UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C.  20549





FORM
10-K





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





For the
fiscal year ended December 31, 2009





OR





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





For the
transition period from _________ to _________





Commission
File Number 1-5735





Provident Community Bancshares, Inc.


(Exact
name of registrant as specified in its charter)





Delaware
                        
                        57-1001177(State
      or other jurisdiction of incorporation
                        
                        (I.R.S.
      Employeror
      organization)
                        
                        Identification No.)





2700 Celanese Road, Rock Hill, South
      Carolina
                        
                        29732(Address
      of principal executive offices)
                        
                        (Zip
      Code)





Registrant’s
telephone number, including area code: (803) 325-9400





Securities
registered pursuant to Section 12(b) of the Exchange Act:





Title of Class
                  
                  Name of each exchange on which
      registeredCommon
      stock, par value $0.01 per share
                  
                  The
      NASDAQ Stock Market
LLC





Securities registered pursuant to Section 12(g) of the Exchange Act:
                      
                      None





Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.  Yes   ̈No  x





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





Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.


Yes  xNo   ̈





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





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





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





(Check
      one):
                Large
      accelerated filer   ̈
                Accelerated
      filer                    ̈Non-accelerated
      filer     ̈
                Smaller
      reporting company  x





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





The
aggregate market value of the voting stock held by non-affiliates, computed
by reference to the price at which the voting stock was last sold on June 30,
2009, which is the last day of the registrant’s second fiscal quarter, was
approximately $5,189,154 (1,572,471 shares at $3.30 per
share).  Solely for this calculation it is assumed that directors and
executive officers are affiliates of the registrant.





As of
March 9, 2010, there were 1,790,599 shares of the registrant’s common stock
issued and outstanding.





DOCUMENTS
INCORPORATED BY REFERENCE





1.
            Portions
      of the Proxy Statement for the 2010 Annual Meeting of Shareholders
      (Part III).









INDEX





PagePart
      IItem
      1.
                      Business
                      1Item
      1A.
                      Risk
      Factors
                      23Item
      1B.
                      Unresolved
      Staff Comments
                      29Item
      2.
                      Properties
                      30Item
      3.
                      Legal
      Proceedings
                      30Item
      4.
                      Submission
      of Matters to a Vote of Security Holders
                      30Part
      IIItem
      5.
                      Market
      for Registrant’s Common Equity, Related Stockholder Matters and
      IssuerPurchases
      of Equity Securities
                      30Item
      6.
                      Selected
      Financial Data
                      31Item
      7.
                      Management’s
      Discussion and Analysis and Results of Operation
                      32Item
      7A.
                      Quantitative
      and Qualitative Disclosures About Market Risk
                      41Item
      8.
                      Financial
      Statements and Supplementary Data
                      41Item
      9.
                      Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosure
                      77Item
      9A(T).
                      Controls
      and Procedures
                      77Item
      9B.
                      Other
      Information
                      78Part
      IIIItem
      10.
                      Directors,
      Executive Officers and Corporate Governance
                      78Item
      11.
                      Executive
      Compensation
                      79Item
      12.
                      Security
      Ownership of Certain Beneficial Owners andManagement
      and Related Stockholder Matters
                      79Item
      13.
                      Certain
      Relationships and Related Transactions, and Director
      Independence
                      80Item
      14.
                      Principal
      Accountant Fees and Services
                      80Part
      IVItem
      15.
                      Exhibits
      and Financial Statement Schedules
                      81SIGNATURES










PART
I





Item
1.  Business





General





Provident Community Bancshares, Inc.
(“Provident Community Bancshares”) is the bank holding company for Provident
Community Bank, N.A. (the “Bank”).  Provident Community Bancshares has
no material assets or liabilities other than its investment in the
Bank.  Provident Community Bancshares’ business activity primarily
consists of directing the activities of the Bank.  Accordingly, the
information set forth in this report, including financial statements and related
data, relates primarily to the Bank.  Provident Community Bancshares
and the Bank are collectively referred to as the “Corporation”
herein.





The Bank’s operations are conducted
through its main office in Rock Hill, South Carolina and eight full-service
banking centers, all of which are located in the upstate area of South Carolina.
The Bank is regulated by the Office of the Comptroller of the Currency (the
“OCC”), is a member of the Federal Home Loan Bank of Atlanta (the “FHLB”) and
its deposits are insured up to applicable limits by the Federal Deposit
Insurance Corporation (the “FDIC”).  Provident Community Bancshares is
subject to regulation by the Federal Reserve Board (the “FRB”).





The business of the Bank primarily
consists of attracting deposits from the general public and originating loans to
consumers and businesses.  The Bank also maintains a portfolio of
investment securities.  The principal sources of funds for the Bank’s
lending activities include deposits received from the general public, interest
and principal repayments on loans and, to a lesser extent, borrowings from the
FHLB and other parties.  The Bank’s primary source of income is
interest earned on loans and investments.  The Bank’s principal
expense is interest paid on deposit accounts and borrowings and expenses
incurred in operating the Bank.





Forward-Looking
Statement





This annual report contains certain
“forward-looking statements” within the meaning of the federal securities
laws.  These forward-looking statements are generally identified by
use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,”
“project” or similar expressions.  These forward-looking statements
include, but are not limited to, estimates and expectations of future
performance with respect to the financial condition and results of operations of
the Corporation and other factors. These forward-looking statements are not
guarantees of future performance and are subject to various factors that could
cause actual results to differ materially from these forward-looking statements.
These factors include, but are not limited to: changes in general economic and
market conditions and the legal and regulatory environment in which the
Corporation operates; the development of an interest rate environment that
adversely affects the Corporation’s interest rate spread or other income
anticipated from the Corporation’s operations; changes in consumer spending,
borrowing and savings habits; adverse changes in the securities markets; changes
in accounting policies and practices; and increased competitive pressures among
financial services companies.  These risks and uncertainties should be
considered in evaluating forward-looking statements and undue reliance should
not be placed on such statements.  The Corporation does not
undertake—and specifically disclaims any obligation—to publicly release the
results of any revisions that may be made to any forward-looking statements to
reflect events or circumstances after the date of such statements or to reflect
the occurrence of anticipated or unanticipated events.





Competition





The Bank faces competition in both the
attraction of deposit accounts and in the origination of mortgage, commercial
and consumer loans.  Its most direct competition for savings deposits
historically has been derived from other commercial banks and thrift
institutions located in and around Union, Laurens, Fairfield, Greenville and
York Counties, South Carolina.  As of June 30, 2009, according to
information presented on the Federal Deposit Insurance Corporation’s website,
the Bank held 39.78% of the deposits in Union County, which was the second
largest share of deposits out of five financial institutions in the
county.  Additionally, the Bank held 27.78% of the deposits in
Fairfield County, which was the second largest out of three financial
institutions in the county, 6.87% of the deposits in Laurens County, which was
the fifth largest share of deposits out of nine financial institutions in the
county and 3.30% of the deposits in York County, which was the tenth largest out
of 17 financial institutions in that county. The Corporation held 0.24% of the
deposits in Greenville County, which was 27th out of
35 financial institutions in the county.  The Bank competes with
super-regional banks, such as BB&T and SunTrust, and large regional banks,
such as First-Citizens Bank and Trust Company of South Carolina and Carolina
First Bank.  These competitors have substantially greater resources
and lending limits than does the Bank and offer services that the Bank does not
provide.  The Bank faces additional significant competition for
investor funds from money market instruments and mutual funds.  It
competes for savings by offering depositors a variety of savings accounts,
convenient office locations and other services.


1





The Bank competes for loans principally
through the interest rates and loan fees it charges and the efficiency and
quality of the services it provides borrowers, real estate brokers and home
builders. The Bank’s competition for real estate loans comes principally from
other commercial banks, thrift institutions and mortgage banking
companies.





Competition has increased and is likely
to continue to increase as a result of legislative, regulatory and technological
changes and the continuing trend of consolidation in the financial services
industry.  Technological advances, for example, have lowered barriers
to market entry, allowed banks to expand their geographic reach by providing
services over the Internet and made it possible for non-depository institutions
to offer products and services that traditionally have been provided by banks.
The Gramm-Leach-Bliley Act, which permits affiliation among banks, securities
firms and insurance companies, also has changed and may continue to change the
competitive environment in which the Bank conducts business.





Lending
Activities





General.   Set
forth below is selected data relating to the composition of the Bank’s loan
portfolio on the dates indicated (dollars in thousands).





At
      December 31,2009
                  
                  
                  2008
                  
                  
                  2007
                  
                  
                  2006
                  
                  
                  2005Amount
                  
                  
                  Percent
                  
                  
                  Amount
                  
                  
                  Percent
                  
                  
                  Amount
                  
                  
                  Percent
                  
                  
                  Amount
                  
                  
                  Percent
                  
                  
                  Amount
                  
                  
                  PercentReal
      estate loans:Residential
                  
                  $
                  16,877
                  
                  
                  
                  6.74
                  %
                  
                  $
                  20,235
                  
                  
                  
                  7.26
                  %
                  
                  $
                  24,989
                  
                  
                  
                  9.74
                  %
                  
                  $
                  29,482
                  
                  
                  
                  12.71
                  %
                  
                  $
                  36,560
                  
                  
                  
                  18.99
                  %Commercial
                  
                  
                  110,901
                  
                  
                  
                  44.28
                  
                  
                  
                  110,589
                  
                  
                  
                  39.68
                  
                  
                  
                  76,864
                  
                  
                  
                  29.97
                  
                  
                  
                  62,450
                  
                  
                  
                  26.93
                  
                  
                  
                  45,665
                  
                  
                  
                  23.71Construction
      loans
                  
                  
                  2,923
                  
                  
                  
                  1.17
                  
                  
                  
                  5,867
                  
                  
                  
                  2.11
                  
                  
                  
                  4,764
                  
                  
                  
                  1.86
                  
                  
                  
                  5,787
                  
                  
                  
                  2.50
                  
                  
                  
                  4,842
                  
                  
                  
                  2.51Total
      real estate loans
                  
                  
                  130,701
                  
                  
                  
                  52.19
                  
                  
                  
                  136,691
                  
                  
                  
                  49.05
                  
                  
                  
                  106,617
                  
                  
                  
                  41.57
                  
                  
                  
                  97,719
                  
                  
                  
                  42.14
                  
                  
                  
                  87,067
                  
                  
                  
                  45.21Consumer
      and installment loans
                  
                  
                  52,287
                  
                  
                  
                  20.88
                  
                  
                  
                  57,002
                  
                  
                  
                  20.45
                  
                  
                  
                  51,846
                  
                  
                  
                  20.21
                  
                  
                  
                  46,136
                  
                  
                  
                  19.90
                  
                  
                  
                  39,876
                  
                  
                  
                  20.71Commercial
      loans
                  
                  
                  73,525
                  
                  
                  
                  29.36
                  
                  
                  
                  94,012
                  
                  
                  
                  33.74
                  
                  
                  
                  104,261
                  
                  
                  
                  40.65
                  
                  
                  
                  93,562
                  
                  
                  
                  40.35
                  
                  
                  
                  70,668
                  
                  
                  
                  36.70Total
      loans
                  
                  
                  256,513
                  
                  
                  
                  102.43
                  
                  
                  
                  287,705
                  
                  
                  
                  103.24
                  
                  
                  
                  262,724
                  
                  
                  
                  102.43
                  
                  
                  
                  237,417
                  
                  
                  
                  102.39
                  
                  
                  
                  197,611
                  
                  
                  
                  102.62Less:Undisbursed
      loans in process
                  
                  
                  (320
                  )
                  
                  
                  (0.13
                  )
                  
                  
                  (1,926
                  )
                  
                  
                  (0.69
                  )
                  
                  
                  (2,379
                  )
                  
                  
                  (0.93
                  )
                  
                  
                  (2,238
                  )
                  
                  
                  (0.97
                  )
                  
                  
                  (1,980
                  )
                  
                  
                  (1.03
                  )Loan
      discount unamortized
                  
                  
                  (309
                  )
                  
                  
                  (0.12
                  )
                  
                  
                  (383
                  )
                  
                  
                  (0.14
                  )
                  
                  
                  (476
                  )
                  
                  
                  (0.18
                  )
                  
                  
                  (607
                  )
                  
                  
                  (0.26
                  )
                  
                  
                  (764
                  )
                  
                  
                  (0.40
                  )Allowance
      for loan losses
                  
                  
                  (5,579
                  )
                  
                  
                  (2.23
                  )
                  
                  
                  (6,778
                  )
                  
                  
                  (2.43
                  )
                  
                  
                  (3,344
                  )
                  
                  
                  (1.30
                  )
                  
                  
                  (2,754
                  )
                  
                  
                  (1.19
                  )
                  
                  
                  (2,394
                  )
                  
                  
                  (1.24
                  )Deferred
      loan fees
                  
                  
                  115
                  
                  
                  
                  0.05
                  
                  
                  
                  47
                  
                  
                  
                  0.02
                  
                  
                  
                  (38
                  )
                  
                  
                  (0.02
                  )
                  
                  
                  68
                  
                  
                  
                  0.03
                  
                  
                  
                  104
                  
                  
                  
                  0.05Net
      loans receivable
                  
                  $
                  250,420
                  
                  
                  
                  100.00
                  %
                  
                  $
                  278,665
                  
                  
                  
                  100.00
                  %
                  
                  $
                  256,487
                  
                  
                  
                  100.00
                  %
                  
                  $
                  231,886
                  
                  
                  
                  100.00
                  %
                  
                  $
                  192,577
                  
                  
                  
                  100.00
                  %




2


The
following table sets forth, at December 31, 2009, certain information regarding
the dollar amount of principal repayments for loans becoming due during the
periods indicated (in thousands).  Demand loans (loans having no
stated schedule of repayments and no stated maturity) and overdrafts are
reported as due in one year or less.


Due
                  Within
                  One
      Year
                
                
                Due
                  After
                  1
      Year
                  Through
                  5
      Years
                
                
                Due
      After
                  5
      Years
                
                
                TotalReal
      estate loans:Residential
      loans
                
                $
                39
                
                
                $
                1,322
                
                
                $
                15,516
                
                
                $
                16,877Commercial
      loans
                
                
                26,829
                
                
                
                58,788
                
                
                
                25,284
                
                
                
                110,901Construction
      loans (1)
                
                
                2,923
                
                
                
                —
                
                
                
                —
                
                
                
                2,923Consumer
      and installment loans
                
                
                7,157
                
                
                
                21,307
                
                
                
                23,823
                
                
                
                52,287Commercial
      loans
                
                
                42,590
                
                
                
                20,313
                
                
                
                10,622
                
                
                
                73,525Total
                
                $
                79,538
                
                
                $
                101,730
                
                
                $
                75,245
                
                
                $
                256,513







(1)    Includes
construction/permanent loans.





The actual average life of mortgage
loans is substantially less than their contractual term because of loan
repayments and because of enforcement of due-on-sale clauses that give the Bank
the right to declare a loan immediately due and payable if, among other things,
the borrower sells the real property subject to the mortgage and the loan is not
repaid.  The average life of mortgage loans tends to increase,
however, when current mortgage loan rates substantially exceed rates on existing
mortgage loans.





The following table sets forth, at
December 31, 2009, the dollar amount of loans due after December 31, 2010 which
have fixed rates of interest and which have adjustable rates of interest (in
thousands).





Fixed
                  
                  
                  Adjustable
                  
                  
                  TotalReal
      estate loans:Residential
      loans
                  
                  $
                  10,635
                  
                  
                  $
                  6,203
                  
                  
                  $
                  16,838Commercial
      loans
                  
                  
                  60,875
                  
                  
                  
                  23,197
                  
                  
                  
                  84,072Consumer
      and installment loans
                  
                  
                  20,612
                  
                  
                  
                  24,518
                  
                  
                  
                  45,130Commercial
      loans
                  
                  
                  17,612
                  
                  
                  
                  13,323
                  
                  
                  
                  30,935Total
                  
                  $
                  109,734
                  
                  
                  $
                  67,241
                  
                  
                  $
                  176,975





Real Estate
Loans. The Bank originates residential mortgage loans to enable borrowers
to purchase existing single family homes or to construct new homes. At December
31, 2009, $16.9 million, or 6.7% of the Corporation’s net loan portfolio
consisted of loans secured by residential real estate (net of undisbursed
principal, excluding construction loans).





Office of the Comptroller of the
Currency regulations limit the amount that national banks may lend in
relationship to the appraised value of the real estate securing the loan, as
determined by an appraisal at the time of loan origination. Federal banking
regulations permit a maximum loan-to-value ratio of 100% for one-to four-family
dwellings and 85% for all other real estate loans.  The Bank’s lending
policies, however, limit the maximum loan-to-value ratio on one-to four-family
real estate mortgage loans to 80% of the lesser of the appraised value or the
purchase price.  Any single-family loan made in excess of an 80%
loan-to-value ratio and any commercial real estate loan in excess of a 75%
loan-to-value ratio is required to have private mortgage insurance or additional
collateral.  In the past, the Bank has originated some commercial real
estate loans in excess of a 75% loan-to-value ratio without private mortgage
insurance or additional collateral.


3


The loan-to-value ratio, maturity and
other provisions of the loans made by the Bank generally have reflected a policy
of making less than the maximum loan permissible under applicable regulations,
market conditions, and underwriting standards established by the Bank. Mortgage
loans made by the Bank generally are long-term loans (15-30 years), amortized on
a monthly basis, with principal and interest due each month.  In the
Bank’s experience, real estate loans remain outstanding for significantly
shorter periods than their contractual terms.  Borrowers may refinance
or prepay loans, at their option, with no prepayment penalty.





The Bank offers a full complement of
mortgage lending products with both fixed and adjustable rates.  Due
to the nature of the Bank’s marketplace, only a small percentage of residential
loans are adjustable-rate mortgage loans (“ARMs”). The Bank offers ARMs tied to
U.S. Treasury Bills with a maximum interest rate adjustment of 2% annually and
6% over the life of the loan.  At December 31, 2009, the Bank had
approximately $6.2 million of ARMs, or 2.4% of the Bank’s total loans
receivable. At December 31, 2009, $10.7 million, or 4.2%, of the Bank’s loan
portfolio consisted of long-term, fixed-rate residential real estate
loans.





Net interest income depends to a large
extent on how successful the Bank is in “matching” interest-earning assets and
interest-bearing liabilities.  The Corporation has taken steps to
reduce its exposure to rising interest rates.  For a discussion of
these steps, see “Management’s Discussion and Analysis of Financial Condition
and Results of Operations.”





Commercial real estate loans
constituted approximately $110.9 million, or 44.3%, of the Bank’s net loan
portfolio at December 31, 2009. Commercial real estate loans consist of
permanent loans secured by multi-family loans, generally apartment houses, as
well as commercial and industrial properties, including office buildings,
warehouses, shopping centers, hotels, motels and other special purpose
properties.  Commercial real estate loans are originated and purchased
for inclusion in the Bank’s portfolio. These loans generally have 20 to 30-year
amortization schedules and are callable or have balloon payments after five
years. Typically, the loan documents provide for adjustment of the interest rate
every one to three years.  Fixed-rate loans secured by multi-family
residential and commercial properties have terms ranging from 20 to 25
years.





Loans secured by multi-family and
commercial real estate properties may involve greater risk than single-family
residential loans.  Such loans generally are substantially larger than
single-family residential loans.  Further, the payment experience on
loans secured by commercial properties typically depends on the successful
operation of the properties, and thus may be subject to a greater extent to
adverse conditions in the real estate market or in the economy generally. Our
largest commercial real estate loan relationship was a $5.4 million loan secured
by commercial real estate including land and buildings located in Greenville,
South Carolina. This loan was performing according to its original terms at
December 31, 2009.





Construction
Loans.  The Bank engages in construction lending that primarily
is secured by single family residential real estate and, to a much lesser
extent, commercial real estate. The Bank grants construction loans to
individuals with a takeout for permanent financing from one of our correspondent
mortgage lenders or another financial institution, and to approved builders on
both presold and unsold properties.





Construction loans to individuals are
originated for a term of one year or less or are originated to convert to
permanent loans at the end of the construction period.  Construction
loans are originated to builders for a term not to exceed 12
months.  Generally, draw inspections are handled by the appraiser who
initially appraised the property; however, in some instances the draw
inspections are performed by a new appraisal firm.





Construction financing affords the Bank
the opportunity to achieve higher interest rates and fees with shorter terms to
maturity than do single-family permanent mortgage loans.  However,
construction loans generally  are considered to involve a higher
degree of risk than single-family permanent mortgage lending due
to:  (1) the concentration of principal among relatively few borrowers
and development projects; (2) the increased difficulty at the time the loan is
made of estimating the building costs and the selling price of the property to
be built; (3) the increased difficulty and costs of monitoring the loan; (4) the
higher degree of sensitivity to increases in market rates of interest; and (5)
the increased difficulty of working out loan problems.


4





At December 31, 2009, the Bank had
approximately $2.9 million outstanding in construction loans, including
approximately $320,000 in undisbursed proceeds. Substantially all of these loans
were secured by one- to four-family residences.





Consumer
Loans.  The Bank’s consumer loan portfolio primarily consists
of automobile loans on new and used vehicles, mobile home loans, boat loans,
second mortgage loans, loans secured by savings accounts and unsecured
loans.  The Bank makes consumer loans to serve the needs of its
customers and as a way to improve the interest-rate sensitivity of the Bank’s
loan portfolio.





Consumer loans tend to bear higher
rates of interest and have shorter terms to maturity than residential mortgage
loans.  However, consumer loans historically have tended to have a
higher rate of default than residential mortgage loans.  Additionally,
consumer loans entail greater risk than do residential mortgage loans,
particularly in the case of loans that are unsecured or secured by rapidly
depreciating assets such as automobiles.  In these cases, any
repossessed collateral for a defaulted consumer loan may not provide an adequate
source of repayment of the outstanding loan balance as a result of the greater
likelihood of damage, loss or depreciation.  The remaining deficiency
often does not warrant further substantial collection efforts against the
borrower beyond obtaining a deficiency judgment.  In addition,
consumer loan collections are dependent on the borrower’s continuing financial
stability, and thus are more likely to be affected adversely by job loss,
divorce, illness or personal bankruptcy.





Commercial
Loans.Commercial business
loans are made primarily in our market area to small businesses through our
branch network. Each county location of the branch network has an experienced
commercial lender that is responsible for the generation of this product. In
selective cases, we will enter into a loan participation within our market area
to purchase a portion of a commercial loan that meets the Bank’s underwriting
criteria. We offer secured commercial loans with maturities of up to 20 years.
The term for repayment will normally be limited to the lesser of the expected
useful life of the asset being financed or a fixed amount of time, generally
less than seven years. These loans have adjustable rates of interest indexed to
the prime rate as reported in The Wall Street
Journal.  When making commercial loans, we consider the
financial statements of the borrower, the borrower’s payment history of both
corporate and personal debt, the debt service capabilities of the borrower, the
projected cash flows of the business, the viability of the industry in which the
customer operates and the value of the collateral.  A commercial loan
generally is secured by a variety of collateral, primarily accounts receivable,
inventory and equipment, and generally are supported by personal
guarantees.  Depending on the collateral used to secure the loans,
commercial loans are made in amounts of up to 80% of the value of the collateral
securing the loan.  Our largest commercial loan relationship was a
$3.5 million loan secured by petroleum assets located in Winnsboro, South
Carolina. This loan was performing according to its original terms at December
31, 2009.





Unlike residential mortgage loans,
which are generally made on the basis of the borrower’s ability to make
repayment from his or her employment or other income, and which are secured by
real property whose value tends to be more easily ascertainable, commercial
loans are of higher risk and typically are made on the basis of the borrower’s
ability to make repayment from the cash flows of the borrower’s business. As a
result, the availability of funds for the repayment of commercial loans may
depend substantially on the success of the business itself. Further, any
collateral securing such loans may depreciate over time, may be difficult to
appraise and may fluctuate in value.





Loan Solicitation
and Processing.  Loan originations come from walk-in customers,
sales and solicitations from loan officers and loan
participations.  The Bank utilizes various officers and loan
committees for the approval of real estate loans. The Board of Directors has
appointed a Board Loan Committee comprised of two members elected annually from
the Board of Directors and four senior executive officers of the
Bank.  A quorum of three members, including at least one Board member,
is required for any action.  This Committee has the authority to
approve all secured and unsecured loan requests with the exception of a single
loan request exceeding $3.0 million, which requires approval of the entire Board
of Directors.


