature by providing a single source of authoritative nongovernmentalGAAP.  The guidance is presented in atopically organized structure referred to as the FASB Accounting StandardsCodification (“ASC”). The new structure is effective for interim or annualperiods ending after September 15, 2009. All existing accounting standardshave been superseded and all other accounting literature not included isconsidered nonauthoritative.

 

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**HCSBFINANCIAL CORPORATION AND SUBSIDIARY**

 

**NOTE 1 - ORGANIZATION AND SIGNIFICANTACCOUNTING POLICIES** - *continued*

 

The FASB issued new accounting guidance onaccounting for transfers of financial assets in June 2009.  The guidance limits the circumstances inwhich a financial asset should be derecognized when the transferor has nottransferred the entire financial asset by taking into consideration thetransferor’s continuing involvement.  Thestandard requires that a transferor recognize and initially measure at fairvalue all assets obtained (including a transferor’s beneficial interest) andliabilities incurred as a result of a transfer of financial assets accountedfor as a sale.  The concept of aqualifying special-purpose entity is no longer applicable.  The standard is effective for the firstannual reporting period that begins after November 15, 2009, for interimperiods within the first annual reporting period, and for interim and annualreporting periods thereafter.  Earlierapplication is prohibited.  The Companydoes not expect the guidance to have any impact on the Company’s financialstatements.

 

In January 2010, guidance was issued toalleviate diversity in the accounting for distributions to shareholders thatallow the shareholder to elect to receive their entire distribution in cash orshares but with a limit on the aggregate amount of cash to be paid.  The amendment states that the stock portionof a distribution to shareholders that allows them to elect to receive cash orshares with a potential limitation on the total amount of cash that allshareholders can elect to receive in the aggregate is considered a shareissuance.  The amendment is effective forinterim and annual periods ending on or after December 15, 2009 and had noimpact on the Company’s financial statements.

 

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

 

**Risksand Uncertainties** - In the normal course of its business, theCompany encounters two significant types of risks: economic andregulatory.  There are three maincomponents of economic risk:  interestrate risk, credit risk and market risk. The Company is subject to interest rate risk to the degree that itsinterest-bearing liabilities mature or reprice at different speeds, or ondifferent basis, than its interest-earning assets.  Credit risk is the risk of default on theCompany’s loan portfolio that results from borrower’s inability orunwillingness to make contractually required payments.  Market risk reflects changes in the value ofcollateral underlying loans receivable and the valuation of real estate held bythe Company.

 

TheCompany is subject to the regulations of various governmental agencies.  These regulations can and do changesignificantly from period to period.  TheCompany also undergoes periodic examinations by the regulatory agencies, whichmay subject it to further changes with respect to asset valuations, amounts of requiredloss allowances and operating restrictions from the regulators’ judgments basedon information available to them at the time of their examination.

 

Additionally,the Company is subject to certain regulations due to our participation in theCapital Purchase Program.  Pursuant tothe terms of the CPP Purchase Agreement between us and the Treasury, we adoptedcertain standards for executive compensation and corporate governance for theperiod during which the Treasury holds the equity issued pursuant to the CPPPurchase Agreement, including the common stock which may be issued pursuant tothe CPP Warrant.  These standardsgenerally apply to our named executive officers. The standards include(1) ensuring that incentive compensation for senior executives does notencourage unnecessary and excessive risks that threaten the value of thefinancial institution; (2) required clawback of any bonus or incentivecompensation paid to a senior executive based on statements of earnings, gainsor other criteria that are later proven to be materially inaccurate;(3) prohibition on making golden parachute payments to senior executives;(4) prohibition on providing tax gross-up provisions; and(5) agreement not to deduct for tax purposes executive compensation inexcess of $500,000 for each senior executive.  In particular, the change to the deductibilitylimit on executive compensation will likely increase the overall cost of ourcompensation programs in future periods and may make it more difficult toattract suitable candidates to serve as executive officers.

 

InFebruary, 2005 the Bank purchased a $500,000 15-year renewable and convertibleterm life insurance policy through Banner Life Insurance Company on the life ofJames R. Clarkson, President and CEO. The Bank is both the owner and the beneficiary of this key personpolicy.  The purpose of securing thispolicy was to provide the Bank

 

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**HCSBFINANCIAL CORPORATION AND SUBSIDIARY**

 

**NOTE 1 - ORGANIZATION ANDSIGNIFICANT ACCOUNTING POLICIES** - *continued*

 

withfinancial protection in the event of the unexpected death of Mr. Clarksonand better enable the Bank to attract a qualified replacement forMr. Clarkson in such a situation.

 

Legislationthat has been adopted after we closed on our sale of Series T PreferredStock and warrants to the Treasury for $12.9 million pursuant to the CapitalPurchase Program on March 6, 2009, or any legislation or regulations thatmay be implemented in the future, may have a material impact on the termsof our Capital Purchase Program transaction with the Treasury.   If we determine that any such legislation orany regulations, in whole or in part, alter the terms of our Capital PurchaseProgram transaction with the Treasury in ways that we believe are adverse toour ability to effectively manage our business, then it is possible that we mayseek to unwind, in whole or in part, the Capital Purchase Program transactionby repurchasing some or all of the preferred stock and warrants that we sold tothe Treasury pursuant to the Capital Purchase Program.  If we were to repurchase all or a portion ofsuch preferred stock or warrants, then our capital levels could be materiallyreduced.

 

**Reclassifications** - Certaincaptions and amounts in the 2008 financial statements were reclassified to conformto the 2009 presentation.

 

#### **NOTE 2 - CASH ANDDUE FROM BANKS**

#### ** **

The Bank is required by regulation to maintain anaverage cash reserve balance based on a percentage of deposits.  At December 31, 2009 and 2008, therequirements were satisfied by amounts on deposit with the Federal Reserve Bankand cash on hand.

 

#### **NOTE 3 -INVESTMENT SECURITIES**

#### ** **

Securities available-for-sale consisted of thefollowing:

 
| ** **                                 | ** ** | **Amortized** | ** ** | **Gross Unrealized** | ** ** | **Estimated** | ** ** |
|--------------------------------------------|------------|---------------|------------|----------------------|------------|---------------|------------|
| **(Dollars in thousands)**                 | ** ** | **Cost**      | ** ** | **Gains**            | ** ** | **Losses**    | ** ** | **Fair Value** | ** ** |
| **December 31, 2009**                 | ** ** | ** **    | ** ** | ** **           | ** ** | ** **    | ** ** | ** ** | ** ** |
| Government-sponsored enterprises           |       | $             | 27,730     |                 | $          | 98            |       | $ | 317 |   | $ | 27,511 |   |
| Mortgage-backed securities                 |       | 135,386       |       | 1,928                |       | 1,059         |       | 136,255 |   |
| Obligations of state and local governments |       | 5,462         |       | 257                  |       | 22            |       | 5,697 |   |
|                                       |       |          |       |                 |       |          |       |   |   |
| Total                                      |       | $             | 168,578    |                 | $          | 2,283         |       | $ | 1,398 |   | $ | 169,463 |   |
| **December 31, 2008**                 | ** ** | ** **    | ** ** | ** **           | ** ** | ** **    | ** ** | ** ** | ** ** |
| Government-sponsored enterprises           |       | $             | 18,953     |                 | $          | 363           |       | $ | — |   | $ | 19,316 |   |
| Mortgage-backed securities                 |       | 138,682       |       | 2,374                |       | 1,048         |       | 140,008 |   |
| Obligations of state and local governments |       | 7,613         |       | 157                  |       | 102           |       | 7,668 |   |
|                                       |       |          |       |                 |       |          |       |   |   |
| Total                                      |       | $             | 165,248    |                 | $          | 2,894         |       | $ | 1,150 |   | $ | 166,992 |   |

 

Thefollowing is a summary of maturities of securities available-for-sale as ofDecember 31, 2009.  The amortizedcost and estimated fair values are based on the contractual maturity dates.  Actual maturities may differ from contractualmaturities because borrowers may have the right to call or prepay obligationswith or without penalty.

 

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**HCSBFINANCIAL CORPORATION AND SUBSIDIARY**

 

**NOTE 3 - INVESTMENT SECURITIES****- *continued***

 
| ** **                                 | ** ** | **Securities**         | ** **  |
|--------------------------------------------|------------|------------------------|-------------|
| ** **                                 | ** ** | **Available-For-Sale** | ** **  |
| ** **                                 | ** ** | **Amortized**          | ** **  | **Estimated** | ** ** |
| **(Dollars in thousands)**                 | ** ** | **Cost**               | ** **  | **Fair  Value** | ** ** |
|                                       |       |                   |        |   |   |
| Due  in less than one year                 |       | $                      | 784         |   | $ | 787 |   |
| Due  after one year but within five years  |       | 5,939                  |        | 6,045 |   |
| Due  after five years but within ten years |       | 26,896                 |        | 26,998 |   |
| Due  after ten years                       |       | 134,959                |        | 135,633 |   |
|                                       |       |                   |        |   |   |
| Total                                      | ** ** | **$**                  | **168,578** | ** ** | **$** | **169,463** | ** ** |

 

The following table showsgross unrealized losses and fair value, aggregated by investment category, andlength of time that individual securities have been in a continuous unrealizedloss position, at:

 