5


Loan
Originations, Purchases and Sales.  During 2001, we phased out
broker loan purchases and originations and reduced our mortgage lending
operations to provide an increased capital allocation for consumer and
commercial lending. Consequently, the Bank did not securitize any loans in
either the 2009 or 2008 fiscal years.  The Bank does not have any
current plans to sell a large volume of loans, other than fixed-rate mortgage
loans it originates through its retail branch network. The Bank purchases
participation interests in loans originated by other institutions. The Bank had
total purchases of participation interests of $3.4 million in 2009. These
participation interests are primarily on commercial properties and carry either
a fixed or adjustable interest rate. The Bank performs its own underwriting
analysis on each of its participation interests before purchasing such loans and
therefore believes there is no greater risk of default on these obligations.
However, in a purchased participation loan, the Bank does not service the loan
and thus is subject to the policies and practices of the lead lender with regard
to monitoring delinquencies, pursuing collections and instituting foreclosure
proceedings. The Bank is permitted to review all of the documentation relating
to any loan in which the Bank participates, including any annual financial
statements provided by a borrower. Additionally, the Bank receives periodic
updates on the loan from the lead lender.





The following table sets forth the
Bank’s loan origination activity for the periods indicated (in
thousands):





Year
      Ended December 31,2009
                    
                    
                    2008
                    
                    
                    2007Loans
      originated:Real
      estate loans:Residential
      loans
                    
                    $
                    2,324
                    
                    
                    $
                    3,504
                    
                    
                    $
                    5,338Construction
      loans
                    
                    
                    –
                    
                    
                    
                    1,556
                    
                    
                    
                    –Commercial
      loans
                    
                    
                    11,515
                    
                    
                    
                    33,725
                    
                    
                    
                    14,414Total
      mortgage loans originated
                    
                    
                    13,839
                    
                    
                    
                    38,785
                    
                    
                    
                    19,752Consumer
      and installment loans
                    
                    
                    5,419
                    
                    
                    
                    20,769
                    
                    
                    
                    17,924Commercial
      loans
                    
                    
                    11,484
                    
                    
                    
                    30,055
                    
                    
                    
                    45,449Total
      loans originated
                    
                    $
                    30,742
                    
                    
                    $
                    89,609
                    
                    
                    $
                    83,125Loan
      participations purchased
                    
                    $
                    3,400
                    
                    
                    $
                    13,550
                    
                    
                    $
                    27,636Loan
      participations sold
                    
                    $
                    –
                    
                    
                    $
                    1,000
                    
                    
                    $
                    2,000





Asset Quality.We maintain loan quality monitoring policies and systems that require
detailed monthly and quarterly analyses of delinquencies, non-performing loans,
real estate owned and other repossessed assets. Reports of such loans and assets
by various categories are reviewed by management and the Board of Directors. The
majority of our loans are originated in upstate South Carolina.





We closely monitor trends in problem
assets which include non-accrual loans, renegotiated loans, and real estate and
other assets acquired in the settlement of loans. Renegotiated loans, or
troubled debt restructurings, are those loans where the borrower is experiencing
financial difficulties and we have agreed to concessions of the terms such as
changes in the interest rate charged and/or other concessions.





Problem
Assets.  TheBankdetermines a loan to be delinquent when
payments have not been made according to contractual terms, typically evidenced
by nonpayment of a monthly installment by the due date. The accrual of interest
on loans is discontinued at the time the loan is 90 days delinquent.Subsequent
payments are either applied to the outstanding principal balance or recorded as
interest income, depending on the assessment of the ultimate collectability of
the loan.  See Notes 1 and 3 of Notes to Consolidated Financial
Statements.





A loan is impaired when it is probable,
based on current information, the Bank will be unable to collect all contractual
principal and interest payments due in accordance with the terms of the loan
agreement. Management has determined that, generally, a failure to make a
payment within a 90-day period constitutes a minimum delay or shortfall and
generally does not constitute an impaired loan.  However, management
reviews each past due loan on a loan-by-loan basis and may determine a loan to
be impaired before the loan becoming over 90 days past due, depending upon the
circumstances of that particular loan.  A loan is classified as
non-accrual at the time management believes that the collection of interest is
improbable, generally when a loan becomes 90 days past due.  The
Bank’s policy for charge-off of impaired loans is on a loan-by-loan
basis.  At the time management believes the collection of interest and
principal is remote, the loan is charged off.  It is our policy to
evaluate impaired loans based on the fair value of the
collateral.  Interest income from impaired loans is recorded using the
cash method.


6





Real estate acquired as a result of
foreclosure or by deed in lieu of foreclosure is classified as real estate
owned. When such property is acquired it is recorded at the lower of the unpaid
principal balance of the related loan or its fair market value less selling
costs.  Any subsequent write-down of the property is charged to
income.





The Bank adjusts balances on real
estate acquired in settlement of loans to the lower of cost or market based on
appraised value when the property is received in settlement. These values
reflect current market conditions and sales experience.  See Notes 1
and 3 of Notes to Consolidated Financial Statements.





The
following table illustrates trends in problem assets and other asset quality
indicators for the periods indicated (dollars in thousands).


At
      December 31,2009
                
                
                2008
                
                
                2007
                
                
                2006
                
                
                2005Non-accrual
      loans
                
                $
                20,869
                
                
                $
                16,001
                
                
                $
                2,972
                
                
                $
                1,295
                
                
                $
                1,246Troubled
      debt restructurings
                
                
                3,320
                
                
                
                316
                
                
                
                102
                
                
                
                113
                
                
                
                127Accruing
      loans which are contractually past due 90 days or more
                
                
                –
                
                
                
                –
                
                
                
                –
                
                
                
                –
                
                
                
                –Real
      estate owned, net
                
                
                5,917
                
                
                
                667
                
                
                
                856
                
                
                
                148
                
                
                
                224Total
                
                $
                30,106
                
                
                $
                16,984
                
                
                $
                3,930
                
                
                $
                1,556
                
                
                $
                1,597As
      a percent of loans receivable and real estate acquired in settlement of
      loans
                
                
                11.74
                %
                
                
                5.88
                %
                
                
                1.49
                %
                
                
                0.62
                %
                
                
                0.76
                %As
      a percent of total assets
                
                
                6.59
                %
                
                
                3.91
                %
                
                
                0.96
                %
                
                
                0.40
                %
                
                
                0.43
                %Allowance
      for loan losses as a percent of problem assets
                
                
                18.53
                %
                
                
                39.91
                %
                
                
                85.09
                %
                
                
                176.99
                %
                
                
                149.91
                %





The following table sets forth
information with respect to the Bank’s non-performing assets for the
periods indicated (dollars in thousands).


At
      December 31,2009
                
                
                2008
                
                
                2007
                
                
                2006
                
                
                2005Real
      estate
                
                $
                649
                
                
                $
                389
                
                
                $
                356
                
                
                $
                459
                
                
                $
                461Commercial
                
                
                19,045
                
                
                
                13,345
                
                
                
                2,445
                
                
                
                631
                
                
                
                436Consumer
                
                
                1,175
                
                
                
                2,267
                
                
                
                171
                
                
                
                205
                
                
                
                349Total
                
                
                20,869
                
                
                
                16,001
                
                
                
                2,972
                
                
                
                1,295
                
                
                
                1,246Accruing
      loans which are contractually past due 90 days or more
                
                
                –
                
                
                
                –
                
                
                
                –
                
                
                
                –
                
                
                
                –Real
      estate owned, net
                
                
                5,917
                
                
                
                667
                
                
                
                856
                
                
                
                148
                
                
                
                224Total
      non-performing assets
                
                $
                26,786
                
                
                $
                16,668
                
                
                $
                3,828
                
                
                $
                1,443
                
                
                $
                1,470Percentage
      of non-performing assets to loans receivable, net
                
                
                10.69
                %
                
                
                5.98
                %
                
                
                1.49
                %
                
                
                0.62
                %
                
                
                0.76
                %





Non-performingassetsincreased $10.1 millionfrom $16.7 millionat December 31, 2008to $26.8 millionat D
 ecember 31, 2009.The majority of this increase relates
primarily to four commercial real estate relationships totaling $9.7 million
that have been affected by the downturn in the residential housing
market.Slow housing
conditions have affected these borrowers’s ability to sell the completed
projects in a timely manner.These loans areare primarily supported by commercial
real estate and arecurrently being carried at management’s
best estimate of net realizable value, although no assurance can be given that
no further losses will be incurred on these loans until the collateral has been
acquired and liquidated or other arrangements can be
made.


7





In addition to non-accrual loans of
$20.9 million at December 31, 2009, management has identified approximately
$17.8 million in potential problem loans that could move to non-accrual status
in future periods. Potential problem loans are loans where know information
about possible credit problems of the borrowers causes management to have
concerns as to the ability of such borrowers to comply with the present
repayment terms and may result in disclosure of such loans as non-accrual in
future periods. Management is actively working a plan of action to mitigate any
loss exposure and will continue to monitor their respective cash flow
positions.





Troubled debt restructuringsincreased $3.0 millionfrom $316,000at December 31, 2008to $3.3 millionat December 31, 2009.The majority of this increase relates primarily to two commercial real estate
relationships totaling $2.5 million that have been affected by the downturn in
the commercial real estate market.





Real estate acquired through foreclosure
increased $5.2 millionto $5.9 millionatDecember31, 2009 from $667,000 at December 31,
2008, as a result of foreclosure on commercial real estate properties.
Approximately 88%, or $4,800,000, of the increase was due to the foreclosure of
two commercial real estate projects where  the collateral values are
supported by residential housing and undeveloped land. The properties are being
actively marketed and maintained with the primary objective of liquidating the
collateral at a level which most accurately approximates fair market value and
allows recovery of as much of the unpaid balance as possible upon the sale of
the properties in a reasonable period of time. The carrying value of these
assets are believed to be representative of their fair market value, although
there can be no assurance that the ultimate proceeds from the sale of these
assets will be equal to or greater than the carrying values.





Interest
income that would have been recorded for the year ended December 31, 2009 had
non-accruing loans been current in accordance with their original terms amounted
to approximately $1.3 million. There was no interest included in interest income
on such loans for the year ended December 31, 2009. Other than disclosed in the
table above, there are no other loans at December 31, 2009 that management has
serious doubts about the ability of borrowers to comply with present loan
payment terms.





Allowance for
Loan Losses.  In originating loans, we recognize that losses
will be experienced and that the risk of loss will vary with, among other
things, the type of loan being made, the creditworthiness of the borrower over
the term of the loan, general economic conditions and, in the case of a secured
loan, the quality of the security for the loan.  To cover losses
inherent in the portfolio of performing loans, the Bank maintains an allowance
for loan losses.  Management’s periodic evaluation of the adequacy of
the allowance is based on a number of factors, including management’s evaluation
of the collectability of the loan portfolio, the composition and size of the
portfolio, credit concentrations, trends in historical loss experience and
economic conditions.  Upon completion of the qualitative adjustments,
the allowance is allocated to the components of the portfolio based on the
adjusted factors. The amount of the allowance is based on the estimated value of
the collateral securing the loan and other analysis pertinent to each
situation.





The unallocated component of the
allowance exists to mitigate the imprecision inherent in management’s estimates
of expected credit losses and includes its determination of the amounts
necessary for concentrations, economic uncertainties and other subjective
factors that may not have been fully considered in the allocated allowance. The
relationship of the unallocated component to the total allowance may fluctuate
from period to period. As of December 31, 2009, management has allocated the
allowance to specific loan categories and, as a result, there was not an
unallocated component of the allowance.





The Bank increases its allowance for
loan losses by charging provisions for loan losses against
income.  The allowance for loan losses is maintained at an amount
management considers adequate to absorb losses inherent in the
portfolio.  Although management believes that it uses the best
information available to make such determinations, future adjustments to the
allowance for loan losses may be necessary and results of operations could be
affected significantly and adversely if circumstances substantially differ from
the assumptions used in making the determinations.




The provision for loan loss calculation
includes a segmentation of loan categories subdivided by residential mortgage,
commercial and consumer loans. Each category is rated for all loans including
performing groups. The weights assigned to each performing group are developed
from previous loan loss experience and as the loss experience changes, the
category weight is adjusted accordingly. In addition, as the amount of loans in
each category increases and decreases, the provision for loan loss calculation
adjusts accordingly.


8





While we believe that we have
established the existing allowance for loan losses in accordance with generally
accepted accounting principles, there can be no assurance that regulators, in
reviewing our loan portfolio, will not request the Bank to increase
significantly the allowance for loan losses.  In addition, because
future events affecting borrowers and collateral cannot be predicted with
certainty, there can be no assurance that the existing allowance for loan losses
is adequate or that a substantial increase will not be necessary should the
quality of any loans deteriorate as a result of the factors discussed
above.  Any material increase in the allowance for loan losses may
affect adversely the Corporation’s financial condition and results of
operations. See Notes 1 and 3 of Notes to Consolidated Financial Statements for
information concerning the provision and allowance for loan losses.





The following table sets forth an
analysis of the Bank’s allowance for loan losses for the periods indicated
(dollars in thousands):





For
      the Year Ended
                    December
      31,2009
                  
                  
                  2008
                  
                  
                  2007
                  
                  
                  2006
                  
                  
                  2005Balance
      at beginning of year
                  
                  $
                  6,778
                  
                  
                  $
                  3,344
                  
                  
                  $
                  2,754
                  
                  
                  $
                  2,394
                  
                  
                  $
                  2,026Loans
      charged off:Real
      estate
                  
                  
                  (123
                  )
                  
                  
                  (28
                  )
                  
                  
                  –
                  
                  
                  
                  (25
                  )
                  
                  
                  (75
                  )Commercial
                  
                  
                  (8,460
                  )
                  
                  
                  (783
                  )
                  
                  
                  (668
                  )
                  
                  
                  (141
                  )
                  
                  
                  (302
                  )Consumer
                  
                  
                  (1,533
                  )
                  
                  
                  (65
                  )
                  
                  
                  (45
                  )
                  
                  
                  (74
                  )
                  
                  
                  (195
                  )Total
      charge-offs
                  
                  
                  (10,116
                  )
                  
                  
                  (876
                  )
                  
                  
                  (713
                  )
                  
                  
                  (240
                  )
                  
                  
                  (572
                  )Recoveries:Real
      estate
                  
                  
                  16
                  
                  
                  
                  23
                  
                  
                  
                  13
                  
                  
                  
                  44
                  
                  
                  
                  35Commercial
                  
                  
                  203
                  
                  
                  
                  45
                  
                  
                  
                  218
                  
                  
                  
                  66
                  
                  
                  
                  26Consumer
                  
                  
                  3
                  
                  
                  
                  32
                  
                  
                  
                  6
                  
                  
                  
                  20
                  
                  
                  
                  10Total
      recoveries
                  
                  
                  222
                  
                  
                  
                  100
                  
                  
                  
                  237
                  
                  
                  
                  130
                  
                  
                  
                  71Net
      charge-offs
                  
                  
                  (9,894
                  )
                  
                  
                  (776
                  )
                  
                  
                  (476
                  )
                  
                  
                  (110
                  )
                  
                  
                  (501
                  )Provision
      for loan losses (1)
                  
                  
                  8,695
                  
                  
                  
                  4,210
                  
                  
                  
                  1,066
                  
                  
                  
                  470
                  
                  
                  
                  869Balance
      at end of year
                  
                  $
                  5,579
                  
                  
                  $
                  6,778
                  
                  
                  $
                  3,344
                  
                  
                  $
                  2,754
                  
                  
                  $
                  2,394Balance
      as a percent of loans
                  
                  
                  2.18
                  %
                  
                  
                  2.36
                  %
                  
                  
                  1.28
                  %
                  
                  
                  1.17
                  %
                  
                  
                  1.23
                  %Ratio
      of net charge-offs to average gross loans outstanding during the
      period
                  
                  
                  3.64
                  %
                  
                  
                  0.28
                  %
                  
                  
                  0.20
                  %
                  
                  
                  0.05
                  %
                  
                  
                  0.27
                  %










(1)
            See
      “Management’s Discussion and Analysis of Financial Condition and Results
      of Operations” for a discussion of the factors responsible for changes in
      the provision for loan losses between the
  periods.





National
credit conditions have resulted in historically high credit cost levels from the
extraordinarily low cost levels over the past couple of years. The markets in
which we operate are not immune from these conditions and have impacted our
delinquencies, non-accrual loans, and charge-offs. The increasing trends in
non-performing assets we have experienced over the past two fiscal years has
warranted the increase in the provision for loan losses and charge-offs to $8.7
million for 2009 compared to $4.2 million for the year ending December 31,
2008.





The
Corporation experienced bad debt charge-offs, net of recoveries, of
approximately $9.9 million for fiscal 2009 compared to $776,000 for fiscal 2008.
The increase in bad debt charge-offs over the previous year relates primarily to
additional write-downs required in the disposition of commercial real estate and
consumer loans as a result of declining collateral values.


9





The following table sets forth the
breakdown of the allowance for loan losses by loan category and the
percentage of loans in each category to total loans for the periods indicated.
Management believes that the allowance can be allocated by category only on an
approximate basis. The allocation of the allowance to each category is not
necessarily indicative of further losses and does not restrict the use of the
allowance to absorb losses in any category (dollars in thousands):


At
      December 31,2009
                          
                          
                          2008
                          
                          
                          2007
                          
                          
                          2006
                          
                          
                          2005Amount
                          
                          
                          % of Loans
                            in
      Each
                            Category to
                            Total Loans
                          
                          
                          Amount
                          
                          
                          %
      of Loans
                            in
      Each
                            Category
      to
                            Total
      Loans
                          
                          
                          Amount
                          
                          
                          %
      of Loans
                            in
      Each
                            Category
      to
                            Total
      Loans
                          
                          
                          Amount
                          
                          
                          %
      of Loans
                            in
      Each
                            Category
      to
                            Total
      Loans
                          
                          
                          Amount
                          
                          
                          %
      of Loans
                            in
      Each
                            Category
      to
                            Total
      LoansReal
      estate
                          
                          $
                          2,842
                          
                          
                          
                          50.95
                          %
                          
                          $
                          3,068
                          
                          
                          
                          47.51
                          %
                          
                          $
                          1,297
                          
                          
                          
                          40.58
                          %
                          
                          $
                          993
                          
                          
                          
                          41.16
                          %
                          
                          $
                          975
                          
                          
                          
                          44.06
                          %Commercial
                          
                          
                          1,599
                          
                          
                          
                          28.66
                          
                          
                          
                          2,110
                          
                          
                          
                          32.68
                          
                          
                          
                          1,268
                          
                          
                          
                          39.68
                          
                          
                          
                          956
                          
                          
                          
                          39.41
                          
                          
                          
                          447
                          
                          
                          
                          20.18Consumer
                          
                          
                          1,138
                          
                          
                          
                          20.39
                          
                          
                          
                          1,280
                          
                          
                          
                          19.81
                          
                          
                          
                          630
                          
                          
                          
                          19.74
                          
                          
                          
                          471
                          
                          
                          
                          19.43
                          
                          
                          
                          792
                          
                          
                          
                          35.76Unallocated
                          
                          
                          —
                          
                          
                          
                          N/A
                          
                          
                          
                          320
                          
                          
                          
                          N/A
                          
                          
                          
                          149
                          
                          
                          
                          N/A
                          
                          
                          
                          334
                          
                          
                          
                          N/A
                          
                          
                          
                          180
                          
                          
                          
                          N/ATotal
      allowance for loan losses
                          
                          $
                          5,579
                          
                          
                          
                          100.00
                          %
                          
                          $
                          6,778
                          
                          
                          
                          100.00
                          %
                          
                          $
                          3,344
                          
                          
                          
                          100.00
                          %
                          
                          $
                          2,754
                          
                          
                          
                          100.00
                          %
                          
                          $
                          2,394
                          
                          
                          
                          100.00
                          %





Asset
Classification.  The Office of
the Comptroller of the Currency requires national banks to classify problem
assets.  Problem assets are classified as “substandard” or “impaired,”
depending on the presence of certain characteristics. Assets that currently do
not expose the insured institution to sufficient risk to warrant classification
in the above-mentioned categories but possess weaknesses are designated “special
mention.” An asset is considered “substandard” if it is inadequately protected
by the current net worth and paying capacity of the borrower or of the
collateral pledged, if any. “Substandard” assets include those characterized by
the “distinct possibility” that the institution will sustain some loss if the
deficiencies are not corrected.  Assets classified as “impaired” have
all of the weaknesses inherent in those classified as “substandard” with the
added characteristic that the weaknesses present make “collection or liquidation
in full,” on the basis of currently existing facts, conditions, and values,
“highly questionable and improbable.”





When an institution classifies problem
assets as either special mention or substandard, it is required to establish
general allowances for loan losses in an amount deemed prudent by
management.  General allowances represent loss allowances that have
been established to recognize the inherent risk associated with lending
activities, but which, unlike specific allowances, have not been allocated to
particular problem assets. When an institution classifies problem assets or a
portion of assets as impaired, it is required either to establish a specific
allowance for losses equal to 100% of the amount of the asset or a portion
thereof so classified or to charge-off such amount.  An institution’s
determination as to the classification of its assets and the amount of its
valuation allowances is subject to review by the Comptroller of the Currency who
can order the establishment of additional general or specific loss allowances
The Corporation considers all
non-accrual loans to be impaired. Therefore, at December 31, 2009,loans classified asimpaired totaled $20.9 million.


10


Investment
Activities





The following table sets forth the
Corporation’s investment and mortgage-backed securities portfolio at the dates
indicated (dollars in thousands):





At
      December 31,2009
                  
                  
                  2008
                  
                  
                  2007Available
      for sale:
                  
                  Carrying
                    Value
                  
                  
                  Percent
      of
                    Portfolio
                  
                  
                  Carrying
                    Value
                  
                  
                  Percent
      of
                    Portfolio
                  
                  
                  Carrying
                    Value
                  
                  
                  Percent
      of
                    PortfolioInvestment
      securities:U.S.
      Agency obligations
                  
                  $
                  4
                  
                  
                  
                  0.01
                  %
                  
                  $
                  6
                  
                  
                  
                  0.01
                  %
                  
                  $
                  488
                  
                  
                  
                  0.45
                  %Government
      Sponsored Enterprises
                  
                  
                  78,471
                  
                  
                  
                  53.08
                  
                  
                  
                  28,230
                  
                  
                  
                  28.11
                  
                  
                  
                  40,665
                  
                  
                  
                  37.63Municipal
      securities
                  
                  
                  6,042
                  
                  
                  
                  4.09
                  
                  
                  
                  6,358
                  
                  
                  
                  6.33
                  
                  
                  
                  9,601
                  
                  
                  
                  8.88Trust
      Preferred securities
                  
                  
                  5,912
                  
                  
                  
                  4.00
                  
                  
                  
                  8,392
                  
                  
                  
                  8.36
                  
                  
                  
                  12,093
                  
                  
                  
                  11.20Total
      investment securities
                  
                  
                  90,429
                  
                  
                  
                  61.18
                  
                  
                  
                  42,986
                  
                  
                  
                  42.81
                  
                  
                  
                  62,847
                  
                  
                  
                  58.16Mortgage-backed
      and related securities
                  
                  
                  57,387
                  
                  
                  
                  38.82
                  
                  
                  
                  57,432
                  
                  
                  
                  57.19
                  
                  
                  
                  45,214
                  
                  
                  
                  41.84Total
                  
                  $
                  147,816
                  
                  
                  
                  100.00
                  %
                  
                  $
                  100,418
                  
                  
                  
                  100.00
                  %
                  
                  $
                  108,061
                  
                  
                  
                  100.00
                  %





At
      December 31,2009
                    
                    
                    2008
                    
                    
                    2007Held
      to maturity:
                    
                    Carrying
                      Value
                    
                    
                    Percent
      of
                      Portfolio
                    
                    
                    Carrying
                      Value
                    
                    
                    Percent
      of
                      Portfolio
                    
                    
                    Carrying
                      Value
                    
                    
                    Percent
      of
                      PortfolioMunicipal
      securities
                    
                    $
                    3,934
                    
                    
                    
                    100.00
                    %
                    
                    $
                    2,430
                    
                    
                    
                    100.00
                    %
                    
                    $
                    3,126
                    
                    
                    
                    100.00
                    %





The Corporation increased its level of
investment securities over the previous year with funds from signficant deposit
growth above what was needed to fund loan growth.