**SecuritiesAvailable for Sale**

 
| ** **                                 | ** ** | **December 31, 2009**  | ** ** |
|--------------------------------------------|------------|-----------------------------|------------|
| ** **                                 | ** ** | **Less than twelve months** | ** ** | **Twelve months or more** | ** ** | **Total** | ** ** |
| **(Dollars in thousands)**                 | ** ** | **Fair  Value**             | ** ** | **Unrealized  losses** | ** ** | **Fair  Value** | ** ** | **Unrealized  losses** | ** ** | **Fair Value** | ** ** | **Unrealized  losses** | ** ** |
| Government-sponsored enterprises           |       | $                           | 14,835     |   | $ | 316 |   | $ | — |   | $ | — |   | $ | 14,835 |   | $ | 317 |   |
| Mortgage-backed securities                 |       | 25,493                      |       | 946 |   | 1,218 |   | 113 |   | 26,711 |   | 1,059 |   |
| Obligations of state and local governments |       | 253                         |       | 22 |   | — |   | — |   | 253 |   | 22 |   |
| **Total**                                  | ** ** | **$**                       | **40,581** | ** ** | **$** | **1,284** | ** ** | **$** | **1,218** | ** ** | **$** | **113** | ** ** | **$** | **41,799** | ** ** | **$** | **1,398** | ** ** |

 
| ** **                                 | ** ** | **December 31, 2008**  | ** ** |
|--------------------------------------------|------------|-----------------------------|------------|
| ** **                                 | ** ** | **Less than twelve months** | ** ** | **Twelve months or more** | ** ** | **Total** | ** ** |
| **(Dollars in thousands)**                 | ** ** | **Fair  Value**             | ** ** | **Unrealized  losses** | ** ** | **Fair  Value** | ** ** | **Unrealized  losses** | ** ** | **Fair Value** | ** ** | **Unrealized  losses** | ** ** |
| Government-sponsored enterprises           |       | $                           | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Mortgage-backed securities                 |       | 25,080                      |       | 1,036 |   | 1,741 |   | 12 |   | 26,821 |   | 1,048 |   |
| Obligations of state and local governments |       | 403                         |       | 3 |   | 1,401 |   | 99 |   | 1,804 |   | 102 |   |
| **Total**                                  | ** ** | **$**                       | **25,483** | ** ** | **$** | **1,039** | ** ** | **$** | **3,142** | ** ** | **$** | **111** | ** ** | **$** | **28,625** | ** ** | **$** | **1,150** | ** ** |

 

Management evaluates its investment portfolioperiodically to identify any impairment that is other than temporary.  At December 31, 2009, the Company hadtwo individual securities, or 0.72% of the security portfolio, that have beenin an unrealized loss position for more than twelve months.  Management believes these losses aretemporary and are a result of the current interest rate environment.  The Company does not intend to sell thesesecurities and it is more likely than not that the Company will not be requiredto sell these securities before recovery of their amortized cost.

 

At December 31, 2009 and 2008, investmentsecurities with a book value of $142,877,000 and $112,682,000, respectively,and a market value of $143,744,000 and $114,891,000, respectively, were pledgedto secure deposits.

 

Gross realized gains on sales of available-for-salesecurities in 2009 were $4,102,000. There were no losses experienced on sales of available-for-salesecurities during 2009.

 

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**HCSBFINANCIAL CORPORATION AND SUBSIDIARY**

 

#### **NOTE 4 - LOANSRECEIVABLE**

#### ** **

Loansconsisted of the following:

 
| ** **                                      | ** ** | **December 31,** | ** ** |
|-------------------------------------------------|------------|-----------------------|------------|
| **(Dollars in thousands)**                      | ** ** | **2009**              | ** ** | **2008** | ** ** |
| Real estate - construction and land development |       | $                     | 95,788     |   | $ | 60,643 |   |
| Real estate - mortgage and commercial           |       | 305,561               |       | 253,450 |   |
| Agricultural                                    |       | 10,338                |       | 7,613 |   |
| Commercial and industrial                       |       | 60,914                |       | 84,568 |   |
| Consumer                                        |       | 15,871                |       | 19,655 |   |
| All other loans (including overdrafts)          |       | 3,180                 |       | 3,109 |   |
| **Total gross loans**                           |       | $                     | 491,652    |   | $ | 429,038 |   |

 

Certain parties (principally certain directors andofficers of the Company, their immediate families, and business interests) wereloan customers and had other transactions in the normal course of business withthe Company.  Related party loans aremade on substantially the same terms, including interest rates and collateral,as those prevailing at the time for comparable transactions with unrelatedpersons and do not involve more than normal risk of collectibility.  The aggregate dollar amounts of loans torelated parties were $14,974,000 and $16,957,000 at December 31, 2009 and2008, respectively.  During 2009,advances on related party loans totaled $7,139,000, and repayments were$8,878,000.

 

Transactions in the allowance for loan losses are summarizedbelow:

 
| ** **                                  | ** ** | **Years  Ended December 31,** | ** ** |
|---------------------------------------------|------------|------------------------------------|------------|
| **(Dollars in thousands)**                  | ** ** | **2009**                           | ** ** | **2008** | ** ** |
|                                        |       |                               |       |   |   |
| Balance,  beginning of year                 |       | $                                  | 4,416      |   | $ | 3,535 |   |
| Provision  charged to operations            |       | 10,361                             |       | 1,754 |   |
| Recoveries  on loans previously charged off |       | 2,556                              |       | 379 |   |
| Loans  charged off                          |       | (9,808                             | )          | (1,252 | ) |
|                                        |       |                               |       |   |   |
| Balance,  end of year                       | ** ** | **$**                              | **7,525**  | ** ** | **$** | **4,416** | ** ** |

 

Loanson the Company’s problem loan watch list are considered potentially impairedloans.  These loans are evaluated indetermining whether all outstanding principal and interest are expected to becollected.  Loans are not consideredimpaired if a minimal delay occurs and all amounts due, including accruedinterest at the contractual interest rate for the period of the delay, areexpected to be collected.

 

As of December 31, 2009 and 2008, the Companyhad nonaccrual loans of approximately $23,138,000 and $9,040,000,respectively.  These loans comprise asubstantial majority of loans classified as impaired.  At December 31, 2009, the Company didnot have any loans that were contractually past due 90 days or more and stillaccruing interest.  The additionalinterest income, which would have been recognized into earnings if theCompany’s nonaccrual loans had been current in accordance with their originalterms, was $1,141,000 and $391,000 during 2009 and 2008, respectively.  Average impaired loans as ofDecember 31, 2009 and 2008 were $16,954,000 and $5,131,000,respectively.  Total impaired loans atDecember 31, 2009 and 2008 were $37,275,389 and $14,892,060.  At December 31, 2009, $19,235,851 ofimpaired loans had a specific allowance of $3,620,511 and $18,039,538 ofimpaired loans had no specific allowance. At December 31, 2008, $14,892,060 of total impaired loans had anallowance of $1,792,157.

 

TheCompany is a party to financial instruments with off-balance-sheet risk in thenormal course of business to meet the financing needs of its customers.  These financial instruments includecommitments to extend credit and standby letters of credit.  These instruments involve, to varying degrees,elements of credit and interest rate risk in excess of the amount recognized inthe balance sheets.

 

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**HCSB FINANCIAL CORPORATION AND SUBSIDIARY**

 

TheCompany’s exposure to credit loss in the event of nonperformance by the otherparty to the financial instrument for commitments to extend credit and standbyletters of credit is represented by the contractual or notional amount of thoseinstruments.  The Company uses the samecredit policies in making commitments and conditional obligations as it doesfor on-balance-sheet instruments.

 

Standbyletters of credit are conditional commitments issued by the Company toguarantee the performance of a customer to a third party.  The credit risk involved in issuing lettersof credit is essentially the same as that involved in extending loans tocustomers.  The fair value of standbyletters of credit is insignificant.

 

Commitmentsto extend credit are agreements to lend to a customer as long as there is noviolation of any condition established in the contract.  Commitments generally have fixed expirationdates or other termination clauses and may require payment of a fee.  Since some of the commitments are expected toexpire without being drawn upon, the total commitment amounts do notnecessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-casebasis.  The amount of collateral obtained,if deemed necessary by the Company upon extension of credit, is based onmanagement’s credit evaluation of the counter-party.

 

Collateral held for commitments to extend credit andstandby letters of credit varies but may include accounts receivable,inventory, property, plant, equipment, and income-producing commercial properties.  The following table summarizes the Company’soff-balance-sheet financial instruments whose contract amounts represent creditrisk:

 
| ** **                    | ** ** | **December 31,** | ** ** |
|-------------------------------|------------|-----------------------|------------|
| **(Dollars in thousands)**    | ** ** | **2009**              | ** ** | **2008** | ** ** |
|                          |       |                  |       |   |   |
| Commitments  to extend credit |       | $                     | 53,840     |   | $ | 61,918 |   |
| Standby  letters of credit    |       | 1,137                 |       | 1,137 |   |
|                               |            |                       |            |  |  |  |  |

 

#### **NOTE 5 - PREMISES,FURNITURE AND EQUIPMENT**

#### ** **

Premises,furniture and equipment consisted of the following:

 
| ** **                              | ** ** | **December 31,** | ** ** |
|-----------------------------------------|------------|-----------------------|------------|
| **(Dollars in thousands)**              | ** ** | **2009**              | ** ** | **2008** | ** ** |
|                                    |       |                  |       |   |   |
| Land                                    |       | $                     | 7,099      |   | $ | 7,099 |   |
| Buildings  and land improvements        |       | 16,160                |       | 10,567 |   |
| Furniture  and equipment                |       | 7,370                 |       | 5,966 |   |
| Leasehold  improvements                 |       | 65                    |       | 65 |   |
| Construction  in progress               |       | —                |       | 972 |   |
|                                    |       |                  |       |   |   |
|                                    |       | 30,694                |       | 24,669 |   |
| Less  accumulated depreciation          |       | (6,542                | )          | (5,613 | ) |
|                                    |       |                  |       |   |   |
| Premises,  furniture and equipment, net | ** ** | **$**                 | **24,152** | ** ** | **$** | **19,056** | ** ** |

 

Depreciation expense for the years endedDecember 31, 2009 and 2008 was $944,000 and $874,000, respectively.

 

In2006, the Company purchased a 5-acre lot of land in the Loris Commerce Centerin Loris, S.C. to construct a new Operations Center to accommodate itsexecutive offices and all support services. The amounts shown as construction in progress for the years endedDecember 31, 2008 reflect the Company’s investment in this property.  The Company completed all phases of theconstruction process during the fourth quarter of 2009 and at that timeallocated the balance in construction in progress among land, buildings andland improvements, furniture and fixtures and equipment.

 

45

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**HCSB FINANCIALCORPORATION AND SUBSIDIARY**

 

#### **NOTE 6 - OTHERASSETS**

#### ** **

Otherassets consisted of the following:

 
| ** **                      | ** ** | **December 31,** | ** ** |
|---------------------------------|------------|-----------------------|------------|
| **(Dollars in thousands)**      | ** ** | **2009**              | ** ** | **2008** | ** ** |
|                            |       |                  |       |   |   |
| Other  real estate owned        |       | $                     | 6,432      |   | $ | 2,965 |   |
| Prepaid  expenses and insurance |       | 4,131                 |       | 426 |   |
| Unamortized  software           |       | 191                   |       | 221 |   |
| Net  deferred tax asset         |       | 66                    |       | 975 |   |
| Other                           |       | 2,782                 |       | 1,246 |   |
|                            |       |                  |       |   |   |
| Total                           | ** ** | **$**                 | **13,602** | ** ** | **$** | **5,833** | ** ** |

 

**NOTE 7- DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES**

 

TheCompany maintains an overall interest-rate risk-management strategy that incorporatesthe use of derivatives to minimize significant unplanned fluctuations inearnings that are caused by interest-rate volatility.  As part of this strategy, the Company enteredcertain interest rate swap agreements. Such interest rate swaps are derivative financial instruments(“derivatives”).  Interest rate swapsgenerally involve the exchange of fixed and variable rate interest paymentsbetween two parties, based on a common notional amount and maturity date.  The Company’s goal is to manage interest-ratesensitivity by modifying the repricing or maturity characteristics of specificbalance-sheet assets and liabilities so that the net-interest margin is not, ona material basis, adversely affected by movements in interest rates. Theinterest-rate swaps entered by the Company converted certain nonprepayablefixed rate long term debt to floating rates. As a result of interest-ratefluctuations, hedged assets and liabilities will appreciate or depreciate inmarket value.  The effect of thisunrealized appreciation or depreciation will generally be offset by income orloss on the derivatives that are linked to the hedged assets andliabilities.  The Company views thisstrategy as a prudent management of interest-rate sensitivity, such thatearnings are not exposed to undue risk presented by changes in interest rates.

 

By using derivative instruments, the Company is exposed to credit andmarket risk.  If the counterparty failsto perform, credit risk is equal to the extent of the fair-value gain in aderivative.  When the fair value of aderivative contract is positive, this generally indicates that the counterpartyowes the Company, and, therefore, creates a repayment risk for the Company.  When the fair value of a derivative contractis negative, the Company owes the counterparty and, therefore, it has norepayment risk.  The Company minimizesthe credit (or repayment) risk in derivative instruments by entering intotransactions with high-quality counterparties that are reviewed by theCompany’s credit committee.

 

Market risk is the adverse effect that a change in interest rates,currency, or implied volatility rates has on the value of a financialinstrument.  The Company manages themarket risk associated with interest rate swap contracts by establishing andmonitoring limits as to the types and degree of risk that may beundertaken.  The Company periodicallymeasures this risk by using a value-at-risk methodology.

 

The Company’s derivatives activities are monitored by itsrisk-management committee as part of that committee’s oversight of theCompany’s asset/liability and treasury functions.  The Company’s asset/liability committee isresponsible for implementing various hedging strategies that are developedthrough its analysis of data from financial simulation models and otherinternal and industry sources.  Theresulting hedging strategies are then incorporated into the Company’s overallinterest-rate risk-management and trading strategies.

 

The interest rate swap agreements provide for the Company to makepayments at a variable rate determined by a specified index (three month LIBOR)in exchange for receiving payments at a fixed rate of 3.4%.  In May 2009, the Company terminated theinterest rate swaps that hedged our three highest costing Federal Home LoanBank advances.  The unwinding of theseinterest rate swaps produced a gain of $82,000 recognized as a reduction ininterest expense on our Federal Home Loan Bank advances.  During 2008, the Company recognized $56,000in interest expense as a result of its interest rate swaps.  Currently, the Company does not utilize swapsto hedge interest rate risk.

 

46

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**HCSBFINANCIAL CORPORATION AND SUBSIDIARY**

 

**NOTE 8 - NOTE PAYABLE**

 

OnSeptember 25, 2008 the Company entered into a line of credit agreementwith South Carolina Bank & Trust to borrow up to $5,000,000.  At December 31, 2008 the balanceextended under the agreement was $4,500,000. On March 6, 2009 all principal and interest was repaid.  The line of credit agreement expired onSeptember 25, 2009.

 

#### **NOTE 9 - DEPOSITS**

#### ** **

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

 
| **(Dollars in thousands)** | ** ** | ** ** | ** **  |
|----------------------------|------------|------------|-------------|
| **Maturing In**            | ** ** | **Amount** | ** **  |
|                       |       |       |        |
| 2010                       |       | $          | 294,576     |   |
| 2011                       |       | 44,308     |        |
| 2012                       |       | 3,867      |        |
| 2013                       |       | 2,130      |        |
| 2014  and thereafter       |       | 1,220      |        |
|                       |       |       |        |
| Total                      | ** ** | **$**      | **346,101** | ** ** |

 

Overdrawntransaction accounts in the amount of $125,000 and $161,000 were classified asloans as of December 31, 2009 and 2008, respectively.

 

Relatedparty deposits by directors including their affiliates and executive officerstotaled approximately $4,861,000 and $4,568,000 at December 31, 2009 and2008, respectively.

 

47

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**HCSBFINANCIAL CORPORATION AND SUBSIDIARY**

 

#### **NOTE 10 - ADVANCES FROMTHE FEDERAL HOME LOAN BANK**

 

Advances from the FederalHome Loan Bank consisted of the following:

 
| ** **                           | ** ** | **Interest** | ** ** | **December 31,** | ** **  |
|--------------------------------------|------------|--------------|------------|-----------------------|-------------|
| **(Dollars in thousands)** | ** ** | **Rate**     | ** ** | **2009**              | ** **  | **2008** | ** ** |
| ** **                           |       |         |       |                  |        |   |   |
| **Advances maturing on:**            |       |         |       |                  |        |   |   |
| April 2,  2009                  |       | 0.46         | %          | $                     | —      |   | $ | 8,400 |   |
| March 1,  2010                  |       | 5.92         | %          | 5,000                 |        | 5,000 |   |
| May 24,  2010                   |       | 6.49         | %          | 4,600                 |        | 4,600 |   |
| October 15,  2010               |       | 4.59         | %          | 5,000                 |        | 5,000 |   |
| March 16,  2011                 |       | 1.94         | %          | 500                   |        | — |   |
| March 22,  2011                 |       | 0.25         | %          | 5,000                 |        | 5,000 |   |
| January 17,  2012               |       | 0.28         | %          | 5,000                 |        | 5,000 |   |
| March 19,  2012                 |       | 2.56         | %          | 500                   |        | — |   |
| April 13,  2012                 |       | 2.56         | %          | 1,000                 |        | — |   |
| July 23,  2012                  |       | 3.81         | %          | 5,000                 |        | 5,000 |   |
| September 4,  2012              |       | 4.42         | %          | 5,000                 |        | 5,000 |   |
| September 7,  2012              |       | 4.05         | %          | 1,000                 |        | 1,000 |   |
| January 29,  2013               |       | 2.87         | %          | 2,000                 |        | — |   |
| February 20,  2013              |       | 2.93         | %          | 2,000                 |        | — |   |
| March 4,  2013                  |       | 2.90         | %          | 3,000                 |        | — |   |
| April 8,  2013                  |       | 2.86         | %          | 2,000                 |        | — |   |
| April 15,  2013                 |       | 2.65         | %          | 2,000                 |        | — |   |
| April 22,  2013                 |       | 2.55         | %          | 2,000                 |        | — |   |
| May 1,  2013                    |       | 2.60         | %          | 2,000                 |        | — |   |
| October 18,  2013               |       | 2.63         | %          | 5,000                 |        | 5,000 |   |
| January 22,  2014               |       | 2.95         | %          | 200                   |        | — |   |
| March 20,  2014                 |       | 3.05         | %          | 2,000                 |        | — |   |
| April 21,  2014                 |       | 2.95         | %          | 3,000                 |        | — |   |
| April 28,  2014                 |       | 2.95         | %          | 2,000                 |        | — |   |
| May 8,  2014                    |       | 3.00         | %          | 3,000                 |        | — |   |
| October 1,  2014                |       | 2.89         | %          | 3,000                 |        | — |   |
| December 8,  2014               |       | 3.24         | %          | 5,000                 |        | 5,000 |   |
| January 26,  2015               |       | 2.73         | %          | 2,000                 |        | 2,000 |   |
| March 19,  2015                 |       | 2.66         | %          | 4,000                 |        | 4,000 |   |
| August 20,  2018                |       | 3.44         | %          | 5,000                 |        | 5,000 |   |
| September 4,  2018              |       | 3.60         | %          | 2,000                 |        | 2,000 |   |
| September 4,  2018              |       | 3.32         | %          | 5,000                 |        | 5,000 |   |
| September 10,  2018             |       | 3.25         | %          | 5,000                 |        | 5,000 |   |
| September 10,  2018             |       | 3.45         | %          | 5,000                 |        | 5,000 |   |
| September 18,  2018             |       | 2.95         | %          | 5,000                 |        | 5,000 |   |
| October 10,  2018               |       | 2.63         | %          | 5,000                 |        | 5,000 |   |
| August 20,  2019                |       | 3.86         | %          | 5,000                 |        | — |   |
|                                 |       |         |       |                  |        |   |   |
| **Total**                            | ** ** | ** **   | ** ** | **$**                 | **118,800** | ** ** | **$** | **92,000** | ** ** |

 

48

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**HCSBFINANCIAL CORPORATION AND SUBSIDIARY**

 

#### **NOTE 10 - ADVANCES FROMTHE FEDERAL HOME LOAN BANK***-continued*

 

As of December 31,2009, the Company’s portfolio of FHLB advances consisted of $10,000,000 ofadjustable rate credits, $49,800,000 of fixed rate credits, and $59,000,000 ofconvertible advances.  Interest on fixedrate advances is generally payable monthly and interest on all other advancesis payable quarterly.  Convertibleadvances are callable by the Federal Home Loan Bank on their respective calldates.  The Company has the option toeither repay any advance that has been called or to refinance the advance as aconvertible advance.

 

At December 31,2009, the Company had pledged as collateral for FHLB advances approximately$18,585,000 of one-to-four family first mortgage loans, $3,867,000 ofcommercial real estate loans, $6,341,000 in home equity lines of credit and$93,238,000 of agency and private issue mortgage-backed securities.  The Company has an investment in Federal HomeLoan Bank stock of $6,504,000.  TheCompany has $550,000 in excess borrowing capacity with the Federal Home LoanBank that is available if liquidity needs should arise.