The
Corporation purchases mortgage-backed securities, both fixed-rate and
adjustable-rate, from Freddie Mac, Fannie Mae and Ginnie Mae with maturities
from five to thirty years. The Corporation maintained its level of
mortgage-backed securities and increased its level of government sponsored
enterprises securities that have the potential to increase to a higher rate
depending on the interest rate environment.





The Corporation in previous years
purchased mortgage derivative securities in the form of collateralized mortgage
obligations (“CMOs”) issued by financial corporations.   The
amortized cost of the CMOs at December 31, 2009 was approximately $597,000 with
a fair value of $480,000.





The Corporation has in the past
purchased trust preferred corporate securities, both fixed-rate and
adjustable-rate, with maturities up to thirty years. Trust preferred securities
are issued by financial institutions through a pooled trust preferred and single
issue capital offerings. Because of the current trading dislocations in the debt
markets, the traditional methods of market quotes have become unreliable.
Accounting standards permit the use of reasonable management judgment regarding
the probability of collecting all projected cash flows generated by the
financial instrument. An other
than temporary investment charge of $3.8 millionwas recorded for 2009 that was related
to these trust preferred securities. The other than temporary impairment charge
was due to write-downs recorded on trust preferred securities as a result of
projected shortfalls of interest and principal payments in the cash flow
analysis of the securities.The total amortized cost of
the trust preferred securities at December 31, 2009 was approximately $8.6
million with a fair value of $5.9 million. See Note 2 of Notes to Consolidated
Financial Statements for more information regarding investment and
mortgage-backed securities.





Management reviews securities for
other-than-temporary impairment at least on a quarterly basis, and more
frequently when economic or market concerns warrant such evaluation.
Consideration is given to (1) the length of time and the extent to which the
fair value has been less than cost, (2) the financial condition and near-term
prospects of the issuer, and (3) the intent and ability of the Corporation to
retain its investment in the issuer for a period of time sufficient to allow for
any anticipated recovery in fair value.


11





To determine which individual securities
are at risk for other-than-temporary impairment, the Corporation considers
various characteristics of each security including but not limited to the credit
rating, the duration and amount of the unrealized loss, and any credit
enhancements. The relative importance of this information varies based on the
facts and circumstances surrounding each security, as well as the economic
environment at the time of the assessment. As a result of this review, the
Corporation identifies individual securities believed to be at risk for
other-than-temporary impairment. These securities are evaluated by estimating
projected cash flows based on the structure of the security and certain
assumptions, such as prepayments, default rates, and loss severity to determine
whether the Corporation expects to receive all of the contractual cash flows as
scheduled. The Corporation recognizes an other-than-temporary impairment credit
loss when the present value of the investment security’s cash flows expected to
be collected are less than the amortized cost basis.


12





The
following table sets forth at amortized cost (held to maturity) and market value
(available for sale) the maturities and weighted average yields* of the
Corporation’s investment and mortgage-backed securities portfolio at December
31, 2009 (dollars in thousands):





Amount
      Due or Repricing within:One
      Year
                    or
      Less
                  
                  
                  Over
      One to
                    Five
      Years
                  
                  
                  Over
      Five to
                    Ten
      Years
                  
                  
                  Over
                    Ten
      Years
                  
                  
                  TotalCarrying
                    Value
                  
                  
                  Weighted
                    Average
                    Yield
                  
                  
                  Carrying
                    Value
                  
                  
                  Weighted
                    Average
                    Yield
                  
                  
                  Carrying
                    Value
                  
                  
                  Weighted
                    Average
                    Yield
                  
                  
                  Carrying
                    Value
                  
                  
                  Weighted
                    Average
                    Yield
                  
                  
                  Carrying
                    Value
                  
                  
                  Weighted
                    Average
                    YieldAvailable
      for Sale:Investment
      securities:U.S.
      Agency obligations
                  
                  $
                  —
                  
                  
                  
                  —
                  %
                  
                  $
                  4
                  
                  
                  
                  8.07
                  %
                  
                  $
                  —
                  
                  
                  
                  —
                  %
                  
                  $
                  —
                  
                  
                  
                  —
                  %
                  
                  $
                  4
                  
                  
                  
                  8.07
                  %Government
      sponsored enterprises (1)
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  17,859
                  
                  
                  
                  3.50
                  
                  
                  
                  60,612
                  
                  
                  
                  4.15
                  
                  
                  
                  78,471
                  
                  
                  
                  4.00Municipal
      securities
                  
                  
                  727
                  
                  
                  
                  4.80
                  
                  
                  
                  352
                  
                  
                  
                  4.57
                  
                  
                  
                  728
                  
                  
                  
                  4.84
                  
                  
                  
                  4,235
                  
                  
                  
                  4.84
                  
                  
                  
                  6,042
                  
                  
                  
                  4.82Trust
      Preferred securities
                  
                  
                  4,663
                  
                  
                  
                  4.59
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  1,249
                  
                  
                  
                  7.00
                  
                  
                  
                  5,912
                  
                  
                  
                  5.10Total
      investment securities
                  
                  
                  5,390
                  
                  
                  
                  4.61
                  
                  
                  
                  356
                  
                  
                  
                  4.61
                  
                  
                  
                  18,587
                  
                  
                  
                  3.55
                  
                  
                  
                  66,096
                  
                  
                  
                  4.24
                  
                  
                  
                  90,429
                  
                  
                  
                  4.13Mortgage-backed
      and related securities
                  
                  
                  2,145
                  
                  
                  
                  2.34
                  
                  
                  
                  336
                  
                  
                  
                  2.91
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  54,906
                  
                  
                  
                  4.61
                  
                  
                  
                  57,387
                  
                  
                  
                  4.52Total
      available for sale
                  
                  $
                  7,535
                  
                  
                  
                  3.97
                  
                  
                  $
                  692
                  
                  
                  
                  3.78
                  
                  
                  $
                  18,587
                  
                  
                  
                  3.55
                  
                  
                  $
                  121,002
                  
                  
                  
                  4.41
                  
                  
                  $
                  147,816
                  
                  
                  
                  4.28Held
      to Maturity:Municipal
      securities
                  
                  $
                  —
                  
                  
                  
                  —
                  %
                  
                  $
                  —
                  
                  
                  
                  —
                  %
                  
                  $
                  —
                  
                  
                  
                  —
                  %
                  
                  $
                  3,934
                  
                  
                  
                  4.25
                  %
                  
                  $
                  3,934
                  
                  
                  
                  4.25
                  %




(1)The
following GSE issuers exceed 10% of shareholders’ equity at
12/31/09.





Issuer
                    
                    Book Value
                    
                    
                    Market ValueFannie
      Mae (FNMA)
                    
                    $
                    51,404
                    
                    
                    $
                    51,174Federal
      Home Loan Bank (FHLB)
                    
                    
                    7,050
                    
                    
                    
                    6,804Freddie
      Mac (FHLMC)
                    
                    
                    17,709
                    
                    
                    
                    17,471$
                    76,163
                    
                    
                    $
                    75,449


*The
weighted average yield is based upon the cost value and the total income
received of the instrument.  The weighted average yield on tax-exempt
securities is not presented on a tax-equivalent basis.


13


At December 31, 2009, approximately
$2.4 million of mortgage-backed securities were
adjustable-rate securities.





Deposits
and Borrowings





General deposits are the major source
of our funds for lending and other investment purposes.  In addition
to deposits, we derive funds from principal repayments and interest payments on
loans and investment and mortgage-backed securities. Principal repayments and
interest payments are a relatively stable source of funds, although principal
prepayments tend to slow when interest rates increase. Deposit inflows and
outflows may be influenced significantly by general market interest rates and
money market conditions. During 2009, the Bank experienced a net increase in
deposits of approximately $25.9 million due to various deposit promotion
programs with continued emphasis on increasing core deposits. The Bank used the
excess funds from the deposit growth to purchase agency and mortgage-backed
securities.





Deposits.  Local deposits
are, and traditionally have been, the primary source of the Bank’s funds for use
in lending and for other general business purposes.  We offer a number
of deposit accounts including NOW accounts, money market savings accounts,
passbook and statement savings accounts, individual retirement accounts and
certificate of deposit accounts. Deposit accounts vary as to terms regarding
withdrawal provisions, deposit provisions and interest rates.





We adjust the interest rates offered on
our deposit accounts as necessary so as to remain competitive with other
financial institutions in Union, Laurens, York, Greenville and Fairfield
Counties in South Carolina.





The following table sets forth the time
deposits of the Bank classified by rates as of the dates indicated (in
thousands):





At
      December 31,2009
                  
                  
                  2008
                  
                  
                  2007Up
      to
      2.0%
                  
                  $
                  79,098
                  
                  
                  $
                  13,254
                  
                  
                  $
                  2282.01%
      to
      4.0%
                  
                  
                  76,850
                  
                  
                  
                  107,641
                  
                  
                  
                  31,8054.01%
      to
      6.0%
                  
                  
                  14,875
                  
                  
                  
                  66,143
                  
                  
                  
                  129,5366.01%
      to
      8.0%
                  
                  
                  28
                  
                  
                  
                  28
                  
                  
                  
                  26Total
      time
      deposits
                  
                  $
                  170,851
                  
                  
                  $
                  187,066
                  
                  
                  $
                  161,595





The following table sets forth the
maturities of time deposits at December 31, 2009 (in thousands):





AmountWithin
      three months
                    
                    $
                    47,709After
      three months but within six months
                    
                    
                    48,860After
      six months but within one year
                    
                    
                    23,117After
      one year but within three years
                    
                    
                    50,814After
      three years but within five years
                    
                    
                    351Total
                    
                    $
                    170,851





Certificates of deposit with maturities
of less than one year decreased to $119.7 million at December 31, 2009 from
$141.9 million at December 31, 2008.  Historically, we have been able
to retain a significant amount of deposits as they mature.  In
addition, we believe that we can adjust the offering rates of savings
certificates to retain deposits in changing interest rate
environments.


14


The following table indicates the
amount of the Bank’s jumbo certificates of deposit by time remaining until
maturity as of December 31, 2009 (in thousands).  Jumbo certificates
of deposit are certificates in amounts of $100,000 or more.





Maturity
      Period
                    
                    AmountThree
      months or less
                    
                    $
                    19,044Over
      three through six months
                    
                    
                    19,508Over
      six months through twelve months
                    
                    
                    11,227Over
      twelve months
                    
                    
                    18,431Total
      jumbo certificates
                    
                    $
                    68,210





See Note 7 of Notes to Consolidated
Financial Statements for additional information about deposit
accounts.





Borrowings.  The
Corporation utilizes advances from the FHLB agreements and other borrowings
(treasury, tax and loan deposits, security repurchase agreements and trust
preferred capital obligations) to supplement its supply of lendable funds for
granting loans, making investments and meeting deposit withdrawal
requirements.  See “Regulation and Supervision — Federal Home Loan
Bank System.”





The following tables set forth certain
information regarding borrowings by the Bank at the dates and for the periods
indicated (dollars in thousands):





At
      December 31,2009
                  
                  
                  2008
                  
                  
                  2007Balance
      outstanding at end of period:FHLB
      advances
                  
                  $
                  64,500
                  
                  
                  $
                  69,500
                  
                  
                  $
                  69,500Floating
      rate junior subordinated deferrable interest debentures
                  
                  
                  12,372
                  
                  
                  
                  12,372
                  
                  
                  
                  12,372Securities
      sold under agreement to repurchase
                  
                  
                  18,520
                  
                  
                  
                  19,005
                  
                  
                  
                  24,131Weighted
      average rate paid on:FHLB
      advances
                  
                  
                  4.23
                  %
                  
                  
                  4.16
                  %
                  
                  
                  4.55
                  %Floating
      rate junior subordinated deferrable interest debentures
                  
                  
                  3.77
                  %
                  
                  
                  5.07
                  %
                  
                  
                  6.68
                  %Securities
      sold under agreement to repurchase
                  
                  
                  1.52
                  %
                  
                  
                  1.70
                  %
                  
                  
                  4.00
                  %




15





At
      or For the Year Ended December 31,2009
                  
                  
                  2008
                  
                  
                  2007Maximum
      amount of borrowings outstanding at any month end:FHLB
      advances
                  
                  $
                  69,500
                  
                  
                  $
                  77,500
                  
                  
                  $
                  85,250Floating
      rate junior subordinated deferrable interest debentures
                  
                  
                  12,372
                  
                  
                  
                  12,372
                  
                  
                  
                  12,372Securities
      sold under agreement to repurchase
                  
                  
                  20,411
                  
                  
                  
                  23,389
                  
                  
                  
                  39,175Approximate
      average borrowings outstanding:FHLB
      advances
                  
                  $
                  65,862
                  
                  
                  
                  70,107
                  
                  
                  
                  66,893Floating
      rate junior subordinated deferrable interest debentures
                  
                  
                  12,372
                  
                  
                  
                  12,372
                  
                  
                  
                  12,372Securities
      sold under agreement to repurchase
                  
                  
                  18,134
                  
                  
                  
                  21,588
                  
                  
                  
                  28,560Approximate
      weighted average rate paid on:FHLB
      advances
                  
                  
                  4.23
                  %
                  
                  
                  4.23
                  %
                  
                  
                  4.77
                  %Floating
      rate junior subordinated deferrable interest debentures
                  
                  
                  4.28
                  %
                  
                  
                  5.83
                  %
                  
                  
                  7.25
                  %Securities
      sold under agreement to  repurchase
                  
                  
                  1.56
                  %
                  
                  
                  2.53
                  %
                  
                  
                  4.44
                  %





At December 31, 2009, the Corporation
had unused short-term secured lines of credit to purchase federal funds from
unrelated banks totaling $4.0 million. These lines of credit are available on a
one-to-ten day basis for general purposes of the Corporation.  All of
the lenders have reserved the right to withdraw these lines at their
option.  At December 31, 2009, the Bank had unused secured lines of
credit for longer term advances totaling $54.0 million.





Subsidiary
Activities





Under OCC regulations, the Bank
generally may invest in operating subsidiaries, which may engage in activities
permissible for the Bank itself.  The Bank currently holds Provident
Financial Services, Inc. as a non-active subsidiary.





Provident Community Bancshares
maintains two subsidiaries other than the Bank. In fiscal year 2006, Provident
Community Bancshares Capital Trust I and Capital Trust II were established as
capital trusts under Delaware law to issue trust preferred
securities.  Provident Community Bancshares Capital Trust I issued
trust preferred securities on July 21, 2006 while Capital Trust II issued trust
preferred securities on December 15, 2006.





Employees





The Corporation has 71 full-time
employees and 8 part-time employees.  None of the employees are
represented by a collective bargaining unit.  We believe that
relations with our employees are excellent.





REGULATION
AND SUPERVISION





General





Provident Community Bancshares, which
is a bank holding company, is required to file certain reports with the Federal
Reserve Board and otherwise comply with the Bank Holding Company Act of 1956, as
amended (“BHCA”) and the rules and regulations promulgated
thereunder.


16





The Bank, as a national bank, is
subject to extensive regulation, examination and supervision by the Office of
the Comptroller of the Currency, as its primary regulator, and the Federal
Deposit Insurance Corporation, as the deposit insurer.  The Bank’s
deposit accounts are insured up to applicable limits by the Deposit Insurance
Fund managed by the FDIC.  The Bank must file reports with the OCC and
the FDIC concerning its activities and financial condition in addition to
obtaining regulatory approvals prior to entering into certain transactions such
as mergers with, or acquisitions of, other institutions.  The OCC
and/or the FDIC conduct periodic examinations to test the Bank’s safety and
soundness and compliance with various regulatory requirements.  Many
aspects of the Bank’s operations are regulated by federal law including
allowable activities, reserves against deposits, branching, mergers and
investments.  This regulation and supervision establishes a
comprehensive framework of activities in which an institution can engage and is
intended primarily for the protection of the insurance fund and
depositors.  The regulatory structure also gives the regulatory
authorities extensive discretion in connection with their supervisory and
enforcement activities and examination policies, including policies with respect
to the classification of assets and the establishment of adequate loan loss
reserves for regulatory purposes.  Any change in such regulatory
requirements and policies, whether by the OCC, the FDIC, or Congress, could have
a material adverse impact on Provident Community Bancshares or the Bank and
their operations.





Certain regulatory requirements
applicable to the Bank and Provident Community Bancshares are referred to below
or elsewhere herein.  This description of statutory provisions and
regulations applicable to national banks and their holding companies does not
purport to be a complete description of such statutes and regulations and their
effects on the Bank and Provident Community Bancshares.





Holding
Company Regulation





Federal
Regulation.As a bank holding company, Provident Community
Bancshares is subject to examination, regulation and periodic reporting under
the BHCA, as administered by the FRB.  Provident Community Bancshares
is required to obtain the prior approval of the FRB to acquire all, or
substantially all, of the assets of any bank or bank holding company or merge
with another bank holding company.  Prior FRB approval is also
required for Provident Community Bancshares to acquire direct or indirect
ownership or control of any voting securities of any bank or bank holding
company if, after giving effect to such acquisition, Provident Community
Bancshares would, directly or indirectly, own or control more than 5% of any
class of voting shares of the bank or bank holding company.  In
evaluating such transactions, the FRB considers such matters as the financial
and managerial resources of and future prospects of the companies and banks
involved, competitive factors and the convenience and needs of the communities
to be served.  Bank holding companies have authority under the BHCA to
acquire additional banks in any state, subject to certain restrictions such as
deposit concentration limits.  In addition to the approval of the FRB,
before any bank acquisition can be completed, prior approval may also be
required from other agencies having supervisory jurisdiction over the banks to
be acquired.





A bank holding company generally is
prohibited from engaging in, or acquiring direct or indirect control of more
than 5% of the voting securities of any company conducting non-banking
activities.  One of the principal exceptions to this prohibition is
for activities found by the FRB to be so closely related to banking or managing
or controlling banks to be a proper incident thereto.  Some of the
principal activities that the FRB has determined by regulation to be closely
related to banking are:  (1) making or servicing loans; (2) performing
certain data processing services; (3) providing discount brokerage services; (4)
acting as fiduciary, investment or financial advisor; (5) finance leasing
personal or real property; (6) making investments in corporations or projects
designed primarily to promote community welfare; and (7) acquiring a savings
association, provided that the savings association only engages in activities
permitted by bank holding companies.





The Gramm-Leach-Bliley Act of 1999
authorizes a bank holding company that meets specified conditions, including
being “well-capitalized” and “well managed,” to opt to become a “financial
holding company” and thereby engage in a broader array of financial activities
than previously permitted.  Such activities may include insurance
underwriting and investment banking.  The Gramm-Leach-Bliley Act also
authorizes banks to engage through “financial subsidiaries” in certain of the
activities permitted for financial holding companies.  Financial
subsidiaries are generally treated as affiliates for purposes of restrictions on
a bank’s transactions with affiliates.


17





The FRB has adopted capital adequacy
guidelines for bank holding companies (on a consolidated basis) substantially
similar to those of the OCC for the Bank.  See “Capital
Requirements.”  Provident Community Bancshares’ total and Tier 1
capital exceed these requirements as of December 31, 2009.





Bank holding companies are generally
required to give the FRB prior written notice of any purchase or redemption of
its outstanding equity securities if the gross consideration for the purchase or
redemption, when combined with the net consideration paid for all such purchases
or redemptions during the preceding 12 months, is equal to 10% or more of their
consolidated net worth.  The FRB may disapprove such a purchase or
redemption if it determines that the proposal would constitute an unsafe and
unsound practice, or would violate any law, regulation, FRB order or directive,
or any condition imposed by, or written agreement with, the
FRB.  There is an exception to this approval requirement for
well-capitalized bank holding companies that meet certain other
conditions.





The FRB has issued a policy statement
regarding the payment of dividends by bank holding companies.  In
general, the FRB’s policies provide that dividends should be paid only out of
current earnings and only if the prospective rate of earnings retention by the
Bank holding company appears consistent with the organization’s capital needs,
asset quality, and overall financial condition.  The FRB’s policies
also require that a bank holding company serve as a source of financial strength
to its subsidiary banks by standing ready to use available resources to provide
adequate capital funds to those banks during periods of financial stress or
adversity and by maintaining the financial flexibility and capital-raising
capacity to obtain additional resources for assisting its subsidiary banks where
necessary.  Furthermore, the FRB has authority to prohibit a bank
holding company from paying a capital distribution where a subsidiary bank is
undercapitalized. These regulatory policies could affect the ability of
Provident Community Bancshares to pay dividends or otherwise engage in capital
distributions.





The FRB has general authority to
enforce the BHCA as to Provident Community Bancshares and may require a bank
holding company to cease any activity or terminate control of any subsidiary
engaged in an activity that the FRB believes constitutes a serious risk to the
safety, soundness or stability of its bank subsidiaries.





Provident Community Bancshares and its
subsidiaries will be affected by the monetary and fiscal policies of various
agencies of the United States Government, including the Federal Reserve
System.  In view of changing conditions in the national economy and
money markets, it is impossible for the management of Provident Community
Bancshares accurately to predict future changes in monetary policy or the effect
of such changes on the business or financial condition of Provident Community
Bancshares or the Bank.





Acquisition
of Provident Community Bancshares





Federal
Regulation.  Federal law requires that a notice be submitted to
the FRB if any person (including a company), or group acting in concert, seeks
to acquire 10% or more of Provident Community Bancshares’ outstanding voting
stock, unless the FRB has found that the acquisition will not result in a change
in control of Provident Community Bancshares.  The FRB has 60 days
from the filing of a complete notice to act, taking into consideration certain
factors, including the financial and managerial resources of the acquirer and
the anti-trust effects of the acquisition.





Under the BHCA, any company would be
required to obtain prior approval from the FRB before it may obtain “control” of
Provident Community Bancshares within the meaning of the
BHCA.  “Control” generally is defined to mean the ownership or power
to vote 25% or more of any class of voting securities of Provident Community
Bancshares or the ability to control in any manner the election of a majority of
Provident Community Bancshares’ directors.  An existing bank holding
company would be required to obtain the FRB’s prior approval under the BHCA
before acquiring more than 5% of Provident Community Bancshares’ voting
stock.  See “Holding Company Regulation.”


18





Federal
Banking Regulations





Capital
Requirements.  The OCC’s capital regulations require national
banks to meet two minimum capital standards:  a 4% Tier 1 capital to
total adjusted assets ratio for most banks (3% for national banks with the
highest examination rating) (the “leverage” ratio) and an 8% risk-based capital
ratio.  In addition, the prompt corrective action standards discussed
below also establish, in effect, a minimum 2% tangible capital to total assets
standard, a 4% leverage ratio (3% for institutions receiving the highest rating
on the financial institution examination rating system) and, together with the
risk-based capital standard itself, a 4% Tier 1 capital to risk-based assets
standard.  “Tier 1 capital” is generally defined as common
stockholders’ equity (including retained earnings), certain noncumulative
perpetual preferred stock and related surplus and minority interests in equity
accounts of consolidated subsidiaries, less intangibles (other than certain
mortgage servicing rights and credit card relationships), a percentage of
certain non-financial equity investments and certain other specified
items.





The risk-based capital standard
requires the maintenance of Tier 1 and total capital (which is defined as Tier 1
capital plus Tier 2 capital) to risk-weighted assets of at least 4% and 8%,
respectively.  In determining the amount of risk-weighted assets, all
assets, including certain off-balance sheet activities, are multiplied by a
risk-weight factor of 0% to 100%, as assigned by the OCC capital regulation
based on the risks that the agency believes are inherent in the type of
asset.  The regulators have recently added a market risk adjustment to
cover a bank’s trading account, foreign exchange and commodity
positions.  Tier 2 capital may include cumulative preferred stock,
long-term perpetual preferred stock, mandatory convertible securities,
subordinated debt and intermediate preferred stock, the allowance for loan and
lease losses limited to a maximum of 1.25% of risk-weighted assets, and up to
45% of unrealized gains on available-for-sale equity securities with readily
determinable fair market values.  Overall, the amount of Tier 2
capital included as part of total capital cannot exceed 100% of Tier 1
capital.





The FRB has adopted capital adequacy
guidelines for bank holding companies (on a consolidated basis) substantially
similar to those of the OCC for the Bank.  Provident Community
Bancshares’ total and Tier 1 capital exceed these requirements.





Both the OCC and the FRB have the
discretion to establish higher capital requirements on a case-by-case basis
where deemed appropriate in the circumstances of a particular bank or bank
holding company.





At
December 31, 2009, the Bank met each of its capital requirements.





Prompt Corrective
Regulatory Action.  Under the prompt corrective action
regulations, the OCC is required to take certain supervisory actions against
undercapitalized institutions under its jurisdiction, the severity of which
depends upon the institution’s degree of
undercapitalization.  Generally, an institution that has a ratio of
total capital to risk-weighted assets of less than 8%, a ratio of Tier 1 (core)
capital to risk-weighted assets of less than 4% or a ratio of core capital to
total assets of less than 4% (3% or less for institutions with the highest
examination rating) is considered to be “undercapitalized.”  An
institution that has a total risk-based capital ratio less than 6%, a Tier 1
capital ratio of less than 3% or a leverage ratio that is less than 3% is
considered to be “significantly undercapitalized” and an institution that has a
tangible capital to assets ratio equal to or less than 2% is deemed to be
“critically undercapitalized.”  Subject to a narrow exception, the OCC
is required to appoint a receiver or conservator within specified time frames
for an institution that is “critically undercapitalized.”  The
regulation also provides that a capital restoration plan must be filed with the
OCC within 45 days of the date an institution receives notice that it is
“undercapitalized,” “significantly undercapitalized” or “critically
undercapitalized.”  Compliance with the plan must be guaranteed by any
parent holding company in the amount of the lesser of 5% of the bank’s total
assets or the amount necessary to achieve compliance with applicable capital
regulations.  In addition, numerous mandatory supervisory actions
become immediately applicable to an undercapitalized institution, including, but
not limited to, increased monitoring by regulators and restrictions on growth,
capital distributions and expansion.  The OCC could also take any one
of a number of discretionary supervisory actions, including the issuance of a
capital directive and the replacement of senior executive officers and
directors.





Insurance of
Deposit Accounts.  The Bank’s deposits are insured up to
applicable limits by the Deposit Insurance Fund of the FDIC.  The
Deposit Insurance Fund is the successor to the Bank Insurance Fund and the
Savings Association Insurance Fund, which were merged in 2006.


19





Under the FDIC’s risk-based assessment
system, insured institutions are assigned to one of four risk categories based
on supervisory evaluations, regulatory capital levels and certain other factors,
with less risky institutions paying lower assessments.  An
institution’s assessment rate depends upon the category to which it is
assigned.  For 2008, assessments ranged from five to forty-three basis
points of assessable deposits.  Due to losses incurred by the Deposit
Insurance Fund in 2008 from failed institutions, and anticipated future losses,
the FDIC has adopted, pursuant to a Restoration Plan to replenish the fund, an
across the board seven basis point increase in the assessment range for the
first quarter of 2009.  The FDIC has proposed further refinements to
its risk-based assessment that would be effective April 1, 2009 and would
effectively make the range eight to 771/2 basis
points.  The FDIC may adjust the scale uniformly from one quarter to
the next, except that no adjustment can deviate more than three basis points
from the base scale without notice and comment rulemaking.  No
institution may pay a dividend if in default of the federal deposit insurance
assessment.





The FDIC imposed on all insured
institutions a special emergency assessment of five basis points of total assets
minus tier 1 capital, as of June 30, 2009 (capped at ten basis points of an
institution’s deposit assessment base), to cover losses to the Deposit Insurance
Fund.  That special assessment was collected on September 30,
2009.  The FDIC provided for similar assessments during the final two
quarters of 2009, if deemed necessary.  However, in lieu of further
special assessments, the FDIC required insured institutions to prepay estimated
quarterly risk-based assessments for the fourth quarter of 2009 through the
fourth quarter of 2012.  The estimated assessments, which include an
assumed annual assessment base increase of 5%, were recorded as a prepaid
expense asset as of December 30, 2009.  As of December 31, 2009, and
each quarter thereafter, a charge to earnings will be recorded for each regular
assessment with an offsetting credit to the prepaid asset.





Due to the recent difficult economic
conditions, deposit insurance per account owner has been raised to $250,000 for
all types of accounts until January 1, 2014.  In addition, the FDIC
adopted an optional Temporary Liquidity Guarantee Program by which, for a fee,
noninterest bearing transaction accounts received unlimited insurance coverage
until December 31, 2009, subsequently extended until June 30,
2010.  Certain senior unsecured debt issued by institutions and their
holding companies during specified time periods could also be guaranteed by the
FDIC through June 30, 2012.  The Bank made the business decision to
participate in the unlimited noninterest bearing transaction account coverage
and the Bank and Provident Community Bancshares opted to participate in the
unsecured debt guarantee program.





Federal law also provides for the
possibility that the FDIC may pay dividends to insured institutions once the
Deposit Insurance fund reserve ratio equals or exceeds 1.35% of estimated
insured deposits.





In addition to the assessment for
deposit insurance, institutions are required to make payments on bonds issued in
the late 1980s by the Financing Corporation to recapitalize a predecessor
deposit insurance fund.  This payment is established quarterly and
during the calendar year ending December 31, 2009 averaged 1.06 basis points of
assessable deposits.





The Federal Deposit Insurance
Corporation has authority to increase insurance assessments.  A
significant increase in insurance premiums would likely have an adverse effect
on the operating expenses and results of operations of the
Bank.  Management cannot predict what insurance assessment rates will
be in the future.





Insurance of deposits may be terminated
by the Federal Deposit Insurance Corporation upon a finding that the institution
has engaged in unsafe or unsound practices, is in an unsafe or unsound condition
to continue operations or has violated any applicable law, regulation, rule,
order or condition imposed by the Federal Deposit Insurance Corporation or the
Office of Thrift Supervision.  The management of the Bank does not
know of any practice, condition or violation that might lead to termination of
deposit insurance.





Loans to One
Borrower.  National banks are subject to limits on the amount
that they may lend to single borrowers.  Generally, banks may not make
a loan or extend credit to a single or related group of borrowers in excess of
15% of its capital and surplus (including Tier 1 capital, Tier 2 capital and the
amount of the allowance for loan and lease losses not included in Tier 2
capital).  An additional amount may be lent, equal to 10% of capital
and surplus, if such loan is secured by readily-marketable collateral, which is
defined to include certain financial instruments and bullion.  At
December 31, 2009, the Bank’s limit on loans to one borrower was $5.5 million
and the Bank’s largest aggregate outstanding balance of loans to one borrower
was $5.4 million.


20





Limitation on
Capital Distributions.  National banks may not pay dividends
out of their permanent capital and may not, without OCC approval, pay dividends
in excess of the total of the bank’s retained net income for the year combined
with retained net income for the prior two years less any transfers to surplus
and capital distributions.  A national bank may not pay a dividend
that would cause it to fall below any applicable regulatory capital
standard.





Branching.National
banks are authorized to establish branches within the state in which they are
headquartered to the extent state law allows branching by state
banks.  Federal law also provides for interstate branching for
national banks.  Interstate branching by merger was authorized as of
June 1, 1997 unless the state in which the bank is to branch has enacted a law
opting out of interstate branching or expedites the effective date by passing
legislation.  De
novo interstate branching is permitted to the extent the state into which
the bank is to branch has enacted a law authorizing out-of-state banks to
establish de novo
branches.





Transactions with
Related Parties.The authority of a depository institution to
engage in transactions with related parties or “affiliates” (e.g., any company that
controls or is under common control with an institution, including, in this
case, Provident Community Bancshares) is limited by Sections 23A and 23B of the
Federal Reserve Act (“FRA”).  Section 23A limits the aggregate amount
of covered transactions with any individual affiliate to 10% of the capital and
surplus of the depository institution.  The aggregate amount of
covered transactions with all affiliates is limited to 20% of the depository
institution’s capital and surplus.  Certain transactions with
affiliates are required to be secured by collateral in an amount and of a type
described in Section 23A and the purchase of low quality assets from affiliates
is generally prohibited.  Section 23B generally provides that certain
transactions with affiliates, including loans and asset purchases, must be on
terms and under circumstances, including credit standards, that are
substantially the same or at least as favorable to the institution as those
prevailing at the time for comparable transactions with non-affiliated
companies.





The authority of the Bank to extend
credit to executive officers, directors and 10% or greater shareholders
(“insiders”), as well as entities such persons control, is governed by Sections
22(g) and 22(h) of the FRA and Regulation O thereunder.  Among other
things, such loans are required to be made on terms substantially the same as
those offered to unaffiliated individuals and are not to involve more than the
normal risk of repayment.  There is an exception to this requirement
for loans made pursuant to a benefit or compensation program that is widely
available to all employees of the institution and does not give preference to
insiders over other employees.  Regulation O also places individual
and aggregate limits on the amount of loans that institutions may make to
insiders based, in part, on the institution’s capital position and requires
certain board approval procedures to be followed. Extensions of credit to
executive officers are subject to additional restrictions.





Enforcement.The
OCC has primary enforcement responsibility over national banks and has the
authority to bring actions against such banks and all institution-affiliated
parties, including directors, officers, stockholders, and any attorneys,
appraisers and accountants who knowingly or recklessly participate in wrongful
action likely to have an adverse effect on an insured
institution.  Formal enforcement action may range from the issuance of
a capital directive or cease and desist order to removal of officers and/or
directors to institution of receivership or conservatorship.  Civil
penalties cover a wide range of violations and can amount to $25,000 per day, or
even $1.0 million per day in especially egregious cases.  The FDIC has
the authority to recommend to the OCC that it take enforcement action with
respect to a national bank.  If action is not taken by the agency, the
FDIC has authority to take such action under certain
circumstances.  Federal law also establishes criminal penalties for
certain violations.  The FRB has generally similar enforcement
authority with respect to Provident Community Bancshares.  Neither
Provident Community Bancshares nor the Bank are under any enforcement
action.





Assessments. National banks are
required to pay assessments to the OCC to fund the agency’s
operations.  The general assessments, paid on a semi-annual basis, are
computed based upon the national bank’s (including consolidated subsidiaries)
total balance sheet assets and financial condition.  The OCC
assessments paid by the Bank for 2009 totaled $118,000.





Standards for
Safety and Soundness.The federal banking agencies have
adopted Interagency Guidelines Prescribing Standards for Safety and Soundness
(“Guidelines”) and a final rule to implement safety and soundness standards
required under federal law.  The Guidelines set forth the safety and
soundness standards that the federal banking agencies use to identify and
address problems at insured depository institutions before capital becomes
impaired.  The standards address internal controls and information
systems; internal audit system; credit underwriting; loan documentation;
interest rate risk exposure; asset quality and growth; earnings; and
compensation, fees and benefits.  If the appropriate federal banking
agency determines that an institution fails to meet any standard prescribed by
the Guidelines, the agency may require the institution to submit to the agency
an acceptable plan to achieve compliance with the standard.  The final
rule establishes deadlines for the submission and review of such safety and
soundness compliance plans when such plans are required.


21





Community
Reinvestment Act.The Community Reinvestment Act, (“CRA”), as
implemented by OCC regulations, provides that a national bank has a continuing
and affirmative obligation consistent with its safe and sound operation to help
meet the credit needs of its entire community, including low and moderate income
neighborhoods.  The CRA does not establish specific lending
requirements or programs for financial institutions nor does it limit an
institution’s discretion to develop the types of products and services that it
believes are best suited to its particular community, consistent with the
CRA.  The CRA requires the OCC, in connection with its examination of
a bank, to assess the institution’s record of meeting the credit needs of its
community and to take such record into account in its evaluation of certain
corporate applications by such institution, such as mergers and
branching.  The Bank’s most recent rating was
“satisfactory.”





USA Patriot
Act.The USA Patriot Act of 2001 (the “Patriot Act”), designed
to deny terrorists and others the ability to obtain anonymous access to the
United States financial system, has significant implications for depository
institutions, brokers, dealers and other businesses involved in the transfer of
money.  The Patriot Act mandated that financial institutions to
implement additional policies and procedures with respect to, or additional
measures designed to address matters such as:  money laundering,
suspicious activities and currency transaction reporting.





Federal
Reserve System





The FRB regulations require savings
institutions to maintain non-interest earning reserves against their transaction
accounts (primarily NOW and regular checking accounts).  For 2009, the
regulations generally provided that reserves be maintained against aggregate
transaction accounts as follows: for accounts aggregating $44.4 million or less
(subject to adjustment by the FRB) the reserve requirement was 3%; and for
accounts aggregating greater than $44.4 million, a reserve requirement of 10%
(subject to adjustment by the FRB between 8% and 14%) was applied against that
portion of total transaction accounts in excess of $44.4 million. The first
$10.3 million of otherwise reservable balances (subject to adjustments by the
FRB) were exempted from the reserve requirements.  These amounts are
adjusted annually and, for 2010, require a 3% ratio for up to $55.2 million and
an exemption of $10.7 million.  The Bank complies with the foregoing
requirements.





Federal
Home Loan Bank System





The Bank is a member of the Federal
Home Loan Bank System, which consists of 12 regional Federal Home Loan Banks.
The Federal Home Loan Bank provides a central credit facility primarily for
member institutions.  The Bank, as a member of the Federal Home Loan
Bank of Atlanta, is required to acquire and hold shares of capital stock in the
Federal Home Loan Bank of Atlanta. The Bank was in compliance with this
requirement with an investment in Federal Home Loan Bank stock at December 31,
2009 of $3.9 million.





The Federal Home Loan Banks are
required to provide funds for the resolution of insolvent thrifts in the late
1980s and to contribute funds for affordable housing programs.  These
requirements could reduce the amount of dividends that the Federal Home Loan
Banks pay to their members and could also result in the Federal Home Loan Banks
imposing a higher rate of interest on advances to their members.  If
dividends were reduced, or interest on future Federal Home Loan Bank advances
increased, the Bank’s net interest income would likely also be
reduced.





Regulatory Restructuring
Legislation





The Obama Administration has proposed,
and the House of Representatives and Senate are currently considering,
legislation that would restructure the regulation of depository
institutions.  Proposals range from the merger of the Office of Thrift
Supervision with the Office of the Comptroller of the Currency to the creation
of an independent federal agency that would assume the regulatory
responsibilities of the Office of Thrift Supervision, FDIC, OCC and the
FRB.  Also proposed is the creation of a new federal agency to
administer and enforce consumer and fair lending laws, a function that is now
performed by the depository institution regulators.  The federal
preemption of state laws currently accorded federally chartered depository
institutions would be reduced under certain proposals as well.


22





Enactment of any of these proposals may
revise the regulatory structure imposed on the Bank, which could result in more
stringent regulation.  At this time, management has no way of
predicting the contents of any final legislation, or whether any legislation
will be enacted at all.





Item 1A. Risk
Factors





An investment in shares of our common
stock involves various risks.  Before deciding to invest in our common
stock, you should carefully consider the risks described below in conjunction
with the other information in this annual report, including the items included
as exhibits.  Our business, financial condition and results of
operations could be harmed by any of the following risks or by other risks that
have not been identified or that we may believe are immaterial or
unlikely.  The value or market price of our common stock could decline
due to any of these risks, and you may lose all or part of your
investment.  The risks discussed below also include forward-looking
statements, and our actual results may differ substantially from those discussed
in these forward-looking statements.





Our
provision for loan losses increased substantially during the past fiscal year
and we may be required to make further increases in our provision for loan
losses and to charge-off additional loans in the future, each of which could
adversely affect our results of operations.





For the year ended December 31, 2009,
we recorded a provision for loan losses of $8.7 million.  We also
recorded net loan charge-offs of $9.9 million.  We are experiencing
increasing loan delinquencies and credit losses.  The deterioration in
the general economy and our market area has become a significant contributing
factor to the increased levels of loan delinquencies and non-performing
assets.  General economic conditions, decreased home prices, slower
sales and excess inventory in the housing market have caused the increase in
delinquencies.





At
December 31, 2009, our non-performing loans totaled $20.9 million, representing
8.1% of total loans.  Total loans that we have classified as impaired,
substandard or special mention including our non-performing loans totaled $51.4
million, representing 20.0% of total loans. If these loans do not perform
according to their terms and the collateral is insufficient to pay any remaining
loan balance, we may experience loan losses, which could have a material effect
on our operating results.  Like all financial institutions, we
maintain an allowance for loan losses to provide for loans in our portfolio that
may not be repaid in their entirety.  We believe that our allowance
for loan losses is maintained at a level adequate to absorb probable losses
inherent in our loan portfolio as of the corresponding balance sheet
date.  However, our allowance for loan losses may not be sufficient to
cover actual loan losses, and future provisions for loan losses could materially
adversely affect our operating results.





In
evaluating the adequacy of our allowance for loan losses, we consider numerous
quantitative factors, including our historical charge-off experience, growth of
our loan portfolio, changes in the composition of our loan portfolio and the
volume of delinquent and classified loans.  In addition, we use
information about specific borrower situations, including their financial
position and estimated collateral values, to estimate the risk and amount of
loss for those borrowers.  Finally, we also consider many qualitative
factors, including general and economic business conditions, current general
market collateral valuations, trends apparent in any of the factors we take into
account and other matters, which are by nature more subjective and
fluid.  Our estimates of the risk of loss and amount of loss on any
loan are complicated by the significant uncertainties surrounding our borrowers’
abilities to successfully execute their business models through changing
economic environments, competitive challenges and other
factors.  Because of the degree of uncertainty and susceptibility of
these factors to change, our actual losses may vary from our current
estimates.





At
December 31, 2009, our allowance for loan losses as a percentage of total loans
was 2.2%.  Our regulators, as an integral part of their examination
process, periodically review our allowance for loan losses and may require us to
increase our allowance for loan losses by recognizing additional provisions for
loan losses charged to expense, or to decrease our allowance for loan losses by
recognizing loan charge-offs, net of recoveries.  Any such additional
provisions for loan losses or charge-offs, as required by these regulatory
agencies, could have a material adverse effect on our financial condition and
results of operations.


23







Further
economic downturns may adversely affect our investment securities portfolio and
profitability.





At December 31, 2009, the cost basis of
our available for sale investment portfolio was $149.3 million, including
$597,000 of collateralized mortgage obligations (“CMOs”) and $8.6 million of
collateralized debt obligations (“CDOs”) secured by trust preferred securities
issued by various financial institutions. These CMOs are secured by first lien
residential jumbo mortgage loans geographically dispersed across the United
States with a significant amount of the CMOs secured by properties located in
California.





At December 31, 2009, the fair value of
these securities was $147.8 million. Under U.S. generally accepted accounting
principles, declines in the fair value of held-to-maturity and
available-for-sale securities below their cost that are deemed to be other than
temporary are reflected in earnings as realized losses to the extent the
impairment is related to credit losses. The amount of the impairment related to
other non-credit related factors is recognized in other comprehensive
income.





For the year ended December 31, 2009,
we recognized a $3.8 million OTTI charge on CDOs of which the entire amount was
identified as credit related. These OTTI charges were determined by, among other
things, a constant default rate, prepayments and loss severity of the
security.





We closely monitor these and our other
investment securities for changes in credit risk. The valuation of our
investment securities and the determination of any OTTI with respect to such
securities are highly complex and involve a comprehensive process, including
quantitative modeling significant judgment. The valuation of our investment
securities will also continue to be influenced by external markets and other
factors, including implementation of Securities and Exchange Commission and
Financial Accounting Standards Board guidance on fair value accounting, and
default rates of specific CMOs and CDOs, rating agency actions, and the prices
at which observable market transactions occur. The current market environment
significantly limits our ability to mitigate our exposure to valuation changes
in our CMO and CDO securities by selling them. Accordingly, if market conditions
do not improve or deteriorate further and we determine our holdings of these or
other investment securities have additional OTTI, our future earnings and
shareholders’ equity could be materially adversely affected.





We
may need to raise additional capital in the future, but that capital may not be
available when it is needed.




We are
required by federal regulatory authorities to maintain adequate levels of
capital to support our operations.  While we currently have sufficient
capital resources to satisfy our capital requirements, we may at some point,
however, need to raise additional capital to augment our balance sheet if our
asset quality continues to weaken.  If we raise capital through the
issuance of additional shares of our common stock or other securities, it would
dilute the ownership interests of existing shareholders and may dilute the per
share book value of our common stock.  New investors may also have
rights, preferences and privileges senior to our current shareholders which may
adversely impact our current shareholders.





Our
ability to raise additional capital, if needed, will depend on conditions in the
capital markets at that time, which are outside of our control, and on our
financial performance.  Accordingly, we may not be able to raise
additional capital, if needed, on terms acceptable to us.  If we
cannot raise additional capital when needed, we may become subject to additional
regulatory restrictions or have to shrink our balance sheet.




24




Our
increased emphasis on commercial lending may expose us to increased lending
risks.


At December 31, 2009, 44.3% of our loan
portfolio consisted of commercial real estate loans and 29.4% of our loan
portfolio consisted of commercial business loans.  We have increased
our emphasis on these types of loans since we converted to a national bank
charter in July 2003.  These types of loans generally expose a lender
to greater risk of non-payment and loss than one- to four-family residential
mortgage loans because repayment of the loans often depends on the successful
operation of the property and the income stream of the
borrowers.  Such loans typically involve larger loan balances to
single borrowers or groups of related borrowers compared to one- to four-family
residential mortgage loans.  Commercial business loans expose us to
additional risks since they typically are made on the basis of the borrower’s
ability to make repayments from the cash flow of the borrower’s business and are
secured by non-real estate collateral that may depreciate over
time.  In addition, since such loans generally entail greater risk
than one- to four-family residential mortgage loans, we may need to increase our
allowance for loan losses in the future to account for the likely increase in
probable incurred credit losses associated with the growth of such
loans.  Also, many of our commercial borrowers have more than one loan
outstanding with us.  Consequently, an adverse development with
respect to one loan or one credit relationship can expose us to a significantly
greater risk of loss compared to an adverse development with respect to a one-
to four-family residential mortgage loan.





The
unseasoned nature of a significant portion of our commercial loan portfolio may
result in errors in judging its collectability, which may lead to additional
loan charge-offs and provisions for loan losses, which would hurt our
profits.





Our commercial loan portfolio, which
includes loans secured by commercial real estate as well as business assets, has
increased from $116.3 million, or 58.9% of total loans, at December 31, 2005 to
$184.4 million, or 71.9% of total loans, at December 31, 2009.  A
large portion of our commercial loan portfolio is unseasoned and does not
provide us with a significant payment history pattern with which to judge future
collectability.  These loans have also not been subjected to
unfavorable economic conditions.  As a result, it is difficult to
predict the future performance of this part of our loan portfolio. These loans
may have delinquency or charge-off levels above our historical experience, which
could adversely affect our future performance.  Further, commercial
loans generally have larger balances and involve a greater risk than one- to
four-family residential mortgage loans.  Accordingly, if we make any
errors in judgment in the collectability of our commercial loans, any resulting
charge-offs may be larger on a per loan basis that those incurred with our
residential mortgage loan portfolio.





If
the value of real estate in northwestern South Carolina were to continue to
decline, a significant portion of our loan portfolio could become
under-collateralized, which could have a material adverse effect on
us.





Northwestern South Carolina has
experienced declines in home prices over the last two years.  A
further decline in local economic conditions or real estate values could
adversely affect the value of the real estate collateral securing our
loans.  A continued decline in property values would diminish our
ability to recover on defaulted loans by selling the real estate collateral,
making it more likely that we would suffer losses on defaulted
loans.  Additionally, a decrease in asset quality could require
additions to our allowance for loan losses through increased provisions for loan
losses, which would hurt our profits.  Also, a decline in local
economic conditions may have a greater effect on our earnings and capital than
on the earnings and capital of larger financial institutions whose real estate
loan portfolios are more geographically diverse.  Real estate values
are affected by various factors in addition to local economic conditions,
including, among other things, changes in general or regional economic
conditions, governmental rules or policies and natural disasters.





Our
business is subject to the success of the local economy in which we
operate.





Since the latter half of 2007,
depressed economic conditions have existed throughout the United States,
including our market area.  Our market area has experienced home price
declines increased foreclosures and increased unemployment
rates.  Continued deterioration of economic conditions in our market
area could reduce our growth rate, affect the ability of our customers to repay
their loans and generally affect our financial condition and results of
operations.  Conditions such as inflation, recession, unemployment,
high interest rates, short money supply, scarce natural resources, international
disorders, terrorism and other factors beyond our control may adversely affect
our profitability. We are less able than a larger institution to spread the
risks of unfavorable local economic conditions across a large number of
diversified economies.  Any sustained period of increased payment
delinquencies, foreclosures or losses caused by adverse market or economic
conditions in the State of South Carolina could adversely affect the value of
our assets, revenues, results of operations and financial
condition.  Moreover, we cannot give any assurance we will benefit
from any market growth or favorable economic conditions in our primary market
areas if they do occur.