 

As of December 31,2009, scheduled principal reductions include $14,600,000 in 2010, $5,500,000 in2011, $17,500,000 in 2012, $20,000,000 in 2013, $18,200,000 in 2014, and$43,000,000 in years thereafter.

 

As discussed in Note 7,the Company had entered into interest rate swap agreements associated withFederal Home Loan Bank advances maturing on March 1, 2010, May 24,2010 and March 22, 2011.  The interestrate swaps effectively converted the fixed interest rates on the advances to avariable rate.  The interest rate swapsthat hedged these Federal Home Loan Bank advances are no longer in effect asreferenced in Note 7 — Derivative Instruments and Hedging Activities.

 

**NOTE 11- JUNIOR SUBORDINATED DEBENTURES**

 

On December 21,2004, HCSB Financial Trust I, (a non-consolidated subsidiary) issued $6.0million floating rate trust preferred securities with a maturity ofDecember 31, 2034.  The rate isadjusted quarterly and was 2.65% at December 31, 2009.  In accordance with current accountingstandards, the trust has not been consolidated in these financialstatements.  The Company received fromthe Trust the $6.0 million proceeds from the issuance of the securities and the$186,000 initial proceeds from the capital investment in the Trust, andaccordingly has shown the funds due to the trust as a $6,186,000 juniorsubordinated debenture.  The currentregulatory rules allow certain amounts of junior subordinated debenturesto be included in the calculation of regulatory capital.  The debenture issuance costs, net ofaccumulated amortization, totaled $91,000 at December 31, 2009 and areincluded in other assets on the consolidated balance sheet.  Amortization of debt issuance costs totaled$3,667 for each of the years ended December 31, 2009 and 2008.

 

The Company invested$5,880,000 in the Company’s wholly-owned subsidiary, Horry County StateBank.  The remaining balance is beingmaintained by the Company to fund operations.

 

49

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**HCSBFINANCIAL CORPORATION AND SUBSIDIARY**

 

#### **NOTE 12 - LEASECOMMITMENTS**

 

On January 1, 2008,the Company renewed a lease agreement for land on which to operate its TaborCity branch.  The lease has a five-yearterm that expires December 31, 2012. The Company has an option for nine additional five-year renewal periodsthereafter.  The lease has a rentalamount of $1,047 per month through December 31, 2012.  The lease gives the Company the first rightof refusal to purchase the property at an unimproved value if the owners decideto sell.  The Company also paysapplicable property taxes on the property.

 

Future minimum leasepayments are expected to be approximately $12,564 per year.

 

#### **NOTE 13 - COMMITMENTS ANDCONTINGENCIES**

 

In the ordinary course ofbusiness, the Company may, from time to time, become a party to legal claimsand disputes.  At December 31, 2009management was not aware of any pending or threatened litigation or unassertedclaims that could result in losses, if any, that would be material to thefinancial statements.

 

#### **NOTE 14 - SHAREHOLDERS’EQUITY**

 

**StockDividends** -In January 2009, the Board of Directors declared a 3% stock dividendpayable on February 20, 2009, to shareholders of record on February 6,2009.  As a result of the dividend,110,338 shares were issued.  All shareand per share amounts have been adjusted to reflect these dividends.

 

**Restrictionson Dividends**- South Carolina banking regulations restrict the amount of dividends that canbe paid to shareholders.  All of theBank’s dividends to HCSB Financial Corporation are payable only from theundivided profits of the Bank.  AtDecember 31, 2009 the Bank’s undivided profits were $17,132,440.  The Bank is authorized to pay cash dividendsup to 100% of net income in any calendar year without obtaining the priorapproval of the Commissioner of Banking provided that the Bank received acomposite rating of one or two at the last Federal or State regulatoryexamination.  Under Federal Reserve Boardregulations, the amounts of loans or advances from the Bank to the parentcompany are also restricted.  The Companyis prohibited from declaring any dividends on its common stock untilMarch 6, 2012 with Treasury’s approval unless the 12,985 shares ofpreferred stock have been repurchased from Treasury.

 

50

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**HCSBFINANCIAL CORPORATION AND SUBSIDIARY**

 

#### **NOTE 15 - CAPITALREQUIREMENTS**

 

The Company and the Bankare subject to various regulatory capital requirements administered by thefederal banking agencies.  Failure tomeet minimum capital requirements can initiate certain mandatory and possiblyadditional discretionary actions by regulators that, if undertaken, could havea material effect on the Company’s financial statements.  Under capital adequacy guidelines and theregulatory framework for prompt corrective action, the Bank must meet specificcapital guidelines that involve quantitative measures of the Company’s and theBank’s assets, liabilities, and certain off-balance-sheet items as calculatedunder regulatory accounting practices. The Company’s and the Bank’s capital amounts and classifications arealso subject to qualitative judgments by the regulators about components,risk-weightings, and other factors.

 

Quantitative measuresestablished by regulation to ensure capital adequacy require the Company andthe Bank to maintain minimum ratios (set forth in the table below) of Tier 1and total capital as a percentage of assets and off-balance-sheet exposures,adjusted for risk-weights ranging from 0% to 100%.  Tier 1 capital of the Bank consists of commonshareholders’ equity, excluding the unrealized gain or loss on securitiesavailable for sale, minus certain intangible assets.  Tier 2 capital consists of the allowance forloan losses subject to certain limitations. Total capital for purposes of computing the capital ratios consists ofthe sum of Tier 1 and Tier 2 capital.

 

The Company and the Bankare also required to maintain capital at a minimum level based on quarterlyaverage assets (as defined), which is known as the leverage ratio.  Only the strongest institutions are allowedto maintain capital at the minimum requirement of 3%.  All others are subject to maintaining ratios1% to 2% above the minimum.

 

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

 

The following tablesummarizes the capital ratios and the regulatory minimum requirements for theCompany and the Bank.

 
| ** **                                | ** ** | **Actual** | ** ** | **Minimum  Requirement  For Capital Adequacy  Purposes** | ** ** | **To  Be Well-  Capitalized Under  Prompt Corrective  Action Provisions** | ** ** |
|-------------------------------------------|------------|------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| **(Dollars  in thousands)**               | ** ** | **Amount** | ** ** | **Ratio**                                                | ** ** | **Amount**                                                                | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| **December 31, 2009**                | ** ** | ** ** | ** ** | ** **                                               | ** ** | ** **                                                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **The Company**                           | ** ** | ** ** | ** ** | ** **                                               | ** ** | ** **                                                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total  capital (to risk-weighted assets)  |       | $          | 57,172     |                                                     | 10.75      | %                                                                         | $          | 42,541 |   | 8.00 | % | N/A |   | N/A |   |
| Tier  1 capital (to risk-weighted assets) |       | 50,514     |       | 9.50                                                     | %          | 21,270                                                                    |       | 4.00 | % | N/A |   | N/A |   |
| Tier  1 capital (to average assets)       |       | 50,514     |       | 6.94                                                     | %          | 29,097                                                                    |       | 4.00 | % | N/A |   | N/A |   |
| **The Bank**                              | ** ** | ** ** | ** ** | ** **                                               | ** ** | ** **                                                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total  capital (to risk-weighted assets)  |       | $          | 56,617     |                                                     | 10.65      | %                                                                         | $          | 42,544 |   | 8.00 | % | $ | 53,180 |   | 10.00 | % |
| Tier  1 capital (to risk-weighted assets) |       | 49,959     |       | 9.39                                                     | %          | 21,272                                                                    |       | 4.00 | % | 31,908 |   | 6.00 | % |
| Tier  1 capital (to average assets)       |       | 49,959     |       | 6.47                                                     | %          | 30,894                                                                    |       | 4.00 | % | 38,618 |   | 5.00 | % |
| **December 31, 2008**                | ** ** | ** ** | ** ** | ** **                                               | ** ** | ** **                                                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **The Company**                           | ** ** | ** ** | ** ** | ** **                                               | ** ** | ** **                                                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total  capital (to risk-weighted assets)  |       | $          | 43,768     |                                                     | 9.55       | %                                                                         | $          | 36,652 |   | 8.00 | % | N/A |   | N/A |   |
| Tier  1 capital (to risk-weighted assets) |       | 39,352     |       | 8.59                                                     | %          | 18,326                                                                    |       | 4.00 | % | N/A |   | N/A |   |
| Tier  1 capital (to average assets)       |       | 39,352     |       | 7.41                                                     | %          | 21,251                                                                    |       | 4.00 | % | N/A |   | N/A |   |
| **The Bank**                              | ** ** | ** ** | ** ** | ** **                                               | ** ** | ** **                                                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total  capital (to risk-weighted assets)  |       | $          | 47,130     |                                                     | 10.31      | %                                                                         | $          | 36,553 |   | 8.00 | % | $ | 45,692 |   | 10.00 | % |
| Tier  1 capital (to risk-weighted assets) |       | 42,714     |       | 9.35                                                     | %          | 18,277                                                                    |       | 4.00 | % | 27,415 |   | 6.00 | % |
| Tier  1 capital (to average assets)       |       | 42,714     |       | 6.86                                                     | %          | 24,898                                                                    |       | 4.00 | % | 31,122 |   | 5.00 | % |

 

51

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**HCSBFINANCIAL CORPORATION AND SUBSIDIARY**

 

#### **NOTE 16 - RETIREMENT ANDBENEFITS**

 

##### ***TrusteedRetirement Savings Plan*** - The Bank has a trustee retirement savings plan whichprovides retirement benefits to substantially all officers and employees whomeet certain age and service requirements. The plan includes a “salary reduction” feature pursuant toSection 401(k) of the Internal Revenue Code.  Under the plan and present policies,participants are permitted to contribute up to 15% of their annualcompensation.  At its discretion, theBank can make matching contributions up to 4% of the participants’compensation.  The Company charged$259,000 and $233,000 to earnings for the retirement savings plan in 2009 and2008, respectively.