25





The
building of market share through our branching strategy could cause our expenses
to increase faster than revenues.




We opened
a banking center in Simpsonville in March 2006 and a second banking center in
Rock Hill in October 2006.  There are considerable costs involved in
opening branches and new branches generally require a period of time to generate
sufficient revenues to offset their costs, especially in areas in which we do
not have an established presence.  Accordingly, any new branch can be
expected to negatively impact our earnings for some period of time until the
branch reaches certain economies of scale.




Our
market area limits our growth potential.





Some of our offices are located in
areas that have experienced population and economic decline.  Thus,
our ability to originate loans and grow deposits in these areas may be
limited.  To counter this, we have attempted to expand our operations
into communities that are experiencing population growth and economic
expansion.  This was the impetus for the opening of our banking
centers in Rock Hill in York County and Simpsonville in Greenville County and
the relocation of our main office to Rock Hill.  However, we can
provide no assurance that we will be able to successfully enter new markets with
similar growth potential.  If we are unable to do so, our ability to
grow our business and our earnings will be restricted.





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




As a
result of the general economic downturn and uncertainty in the financial
markets, commercial as well as consumer loan portfolio performances have
deteriorated at many institutions and the competition for deposits and quality
loans has increased significantly. In addition, the values of real estate
collateral supporting many commercial loans and home mortgages have declined and
may continue to decline. Bank and bank holding company stock prices have been
negatively affected, as has the ability of banks and bank holding companies to
raise capital or borrow in the debt markets compared to recent years. As a
result, there is a potential for new federal or state laws and regulations
regarding lending and funding practices and liquidity standards, and bank
regulatory agencies are expected to be very aggressive in responding to concerns
and trends identified in examinations, including the expected issuance of many
formal enforcement orders.  Negative developments in the financial
industry and the domestic and international credit markets, and the impact of
new legislation in response to those developments, may negatively impact our
operations by restricting our business operations, including our ability to
originate or sell loans, and adversely impact our financial performance or our
stock price.





Increased
and/or special FDIC assessments will hurt our earnings.




Beginning
in late 2008, the economic environment caused higher levels of bank failures,
which dramatically increased FDIC resolution costs and led to a significant
reduction in the Deposit Insurance Fund. As a result, the FDIC has significantly
increased the initial base assessment rates paid by financial institutions for
deposit insurance.  These increases in the base assessment rate have
increased our deposit insurance costs and negatively impacted our
earnings.  In addition, in May 2009, the FDIC imposed a special
assessment on all insured institutions due to recent bank and savings
association failures.  Our special assessment, which was reflected in
earnings for the quarter ended June 30, 2009, was $211,000.




In lieu
of imposing an additional special assessment, the FDIC adopted a rule requiring
that all institutions prepay their assessments for the fourth quarter of 2009
and all of 2010, 2011 and 2012.  This prepayment was due on December
30, 2009.  Under the rule, the assessment rate for the fourth quarter
of 2009 and for 2010 is based on each institution’s total base assessment rate
for the third quarter of 2009, modified to assume that the assessment rate in
effect on September 30, 2009 had been in effect for the entire third quarter,
and the assessment rate for 2011 and 2012 will be equal to the modified third
quarter assessment rate plus an additional three basis points.  In
addition, each institution’s base assessment rate for each period will be
calculated using its third quarter assessment base, adjusted quarterly for an
estimated 5% annual growth rate in the assessment base through the end of
2012.  Under this rule, we made a payment of approximately $2.0
million to the FDIC on December 30, 2009 as a prepaid assessment and will
amortize the expense over the three year assessment period.


26





The
limitations on dividends and repurchases imposed through our participation in
the Capital Purcahse Program may make our common stock less attractive of an
investment.





On March 6, 2009, the United States
Department of the Treasury (the “Treasury”) purchased shares of our preferred
stock as part of the Troubled Asset Relief Program (“TARP”) Capital Purchase
Program.  As part of this transaction, we agreed to not increase the
dividend paid on our common stock and to not repurchase shares of our common
stock for a period of three years.  These capital management devices
contribute to the attractiveness of our common stock and limitations and
prohibitions on such activities may make our common stock less attractive to
investors.





The
limitations on executive compensation imposed through our participation in the
Capital Purchase Program may restrict our ability to attract, retain and
motivate key employees, which could adversely affect our
operations.





As part
of our participation in the TARP Capital Purchase Program, we agreed to be bound
by certain executive compensation restrictions, including limitations on
severance payments and the clawback of any bonus and incentive compensation that
were based on materially inaccurate financial statements or any other materially
inaccurate performance metric criteria.  The American Recovery and
Reinvestment Act of 2009 provides more stringent limitations on severance pay
and the payment of bonuses to certain officers and highly compensated
employees.  To the extent that any of these compensation restrictions
do not permit us to provide a comprehensive compensation package to our key
employees that is competitive in our market area, we have difficulty in
attracting, retaining and motivating our key employees, which could have an
adverse effect on our results of operations.





The
exercise of the warrant by Treasury will dilute existing shareholders’ ownership
interest and may make it more difficult for us to take certain actions that may
be in the best interests of shareholders.





In
addition to the issuance of preferred shares, we also granted the Treasury a
warrant to purchase 179,110 shares of common at a price of $7.77 per
share.  If the Treasury exercises the entire warrant, it would result
in a significant dilution to the ownership interest of our existing stockholders
and dilute the earnings per share value of our common stock.  Further,
if the Treasury exercises the entire warrant, it will become the largest
shareholder of the Company.  The Treasury has agreed that it will not
exercise voting power with regard to the shares that it acquires by exercising
the warrant.  However, Treasury’s abstention from voting may make it
more difficult for us to obtain shareholder approval for those matters that
require a majority of total shares outstanding, such as a business combination
involving the Company.





The
terms governing the issuance of the preferred stock to Treasury may be changed,
the effect of which may have an adverse effect on our operations.





The
Securities Purchase Agreement that we entered into with the Treasury provides
that the Treasury may unilaterally amend any provision of the agreement to the
extent required to comply with any changes in applicable federal statutes that
may occur in the future.  The American Recovery and Reinvestment Act
of 2009 placed more stringent limits on executive compensation for participants
in the TARP Capital Purchase Program and established a requirement that
compensation paid to executives be presented to shareholders for a “non-binding”
vote.  Further changes in the terms of the transaction may occur in
the future.  Such changes may place further restrictions on our
business or results of operations, which may adversely affect the market price
of our common stock.





Our
inability to raise capital at attractive rates may restrict our ability to
redeem the preferred stock we issued, which may lead to a greater cost of that
investment.





The terms
of the preferred stock issued to the Treasury provide that the shares pay a
dividend at a rate of 5% per year for the first five years after which time the
rate will increase to 9% per year.  It is our current goal to repay
the Treasury before the date of the increase in the dividend rate on the
preferred stock.  However, our ability to repay the Treasury will
depend on our ability to raise capital, which will depend on conditions in the
capital markets at that time, which are outside of our control.  We
can give no assurance that we will be able to raise additional capital or that
such capital will be available on terms more attractive to us than the
Treasury’s investment.


27





Strong
competition within our market area could hurt our profits and slow
growth.





We face intense competition both in
making loans and attracting deposits.  This competition has made it
more difficult for us to make new loans and has occasionally forced us to offer
higher deposit rates.  Price competition for loans and deposits might
result in us earning less on our loans and paying more on our deposits, which
reduces net interest income.  According to the Federal Deposit
Insurance Corporation, as of June 30, 2009, we held 2.46% of the deposits in
Fairfield, Greenville, Laurens, Union and York Counties, in South Carolina,
which was the 11th largest
market share of deposits out of the 39 financial institutions that held deposits
in these counties.  Some of the institutions with which we compete
have substantially greater resources and lending limits than we have and may
offer services that we do not provide.  We expect competition to
increase in the future as a result of legislative, regulatory and technological
changes and the continuing trend of consolidation in the financial services
industry.  Our profitability depends upon our continued ability to
compete successfully in our market area.





Changes
in interest rates could reduce our net interest income and
earnings.





Our net
interest income is the interest we earn on loans and investment less the
interest we pay on our deposits and borrowings. Our net interest margin is the
difference between the yield we earn on our assets and the interest rate we pay
for deposits and our other sources of funding.  Changes in interest
rates—up or down—could adversely affect our net interest margin and, as a
result, our net interest income. Although the yield we earn on our assets and
our funding costs tend to move in the same direction in response to changes in
interest rates, one can rise or fall faster than the other, causing our net
interest margin to expand or contract. Our liabilities tend to be shorter in
duration than our assets, so they may adjust faster in response to changes in
interest rates. As a result, when interest rates rise, our funding costs may
rise faster than the yield we earn on our assets, causing our net interest
margin to contract until the yield catches up.  Changes in the slope
of the “yield curve”—or the spread between short-term and long-term interest
rates—could also reduce our net interest margin. Normally, the yield curve is
upward sloping, meaning short-term rates are lower than long-term rates. Because
our liabilities tend to be shorter in duration than our assets, when the yield
curve flattens or even inverts, we could experience pressure on our net interest
margin as our cost of funds increases relative to the yield we can earn on our
assets.





The
trading history of our common stock is characterized by low trading
volume.  Our common stock may be subject to sudden
decreases.





Although our common stock trades on
Nasdaq Capital Market, it has not been regularly traded.  We cannot
predict whether a more active trading market in our common stock will occur or
how liquid that market might become. A public trading market having the desired
characteristics of depth, liquidity and orderliness depends upon the presence in
the marketplace of willing buyers and sellers of our common stock at any given
time, which presence is dependent upon the individual decisions of investors,
over which we have no control.





The market price of our common stock
may be highly volatile and subject to wide fluctuations in response to numerous
factors, including, but not limited to, the factors discussed in other risk
factors and the following:





·
            actual
      or anticipated fluctuations in our operating
  results;





·
            changes
      in interest rates;




·
            changes
      in the legal or regulatory environment in which we
  operate;




·
            press
      releases, announcements or publicity relating to us or our competitors or
      relating to trends in our
industry;


28




·
            changes
      in expectations as to our future financial performance, including
      financial estimates or recommendations by securities analysts and
      investors;




·
            future
      sales of our common stock;




·
            changes
      in economic conditions in our marketplace, general conditions in the U.S.
      economy, financial markets or the banking industry;
  and




·
            other
      developments affecting our competitors or
us.




These factors may adversely affect the
trading price of our common stock, regardless of our actual operating
performance, and could prevent you from selling your common stock at or above
the price you desire.  In addition, the stock markets, from time to
time, experience extreme price and volume fluctuations that may be unrelated or
disproportionate to the operating performance of companies.  These
broad fluctuations may adversely affect the market price of our common stock,
regardless of our trading performance.





We
operate in a highly regulated environment and we may be adversely affected by
changes in laws and regulations.





The Bank is subject to extensive
regulation, supervision and examination by the Office of the Comptroller of the
Currency, its chartering authority and federal regulator, and by the Federal
Deposit Insurance Corporation, as insurer of its deposits.  Provident
Community Bancshares is subject to regulation and supervision by the Federal
Reserve Board.  Such regulation and supervision govern the activities
in which an institution and its holding company may engage, and are intended
primarily for the protection of the insurance fund and for the depositors and
borrowers of the Bank.  The regulation and supervision by the Office
of the Comptroller of the Currency, the Federal Reserve Board and the Federal
Deposit Insurance Corporation are not intended to protect the interests of
investors in Provident Community Bancshares common stock.  Regulatory
authorities have extensive discretion in their supervisory and enforcement
activities, including the imposition of restrictions on our operations, the
classification of our assets and determination of the level of our allowance for
loan losses.  Any change in such regulation and oversight, whether in
the form of regulatory policy, regulations, legislation or supervisory action,
may have a material impact on our operations.





Provisions
of our certificate of incorporation, bylaws and Delaware law, as well as federal
banking regulations, could delay or prevent a takeover of us by a third
party.





Provisions in our certificate of
incorporation and bylaws and the corporate law of the State of Delaware could
delay, defer or prevent a third party from acquiring us, despite the possible
benefit to our shareholders, or otherwise adversely affect the price of our
common stock. These provisions include: supermajority voting requirements for
certain business combinations; the election of directors to staggered terms of
three years; and advance notice requirements for nominations for election to our
board of directors and for proposing matters that shareholders may act on at
shareholder meetings.  In addition, we are subject to Delaware laws,
including one that prohibits us from engaging in a business combination with any
interested shareholder for a period of three years from the date the person
became an interested shareholder unless certain conditions are
met.  These provisions may discourage potential takeover attempts,
discourage bids for our common stock at a premium over market price or adversely
affect the market price of, and the voting and other rights of the holders of,
our common stock.  These provisions could also discourage proxy
contests and make it more difficult for you and other shareholders to elect
directors other than the candidates nominated by our Board.





Item 1B. Unresolved Staff
Comments





None.


29





Item
2.  Properties





The Corporation owns two banking
offices and an operations center in Union, South Carolina, one banking office in
Winnsboro, South Carolina, two banking offices in Rock Hill, South Carolina and
a banking office in each of Laurens, Jonesville and Simpsonville, South
Carolina.  The net book value of the Corporation’s investment in
premises and equipment totaled approximately $5.4 million at December 31,
2009.  See Note 5 of Notes to Consolidated Financial Statements.
All property is in good condition and meets the operating needs of the
Corporation.





Item 3.  Legal
Proceedings





Neither Provident Community Bancshares
nor the Bank is engaged in any legal proceedings of a material nature at the
present time. From time to time, the Bank is involved in routine legal
proceedings occurring in the ordinary course of business wherein it enforces the
Bank’s security interest in mortgage loans the Bank has made.





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





[Reserved]





PART
II





Item 5.  Market
for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases
of Equity Securities





Common Stock
Information





Provident Community Bancshares, Inc.’s
common stock is listed on the Nasdaq Capital Market under the symbol PCBS. As of
March 1, 2010, there were 674 shareholders of record and 1,790,599 shares of
common stock issued and outstanding.





The following table contains the range
of high and low sales prices of Provident Community Bancshares’ common stock as
reported by the Nasdaq Global Market (prior to December 9, 2009) and by the
Nasdaq Capital Market (beginning December 9, 2009) and per share dividend as
declared during each quarter of the last two calendar years.





2009
                  
                  High
                  
                  
                  Low
                  
                  
                  DividendFourth
      Quarter
                  
                  $
                  3.25
                  
                  
                  $
                  1.99
                  
                  
                  $
                  –Third
      Quarter
                  
                  $
                  4.00
                  
                  
                  $
                  2.60
                  
                  
                  $
                  –Second
      Quarter
                  
                  $
                  5.00
                  
                  
                  $
                  2.00
                  
                  
                  $
                  0.03First
      Quarter
                  
                  $
                  10.00
                  
                  
                  $
                  1.50
                  
                  
                  $
                  0.03





2008
                  
                  High
                  
                  
                  Low
                  
                  
                  DividendFourth
      Quarter
                  
                  $
                  10.00
                  
                  
                  $
                  7.25
                  
                  
                  $
                  0.115Third
      Quarter
                  
                  $
                  11.77
                  
                  
                  $
                  6.44
                  
                  
                  $
                  0.115Second
      Quarter
                  
                  $
                  17.75
                  
                  
                  $
                  9.75
                  
                  
                  $
                  0.115First
      Quarter
                  
                  $
                  19.19
                  
                  
                  $
                  17.25
                  
                  
                  $
                  0.115





Provident
Community Bancshares is subject to the requirements of Delaware law, which
generally limits dividends to an amount equal to the excess of the net assets of
Provident Community Bancshares (the amount by which total assets exceed total
liabilities) over its statutory capital or, if there is no excess, to its net
profits for the current year and the immediately preceding fiscal year. See Note
13 to the Consolidated Financial Statements for information regarding certain
limitations imposed on the Bank’s ability to pay cash dividends to the holding
company.


30





As part
of the Company’s participation in the Capital Purchase Program of the U.S.
Department of Treasury’s Troubled Asset Relief Program, prior to the earlier of
March 6, 2012 or the date on which the preferred stock issued in that
transaction has been redeemed in full or the Treasury has transferred its shares
to non-affiliates, the Company cannot increase its quarterly cash dividend above
$0.03 per share, without prior approval by the Treasury.





Purchases
of Equity Securities By Issuer





In May 2005, the Corporation
implemented a share repurchase program under which the Corporation may
repurchase up to 5% of the outstanding shares or 98,000 shares. In August 2006,
the program was expanded by an additional 5% or 92,000 shares.  As of
December 31, 2009, 37,120 shares remained available for repurchase under the
plan.  However, as part of the Company’s participation in the Capital
Purchase Program of the U.S. Department of Treasury’s Troubled Asset Relief
Program, prior to the earlier of March 6, 2012 or the date on which the
preferred stock issued in that transaction has been redeemed in full or the
Treasury has transferred its shares to non-affiliates, the Company cannot
increase repurchase any shares of its common stock, without the prior approval
of the Treasury.  The Company did not repurchase any shares of its
common stock in the fourth quarter of 2009.





Item 6. Selected Financial
Data





Years
      Ended December 31,2009
                    
                    
                    2008
                    
                    
                    2007
                    
                    
                    2006
                    
                    
                    2005Operations
      Data:Interest
      income
                    
                    $
                    20,899
                    
                    
                    $
                    22,785
                    
                    
                    $
                    26,009
                    
                    
                    $
                    $23,491
                    
                    
                    $
                    19,213Interest
      expense
                    
                    
                    (11,593
                    )
                    
                    
                    (13,206
                    )
                    
                    
                    (15,214
                    )
                    
                    
                    (12,967
                    )
                    
                    
                    (8,970
                    )Net
      interest income
                    
                    
                    9,306
                    
                    
                    
                    9,579
                    
                    
                    
                    10,795
                    
                    
                    
                    10,524
                    
                    
                    
                    10,243Provision
      for loan losses
                    
                    
                    (8,695
                    )
                    
                    
                    (4,210
                    )
                    
                    
                    (1,066
                    )
                    
                    
                    (470
                    )
                    
                    
                    (869
                    )Net
      interest income after provision for loan losses
                    
                    
                    611
                    
                    
                    
                    5,369
                    
                    
                    
                    9,729
                    
                    
                    
                    10,054
                    
                    
                    
                    9,374Other
      income
                    
                    
                    34
                    
                    
                    
                    3,684
                    
                    
                    
                    3,162
                    
                    
                    
                    2,876
                    
                    
                    
                    2,543Other
      expense
                    
                    
                    (12,047
                    )
                    
                    
                    (10,046
                    )
                    
                    
                    (10,167
                    )
                    
                    
                    (9,178
                    )
                    
                    
                    (8,537
                    )(Loss)
      income before income taxes
                    
                    
                    (
      11,402
                    )
                    
                    
                    (
      993
                    )
                    
                    
                    2,724
                    
                    
                    
                    3,752
                    
                    
                    
                    3,380Income
      tax (benefit) expense
                    
                    
                    (4,011
                    )
                    
                    
                    (596
                    )
                    
                    
                    (534
                    )
                    
                    
                    (949
                    )
                    
                    
                    (914
                    )Net
      (loss) income
                    
                    
                    ( 7,391
                    )
                    
                    
                    ( 397
                    )
                    
                    
                    2,190
                    
                    
                    
                    2,803
                    
                    
                    
                    2,466Preferred
      stock dividends and accretion
                    
                    
                    382
                    
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    –(Loss)
      income available to common shares
                    
                    $
                    ( 7,773
                    )
                    
                    $
                    ( 397
                    )
                    
                    $
                    2,190
                    
                    
                    $
                    2,803
                    
                    
                    $
                    2,466Net
      (loss) income per common share (Basic)
                    
                    $
                    (4.34
                    )
                    
                    $
                    (0.22
                    )
                    
                    $
                    1.21
                    
                    
                    $
                    1.50
                    
                    
                    $
                    1.29Net
      (loss) income per common share (Diluted)
                    
                    $
                    (4.34
                    )
                    
                    $
                    (0.22
                    )
                    
                    $
                    1.19
                    
                    
                    $
                    1.48
                    
                    
                    $
                    1.26Dividends
      paid per common stock
                    
                    $
                    0.06
                    
                    
                    $
                    0.46
                    
                    
                    $
                    0.455
                    
                    
                    $
                    0.43
                    
                    
                    $
                    0.40Weighted
      average number of common shares outstanding (Basic)
                    
                    
                    1,789,743
                    
                    
                    
                    1,784,412
                    
                    
                    
                    1,810,916
                    
                    
                    
                    1,865,951
                    
                    
                    
                    1,914,357Weighted
      average number of common shares outstanding (Diluted)
                    
                    
                    1,789,743
                    
                    
                    
                    1,784,412
                    
                    
                    
                    1,846,980
                    
                    
                    
                    .1,893,203
                    
                    
                    
                    1,962,920


31





At
      December 31,2009
                          
                          
                          2008
                          
                          
                          2007
                          
                          
                          2006
                          
                          
                          2005(Dollars
      In Thousands)Financial
      Condition:Assets
                          
                          $
                          457,003
                          
                          
                          $
                          434,218
                          
                          
                          $
                          407,641
                          
                          
                          $
                          387,630
                          
                          
                          $
                          371,042Cash
      and due from banks
                          
                          
                          15,631
                          
                          
                          
                          21,370
                          
                          
                          
                          11,890
                          
                          
                          
                          9,124
                          
                          
                          
                          8,380Securities
                          
                          
                          151,750
                          
                          
                          
                          102,848
                          
                          
                          
                          111,187
                          
                          
                          
                          122,185
                          
                          
                          
                          146,283Loans
      (net)
                          
                          
                          250,420
                          
                          
                          
                          278,665
                          
                          
                          
                          256,487
                          
                          
                          
                          231,886
                          
                          
                          
                          192,577Deposits
                          
                          
                          332,762
                          
                          
                          
                          306,821
                          
                          
                          
                          270,399
                          
                          
                          
                          248,440
                          
                          
                          
                          234,988Advances
      from Federal Home Loan Bank and other borrowings
                          
                          
                          64,500
                          
                          
                          
                          69,500
                          
                          
                          
                          69,500
                          
                          
                          
                          70,000
                          
                          
                          
                          75,715Securities
      sold under agreement to repurchase
                          
                          
                          18,520
                          
                          
                          
                          19,005
                          
                          
                          
                          24,131
                          
                          
                          
                          28,533
                          
                          
                          
                          24,615Floating
      rate junior subordinated deferrable interest debentures
                          
                          
                          12,372
                          
                          
                          
                          12,372
                          
                          
                          
                          12,372
                          
                          
                          
                          12,372
                          
                          
                          
                          8,247Shareholders’
      equity
                          
                          
                          26,121
                          
                          
                          
                          23,924
                          
                          
                          
                          27,313
                          
                          
                          
                          25,967
                          
                          
                          
                          25,333





Years
      Ended December 31,2009
                      
                      
                      2008
                      
                      
                      2007
                      
                      
                      2006
                      
                      
                      2005Other Selected
      Data:Average
      interest rate spread
                      
                      
                      2.13
                      %
                      
                      
                      2.37
                      %
                      
                      
                      2.70
                      %
                      
                      
                      2.81
                      %
                      
                      
                      2.87
                      %Net
      interest margin
                      
                      
                      2.20
                      
                      
                      
                      2.51
                      
                      
                      
                      2.91
                      
                      
                      
                      3.01
                      
                      
                      
                      3.02Return
      on average assets
                      
                      
                      (1.61
                      )
                      
                      
                      (0.10
                      )
                      
                      
                      0.55
                      
                      
                      
                      0.75
                      
                      
                      
                      0.68Return
      on average shareholders’ equity
                      
                      
                      (28.89
                      )
                      
                      
                      (1.46
                      )
                      
                      
                      8.25
                      
                      
                      
                      11.19
                      
                      
                      
                      9.68Operating
      expense to average assets
                      
                      
                      2.25
                      
                      
                      
                      2.33
                      
                      
                      
                      2.42
                      
                      
                      
                      2.28
                      
                      
                      
                      2.17Ratio
      of average shareholders’ equity to average assets
                      
                      
                      5.62
                      
                      
                      
                      6.60
                      
                      
                      
                      6.63
                      
                      
                      
                      6.68
                      
                      
                      
                      7.01





Item
7.  Management’s Discussion and Analysis of Financial Condition and
Results of Operations





Critical
Accounting Policies





The Corporation has adopted various
accounting policies that govern the application of accounting principles
generally accepted in the United States of America in the preparation of
financial statements.  The significant accounting policies of the
Corporation are described in the footnotes to the consolidated financial
statements.