##### *** ***

**DirectorsDeferred Compensation Plan** - The Company has a deferred compensation planwhereby directors may elect to defer the payment of their fees.  Under the terms of the plan, the Companyaccrues an expense equal to the amount deferred plus an interest componentbased on the prime rate of interest at the beginning of each year.  The Company has also purchased life insurancecontracts on each of the participating directors.  At December 31, 2009 and 2008,$1,032,000 and $912,000, respectively, of directors’ fees were deferred and areincluded in other liabilities.

 

**PerformanceCompensation for Incentive Plan** - The Company implemented an employee bonus programin 2003 which it refers to as its Performance Compensation Plan.  The plan pays employees based on a scheduleof key performance indicators they are required to meet in order to berewarded.  The plan accrues for itsemployee bonuses based on a percentage of each employee’s annual salary.  The plan has a fiscal year ending onDecember 31, and pays out on January 30 of the following year.  The Company charged $40,000 to earnings forthe plan in 2008.  There was no expensecharged to earnings for the plan in 2009.

 

**SalaryContinuation Plan** - The Company implemented a salary continuation plan for each of theexecutive officers of the Company and key officers of the Bank inApril 2008.  The Plan provides theparticipants with retirement benefits as well as benefits in the event of achange in control of the Company or disability of the participants.  It also provides death benefits to thedesignated beneficiaries of the participants. Benefit amounts are based on 20% of the final projected salaries of theparticipants and the expense of the Plan is offset by the Bank-Owned LifeInsurance (BOLI) in each participant.  AtDecember 31, 2009 and 2008, $271,000 and $169,000, respectively, of salarycontinuation plan expense was charged to earnings.  Also, $480,000 and $313,000 of income wasmade on our BOLI policies during 2009 and 2008, respectively.

 

**NOTE 17- EARNINGS PER SHARE**

 

Earnings per share -basic is computed by dividing net income by the weighted average number ofcommon shares outstanding.  Earnings pershare - diluted is computed by dividing net income by the weighted averagenumber of common shares outstanding and dilutive common share equivalents usingthe treasury stock method.  Dilutive commonshare equivalents include common shares issuable upon exercise of outstandingstock options.  For 2009, common sharesissuable upon exercise of employee stock options have not been included becausetheir inclusion would have an anitdilutive effect applicable to net loss pershare.  All share amounts have beenadjusted for stock splits and dividends.

 

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**HCSBFINANCIAL CORPORATION AND SUBSIDIARY**

 

**NOTE 17- EARNINGS PER SHARE****—***continued*

 
| **(Dollars in thousands, except**                                                        | ** ** | **Years  ended December 31,** | ** ** |
|------------------------------------------------------------------------------------------|------------|------------------------------------|------------|
| **per share amounts)**                                                                   | ** ** | **2009**                           | ** ** | **2008** | ** ** |
| **Basic earnings (loss) per share:**                                                     |       |                               |       |   |   |
|                                                                                     |       |                               |       |   |   |
| Net  income (loss) available to common shareholders                                      | ** ** | **$**                              | **(1,657** | **)** | **$** | **2,244** | ** ** |
|                                                                                     |       |                               |       |   |   |
| Average  common shares outstanding - basic                                               | ** ** | **3,787,327**                      | ** ** | **3,788,296** | ** ** |
|                                                                                     |       |                               |       |   |   |
| Basic  earnings (loss) per share                                                         | ** ** | **$**                              | **(0.44**  | **)** | **$** | **0.59** | ** ** |
|                                                                                     |       |                               |       |   |   |
| **Diluted earnings (loss) per share:**                                                   |       |                               |       |   |   |
|                                                                                     |       |                               |       |   |   |
| Net  income (loss) available to common shareholders                                      |       | $                                  | (1,657     | ) | $ | 2,244 |   |
|                                                                                     |       |                               |       |   |   |
| Average  common shares outstanding - basic                                               |       | 3,787,327                          |       | 3,788,296 |   |
|                                                                                     |       |                               |       |   |   |
| Incremental  shares from assumed conversion of stock options and restricted stock awards |       | —                             |       | 40,765 |   |
|                                                                                     |       |                               |       |   |   |
| Average  common shares outstanding - diluted                                             | ** ** | **3,787,327**                      | ** ** | **3,829,061** | ** ** |
|                                                                                     |       |                               |       |   |   |
| Diluted  earnings (loss) per share                                                       | ** ** | **$**                              | **(0.44**  | **)** | **$** | **0.59** | ** ** |

 

**NOTE 18- STOCK COMPENSATION PLAN**

 

#### **In 2004,upon shareholder approval, the Company adopted an Omnibus Stock Ownership andLong Term Incentive Plan (the “Stock Plan”). The Stock Plan authorizes the grant of options and awards of restrictedstock to certain of our employees for up to 400,000 shares of the Company’scommon stock from time to time during the term of the Stock Plan, subject toadjustments upon change in capitalization. The Stock Plan is administered by the Compensation Committee of theBoard of Directors of the Company.**

#### ** **

#### **Optionsgranted under the Stock Plan are incentive stock options, and they are vestedover a five year period with none vesting at the time of the grant.  All unexercised incentive stock optionsexpire ten years after the date of the grant. A summary of the Company’s incentive stock options as ofDecember 31, 2009 and 2008 is as follows *(withadjustments for the 3% stock dividend and the 2-for1stock split for eachperiod):***

#### ** **

| ** **                        | ** ** | **2009**   | ** ** | **2008**     | ** ** |
|-----------------------------------|------------|------------|------------|--------------|------------|
| ** **                        | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                        | ** ** | ** ** | ** ** | **Average**  | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                        | ** ** | ** ** |       | **Exercise** |       |   |   | **Exercise** |   |
| ** **                        | ** ** | **Shares** | ** ** | **Price**    | ** ** | **Shares** | ** ** | **Price** |   |
|                              |       |       |       |         |       |   |   |   |   |
| Outstanding  at beginning of year |       | 71,676     |       | $            | 13.97      |   | 71,676 |   | $ | 13.97 |   |
| Granted                           |       | —     |       | —       |       | — |   |   |   |
| Exercised                         |       | —     |       | —       |       | — |   | — |   |
| Forfeited                         |       | —     |       | —       |       | — |   |   |   |
| Outstanding  at end of year       | ** ** | **71,676** |       | $            | 13.97      | ** ** | **71,676** |   | $ | 13.97 |   |

 

#### **TheCompany had no options exercised during 2009 or 2008.**

 

53

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**HCSBFINANCIAL CORPORATION AND SUBSIDIARY**

 

**NOTE 18- STOCK COMPENSATION PLAN** - *continued*

 

#### **Restrictedstock awards included in the Stock Plan vest after the first three consecutiveperiods during which the Bank’s return on average assets (ROAA) averages1.15%.  At December 31, 2009 and2008, none of the restricted stock had vested; therefore, no compensationexpense related to the vesting was recognized. All ungranted restricted stock awards expire.  A summary of the Company’s restricted stockawards as of December 31, 2009 and 2008 is as follows*:***

 
| ** **                        | ** ** | **2009**   | ** ** | **2008**     | ** ** |
|-----------------------------------|------------|------------|------------|--------------|------------|
| ** **                        | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                        | ** ** | ** ** | ** ** | **Average**  | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                        | ** ** | ** ** | ** ** | **Exercise** | ** ** | ** ** | ** ** | **Exercise** | ** ** |
| ** **                        | ** ** | **Shares** | ** ** | **Price**    | ** ** | **Shares** | ** ** | **Price** | ** ** |
|                              |       |       |       |         |       |   |   |   |   |
| Outstanding  at beginning of year |       | 48,867     |       | $            | 14.40      |   | 48,867 |   | $ | 14.40 |   |
| Granted                           |       | —     |       | —       |       | — |   | — |   |
| Exercised                         |       | —     |       | —       |       | — |   | — |   |
| Forfeited                         |       | —     |       | —       |       | — |   |   |   |
| Outstanding  at end of year       | ** ** | **48,867** |       | $            | 14.40      | ** ** | **48,867** |   | $ | 14.40 |   |

 

The following tablesummarizes information about stock options outstanding under the Company’splans at December 31, 2009*:*

 
| ** **                       | ** ** | **Outstanding** | ** ** | **Exercisable** | ** ** |
|----------------------------------|------------|-----------------|------------|-----------------|------------|
| Number  of options               |       | 120,543         |       | 57,588          |       |
| Weighted  average remaining life |       | 3 years         |       | 2 months        |       |
| Weighted  average exercise price |       | $               | 14.14      |            | $          | 14.14 |   |
|                                  |            |                 |            |                 |            |  |  |

 

The aggregateintrinsic value of shares outstanding at December 31, 2009 was $2,772,489.

 

The Companymeasures the fair value of each option award on the date of grant using theBlack-Scholes option-pricing model.  TheCompany determines the assumptions used in the Black-Scholes option pricingmodel as follows:  the risk-free interestrate is based on the U.S. Treasury yield curve in effect at the time of thegrant; the dividend yield is based on the Company’s dividend yield at the timeof the grant (subject to adjustment if the dividend yield on the grant date isnot expected to approximate the dividend yield over the expected life of theoptions); the volatility factor is based on the historical volatility of theCompany’s stock (subject to adjustment if historical volatility is reasonablyexpected to differ from the past); the weighted-average expected life is basedon the historical behavior of employees related to exercises, forfeitures andcancellations.

 

There were nostock options granted in 2009 or 2008.

 

A summary of thestatus of the nonvested shares as of December 31, 2009, and changes duringthe year ended December 31, 2009, is presented below:

 
| ** **                           | ** ** | ** ** | ** ** | **Weighted-**   | ** ** |
|--------------------------------------|------------|------------|------------|-----------------|------------|
| ** **                           | ** ** | ** ** | ** ** | **Average**     | ** ** |
| ** **                           | ** ** | ** ** | ** ** | **Grant-Date**  | ** ** |
| **Nonvested  Shares**                | ** ** | **Shares** | ** ** | **Fair  Value** | ** ** |
|                                 |       |       |       |            |       |
| Nonvested  at January 1, 2009   |       | 6,735      |       | 14.49           |       |
| Granted                              |       | —     |       | —          |       |
| Vested                               |       | —     |       | —          |       |
| Forfeited                            |       | —     |       | —          |       |
| Nonvested  at December 31, 2009 | ** ** | **6,735**  | ** ** | **$**           | **14.49**  | ** ** |
|                                      |            |            |            |                 |            |  |

 

54

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**HCSBFINANCIAL CORPORATION AND SUBSIDIARY**

 

**NOTE 18- STOCK COMPENSATION PLAN** - *continued*

 

As of December 31,2009, there was $12,000 of total unrecognized compensation cost related tononvested share-based compensation arrangements granted under the plans.  That cost is expected to be recognized over aweighted-average period of 6 months.  Thetotal fair value of shares vested during the years ended December 31, 2009and 2008 was $161,513 and $690,568, respectively.