Certain accounting policies involve
significant judgments and assumptions by management that could have a material
impact on the carrying value of certain assets and liabilities. Management
considers such accounting policies to be critical accounting policies. The
judgments and assumptions used by management are based on historical experience
and other factors, which are believed to be reasonable under the
circumstances.  Because of the nature of the judgments and assumptions
made by management, actual results could differ from these judgments and
estimates, which could have a material impact on the carrying values of assets
and liabilities and the results of operations of the Corporation.





The Corporation believes the allowance
for loan losses is a critical accounting policy that requires significant
judgments and estimates used in the preparation of consolidated financial
statements. Management reviews the level of the allowance on a monthly basis and
establishes the provision for loan losses based on the size and composition of
the loan portfolio, overall portfolio quality, delinquency levels, a review of
specific problem loans, loss experience, economic conditions, and other factors
related to the collectability of the loan portfolio.  A portion of the
allowance is established by segregating the loans by residential mortgage,
commercial and consumer loans and assigning allocation percentages based on
historical loss experience and delinquency trends. The applied allocation
percentages are reevaluated at least annually to ensure their relevance in the
current economic environment.  Accordingly, increases in the size of
the loan portfolio and the increased emphasis on commercial real estate and
commercial business loans, which carry a higher degree of risk of default and,
thus, a higher allocation percentage, increases the
allowance.  Additionally, a portion of the allowance is established
based on the level of specific classified assets.


32





Although the Corporation believes that
it uses the best information available to establish the allowance for loan
losses, future additions to the allowance may be necessary based on estimates
that are susceptible to change as a result of changes in economic conditions and
other factors.  In addition, the Office of the Comptroller of the
Currency, as an integral part of its examination process, will periodically
review the Corporation’s allowance for loan losses.  Such agency may
require the Corporation to recognize adjustments to the allowance based on its
judgments about information available to it at the time of its
examination.  See Notes 1 and 4 of the Notes to the
Consolidated Financial Statements included in this annual report for a detailed
description of the Corporation’s estimation process and methodology related to
allowance for loans losses.


33


Average
Balances, Interest and Average Yields/Cost





The following table sets forth certain
information for the periods indicated regarding: (1) average balances of assets
and liabilities; (2) the total dollar amounts of interest income from average
interest-earning assets and interest expense on average interest-bearing
liabilities; and (3) average yields and costs.  Such yields and costs
for the periods indicated are derived by dividing income or expense by the
average monthly balance of assets or liabilities, respectively, for the periods
presented.





Years Ended December 31,2009
                      
                      
                      2008
                      
                      
                      2007Average
                        Balance
                      
                      
                      Interest
                      
                      
                      Average
                        Yield/Cost
                      
                      
                      Average
                        Balance
                      
                      
                      Interest
                      
                      
                      Average
                        Yield/Cost
                      
                      
                      Average
                        Balance
                      
                      
                      Interest
                      
                      
                      Average
                        Yield/Cost(Dollars in thousands)Interest-earning
      assets:Loans
      receivable, net (1)
                      
                      $
                      274,662
                      
                      
                      $
                      14,230
                      
                      
                      
                      5.18
                      %
                      
                      $
                      275,238
                      
                      
                      $
                      17,230
                      
                      
                      
                      6.26
                      %
                      
                      $
                      240,192
                      
                      
                      $
                      19,048
                      
                      
                      
                      7.93
                      %Mortgage-backed
      securities
                      
                      
                      73,619
                      
                      
                      
                      3,616
                      
                      
                      
                      4.91
                      
                      
                      
                      50,255
                      
                      
                      
                      2,710
                      
                      
                      
                      5.39
                      
                      
                      
                      30,059
                      
                      
                      
                      1,492
                      
                      
                      
                      4.96Investment
      securities:Taxable
                      
                      
                      53,507
                      
                      
                      
                      2,573
                      
                      
                      
                      4.81
                      
                      
                      
                      41,147
                      
                      
                      
                      2,319
                      
                      
                      
                      5.64
                      
                      
                      
                      83,833
                      
                      
                      
                      4,708
                      
                      
                      
                      5.62Nontaxable
                      
                      
                      9,285
                      
                      
                      
                      430
                      
                      
                      
                      4.63
                      
                      
                      
                      9,991
                      
                      
                      
                      471
                      
                      
                      
                      4.71
                      
                      
                      
                      12,906
                      
                      
                      
                      603
                      
                      
                      
                      4.67Total
      investment securities
                      
                      
                      62,792
                      
                      
                      
                      3,003
                      
                      
                      
                      4.78
                      
                      
                      
                      51,138
                      
                      
                      
                      2,790
                      
                      
                      
                      5.46
                      
                      
                      
                      96,739
                      
                      
                      
                      5,311
                      
                      
                      
                      5.49Deposits
      and federal funds sold
                      
                      
                      12,185
                      
                      
                      
                      50
                      
                      
                      
                      0.41
                      
                      
                      
                      4,364
                      
                      
                      
                      55
                      
                      
                      
                      1.26
                      
                      
                      
                      3,413
                      
                      
                      
                      158
                      
                      
                      
                      4.63Total
      interest-earning assets
                      
                      
                      423,258
                      
                      
                      
                      20,899
                      
                      
                      
                      4.94
                      
                      
                      
                      380,995
                      
                      
                      
                      22,785
                      
                      
                      
                      5.98
                      
                      
                      
                      370,403
                      
                      
                      
                      26,009
                      
                      
                      
                      7.02Non-interest-earning
      assets
                      
                      
                      36,941
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      31,509
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      29,752Total
      assets
                      
                      $
                      460,199
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      $
                      412,504
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      $
                      400,155Interest-bearing
      liabilities:Savings
      accounts
                      
                      
                      13,508
                      
                      
                      
                      69
                      
                      
                      
                      0.51
                      
                      
                      
                      12,888
                      
                      
                      
                      83
                      
                      
                      
                      0.64
                      
                      
                      
                      14,486
                      
                      
                      
                      111
                      
                      
                      
                      0.77Negotiable
      order of withdrawal accounts (2)
                      
                      
                      117,381
                      
                      
                      
                      2,385
                      
                      
                      
                      2.03
                      
                      
                      
                      83,966
                      
                      
                      
                      2,147
                      
                      
                      
                      2.55
                      
                      
                      
                      74,326
                      
                      
                      
                      2,426
                      
                      
                      
                      3.26Certificate
      accounts
                      
                      
                      185,452
                      
                      
                      
                      5,541
                      
                      
                      
                      2.99
                      
                      
                      
                      164,077
                      
                      
                      
                      6,729
                      
                      
                      
                      4.10
                      
                      
                      
                      155,490
                      
                      
                      
                      7,295
                      
                      
                      
                      4.69FHLB
      advances and other borrowings
                      
                      
                      96,368
                      
                      
                      
                      3,598
                      
                      
                      
                      3.73
                      
                      
                      
                      104,496
                      
                      
                      
                      4,247
                      
                      
                      
                      4.06
                      
                      
                      
                      107,823
                      
                      
                      
                      5,382
                      
                      
                      
                      4.99Total
      interest-bearing liabilities
                      
                      
                      412,709
                      
                      
                      
                      11,593
                      
                      
                      
                      2.81
                      
                      
                      
                      365,427
                      
                      
                      
                      13,206
                      
                      
                      
                      3.61
                      
                      
                      
                      352,125
                      
                      
                      
                      15,214
                      
                      
                      
                      4.32Noninterest-bearing
      sources:Non-interest-bearing
      deposits
                      
                      
                      18,659
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      16,807
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      18,288Non-interest-bearing
      liabilities
                      
                      
                      3,249
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      3,026
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      3,007Total
      liabilities
                      
                      
                      434,617
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      385,260
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      373,420Shareholders’
      equity
                      
                      
                      25,582
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      27,244
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      26,735Total
      liabilities and shareholders’ Equity
                      
                      $
                      460,199
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      $
                      412,504
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      $
                      400,155Net
      interest income
                      
                      
                      
                      
                      
                      $
                      9,306
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      $
                      9,579
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      $
                      10,795Interest
      rate spread (3)
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      2.13
                      %
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      2.37
                      %
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      2.70
                      %Impact
      of noninterest-bearing sources
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      0.07
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      0.14
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      0.21Net
      interest margin (4)
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      2.20
                      %
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      2.51
                      %
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      2.91
                      %Ratio
      of average interest-earning assets to average interest-bearing
      liabilities
                      
                      
                      1.03
                      x
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      1.04
                      x
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      1.05
                      x





(1)
            Average
      loans receivable includes non-accruing loans.  Interest income
      does not include interest on loans 90 days or more past
    due.


(2)
            Average
      costs include the affects of non-interest bearing
  deposits.


(3)
            Represents
      difference between weighted average yield on all interest-earning assets
      and weighted average rate on all interest-bearing
    liabilities.


(4)
            Represents
      net interest income before provision for loan losses as a percentage of
      average interest-earning
assets.


34


Rate/Volume
Analysis





The following table sets forth certain
information regarding changes in interest income and interest expense of the
Corporation for the periods indicated. For each category of interest-earning
assets and interest-bearing liabilities, information is provided on changes
attributable to (1) changes in volume (changes in volume multiplied by prior
rate) and (2) changes in rate (changes in rate multiplied by
prior  volume). The net change attributable to the combined impact of
rate and volume has been allocated to rate and volume variances consistently on
a proportionate basis.




Years Ended December 31,
                    2009 vs. 2008Volume
                  
                  
                  Rate
                  
                  
                  Total(Dollars in Thousands)Change
      in interest income:Loans
                  
                  $
                  (36
                  )
                  
                  $
                  (2,964
                  )
                  
                  $
                  (3,000
                  )Mortgage-backed
      securities
                  
                  
                  1 1,260
                  
                  
                  
                  (354
                  )
                  
                  
                  906Investment
      securities (1)
                  
                  
                  998
                  
                  
                  
                  (790
                  )
                  
                  
                  208Total
      interest income
                  
                  
                  2,222
                  
                  
                  
                  (4,108
                  )
                  
                  
                  (1,886
                  )Change
      in interest expense:Deposits
                  
                  
                  1,847
                  
                  
                  
                  (2,811
                  )
                  
                  
                  (964
                  )Borrowings
      and other
                  
                  
                  (330
                  )
                  
                  
                  (319
                  )
                  
                  
                  (649
                  )Total
      interest expense
                  
                  
                  1,517
                  
                  
                  
                  (3,130
                  )
                  
                  
                  (1,613
                  )Change
      in net interest income
                  
                  $
                  705
                  
                  
                  $
                  (978
                  )
                  
                  $
                  (273
                  )





(1)
Includes fed funds and overnight deposits.





Results
of Operations





Comparison
of Years Ended December 31, 2009 and December 31, 2008





The Corporation recorded a net loss to
common shareholders for year ended December 31, 2009 of approximately $7.8
million compared to net loss of approximately $397,000 for the year ended
December 31, 2008. Net loss to common shareholders per share
was ($4.34) per share (basic and diluted) for the year ended December 31,
2009 compared to ($0.22) per share (basic and diluted) for the year ended
December 31, 2008. Net interest income before the loan loss provision for the
year ended December 31, 2009 decreased $273,000, or 2.8%, to $9.3 million
compared to $9.6 million for the previous year. The decrease was due primarily
to a compression of the net interest margin caused by declining interest rates.
The increase in the net loss was due primarily to an increase in the provision
for loan losses due to an increase in non-performing loans, classified loans and
charge-offs, a decrease in non-interest income due to an other than temporary
impairment charge and an increase in non-interest expense due to goodwill
impairment charges.





Interest
Income.Total interest income decreased $1.9 million, or 8.3%,
from $22.8 million for the year ended December 31, 2008 to $20.9 million
for the year ended December 31, 2009. Interest income on loans decreased $3.0
million, or 17.4%, from $17.2 million for 2008 to $14.2 million for 2009 due
primarily to declining market rates. Interest income on deposits, federal funds
sold and investment securities increased $1.1 million, or 20.1%, from $5.6
million for 2008 to $6.7 million for 2009.  The increase was due primarily
to higher average balances, partially offset by lower investment yields due to
declining market interest rates.


35





Interest
Expense.Interest expense decreased 12.2% to $11.6 million for
2009 from $13.2 million for 2008. Interest expense decreased $964,000 for
deposits and decreased $649,000 for other borrowings and floating rate junior
subordinated deferrable interest debentures. Interest expense for deposits
decreased due primarily to lower market interest rates and a shift in the
composition of the deposit portfolio from certificates of deposits to
transaction accounts, offset by higher average balances. Interest expense on
other borrowings decreased due to lower market interest rates and lower average
balances.





Provision for
Loan Loss.We have developed policies and procedures for evaluating the
overall quality of our credit portfolio and the timely identification of
potential problem credits. The Board of Directors reviews and approves the
appropriate level for our allowance for loan losses quarterly based upon
management’s recommendations, the results of the internal monitoring and
reporting system, quarterly external independent loan reviews and the analysis
of economic conditions in our local markets. Additions to the allowance for loan
losses, which are expensed as the provision for loan losses on our income
statement, are periodically made to maintain the allowance at an appropriate
level based on our analysis of the potential risk in the loan portfolio. Loan
losses, which include write downs and charge offs are charged directly to the
allowance while recoveries are credited against the allowance. The amount of the
provision is a function of the size and composition of loans outstanding, the
level of non-performing loans, historical loan loss experience, the amount of
loan losses actually charged against the reserve during the given period, and
current and anticipated economic conditions.
 
 Our allowance for loan losses is based
upon judgments and assumption of risk elements in the portfolio, future economic
conditions and other factors affecting borrowers. The process includes
identification and analysis of loss potential in various portfolio segments
utilizing a credit risk grading process and specific reviews and evaluations of
significant problem credits. In addition, we monitor overall portfolio quality
through observable trends in delinquencies, charge-offs, and general and
economic conditions in the market area. The adequacy of the allowance for loan
losses and the effectiveness of our monitoring and analysis system are also
reviewed periodically by the banking regulators, which may require that we
increase the allowance for loan losses. Risks are inherent in making all loans,
including risks with respect to the period of time over which loans may be
repaid, risks resulting from changes in economic and industry conditions, risks
inherent in dealing with individual borrowers, and, in the case of a
collateralized loan, risks resulting from uncertainties about the future value
of the collateral.
 
 Our judgment about the adequacy of the
allowance is based upon a number of assumptions about future events, which we
believe to be reasonable, but which may not prove to be accurate. Thus,
charge-offs in future periods could exceed the allowance for loan losses, or
substantial additional increases in the allowance for loan losses could be
required. Additions to the allowance for loan losses would result in a decrease
of our net income and our capital. Based on present information, we believe the
allowance for loan losses is adequate at December 31, 2009 to meet presently
known and inherent risks in the loan portfolio. See “Item 1-Business Lending
Activities-Allowance for Loan Losses” for more information on the determination
of the allowance for loan losses.





The provision for loan losses increased
from $4.2 million for 2008 to $8.7 million for 2009 primarily due to: (1) an
increase in non-performing and classified assets and (2) an increase in
charge-offs. The allowance for loan losses decreased $1.2 million to $5.6
million as of December 31, 2009 compared to $6.8 million as of December 31, 2008
due primarily to the significant increase in loans charged off of $8.9 million
for 2009 compared to 2008. Non-performing assets increased $10.1 million
from $16.7 million at December 31, 2008 to $26.8 million at December 31, 2009.
The majority of this increase relates primarily to acquisition and development
real estate relationships that have been affected by the downturn in the
residential housing market. Slow housing conditions have affected these
borrowers’s ability to sell the completed projects in a timely manner.
Management continues to evaluate and assess all non-performing assets on a
regular basis as part of its well-established loan monitoring and review
process. At December 31, 2009, criticized and classified loans, including
non-performing loans, totaled $51.4 million, compared to $40.9 million at
September 30, 2009 and $32.6 million at December 31, 2008.The majority of this
increase relates primarily to commercial real estate relationships that have
been affected by the current economic downturn. Management has sought to provide
an amount estimated to be necessary to maintain an allowance for loan losses
that is adequate to cover the level of loss that management believed to be
inherent in the portfolio as a whole, taking into account the Corporation’s
experience, economic conditions and information about borrowers available at the
time of the analysis. However, if expectations regarding economic conditions in
the Corporation’s market areas is worse than currently anticipated, especially
its effect on real estate related activities and real property values, further
additions in provisions for loan losses could be needed in the
future.


36




The
Corporation experienced loan charge-offs, net of recoveries, of approximately
$9.9 million for 2009 compared to $776,000 for 2008.  The loan charge-offs
for 2009 related primarily to write-downs required in the disposition of
commercial loans. The allowance for loan losses to total loans at December 31,
2009 was 2.18% compared to 2.36% at December 31, 2008.  The allowance for
loan losses to non-performing loans at December 31, 2009 was 26.7% compared to
40.6% at December 31, 2008.





Our non-performing loans totaled
$20.9 million at December 31, 2009 compared to $16.0 million at December
30, 2008. Nonperforming loans totaled $21.0 million at June 30, 2009 and
$16.6 million at March 31, 2009. While management uses the best information
available to establish the allowance for loan losses, future adjustments to the
allowance may be necessary if economic conditions differ substantially from the
assumptions used in making the valuations. Such adjustments would be made in the
relevant period and may be material to the financial
statements.





Non-Interest
Income


(Dollars
in thousands)





Year
      ended December 312009
                                  
                                  
                                  2008
                                  
                                  
                                  2007Amount
                                  
                                  
                                  %
                                    Change
                                  
                                  
                                  Amount
                                  
                                  
                                  %Change
                                  
                                  
                                  AmountNet
      gain  on sale of investments
                                  
                                  $
                                  775
                                  
                                  
                                  
                                  55.62
                                  %
                                  
                                  $
                                  498
                                  
                                  
                                  
                                  758.62
                                  %
                                  
                                  $
                                  58Fees
      for financial services
                                  
                                  
                                  2,932
                                  
                                  
                                  
                                  (4.95
                                  )
                                  
                                  
                                  3,085
                                  
                                  
                                  
                                  2.42
                                  
                                  
                                  
                                  3,012Other–than-temporary-impairment
      write-down on securities
                                  
                                  
                                  (3,756
                                  )
                                  
                                  
                                  100.00
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  —Other
      fees, net
                                  
                                  
                                  83
                                  
                                  
                                  
                                  (17.82
                                  )
                                  
                                  
                                  101
                                  
                                  
                                  
                                  12.22
                                  
                                  
                                  
                                  90Total
      non-interest income
                                  
                                  $
                                  34
                                  
                                  
                                  
                                  (99.08
                                  )
                                  
                                  $
                                  3,684
                                  
                                  
                                  
                                  16.51
                                  
                                  
                                  $
                                  3,162





The decrease in non-interest income was
due primarily to an other-than-temporary impairment charge of $3.8 million from
write-downs recorded on pooled trust preferred securities as a result of
projected shortfalls of interest and principal payments in the cash flow
analysis of the securities. Fees for financial services decreased primarily due
to lower fees from a reduction in loan volumes along with lower fees generated
from third party investment brokerage and financing receivables programs as a
result of lower product volumes.  Gains on sale of investments were
$775,000 for 2009 as the Corporation sold $40.0 million in investment securities
to improve yield.





Non-Interest
Expense


(Dollars
in thousands)





Year
      ended December 312009
                                      
                                      
                                      2008
                                      
                                      
                                      2007Amount
                                      
                                      
                                      % Change
                                      
                                      
                                      Amount
                                      
                                      
                                      % Change
                                      
                                      
                                      AmountCompensation
      and employee benefits
                                      
                                      $
                                      4,512
                                      
                                      
                                      
                                      (8.77
                                      )%
                                      
                                      $
                                      4,946
                                      
                                      
                                      
                                      (0.08
                                      )%
                                      
                                      $
                                      4,950Occupancy
      and equipment
                                      
                                      
                                      2,685
                                      
                                      
                                      
                                      8.44
                                      
                                      
                                      
                                      2,476
                                      
                                      
                                      
                                      (2.06
                                      )
                                      
                                      
                                      2,528Deposit
      insurance premiums
                                      
                                      
                                      871
                                      
                                      
                                      
                                      771.00
                                      
                                      
                                      
                                      100
                                      
                                      
                                      
                                      233.33
                                      
                                      
                                      
                                      30Professional
      services
                                      
                                      
                                      371
                                      
                                      
                                      
                                      3.34
                                      
                                      
                                      
                                      359
                                      
                                      
                                      
                                      (22.13
                                      )
                                      
                                      
                                      461Advertising
      and public relations
                                      
                                      
                                      85
                                      
                                      
                                      
                                      (61.54
                                      )
                                      
                                      
                                      221
                                      
                                      
                                      
                                      (11.60
                                      )
                                      
                                      
                                      250Loan
      operations
                                      
                                      
                                      555
                                      
                                      
                                      
                                      198.38
                                      
                                      
                                      
                                      186
                                      
                                      
                                      
                                      24.00
                                      
                                      
                                      
                                      150Telephone
                                      
                                      
                                      192
                                      
                                      
                                      
                                      1.05
                                      
                                      
                                      
                                      190
                                      
                                      
                                      
                                      0.00
                                      
                                      
                                      
                                      190Items
      processing
                                      
                                      
                                      338
                                      
                                      
                                      
                                      30.50
                                      
                                      
                                      
                                      259
                                      
                                      
                                      
                                      17.19
                                      
                                      
                                      
                                      221Intangible
      amortization
                                      
                                      
                                      324
                                      
                                      
                                      
                                      (22.12
                                      )
                                      
                                      
                                      416
                                      
                                      
                                      
                                      (13..33
                                      )
                                      
                                      
                                      480Impairment
      of intangible assets
                                      
                                      
                                      1,349
                                      
                                      
                                      
                                      100.00
                                      
                                      
                                      
                                      —
                                      
                                      
                                      
                                      —
                                      
                                      
                                      
                                      —Other
                                      
                                      
                                      765
                                      
                                      
                                      
                                      (14.33
                                      )
                                      
                                      
                                      893
                                      
                                      
                                      
                                      (1.54
                                      )
                                      
                                      
                                      907Total
      non-interest expense
                                      
                                      $
                                      12,047
                                      
                                      
                                      
                                      19.92
                                      
                                      
                                      $
                                      10,046
                                      
                                      
                                      
                                      (1.19
                                      )
                                      
                                      $
                                      10,167


37


Compensation
and employee benefits decreased 8.8%, or $434,000, compared to the year ended
December 31, 2008 due primarily to reductions in accrued incentive compensation
expense and reductions in employee pension benefit costs. Occupancy and
equipment expenses increased 8.4%, or $209,000, due primarily to additional
expense from outsourcing the staffing function for information technology and
higher ATM expense due to increased fees and usage. Deposit insurance premiums
expense increased $771,000, or 771.0%, to $871,000 for 2009 from $100,000 for
2008, due to higher FDIC premium assessments as a result of a one-time
assessment credit under the Federal Insurance Reform Act becoming fully utilized
in 2008,a special assessment that was charged to all federally insured banks and
higher balances of deposits and higher assessment rates. Professional
services expense increased 3.3%, or $12,000, due primarily to higher legal and
consultant expenses.  Advertising and public relations expense
decreased 61.5%, or $136,000, from the year ended December 31, 2008 to the year
ended December 31, 2009 due primarily to lower product and promotion
expenses. Loan operations costs increased $369,000, or 198.4%, to $555,000
for the year ended December 31, 2009 from $186,000 for the year ended December
31, 2008, due to higher disposition costs associated with foreclosed real estate
properties. Intangible amortization expense decreased $92,000, or
22.1%, to $324,000 for the year ended December 31, 2009 from $416,000 for 2008,
due to deposit premiums related to branch acquisitions becoming fully
amortized. Impairment of intangible assets was $1.3 million for the
year ended December 31, 2009 due to the charge-off of all remaining goodwill and
deposit premium amortization related to a previous acquisition as a result of
the decrease in the Corporation’s market capitalization. Items processing
expense increased $79,000, or 30.5%, to $338,000 for the year ended
December 31, 2009 from $259,000 for the year ended December 31, 2008 due to an
increase in transaction accounts. Other operating expense
decreased 14.3%, or $128,000, for the year ended December 31, 2009 compared
to the year ended December 31, 2008 due primarily to lower loan expense due to
reduced loan volumes and reductions in courier expense as a result of the
installation of branch capture collection systems.