 

#### **NOTE 19 - OTHER EXPENSES**

 

Other expenses aresummarized as follows:

 
| ** **                             | ** ** | **Years  Ended December 31,** | ** ** |
|----------------------------------------|------------|------------------------------------|------------|
| **(Dollars  in thousands)**            | ** ** | **2009**                           | ** ** | **2008** | ** ** |
| Stationery,  printing, and postage     |       | $                                  | 429        |   | $ | 439 |   |
| Telephone                              |       | 260                                |       | 259 |   |
| Director  and advisory fees            |       | 175                                |       | 134 |   |
| ATM  services                          |       | 208                                |       | 167 |   |
| Repossession  and foreclosure expenses |       | 307                                |       | 19 |   |
| Accountant  fees                       |       | 167                                |       | 143 |   |
| Legal  fees                            |       | 265                                |       | 166 |   |
| Courier  services                      |       | 58                                 |       | 138 |   |
| Other                                  |       | 1,405                              |       | 1,231 |   |
| Total                                  | ** ** | **$**                              | **3,274**  | ** ** | **$** | **2,696** | ** ** |

 

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**HCSBFINANCIAL CORPORATION AND SUBSIDIARY**

 

#### **NOTE 20 - INCOME TAXES**

 

Income tax expense(benefit) is summarized as follows:

 
| ** **                                             | ** ** | **Years  Ended December 31,** | ** ** |
|--------------------------------------------------------|------------|------------------------------------|------------|
| **(Dollars in thousands)**                             | ** ** | **2009**                           | ** ** | **2008** | ** ** |
|                                                   |       |                               |       |   |   |
| Currently  payable:                                    |       |                               |       |   |   |
| Federal                                                |       | $                                  | 335        |   | $ | 1,465 |   |
| State                                                  |       | —                             |       | 58 |   |
|                                                   |       |                               |       |   |   |
| Total  current                                         |       | 335                                |       | 1,523 |   |
|                                                   |       |                               |       |   |   |
| Deferred  income taxes                                 |       | (1,492                             | )          | 229 |   |
|                                                   |       |                               |       |   |   |
| Income  tax expense                                    | ** ** | **$**                              | **(1,157** | **)** | **$** | **1,752** | ** ** |
|                                                   |       |                               |       |   |   |
| Income  tax expense (benefit) is allocated as follows: |       |                               |       |   |   |
| To  continuing operations                              |       | $                                  | (840       | ) | $ | 1,104 |   |
| To  shareholders’ equity                          |       | (317                               | )          | 648 |   |
|                                                   |       |                               |       |   |   |
| Total                                                  | ** ** | **$**                              | **(1,157** | **)** | **$** | **1,752** | ** ** |

 

The components of the netdeferred tax asset are as follows:

 
| ** **                                             | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------|------------|-----------------------|------------|
| **(Dollars  in thousands)**                            | ** ** | **2009**              | ** ** | **2008** | ** ** |
|                                                   |       |                  |       |   |   |
| Deferred  tax assets:                                  |       |                  |       |   |   |
| Allowance  for loan losses                             |       | $                     | 2,375      |   | $ | 1,265 |   |
| Net  capitalized loan costs                            |       | 149                   |       | 163 |   |
| State  net operating loss                              |       | 80                    |       | 72 |   |
| Deferred  compensation                                 |       | 499                   |       | 367 |   |
| Nonaccruing  interest                                  |       | 388                   |       | 133 |   |
| Tax  credits                                           |       | 98                    |       | 14 |   |
| Other  real estate owned                               |       | 129                   |       | 88 |   |
| Loss  on equity securities                             |       | 42                    |       | — |   |
|                                                   |       |                  |       |   |   |
| Total  deferred tax assets                             |       | 3,760                 |       | 2,102 |   |
|                                                   |       |                  |       |   |   |
| Valuation  Allowance                                   |       | 122                   |       | 72 |   |
|                                                   |       |                  |       |   |   |
| Total  net deferred tax assets                         |       | 3,638                 |       | 2,030 |   |
|                                                   |       |                  |       |   |   |
| Deferred  tax liabilities:                             |       |                  |       |   |   |
| Accumulated  depreciation                              |       | 1,237                 |       | 854 |   |
| Gain  on sale of real estate                           |       | 73                    |       | 73 |   |
| Net  unrealized gains on securities available-for-sale |       | 328                   |       | 645 |   |
| Prepaid  expenses                                      |       | 112                   |       | 62 |   |
|                                                   |       |                  |       |   |   |
| Total  deferred tax liabilities                        |       | 1,750                 |       | 1,634 |   |
|                                                   |       |                  |       |   |   |
| Net  deferred tax asset                                | ** ** | **$**                 | **1,888**  | ** ** | **$** | **396** | ** ** |

 

56

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**HCSBFINANCIAL CORPORATION AND SUBSIDIARY**

 

#### **NOTE 20 - INCOME TAXES**-*continued*

 

Management has determinedthat a valuation allowance is needed for the deferred tax asset associated withSouth Carolina net operating losses and the capital loss from worthless equitysecurities.  The 2009 net change in thevaluation allowance related to deferred tax assets was an increase of $50,000,relating to unrecognizable deferred tax assets for additional South Carolinanet operating losses created in 2009 and capital losses recognized in 2009.  Deferred tax assets are included in otherassets.

 

The Company has SouthCarolina net operating loss carryforwards of $2,433,475 for income tax purposesas of December 31, 2009.  These netoperating losses will expire in years 2019 through 2029.

 

A reconciliation betweenthe income tax expense (benefit) and the amount computed by applying theFederal statutory rates of 34% to income before income taxes follows:

 
| ** **                                           | ** ** | **Years  ended December 31,** | ** ** |
|------------------------------------------------------|------------|------------------------------------|------------|
| **(Dollars  in thousands)**                          | ** ** | **2009**                           | ** ** | **2008** | ** ** |
|                                                 |       |                               |       |   |   |
| Tax  expense at statutory rate                       |       | $                                  | (744       | ) | $ | 1,138 |   |
| State  income tax, net of federal income tax benefit |       | —                             |       | 38 |   |
| Tax-exempt  interest income                          |       | (78                                | )          | (93 | ) |
| Stock  compensation expense                          |       | 50                                 |       | 50 |   |
| Other                                                |       | (68                                | )          | (29 | ) |
| Income  tax provision                                | ** ** | **$**                              | **(840**   | **)** | **$** | **1,104** | ** ** |

 

#### **NOTE 21 - UNUSED LINES OFCREDIT**

 

As of December 31,2009, the Company had unused lines of credit to purchase federal funds fromunrelated banks totaling $21,000,000. These lines of credit are available on aone to fourteen day basis for general corporate purposes.  The lenders have reserved the right not torenew their respective lines.  TheCompany may also utilize its unpledged securities, which totaled $25,720,000 atDecember 31, 2009, if liquidity needs should arise.

 

#### **NOTE 22 - FAIR VALUE OFFINANCIAL INSTRUMENTS**

 

The fair value of afinancial instrument is the price that would be received to sell an asset orpaid to transfer a liability in an orderly transaction between marketparticipants at the measurement date. Fair value estimates are made at a specific point in time based onrelevant market information and information about the financialinstruments.  Because no market valueexists for a significant portion of the financial instruments, fair valueestimates are based on judgments regarding future expected loss, current economicconditions, risk characteristics of various financial instruments, and otherfactors.

 

The following methods andassumptions were used to estimate the fair value of significant financialinstruments:

 

***Cash and Due from Banks*******- The carrying amount is a reasonableestimate of fair value.

 

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

 

***Time Deposits with Other Banks*** - Time deposits with other banks have aterm less than 90 days and the carrying amount approximates the fair value.

 

57

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**HCSBFINANCIAL CORPORATION AND SUBSIDIARY**

 

#### **NOTE 22 - FAIR VALUE OFFINANCIAL INSTRUMENTS***-continued*

 

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

 

***Nonmarketable Equity Securities*******- The carrying amount is a reasonableestimate of fair value since no ready market exists for these securities.

 

***Loans Held-for-Sale*** - Fair values of mortgage loans held for sale arebased on commitments on hand from investors or market prices.

 

***Loans Receivable*******- For certain categories of loans, such as variablerate loans which are repriced frequently and have no significant change incredit risk and credit card receivables, fair values are based on the carryingamounts.  The fair value of other typesof loans is estimated by discounting the future cash flows using the currentrates at which similar loans would be made to the borrowers with similar creditratings and for the same remaining maturities.

 

***Deposits*******- The fair value of demand deposits, savings, andmoney market accounts is the amount payable on demand at the reportingdate.  The fair values of certificates ofdeposit are estimated using a discounted cash flow calculation that applies currentinterest rates to a schedule of aggregated expected maturities.

 

***Advances from the Federal Home Loan Bank*******- For the portion of borrowingsimmediately callable, fair value is based on the carrying amount.  The fair value of the portion maturing at alater date is estimated using a discounted cash flow calculation that appliesthe interest rate of the immediately callable portion to the portion maturingat the future date.

 

***Junior Subordinated Debentures*** - The carrying value of juniorsubordinated debentures is a reasonable estimate of fair value since thedebentures were issued at a floating rate.

 

***Note Payable-***The fair value of the note payableapproximates its carrying value because it reprices periodically.

*** ***

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

 

***Commitments to Extend Credit and Standby Letters of Credit*******- The contractual amount is a reasonableestimate of fair value for the instruments because commitments to extend creditand standby letters of credit are issued on a short-term or floating rate basisand include no unusual credit risks.

 

***Interest Rate Swaps*** - Fair values are based on the present value offuture cash flows based on the interest rate spread between the fixed rate andthe floating rate.

 

58

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**HCSBFINANCIAL CORPORATION AND SUBSIDIARY**

 

#### **NOTE 22 - FAIR VALUE OFFINANCIAL INSTRUMENTS***—continued*

 

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

 
| ** **                                                          | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                          | ** ** | **2009**              | ** ** | **2008** | ** ** |
| ** **                                                          | ** ** | **Carrying**          | ** ** | **Estimated** | ** ** | **Carrying** | ** ** | **Estimated** | ** ** |
| **(Dollars  in thousands)**                                         | ** ** | **Amount**            | ** ** | **Fair  Value** | ** ** | **Amount** | ** ** | **Fair  Value** | ** ** |
|                                                                |       |                  |       |   |   |   |   |   |   |
| **Financial Assets:**                                               |       |                  |       |   |   |   |   |   |   |
| Cash  and due from banks                                            |       | $                     | 44,902     |   | $ | 44,902 |   | $ | 10,423 |   | $ | 10,423 |   |
| Federal  funds sold                                                 |       | —                |       | — |   | — |   | — |   |
| Investment  securities available-for-sale                           |       | 169,463               |       | 169,463 |   | 166,992 |   | 166,992 |   |
| Nonmarketable  equity securities                                    |       | 6,715                 |       | 6,715 |   | 5,261 |   | 5,261 |   |
| Loans  and loans held-for-sale                                      |       | 493,321               |       | 491,445 |   | 429,108 |   | 433,665 |   |
| Accrued  interest receivable                                        |       | 4,120                 |       | 4,120 |   | 3,625 |   | 3,625 |   |
| Other  assets - interest rate swaps                                 |       | —                |       | — |   | 83 |   | 83 |   |
|                                                                |       |                  |       |   |   |   |   |   |   |
| **Financial Liabilities:**                                          |       |                  |       |   |   |   |   |   |   |
| Demand  deposit, interest-bearing transaction, and savings accounts |       | $                     | 232,191    |   | $ | 232,191 |   | $ | 176,182 |   | $ | 176,182 |   |
| Certificates  of deposit                                            |       | 346,101               |       | 347,721 |   | 308,569 |   | 310,175 |   |
| Repurchase  agreements                                              |       | 8,031                 |       | 8,031 |   | 9,172 |   | 9,172 |   |
| Advances  from the Federal Home Loan Bank                           |       | 118,800               |       | 120,822 |   | 92,000 |   | 94,743 |   |
| Notes  Payable                                                      |       | —                |       | — |   | 4,500 |   | 4,500 |   |
| Junior  subordinated debentures                                     |       | 6,186                 |       | 6,186 |   | 6,186 |   | 6,186 |   |
| Accrued  interest payable                                           |       | 1,444                 |       | 1,444 |   | 2,105 |   | 2,105 |   |
| Other  liabilities - interest rate swaps                            |       | —                |       | — |   | 83 |   | 83 |   |

 
| ** **                                      | ** ** | **Notional** | ** ** | **Estimated**   | ** ** | **Notional** | ** ** | **Estimated**   | ** ** |
|-------------------------------------------------|------------|--------------|------------|-----------------|------------|--------------|------------|-----------------|------------|
| ** **                                      | ** ** | **Amount**   | ** ** | **Fair  Value** | ** ** | **Amount**   | ** ** | **Fair  Value** | ** ** |
| **Off-Balance Sheet Financial****Instruments:** |       |         |       |            |       |         |       |            |       |
| Commitments  to extend credit                   |       | $            | 53,840     |            | $          | N/A          |       | $               | 61,918     |   | N/A |   |
| Standby  letters of credit                      |       | 1,137        |       | N/A             |       | 1,478        |       | N/A             |       |
|                                                 |            |              |            |                 |            |              |            |                 |            |  |  |  |

 

Generally acceptedaccounting principles require disclosures about the fair value of assets andliabilities recognized in the balance sheet in periods subsequent to initialrecognition, whether the measurements are made on a recurring basis (forexample, available-for-sale investment securities) or on a nonrecurring basis(for example, impaired loans).

 

59

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**HCSBFINANCIAL CORPORATION AND SUBSIDIARY**

 

#### **NOTE 22 - FAIR VALUE OFFINANCIAL INSTRUMENTS***- continued*

 

Fair value is theexchange price that would be received for an asset or paid to transfer aliability (an exit price) in the principal or most advantageous market for theasset or liability in an orderly transaction between market participants on themeasurement date.  Accounting principlesestablish a fair value hierarchy, which requires an entity to maximize the useof observable inputs and minimize the use of unobservable inputs when measuringfair value. There are three levels of inputs that may be used to measure fairvalue:

 
| **Level 1** | Quoted prices in active  markets for identical assets or liabilities. Level 1 assets and liabilities  include debt and equity securities and derivative contracts that are traded  in an active exchange market, as well as U.S. Treasuries and money market  funds.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|-------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| **Level 2** | Observable inputs other  than Level 1 prices such as quoted prices for similar assets or liabilities;  quoted prices in markets that are not active; or other inputs that are  observable or can be corroborated by observable market data for substantially  the full term of the assets or liabilities. Level 2 assets and liabilities  include debt securities with quoted prices that are traded less frequently  than exchange-traded instruments, mortgage-backed securities, municipal  bonds, corporate debt securities, and derivative contracts whose value is  determined using a pricing model with inputs that are observable in the  market or can be derived principally from or corroborated by observable  market data. This category generally includes certain derivative contracts  and impaired loans. |
| ** **  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| **Level 3** | Unobservable inputs  that are supported by little or no market activity and that are significant  to the fair value of the assets or liabilities. 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 the determination of fair value requires  significant management judgment or estimation. For example, this category  generally includes certain private equity investments, retained residual  interests in securitizations, residential mortgage servicing rights, and  highly-structured or long-term derivative contracts.                                                                                                                                 |

 
| **(Dollars  in thousands)**               | ** ** | **Quoted  market price in  active markets  (Level 1)** | ** ** | **Significant  other  observable inputs  (Level 2)** | ** ** | **Significant  unobservable  inputs  (Level 3)** | ** ** |
|-------------------------------------------|------------|--------------------------------------------------------|------------|------------------------------------------------------|------------|--------------------------------------------------|------------|
| Available-for-sale  investment securities |       | $                                                      | 12,192     |                                                 | $          | 157,271                                          |       | — |   |
| Mortgage  loans held for sale             |       | —                                                 |       | $                                                    | 1,669      |                                             | —     |   |
| Fair  Value Hedge                         |       | —                                                 |       | —                                               |       | —                                           |       |
| Total                                     |       | $                                                      | 12,192     |                                                 | $          | 158,940                                          |       | — |   |

 

The Company has noliabilities carried at fair value or measured at fair value on a nonrecurringbasis.

 

The Company ispredominantly an asset based lender with real estate serving as collateral on asubstantial majority of loans. Loans which are deemed to be impaired areprimarily valued nonrecurring basis at the fair values of the underlying realestate collateral. Such fair values are obtained using independent appraisals,which the Company considers to be level 2 inputs. The aggregate carrying amountof impaired assets at December 31, 2009 was $29,570,000.

 

60

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**HCSBFINANCIAL CORPORATION AND SUBSIDIARY**

 

#### **NOTE 22 - FAIR VALUE OFFINANCIAL INSTRUMENTS***-continued*

 
| **(Dollars  in thousands)**                 | ** ** | **Quoted  market price in  active markets  (Level 1)** | ** ** | **Significant  other  observable inputs  (Level 2)** | ** ** | **Significant  unobservable  inputs  (Level 3)** | ** ** |
|---------------------------------------------|------------|--------------------------------------------------------|------------|------------------------------------------------------|------------|--------------------------------------------------|------------|
| Nonaccrual  loans (includes impaired loans) |       | $                                                      | —     |                                                 | $          | 23,138                                           |       | — |   |
| Other  real estate owned                    |       | —                                                 |       | $                                                    | 6,432      |                                             | —     |   |
| Total                                       |       | $                                                      | —     |                                                 | $          | 29,570                                           |       | — |   |

 

**NOTE 23- HCSB FINANCIAL CORPORATION (*PARENT COMPANYONLY*)**

 

Presented below are thecondensed financial statements for HCSB Financial Corporation and Subsidiary(Parent Company Only).

 

**CondensedBalance Sheets**

 
| ** **                                       | ** ** | **December 31,** | ** ** |
|--------------------------------------------------|------------|-----------------------|------------|
| **(Dollars  in thousands)**                      | ** ** | **2009**              | ** ** | **2008** | ** ** |
|                                             |       |                  |       |   |   |
| **Assets**                                       |       |                  |       |   |   |
| Cash                                             |       | $                     | 375        |   | $ | 52 |   |
| Investment  in banking subsidiary                |       | 50,517                |       | 43,811 |   |
| Investment  in trust                             |       | 186                   |       | 186 |   |
| Nonmarketable  equity securities                 |       | 25                    |       | 25 |   |
| Other  assets                                    |       | 162                   |       | 1,080 |   |
| Total  assets                                    | ** ** | **$**                 | **51,265** | ** ** | **$** | **45,154** | ** ** |
|                                             |       |                  |       |   |   |
| **Liabilities and shareholders’ equity**    |       |                  |       |   |   |
| Interest  payable-notes payable                  |       | $                     | —     |   | $ | 6 |   |
| Interest  payable-junior subordinated debentures |       | 7                     |       | 12 |   |
| Notes  payable                                   |       | —                |       | 4,500 |   |
| Junior  subordinated debentures                  |       | 6,186                 |       | 6,186 |   |
| Total  liabilities                               |       | 6,193                 |       | 10,704 |   |
| Shareholders’  equity                       |       | 45,072                |       | 34,450 |   |
| Total  liabilities and shareholder’s equity | ** ** | **$**                 | **51,265** | ** ** | **$** | **45,154** | ** ** |

 

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**HCSBFINANCIAL CORPORATION AND SUBSIDIARY**

 

**NOTE 23- HCSB FINANCIAL CORPORATION (*PARENT COMPANYONLY*)**

 