Goodwill
is reviewed for potential impairment at least annually at the reporting unit
level. The Corporation performs its impairment testing in the fourth quarter of
each year and more frequently if circumstances exist that indicate a probable
reduction in the fair value below carrying value. An impairment loss is recorded
to the extent that the carrying amount of goodwill exceeds its implied fair
value. Other intangible assets are evaluated for impairment if events and
circumstances indicate a possible impairment. Such evaluation of other
intangible assets is based on undiscounted cash flow projections. Impairment
charges of $192,000 were recorded related to a deposit premium
impairment.





In
performing the first step (“Step 1”) of the goodwill impairment testing and
measurement process to identify possible impairment, the estimated fair value
was developed using a market valuation approach that utilizes the current stock
price as the primary indicator of fair market value. The results of this Step 1
process indicated that the estimated fair value was less than book value, thus
requiring the Corporation to perform the second step (“Step 2”) of the goodwill
impairment test.  Based on the Step 2 analysis, it was determined that
the implied fair value of goodwill was $0 as of December 31, 2009, which
resulted in a goodwill impairment charge of $1,157,000 for the year ended
December 31, 2008 that was recorded as a component of noninterest expense on the
consolidated statement of operations.





The
primary factor in the determination of goodwill impairment in 2009 was the
Corporation’s relatively low stock price and resulting market valuation. The
Corporation’s stock price has been trading below its book value throughout 2009.
Management attributes its relatively low stock price to both financial services
industry-wide and Corporation specific factors primarily related to credit
quality issues. The goodwill impairment charge is non-cash expense, and since
goodwill is a non interest earning asset, this charge will not impact the
Corporation’s future operating performance.





Income Tax
Expense.Due to the net loss that the Corporation recorded for
the year ended December 31, 2009, the net income tax benefit was $4.0 million
compared to a net income tax benefit of $596,000 for the year ended December 31,
2008.


38





Financial
Condition, Liquidity and Capital Resources





Financial
Condition





Assets.At
December 31, 2009, the Corporation’s assets totaled $457.0 million,
an increase of $22.8 million, or 5.3%, as compared to
$434.2 million at December 31, 2008. Cash and cash equivalents decreased
$5.7 million to $15.6 million from $21.4 million at December 31, 2008. The
decrease was due primarily to a decrease in overnight deposits as those funds
were used to purchase investment securities. Investment and mortgage-backed
securities increased $48.9 million to $151.8 million from $102.8 million at
December 31, 2008 due to the purchase of agency and mortgage-backed securities
that were funded primarily with deposit growth.





Total loans, net, decreased $28.3
million, or 10.1%, to $250.4 million at December 31, 2009 from $278.7 million at
December 31, 2008. The decrease was due to a significant reduction in loan
demand as a result of economic conditions currently present in South Carolina.
Consumer loans decreased $4.7 million, or 8.3%, during 2009, commercial loans
decreased $20.2 million, or 9.9%, and residential mortgage loans decreased $6.3
million or 24.1%.





Real
estate acquired through foreclosure increased $5.2 million to $5.9 million at
December 31, 2009 from $667,000 at December 31, 2008, as a result of foreclosure
on commercial real estate properties. Approximately 88%, or $4.8 million of the
increase was due to the foreclosure of two commercial real estate projects
where  the collateral values are supported by residential housing and
undeveloped land. The properties are being actively marketed and maintained with
the primary objective of liquidating the collateral at a level which most
accurately approximates fair market value and allows recovery of as much of the
unpaid balance as possible. The carrying value of these assets are believed to
be representative of their fair market value, although there can be no assurance
that the ultimate proceeds from the sale of these assets will be equal to or
greater than the carrying values.





Intangible assets decreased $2.8
million to $0 at December 31, 2009 compared to $2.8 million at December 31, 2008
as a result of the charge-off of goodwill and deposit premiums related to a
previous acquisition that resulted from the significant decrease in the
Corporation’s market capitalization. Other assets increased $5.7 million,
or 98.3%, to $11.5 million at December 31, 2009 from $5.8 million at December
31, 2008 due primarily to an increase in deferred income taxes as a result of
the $7.4 million net loss in 2009 compared to the $397,000 net loss for 2008. In
addition, other assets include a prepaid expense for $2.2 million where the FDIC
required all banks to prepay their assessment premiums for a three year
period.





Liabilities.Total
liabilities increased $20.6 million, or 5.0%, to $430.9 million at December 31,
2009 from $410.3 million at December 31, 2008. Total deposits increased $25.9
million, or 8.4%, from $306.8 million at December 31, 2008 to $332.8 million at
December 31, 2009. Time deposits decreased $16.5 million, or 8.7%, from $187.1
million at December 31, 2008 to $170.8 million at December 31, 2009 while
transaction deposit accounts increased $42.2 million, or 35.2%, from $119.8
million at December 31, 2008 to $161.9 million at December 31, 2009. The
increase in transaction accounts was due primarily to a special account
promotion. The Corporation continues to target lower cost demand deposit
accounts versus traditional higher cost certificates of deposits. The increase
in deposits was utilized to fund the growth in investment securities and to pay
down borrowings for the year.





Shareholders’
Equity.On March 13, 2009, the Corporation sold $9.3 million
in preferred shares and warrants to purchase 178,880 shares of common stock,
$0.01 par value, at an exercise price of $7.77 per share to the United States
Department of Treasury pursuant to the federal government’s Troubled Asset
Relief Program Capital Purchase Program.Shareholders’ equity increased $2.2 million, or 9.2%, to $26.1 million at
December 31, 2009 from $23.9 million at December 31, 2008 due to a net loss of
$7.4 million, common stock dividend payments of $0.06 per share at a cost of
$107,000 and preferred stock dividend payments of $310,000 offset by the
preferred stock issuance and a $724,000 decrease in unrealized losses on
securities available for sale. At December 31, 2009, all of the Bank’s capital
ratios continued to be sufficient to classify it as a well-capitalized
institution by regulatory measures.


39





Liquidity





Liquidity is the ability to meet demand
for loan disbursements, deposit withdrawals, repayment of debt, payment of
interest on deposits and other operating expenses. The primary sources of
liquidity are deposits, loan sales and repayments, borrowings, maturities,
prepayment and sales of securities and interest payments.





While maturities and scheduled
amortization of loans and securities are predictable sources of funds, deposit
outflows and mortgage prepayments are greatly influenced by general interest
rates, economic conditions and competition. The primary investing activities of
the Corporation are the origination of commercial and consumer loans and the
purchase of investment and mortgage-backed securities. These activities are
funded primarily by principal and interest payments on loans and investment
securities, deposit growth, securities sold under agreements to repurchase, and
the utilization of FHLB advances. During 2009, the Corporation originated $30.7
million in loans and purchased $3.4 million in loan participations. At December
31, 2009, the Corporation’s holdings of investment and mortgage-backed
securities totaled $151.7 million, $147.8 million of which was available for
sale. Approximately $94.6 million and $80.6 million of investment securities at
December 31, 2009 and December 31, 2008, respectively, were pledged as
collateral to secure deposits of the State of South Carolina, and Union, Laurens
and York counties along with additional borrowings and repurchase
agreements.





During 2009, total deposits
increased $25.9 million. Deposit flows are affected by the overall level of
interest rates, the interest rates and products offered by the Corporation and
its local competitors and other factors. The Corporation closely monitors its
liquidity position on a daily basis. Certificates of deposit, which are
scheduled to mature in one year or less from December 31, 2009, totaled $119.7
million.  The Corporation relies primarily on competitive rates, customer
service, and long-standing relationships with customers to retain deposits. From
time to time, the Corporation will also offer competitive special products to
its customers to increase retention and to attract new deposits. Based upon the
Corporation’s experience with deposit retention and current retention
strategies, management believes that, although it is not possible to predict
future terms and conditions upon renewal, a significant portion of such deposits
will remain with the Corporation. If the Corporation requires funds beyond its
ability to generate them internally, additional external sources of funds are
available through FHLB advances, lines of credit and wholesale deposits. At
December 31, 2009, the Corporation had outstanding $64.5 million of FHLB
borrowings and $18.5 million of securities sold under agreements to repurchase.
At December 31, 2009, the Corporation had unused short-term secured lines
of credit to purchase federal funds from unrelated banks totaling $4.0 million
and the ability to borrow an additional $54.0 million from secured borrowing
lines. Lines of credit are available on a one-to-ten day basis for general
purposes of the Corporation.  All of the lenders have reserved the
right to withdraw these lines at their option.





See Note 17 to the Consolidated
Financial Statements for further information about commitments and
contingencies.





Parent Company Liquidity





Provident Community Bancshares, Inc. is
a separate legal entity from the Bank and must provide for its own liquidity. In
addition to its operating expenses, Provident Community Bancshares is
responsible for paying any dividends declared to its shareholders and paying the
obligations on its outstanding debentures and preferred stock. The Corporation
paid cash dividends per common shareholder of $0.06 per share for 2009 compared
to $0.46 per share for 2008. The payment of cash dividends for common shares was
suspended after the first quarter of 2009 in order to retain capital and it is
unknown at this time when or if the program will resume. Provident Community
Bancshares’ primary sources of income are proceeds that it retained from its
offering of preferred stock and dividends received from the Bank. The amount of
dividends that the Bank may declare and pay to Provident Community Bancshares in
any calendar year, without the receipt of prior approval from the Office of the
Comptroller of the Currency cannot exceed retained net income for that year
combined with retained net income for two years less any transfers to surplus
and capital distributions. At December 31, 2009, Provident Community Bancshares,
Inc. had liquid assets of $1.6 million.


40





Capital
Resources





At December 31, 2009, the Bank exceeded
the OCC’s and the FRB’s capital requirements. See Note 19 to the Consolidated
Financial Statements for further discussion of these capital
requirements.





Off-Balance
Sheet Arrangements





In the normal course of operations, the
Corporation engages in a variety of financial transactions that, in accordance
with generally accepted accounting principles are not recorded in its financial
statements. These transactions involve, to varying degrees, elements of credit,
interest rate and liquidity risk. Such transactions are used primarily to manage
customer’s requests for funding and take the form of legally binding agreements
to lend money to customers at predetermined interest rates for a specified
period of time. Outstanding loan commitments (including commitments to fund
credit lines) totaled $40.1 million at December 31, 2009. Management of the
Corporation anticipates that it will have sufficient funds available to meet its
current loan commitments. Each customer’s credit worthiness is evaluated on a
case-by-case basis. The amount of collateral obtained, if deemed necessary by
the Corporation upon extension of credit, is based on the credit evaluation of
the borrower. Collateral varies but may include accounts receivable, inventory,
property, plant and equipment, commercial and residential real
estate.  The credit risk on these commitments is managed by subjecting
each customer to normal underwriting and risk management processes.





At December 31, 2009, the undisbursed
portion of construction loans was $320,000 and the unused portion of credit
lines was $38.3 million. Funding for these commitments is expected to be
provided from deposits, loan and mortgage-backed securities principal
repayments, maturing investments and income generated from
operations.





For the year ended December 31, 2009,
the Corporation did not engage in any off-balance sheet transactions reasonably
likely to have a material effect on its financial condition, results of
operation and cash flows.





Impact
of Inflation and Changing Prices





The financial statements and related
data presented herein have been prepared in accordance with accounting
principles generally accepted in the United States of America, which require the
measurement of financial position and operating results in terms of historical
dollars without considering changes in the relative purchasing power of money
over time due to inflation. Unlike industrial companies, virtually all of the
assets and liabilities of a financial institution are monetary in nature. As a
result, interest rates have a more significant impact on a financial
institution’s performance than the effects of general levels of inflation.
Interest rates do not necessarily move in the same direction or in the same
magnitude as the prices of goods and services.  However, non-interest
expenses do reflect general levels of inflation.





Item 7A. Quantitative and
Qualitative Disclosures About Market Risk





Not
applicable as issuer is a smaller reporting company.





Item 8.  Financial
Statements and Supplementary Data





Management’s
Report on Internal Control Over Financial Reporting





The management of the Company is
responsible for establishing and maintaining adequate internal control over
financial reporting.  The internal control process has been designed
under our supervision to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of the Company’s financial statements
for external reporting purposes in accordance with accounting principles
generally accepted in the United States of America.


41


Management
conducted an assessment of the effectiveness of the Company’s internal control
over financial reporting as of December 31, 2009, utilizing the framework
established in Internal Control – Integrated Framework issued by the Committee
of Sponsoring Organizations of the Treadway Commission (COSO).  Based
on this assessment, management has determined that the Company’s internal
control over financial reporting as of December 31, 2009 is
effective.





Our internal control over financial
reporting includes policies and procedures that pertain to the maintenance of
records that accurately and fairly reflect, in reasonable detail, transactions
and dispositions of assets; and provide reasonable assurances
that:  (1) transactions are recorded as necessary to permit
preparation of financial statements in accordance with accounting principles
generally accepted in the United States; (2) receipts and expenditures are being
made only in accordance with authorizations of management and the directors of
the Company; and (3) unauthorized acquisition, use, or disposition of the
Company’s assets that could have a material effect on the Company’s financial
statements are prevented or timely detected.





All internal control systems, no matter
how well designed, have inherent limitations.  Therefore, even those
systems determined to be effective can provide only reasonable assurance with
respect to financial statement preparation and presentation.  Also,
projections of any evaluation of effectiveness to future periods are subject to
the risk that controls may become inadequate because of changes in conditions,
or that the degree of compliance with the policies or procedures may
deteriorate.


42








REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
 The Board
of Directors
 Provident
Community Bancshares, Inc.
 Rock
Hill, South Carolina
 
 We have
audited the accompanying consolidated balance sheets of Provident Community
Bancshares, Inc. and Subsidiaries as of December 31, 2009 and 2008, and the
related consolidated statements of income (loss), stockholders’ equity and
comprehensive income (loss), and cash flows for the years then ended. These
consolidated financial statements are the responsibility of the Company’s
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
 
 We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the consolidated
financial statements. An audit also includes assessing the accounting principles
used and the significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
 
 In our
opinion, the consolidated financial statements present fairly, in all material
respects, the consolidated financial position of Provident Community Bancshares,
Inc. and Subsidiaries as of December 31, 2009 and 2008, and the consolidated
results of their operations and their cash flows for the years the ended, in
conformity with accounting principles generally accepted in the United States of
America.
 
 We were
not engaged to examine management’s assertion about the effectiveness of
Provident Community Bancshares, Inc. and Subsidiaries’ internal control over
financial reporting as of December 31, 2009 included in the accompanying
Management’s Report on Internal Control over Financial Reporting, and
accordingly, we do not express an opinion thereon.
 
 
 
 Elliott
Davis, LLC
 Columbia,
South Carolina
 March 3,
2010
 
 Elliott
Davis LLC, 1901 Main Street Suit 1650, P.O. Box 2227, Columbia, SC
29202-2227
 Phone:
803.256.0002   Fax: 803.254.4724 
 www.elliottdavis.com





43





Provident
Community Bancshares, Inc. and Subsidiaries


Consolidated Balance
Sheets





As of December 31,2009
                      
                      
                      2008(In Thousands)AssetsCash
      and due from banks
                      
                      $
                      10,344
                      
                      
                      $
                      8,424Federal
      Funds sold
                      
                      
                      5,287
                      
                      
                      
                      12,946Investments
      and mortgage-backed securitiesHeld
      to maturity (fair value of $3,976,000 and $2,310,000 at December 31, 2009
      and 2008)
                      
                      
                      3,934
                      
                      
                      
                      2,430Available
      for sale
                      
                      
                      147,816
                      
                      
                      
                      100,418Total
      investments and mortgage-backed securities
                      
                      
                      151,750
                      
                      
                      
                      102,848Loans,
      net of allowance for loan losses of $5,579,000 in 2009 and $6,778,000 in
      2008
                      
                      
                      250,420
                      
                      
                      
                      278,665Real
      estate acquired through foreclosure
                      
                      
                      5,917
                      
                      
                      
                      667Federal
      Home Loan Bank stock, at cost
                      
                      
                      3,947
                      
                      
                      
                      3,929Federal
      Reserve Bank stock, at cost
                      
                      
                      832
                      
                      
                      
                      599Office
      properties and equipment, net
                      
                      
                      5,447
                      
                      
                      
                      5,837Accrued
      interest receivable
                      
                      
                      2,238
                      
                      
                      
                      2,087Intangible
      assets
                      
                      
                      –
                      
                      
                      
                      2,845Cash
      surrender value of life insurance
                      
                      
                      9,332
                      
                      
                      
                      9,577Other
      assets
                      
                      
                      11,489
                      
                      
                      
                      5,794Total
      assets
                      
                      $
                      457,003
                      
                      
                      $
                      434,218LiabilitiesDeposits
                      
                      $
                      332,762
                      
                      
                      $
                      306,821Advances
      from the Federal Home Loan Bank
                      
                      
                      64,500
                      
                      
                      
                      69,500Securities
      sold under agreements to repurchase
                      
                      
                      18,520
                      
                      
                      
                      19,005Floating
      rate junior subordinated deferrable interest debentures
                      
                      
                      12,372
                      
                      
                      
                      12,372Accrued
      interest payable
                      
                      
                      581
                      
                      
                      
                      701Other
      liabilities
                      
                      
                      2,147
                      
                      
                      
                      1,895Total
      liabilities
                      
                      
                      430,882
                      
                      
                      
                      410,294Commitments
      and contingencies – Notes 13 and 17Shareholders’ equitySerial
      preferred stock, no par value, authorized – 500,000 shares, issued and
      outstanding – 9,266 shares at December 31, 2009 and none at December 31,
      2008
                      
                      
                      9,245
                      
                      
                      
                      –Common
      stock – $0.01 par value, authorized – 5,000,000 shares issued and
      outstanding – 1,790,599 shares at December 31, 2009 and 1,787,092 shares
      at December 31, 2008
                      
                      
                      20
                      
                      
                      
                      20Common
      stock warrants
                      
                      
                      25
                      
                      
                      
                      –Additional
      paid-in capital
                      
                      
                      12,919
                      
                      
                      
                      12,903Accumulated
      other comprehensive loss
                      
                      
                      (972
                      )
                      
                      
                      (1,696
                      )Retained
      earnings, substantially restricted
                      
                      
                      11,184
                      
                      
                      
                      18,997Treasury
      stock, at cost
                      
                      
                      (6,300
                      )
                      
                      
                      (6,300
                      )Total
      shareholders’ equity
                      
                      
                      26,121
                      
                      
                      
                      23,924Total
      liabilities and shareholders’ equity
                      
                      $
                      457,003
                      
                      
                      $
                      434,218





See
Notes to Consolidated Financial Statements.




44




Provident
Community Bancshares, Inc. and Subsidiaries


ConsolidatedStatements of Income
(Loss)





Years Ended
                  December 31,2009
                
                
                2008(In Thousands, Except Share Data)Interest
      Income:Loans
                
                $
                14,230
                
                
                $
                17,230Deposits
      and federal funds sold
                
                
                50
                
                
                
                55Securities
      available for sale:State
      and municipal (non taxable)
                
                
                286
                
                
                
                352Other
      investments (taxable)
                
                
                6,116
                
                
                
                4,842Securities
      held to maturity and FHLB/FRB stock dividends
                
                
                217
                
                
                
                306Total
      interest income
                
                
                20,899
                
                
                
                22,785Interest
      Expense:Deposit
      accounts
                
                
                7,995
                
                
                
                8,959Floating
      rate junior subordinated deferrable Interest debentures
                
                
                530
                
                
                
                721Advances
      from the FHLB and other borrowings
                
                
                3,068
                
                
                
                3,526Total
      interest expense
                
                
                11,593
                
                
                
                13,206Net
      Interest Income
                
                
                9,306
                
                
                
                9,579Provision
      for loan losses
                
                
                8,695
                
                
                
                4,210Net
      interest income after provision for loan losses
                
                
                611
                
                
                
                5,369Non-Interest
      income:Fees
      for financial services
                
                
                2,932
                
                
                
                3,085Other
      fees, net
                
                
                83
                
                
                
                101Other-than-temporary-impairment
      write-down on securities
                
                
                (3,756
                )
                
                
                —Net
      gain on sale of investments
                
                
                775
                
                
                
                498Total
      non-interest income
                
                
                34
                
                
                
                3,684Non-Interest
      Expense:Compensation
      and employee benefits
                
                
                4,512
                
                
                
                4,946Occupancy
      and equipment
                
                
                2,685
                
                
                
                2,476Deposit
      insurance premiums
                
                
                871
                
                
                
                100Professional
      services
                
                
                371
                
                
                
                359Advertising
      and public relations
                
                
                85
                
                
                
                221Loan
      operations
                
                
                555
                
                
                
                186Telephone
                
                
                192
                
                
                
                190Items
      processing
                
                
                338
                
                
                
                259Intangible
      amortization
                
                
                324
                
                
                
                416Impairment
      of intangible assets
                
                
                1,349
                
                
                
                —Other
                
                
                765
                
                
                
                893Total
      non-interest expense
                
                
                12,047
                
                
                
                10,046Loss
      before income taxes
                
                
                (11,402
                )
                
                
                (993
                )Benefit
      for income taxes
                
                
                (4,011
                )
                
                
                (596
                )Net
      loss
                
                $
                (7,391
                )
                
                $
                (397
                )Accretion
      of preferred stock to redemption value and preferred
    dividends
                
                
                382
                
                
                
                –Net
      to common shareholders
                
                $
                (7,773
                )
                
                $
                (397
                )Net
      loss per common share (basic)
                
                $
                (4.34
                )
                
                $
                (0.22
                )Net
      loss per common share (diluted)
                
                $
                (4.34
                )
                
                $
                (0.22
                )Cash
      dividends per common share
                
                $
                0.06
                
                
                $
                0.46Weighted
      average number of common shares outstanding (basic)
                
                
                1,789,743
                
                
                
                1,784,412Weighted
      average number of common shares outstanding (diluted)
                
                
                1,789,743
                
                
                
                1,784,412See
      Notes to Consolidated Financial Statements.