**CondensedStatements of Income**

 
| ** **                                                                                        | ** ** | **Years  ended December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|------------------------------------|------------|
| **(Dollars  in thousands)**                                                                       | ** ** | **2009**                           | ** ** | **2008** | ** ** |
| **Income**                                                                                        |       |                               |       |   |   |
| Dividends  from banking subsidiary                                                                |       | $                                  | —     |   | $ | 372 |   |
| Dividend  from trust preferred securities                                                         |       | 6                                  |       | 11 |   |
| Other  Income                                                                                     | ** ** | **—**                         | ** ** | **—** | ** ** |
|                                                                                              |       | 6                                  |       | 383 |   |
|                                                                                              |       |                               |       |   |   |
| **Expenses**                                                                                      |       |                               |       |   |   |
| Interest  expense on notes payable                                                                |       | 31                                 |       | 53 |   |
| Interest  expense on junior subordinated debentures                                               |       | 209                                |       | 348 |   |
| Other  expenses                                                                                   |       | 161                                |       | 158 |   |
|                                                                                              |       |                               |       |   |   |
| **Income (loss) before income taxes and equity in  undistributed earnings of banking subsidiary** |       | (395                               | )          | (176 | ) |
|                                                                                              |       |                               |       |   |   |
| Income  tax benefit                                                                               |       | 66                                 |       | 207 |   |
|                                                                                              |       |                               |       |   |   |
| Equity  in undistributed earnings of banking subsidiary                                           |       | (1,019                             | )          | 2,213 |   |
|                                                                                              |       |                               |       |   |   |
| **Net income (loss)**                                                                             | ** ** | **$**                              | **(1,348** | **)** | **$** | **2,244** | ** ** |

 

# **Condensed Statements of Cash Flows**

 
| ** **                                                                         | ** ** | **Years  ended December 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------------------|------------|
| **(Dollars  in thousands)**                                                        | ** ** | **2009**                           | ** ** | **2008** | ** ** |
|                                                                               |       |                               |       |   |   |
| **Cash flows from operating activities:**                                          |       |                               |       |   |   |
| Net  income                                                                        |       | $                                  | (1,348     | ) | $ | 2,244 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |       |                               |       |   |   |
| Equity  in undistributed earnings of banking subsidiary                            |       | 1,019                              |       | (2,213 | ) |
| Increase  in other assets                                                          |       | 918                                |       | (213 | ) |
| Decrease  in other liabilities                                                     |       | (11                                | )          | (2 | ) |
| Dividends  paid on preferred stock                                                 |       | (446                               | )          | — |   |
| Stock  compensation expense                                                        |       | 147                                |       | 147 |   |
|                                                                               |       |                               |       |   |   |
| Net  cash used by operating activities                                             |       | 279                                |       | (37 | ) |
| ** **                                                                         | ** ** | ** **                         | ** ** | ** ** | ** ** |
| **Cash flows from investing activities:**                                          |       |                               |       |   |   |
| Proceeds  from sale of land and building                                           |       | —                             |       | — |   |
|                                                                               |       |                               |       |   |   |
| Net  cash provided (used) from investing activities                                |       | —                             |       | — |   |
|                                                                               |       |                               |       |   |   |
| **Cash flows from financing activities:**                                          |       |                               |       |   |   |
| Net  increase in preferred stock                                                   |       | 12,828                             |       | — |   |
| Increase  (decrease) in notes payable                                              |       | (4,500                             | )          | 4,500 |   |
| Capital  contribution to the Bank                                                  |       | (8,265                             | )          | (4,400 | ) |
| Cash  paid for fractional shares                                                   |       | (19                                | )          | (27 | ) |
|                                                                               |       |                               |       |   |   |
| Net  cash provided (used) by financing activities                                  |       | 44                                 |       | 73 |   |
|                                                                               |       |                               |       |   |   |
| **Increase (decrease) in cash**                                                    |       | 323                                |       | 36 |   |
| **Cash and cash equivalents, beginning of year**                                   |       | 52                                 |       | 16 |   |
| **Cash and cash equivalents, end of year**                                         | ** ** | **$**                              | **375**    | ** ** | **$** | **52** | ** ** |

 

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**HCSBFINANCIAL CORPORATION AND SUBSIDIARY**

 

# **BOARD OF DIRECTORS**

# ** **

| Michael S. Addy               |   | President,  Addy’s Harbor Dodge, Inc.                           |
|-------------------------------|--------|---------------------------------------------------------------------------|
|                          |   |                                                                      |
| Johnny C. Allen               |   | Retired, Horry  County Treasurer                                          |
|                          |   |                                                                      |
| D. Singleton Bailey           |   | President, Loris  Drug Store, Inc.                                   |
|                          |   |                                                                      |
| Franklin C. Blanton           |   | President,  Blanton Supplies, Inc.                                   |
|                          |   | President,  Blanton Supplies of Little River, Inc.                   |
|                          |   |                                                                      |
| Clay D.  Brittain, III   |   | Attorney,  Thompson & Henry, P.A.                                |
|                          |   |                                                                      |
| Rachel B. Broadhurst          |   | President,  Century 21 — Broadhurst & Associates, Inc. |
|                          |   |                                                                      |
| Russell R.  Burgess, Jr. |   | Owner, Aladdin  Realty Company                                            |
|                          |   | Owner and  Broker-In-Charge                                               |
|                          |   | Burgess  Realty & Appraisal Service                              |
|                          |   |                                                                      |
| James R. Clarkson             |   | President and  CEO                                                        |
|                          |   | HCSB Financial  Corporation                                               |
|                          |   | and Horry County  State Bank                                              |
|                          |   |                                                                      |
| J. Lavelle Coleman            |   | Retired, Tabor  City Oil, Inc.                                       |
|                          |   |                                                                      |
| Larry G. Floyd                |   | Retired, Floyd’s  Insulation, Inc.                              |
|                          |   | & Cherry  Grove Sales, Inc.                                      |
|                          |   |                                                                      |
| Boyd R. Ford, Jr.        |   | Retired, Ford’s  Fuel Service, Inc.                             |
|                          |   | & Ford’s  Propane Gas, Inc.                                 |
|                          |   |                                                                      |
| Tommie W. Grainger            |   | President,  Coastal Timber Co., Inc.                                 |
|                          |   |                                                                      |
| Gwyn G. McCutchen             |   | Dentist                                                                   |
|                          |   |                                                                      |
| T. Freddie Moore              |   | Retired, Gateway  Drug Store, Inc.                                   |
|                          |   |                                                                      |
| Carroll D.  Padgett, Jr. |   | Attorney,  Carroll D. Padgett, Jr., P.A.                             |

 

# **OFFICERS OF THE BOARD OF DIRECTORS**

 

| Tommie W.  Grainger |   | Michael S. Addy      |
|---------------------|--------|----------------------|
| Chairman            |   | Vice Chairman        |
|                |   |                 |
| James R.  Clarkson  |   | D. Singleton  Bailey |
| President and  CEO  |   | Secretary            |

 

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**HCSBFINANCIAL CORPORATION AND SUBSIDIARY**

 

**HORRYCOUNTY STATE BANK CORPORATE OFFICERS**

 

James R. Clarkson,President/CEO

Glenn R. Bullard,Senior Executive Vice President

Jerry J.Cox, Jr., Executive Vice President/Inland Region

Denise Floyd,Senior Vice President/Personnel Officer

Margaret H.Fowler, Senior Vice President/Operations Officer

Edward L. Loehr, Jr.,Senior Vice President/CFO

Ron L. Paige,Executive Vice President/Myrtle Beach Region

Douglas E.Shaffer, Executive Vice President/North Strand Region

 

**HORRYCOUNTY STATE BANK BRANCHES AND ATM LOCATIONS**

 
| **Broad  Street, Loris Office*** | ** ** | **Windy  Hill Office***    | ** ** | **Homewood  Office***             |   |
|----------------------------------|------------|----------------------------|------------|-----------------------------------|--------|
| 5009 Broad Street                |       | 4400 Hwy. 17 South         |       | 3201 Hwy. 701 North               |
| Loris, SC 29569                  |       | N. Myrtle Beach, SC  29582 |       | Conway, SC 29526                  |
| 843-756-6333                     |       | 843-663-5600               |       | 843-369-4272                      |
|                             |       |                       |       |                              |
| **Mt.  Olive Office***           | ** ** | **Socastee  Office***      | ** ** | **Meeting  Street, Loris Office** |
| 5264 Hwy. 9                      |       | 4600 Hwy. 17 Bypass S.     |       | 4011 Meeting Street               |
| Green Sea, SC 29545              |       | Myrtle Beach, SC 29577     |       | Loris, SC 29569                   |
| 843-392-6333                     |       | 843-293-7595               |       | 843-756-7168                      |
|                             |       |                       |       |                              |
| **Little  River Office***        | ** ** | **Myrtle  Beach Office***  | ** ** | **Carolina  Forest Office***      |
| 3187 Hwy. 9 E.                   |       | 1701 N. Oak Street         |       | 273 Carolina Forest  Blvd.        |
| Little River, SC 29566           |       | Myrtle Beach, SC 29577     |       | Myrtle Beach, SC 29579            |
| 843-399-9523                     |       | 843-839-9339               |       | 843-903-3223                      |
|                             |       |                       |       |                              |
| **Highway  501 Office***         | ** ** | **Tabor  City Office***    | ** ** | **Ocean  Drive Office***          |
| 1627-A Church Street  (Hwy. 501) |       | 3210 Hwy. 701 Bypass       |       | 609 Highway 17 South              |
| Conway, SC 29526                 |       | Loris, SC 29569            |       | North Myrtle Beach, SC  29582     |
| 843-248-8250                     |       | 910-653-3222               |       | 843-663-1396                      |
|                             |       |                       |       |                              |
| **Downtown  Conway Office***     | ** ** |                       |       | **Covenant  Towers Office**       |
| 1300 2nd Avenue             |       |                       |       | 5001 Little River Road            |
| Conway, SC 29526                 |       |                       |       | Myrtle Beach, SC 29577            |
| **843-488-5510**                 | ** ** | ** **                 | ** ** | **843-449-2484**                  |
|                                  |            |                            |            |                                   |        |  |  |  |  |

 

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*****   Denotes ATM Location

 

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