45


Provident
Community Bancshares, Inc. and Subsidiaries


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


Twelve months ended december
31, 2009 And  2008





Preferred Stock
                    
                    
                    Common Stock
                    
                    
                    
                    
                    
                    
                    
                    
                    Retained
                    
                    
                    AccumulatedShares
                    
                    
                    Amount
                    
                    
                    Shares
                    
                    
                    Amount
                    
                    
                    Warrants
                    
                    
                    Additional
                      Paid-In
                      Capital
                    
                    
                    Earnings,
                      Substantially
                      Restricted
                    
                    
                    Other
                      Comprehensive
                      Income (loss)
                    
                    
                    Treasury
                      Stock
                      At Cost
                    
                    
                    Total
                      Shareholder’s
                      Equity(Dollars
      in Thousands, Except Share Data)Balance
      at December 31, 2007
                    
                    
                    
                    
                    
                    
                    
                    
                    1,794,866
                    
                    
                    $
                    20
                    
                    
                    
                    
                    
                    $
                    12,781
                    
                    
                    $
                    20,276
                    
                    
                    $
                    191
                    
                    
                    $
                    (5,955
                    )
                    
                    $
                    27,313Net
      Income (loss)
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    (397
                    )
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    (397
                    )Other
      comprehensive loss, net of tax on unrealized holding gains arising during
      period
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    
                    
                    
                    
                    (2,173
                    )
                    
                    
                    
                    
                    
                    
                    (2,173
                    )Less
      reclassification adjustment for  gains included in net
      income
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    286
                    
                    
                    
                    —
                    
                    
                    
                    286Comprehensive
      loss
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    (2,284
                    )Stock
      option activity, net
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    1,424
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    2
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    2Dividend
      plan contributions
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    10,508
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    120
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    120Cumulative
      effect of change in accounting principal
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    (60
                    )
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    (60
                    )Share
      repurchase program
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    (19,706
                    )
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    (345
                    )
                    
                    
                    (345
                    )Cash
      dividend ($0.46 per share)
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    (822
                    )
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    (822
                    )Balance
      at December 31, 2008
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    1,787,092
                    
                    
                    $
                    20
                    
                    
                    
                    —
                    
                    
                    $
                    12,903
                    
                    
                    $
                    18,997
                    
                    
                    $
                    (1,696
                    )
                    
                    $
                    (6,300
                    )
                    
                    $
                    23,924Net
      Income (loss)
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    (7,391
                    )
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    (7,391
                    )Other
      comprehensive loss, net of tax on unrealized holding gains arising during
      period
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    2,572
                    
                    
                    
                    —
                    
                    
                    
                    2,572Less
      reclassification adjustment for gains and other than temporary investment
      charge in net loss
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    (1,848
                    )
                    
                    
                    —
                    
                    
                    
                    (1,848
                    )Comprehensive
      loss
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    (6,667
                    )Dividend
      plan contributions
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    3,507
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    16
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    16Issuance
      of preferred stock, net
                    
                    
                    9,266
                    
                    
                    
                    9,240
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    9,240Issuance
      of common stock warrants
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    25
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    25Accretion
      of preferred stock to redemption value
                    
                    
                    —
                    
                    
                    
                    5
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    (5
                    )
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    -Preferred
      stock dividend
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    (310
                    )
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    (310
                    )Cash
      dividend ($0.06 per share)
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    (107
                    )
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    (107
                    )Balance
      at December 31, 2009
                    
                    
                    9,266
                    
                    
                    $
                    9,245
                    
                    
                    
                    1,790,599
                    
                    
                    $
                    20
                    
                    
                    $
                    25
                    
                    
                    $
                    12,919
                    
                    
                    $
                    11,184
                    
                    
                    $
                    (972
                    )
                    
                    $
                    (6,300
                    )
                    
                    $
                    26,121


See
Notes to Consolidated Financial Statements.


46


Provident
Community Bancshares, Inc. and Subsidiaries


ConsolidatedStatements of Cash
Flows





Years
      Ended
                                                            December
      31,2009
                                                          
                                                          
                                                          2008(In
      Thousands)Operating
      activities:Net
      loss
                                                          
                                                          $
                                                          (7,391
                                                          )
                                                          
                                                          $
                                                          (397
                                                          )Adjustments
      to reconcile net loss to net cash provided (used) by operating
      activities:Provision
      for loan losses
                                                          
                                                          
                                                          8,695
                                                          
                                                          
                                                          
                                                          4,210Amortization
      expense
                                                          
                                                          
                                                          324
                                                          
                                                          
                                                          
                                                          523Depreciation
      expense
                                                          
                                                          
                                                          534
                                                          
                                                          
                                                          
                                                          652Recognition
      of deferred income, net of costs
                                                          
                                                          
                                                          (325
                                                          )
                                                          
                                                          
                                                          (515
                                                          )Deferral
      of fee income, net of costs
                                                          
                                                          
                                                          255
                                                          
                                                          
                                                          
                                                          435Other
      than temporary impairment charge on AFS securities
                                                          
                                                          
                                                          3,756
                                                          
                                                          
                                                          
                                                          –Impairment
      of intangible assets
                                                          
                                                          
                                                          1,349
                                                          
                                                          
                                                          
                                                          –Gain
      on investments
                                                          
                                                          
                                                          (775
                                                          )
                                                          
                                                          
                                                          (498
                                                          )(Increase)
      decrease in accrued interest receivable
                                                          
                                                          
                                                          (151
                                                          )
                                                          
                                                          
                                                          538Loss
      on sale of assets acquired from foreclosed loans
                                                          
                                                          
                                                          (2
                                                          )
                                                          
                                                          
                                                          (28
                                                          )Increase
      in bank owned life insurance
                                                          
                                                          
                                                          (400
                                                          )
                                                          
                                                          
                                                          (402
                                                          )Increase
      in other assets
                                                          
                                                          
                                                          (4,523
                                                          )
                                                          
                                                          
                                                          (594
                                                          )Decrease
      in accrued interest payable
                                                          
                                                          
                                                          (120
                                                          )
                                                          
                                                          
                                                          (41
                                                          )Increase
      (decrease) in other liabilities
                                                          
                                                          
                                                          253
                                                          
                                                          
                                                          
                                                          (1,290
                                                          )Net
      cash  provided by operating activities
                                                          
                                                          
                                                          1,479
                                                          
                                                          
                                                          
                                                          2,593Investing
      activities:Purchase
      of investment and mortgage-backed securities:Available
      for sale
                                                          
                                                          
                                                          (161,315
                                                          )
                                                          
                                                          
                                                          (74,450
                                                          )Held
      to maturity
                                                          
                                                          
                                                          (1,504
                                                          )
                                                          
                                                          
                                                          –Proceeds
      from maturity of investment and mortgage-backed
securities:Available
      for sale
                                                          
                                                          
                                                          41,736
                                                          
                                                          
                                                          
                                                          34,650Held
      to maturity
                                                          
                                                          
                                                          250
                                                          
                                                          
                                                          
                                                          696Proceeds
      from sale of investment and mortgage-backed securities:Available
      for sale
                                                          
                                                          
                                                          39,987
                                                          
                                                          
                                                          
                                                          37,040Principal
      repayments on mortgage-backed securitiesAvailable
      for sale
                                                          
                                                          
                                                          29,618
                                                          
                                                          
                                                          
                                                          7,394Net
      decrease (increase) in loans
                                                          
                                                          
                                                          14,372
                                                          
                                                          
                                                          
                                                          (28,063
                                                          )Purchase
      of FHLB/FRB stock
                                                          
                                                          
                                                          (251
                                                          )
                                                          
                                                          
                                                          (103
                                                          )Proceeds
      from redemption of life insurance
                                                          
                                                          
                                                          644
                                                          
                                                          
                                                          
                                                          –Proceeds
      from sales of foreclosed assets, net of costs and
    improvements
                                                          
                                                          
                                                          69
                                                          
                                                          
                                                          
                                                          875Purchase
      of office properties and equipment
                                                          
                                                          
                                                          (144
                                                          )
                                                          
                                                          
                                                          (1,344
                                                          )Net
      cash used in investing activities
                                                          
                                                          
                                                          (36,538
                                                          )
                                                          
                                                          
                                                          (23,305
                                                          )Financing
      activities:Proceeds
      from the exercise of stock options
                                                          
                                                          
                                                          –
                                                          
                                                          
                                                          
                                                          2Proceeds
      from dividend reinvestment plan
                                                          
                                                          
                                                          16
                                                          
                                                          
                                                          
                                                          120Proceeds
      from the issuance of preferred stock, net
                                                          
                                                          
                                                          9,240
                                                          
                                                          
                                                          
                                                          –Proceeds
      from the issuance of warrants
                                                          
                                                          
                                                          25
                                                          
                                                          
                                                          
                                                          –Dividends
      paid in cash
                                                          
                                                          
                                                          (107
                                                          )
                                                          
                                                          
                                                          (821
                                                          )Dividends
      paid on preferred stock
                                                          
                                                          
                                                          (310
                                                          )
                                                          
                                                          
                                                          –Split
      dollar post retirement liability recapitalization
                                                          
                                                          
                                                          –
                                                          
                                                          
                                                          
                                                          (60
                                                          )Repayment
      of term borrowings, net
                                                          
                                                          
                                                          (5,485
                                                          )
                                                          
                                                          
                                                          (5,126
                                                          )Share
      repurchase program
                                                          
                                                          
                                                          –
                                                          
                                                          
                                                          
                                                          (345
                                                          )Increase
      in deposit accounts
                                                          
                                                          
                                                          25,941
                                                          
                                                          
                                                          
                                                          36,422Net
      cash provided by financing activities
                                                          
                                                          
                                                          29,320
                                                          
                                                          
                                                          
                                                          30,192Net
      increase (decrease) in cash and due from banks
                                                          
                                                          
                                                          (5,739
                                                          )
                                                          
                                                          
                                                          9,480Cash
      and cash equivalents at beginning of period
                                                          
                                                          
                                                          21,370
                                                          
                                                          
                                                          
                                                          11,890Cash
      and cash equivalents at end of period
                                                          
                                                          $
                                                          15,631
                                                          
                                                          
                                                          $
                                                          21,370





See
Notes to Consolidated Financial Statements




47




Provident
Community Bancshares, Inc. and Subsidiaries


Notes to Consolidated
Financial Statements





1.
            Summary
      of Significant Accounting Policies





Organization -
Provident Community Bancshares, Inc. (“Provident Community Bancshares”) is the
bank holding company for Provident Community Bank, N.A., a national bank (the
“Bank”). Provident Community Bancshares and the Bank are collectively referred
to as the Corporation in this annual report. The Bank, founded in 1934, offers a
complete array of financial products and services through nine full-service
banking centers in five counties in South Carolina, including checking, savings,
time deposits, individual retirement accounts (IRAs), investment services, and
secured and unsecured consumer loans. The Bank originates and services home
loans and provides financing for small businesses and affordable
housing.





Estimates - The
accounting and reporting policies of the Corporation conform to accounting
principles generally accepted in the United States of America and to general
practice within the banking industry. In preparing the consolidated financial
statements, management is required to make estimates and assumptions that affect
the reported amounts of assets, liabilities, revenues and expenses and
disclosure of commitments and contingencies. Actual results could differ from
those estimates. The following summarizes the more significant
policies.





Basis of
Consolidation - The accompanying consolidated financial statements
include the accounts of Provident Community Bancshares and the
Bank.  All inter-company amounts and balances have been eliminated in
consolidation.





Disclosure Regarding
Segments- The
Corporation reports as one operating segment, as the chief operating
decision-maker reviews the results of operations of the Corporation as a single
enterprise.





Advertising - Advertising,
promotional, and other business development costs are generally expensed as
incurred. External costs incurred in producing media advertising are expensed
the first time the advertising takes place. External costs relating to direct
mailing costs are expensed in the period in which the direct mailings are
sent.





Cash andcash equivalents -
Cash and cash equivalents include cash on hand and amounts due from depository
institutions, federal funds sold and short term, interest-earning
deposits.  From time to time, the Corporation’s cash deposits with
other financial institutions may exceed the FDIC insurance limits.





Investments and
Mortgage-backed Securities - The Corporation accounts for investment
securities in accordance with FASB ASC Topic 320: Investments in Debt and Equity
Securities. In accordance with FASB ASC Topic 320, debt securities that the
Corporation has the positive intent and ability to hold to maturity are
classified as “held to maturity” securities and reported at amortized cost. Debt
and equity securities that are bought and held principally for the purpose of
selling in the near term are classified as “trading” securities and reported at
fair value, with unrealized gains and losses included in
earnings.  Debt and equity securities not classified as either held to
maturity or trading securities are classified as “available for sale” securities
and reported at fair value with unrealized gains and losses excluded from
earnings and reported as a separate component of shareholders’ equity. No
securities have been classified as trading securities.





Purchases
and sales of securities are accounted for on a settlement date basis. Premiums
and discounts on debt securities are amortized or accreted as adjustments to
income over the estimated life of the security using a method approximating the
level yield method. Gains or losses on the sale of securities are based on the
specific identification method. The fair value of securities is based on
quoted market prices or dealer quotes. If a quoted market price is not
available, fair value is estimated using quoted market prices for similar
securities.


48




1.
            Summary
      of Significant Accounting Policies
(continued)





Loans - Loans are
stated at the principal balance outstanding. Mortgage loans consist principally
of conventional one-to four-family residential loans and interim and permanent
financing of non-residential loans that are secured by real estate. Commercial
loans are made primarily on the strength of the borrower’s general credit
standing, the ability to generate repayment from income sources and the
collateral securing such loans. Consumer loans generally consist of home equity
loans, automobile and other personal loans. In many lending transactions,
collateral is taken to provide an additional measure of security. Generally, the
cash flows or earning power of the borrower represents the primary source of
repayment, and collateral liquidation serves as a secondary source of repayment.
The Corporation determines the need for collateral on a case-by-case or
product-by-product basis. Factors considered include the current and prospective
credit worthiness of the customer, terms of the instrument and economic
conditions.





The
Corporation generally originates single-family residential loans within its
primary lending area. The Corporation’s underwriting policies require such loans
to be 80% loan to value based upon appraised values unless private mortgage
insurance is obtained. These loans are secured by the underlying properties.
Loans receivable that management has the intent and ability to hold for the
foreseeable future or until maturity or pay-off are stated at the amount of
unpaid principal, reduced by unearned discount and fees and an allowance for
loan losses. Unearned interest on loans is amortized to income over the life of
the loan, using the interest method. For all other loans, interest is accrued
daily on the outstanding balances.





Loan
origination and commitment fees and certain direct loan origination costs are
deferred and the net amount amortized as an adjustment of the related loan’s
yield. The Corporation is generally amortizing these amounts over the
contractual life. Commitment fees and costs are generally based upon a
percentage of customer’s unused line of credit and are recognized over the
commitment period when the likelihood of exercise is remote. If the commitment
is subsequently exercised during the commitment period, the remaining
unamortized commitment fee at the time of exercise is recognized over the life
of the loan as an adjustment of the yield.





For
impaired loans, accrual of interest is discontinued on a loan when management
believes, after considering collection efforts and other factors that the
borrower’s financial condition is such that collection of interest is doubtful.
Cash collections on impaired loans are credited to the loan receivable balance,
and no interest income is recognized on those loans until the principal balance
has been collected.





The
Corporation determines a loan to be delinquent when payments have not been made
according to contractual terms, typically evidenced by nonpayment of a monthly
installment by the due date.  The accrual of interest on loans is
discontinued at the time the loan is 90 days delinquent.





All
interest accrued but not collected for loans that are placed on non-accrual
status or charged off are reversed against interest income.  The interest
on these loans is accounted for on the cash-basis or cost-recovery method, until
qualifying for return to accrual. Loans are returned to accrual status when all
the principal and interest amounts contractually due are brought current and
future payments are reasonably assured.





Loans on
non-accrual status as well as real estate acquired through foreclosure or deed
taken in lieu of foreclosure are considered non-performing assets.





Allowance for Loan
Losses - The Corporation maintains an allowance for loan losses. The
allowance for loan losses is established through a provision for loan losses
charged to expense. Loans are charged against the allowance for loan losses when
management believes that collectability of the principal is unlikely. Subsequent
recoveries, if any, are credited to the allowance.





49





1.
            Summary
      of Significant Accounting Policies
(continued)





The
allowance is an amount that management believes will be adequate to absorb
estimated losses relating to specifically identified loans, as well as probable
credit losses inherent in the balance of the loan portfolio, based on an
evaluation of the collectability of existing loans and prior loss experience.
 This evaluation also takes into consideration such factors as changes
in the nature and volume of the loan portfolio, overall portfolio quality,
review of specific problem loans, and current economic conditions that may
affect the borrower’s ability to pay. The allowance for loan loss calculation
includes a segmentation of loan categories by residential mortgage, commercial
and consumer loans. Each category is rated for all loans. The weights
assigned to each performing group are developed from previous loan loss
experience and as the loss experience changes, the category weight is
adjusted accordingly. As the loan categories increase and decrease in
balance, the provision for loan loss calculation will adjust accordingly.
The evaluation also includes a component for expected losses on groups of loans
that are related to future events or expected changes in economic conditions.
While management uses the best information available to make its evaluation,
future adjustments to the allowance may be necessary if there are significant
changes in economic conditions. In addition, regulatory agencies, as an integral
part of their examination process, periodically review the Corporation’s
allowance for loan losses, and may require the Corporation to make additions to
the allowance based on their judgment about information available to them at the
time of their examinations.





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





Recovery
of the carrying value of loans is dependent to some extent on the future
economic environment and operating and other conditions that may be beyond the
Corporation’s control.  Unanticipated future adverse changes in such
conditions could result in material adjustments to allowances (and future
results of operation).





Accounting for Impaired
Loans - Impaired loans are measured based on the present value of
expected future cash flows discounted at the loan’s effective interest rate or,
as a practical matter, at the loan’s observable market value or fair value of
the collateral if the loan is collateral dependent. If the resulting value of
the impaired loan is less than the recorded balance, the impairment must be
recognized by creating a valuation allowance for the difference and recognizing
a corresponding bad debt expense.  The risk characteristics used to
aggregate loans are collateral type, borrower’s financial condition and
geographic location.





The
Corporation generally determines a loan to be impaired at the time management
believes that it is probable that the principal and interest may be
uncollectible.  Management has determined that, generally, a failure to
make a payment within a 90-day period constitutes a minimum delay or shortfall
and does not generally constitute an impaired loan. However, management reviews
each past due loan and may determine a loan to be impaired prior to the loan
becoming over 90 days past due, depending upon the circumstances of that
particular loan. The Corporation’s policy for charge-off of impaired loans is on
a loan-by-loan basis. The Corporation’s policy is to evaluate impaired loans
based on the fair value of the collateral.  Interest income from
impaired loans is recorded using the cash method.  At December 31, 2009,
impaired loans totaled $20.9 million and the Corporation had recognized no
interest income from impaired loans. The average balance in impaired loans was
$20.0 million for
2009.





Office Properties and
Equipment - Office properties and equipment are presented at cost less
accumulated depreciation. Depreciation is provided on the straight-line basis
over the estimated useful lives of the assets. Estimated useful lives are twenty
to thirty nine years for buildings and improvements and generally five to ten
years for furniture, fixtures and equipment.





The cost
of maintenance and repairs is charged to expense as incurred, and improvements
and other expenditures, which materially increase property lives, are
capitalized.  The costs and accumulated depreciation applicable
to office properties and equipment retired or otherwise disposed of are
eliminated from the related accounts, and any resulting gains or losses are
credited or charged to income.


50
  1.
              Summary
      of Significant Accounting Policies
(continued)


Securities Sold Under
Agreements to Repurchase - The Corporation enters into sales of
securities under agreements to repurchase. Fixed-coupon reverse repurchase
agreements are treated as financings, with the obligations to repurchase
securities sold being reflected as a liability and the securities underlying the
agreements remaining as an asset. The securities are delivered by appropriate
entry by the Corporation’s safekeeping agent to the counterparties’ accounts.
The dealers may have sold, loaned or otherwise disposed of such securities to
other parties in the normal course of their operations, and have agreed to
resell to the Corporation substantially identical securities at the maturities
of the agreements.





Federal Home Loan Bank
Stock - The Bank, as a member institution of Federal Home Loan
Bank of Atlanta (“FHLB”), is required to own capital stock in the FHLB based
generally upon the Bank’s balances of residential mortgage loans and FHLB
advances. No ready market exists for this stock and it has no quoted market
value. However, redemption of this stock historically has been at par value. The
Bank carries this investment at its original cost.





Federal Reserve Bank
Stock - The Bank, as a member institution of Federal Reserve
Bank of Richmond (“FRB”), is required to own capital stock in the FRB based upon
the Bank’s capital and surplus. No ready market exists for this stock and it has
no quoted market value. However, redemption of this stock historically has been
at par value. The Bank carries this investment at its original
cost.





Real Estate Acquired Through
Foreclosure - Real estate acquired through foreclosure is stated at the
lower of cost or estimated fair value less estimated costs to
sell.  Any accrued interest on the related loan at the date of
acquisition is charged to operations. Costs relating to the development and
improvement of property are capitalized to the extent that such costs do not
exceed the estimated fair value less selling costs of the property, whereas
those relating to holding the property are charged to expense. Real estate
acquired through foreclosure is included in other assets on the balance
sheet.





Intangible
Assets - Intangible assets consist of core deposit premiums
resulting from Provident Community Bank’s branch acquisitions in 1997 and 1999
and the excess of cost over the fair value of net assets resulting from the
acquisition of South Carolina Community Bancshares, Inc. in 1999.





Goodwill
and identified intangible assets with indefinite lives related to acquisitions
are not subject to amortization. Core deposit intangible assets are amortized
over their estimated useful lives using methods that reflect the pattern in
which the economic benefits are utilized.





The
Corporation’s unamortized goodwill and other intangible assets are reviewed
annually to determine whether there have been any events or circumstances to
indicate that the recorded amount is not recoverable from projected undiscounted
net operating cash flows. If the projected undiscounted net operating cash flows
are less than the carrying amount, a loss is recognized to reduce the carrying
amount to fair value, and when appropriate, the amortization period is also
reduced.  Based on the impairment analysis performed, due to the
Corporation’s current market capitalization, all goodwill and deposit premiums
were charged off in 2009.





Interest Income -
Interest on loans is accrued and credited to income monthly based on the
principal balance outstanding and the contractual rate on the loan. The
Corporation places loans on non-accrual status when they become greater than 90
days delinquent or when in the opinion of management, full collection of
principal or interest is unlikely. All interest that was accrued prior to the
loan being placed on non-accrual status is automatically reversed after the 90
day delinquency period. The loans are returned to accrual status when full
collection of principal and interest appears likely.


51
  1.           Summary
of Significant Accounting Policies (continued)


Income Taxes -
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes.
A valuation allowance is established for deferred tax assets that may not be
realized. Also, on a prospective basis, the exception from the requirement to
record deferred taxes on tax basis bad debt reserves in excess of the base year
amounts is eliminated. The tax basis bad debt reserve that arose prior to the
fiscal year 1988 (the base year amount) is frozen, and the book reserves at that
date and all subsequent changes in book and tax basis reserves are included in
the determination of deferred taxes.





Per-Share Data -
Basic earnings per share is computed by dividing net income by the
weighted-average number of shares outstanding for the period.  Diluted
earnings per share is similar to the computation of basic earnings per share
except that the denominator is increased to include the number of additional
common shares that would have been outstanding if the dilutive potential common
shares had been issued. The dilutive effect of options outstanding under
Provident Community Bancshares’s stock option plan is reflected in diluted
earnings per share by the application of the treasury stock
method.  There were no common stock equivalents included in the
diluted earnings per share calculation at December 31, 2009 or
2008.





Fair Values of Financial
Instruments - The following methods and assumptions were used by the
Corporation in estimating fair values of financial instruments as disclosed
herein:





Cash and cash equivalents -
The carrying amounts of cash and due from banks approximate their fair
value.





Available for sale and held to
maturity securities - Fair values for securities are based on quoted
market prices.  The carrying values of restricted equity securities
approximate fair values.If quoted prices are
not available, fair values are measured using independent pricing models or
other model-based valuation techniques such as the present value of future cash
flows, adjusted for the security’s credit rating, prepayment assumptions and
other factors such as credit loss assumptions.





Loans - The Corporation is
predominantly an asset based lender with real estate serving as collateral on a
substantial majority of loans. The Corporation does not record loans at fair
value on a recurring basis. However, from time to time, a loan is considered
impaired and the related impairment is charged against the allowance or a
specific allowance is established. Loans for which it is probable that payment
of interest and principal will not be made in accordance with the contractual
terms of the loan agreement are considered impaired. Loans which are deemed to
be impaired are primarily valued at the fair values of the underlying real
estate collateral. Such fair values are obtained using collateral net
liquidation value, market value of similar debt, enterprise value, and
discounted cash flows. Those impaired loans not requiring a specific allowance
represent loans for which the fair value of the expected repayment or collateral
meet or exceed the recorded investment in such loans. The Corporation considers
all non-accrual loans and troubled debt restructurings to be
impaired.





Cash surrender value of life
insurance -The carrying amounts of cash surrender values of life
insurance approximate their fair value.





Deposit liabilities - The
fair values disclosed for demand deposits are, by definition, equal to the
amount payable on demand at the reporting date (that is, their carrying
amounts). The carrying amounts of variable-rate, fixed-term money-market
accounts and certificates of deposit (CDs) approximate their fair values at the
reporting date. Fair values for fixed-rate CDs are estimated using a discounted
cash flow calculation that applies interest rates currently being offered on
certificates to a schedule of aggregated expected monthly maturities on time
deposits.





Advances from the FHLB and other
borrowings - The fair values of the Corporation’s borrowings are
estimated using discounted cash flow analysis based on the Corporation’s current
incremental borrowing rates for similar types of borrowing
arrangements.





Securities sold under agreements to
repurchase - The fair values of the Corporation’s repurchase agreements
are estimated using discounted cash flow analysis based on the Corporation’s
current incremental borrowing rates for similar types of borrowing
arrangements.





Accrued interest - The
carrying amounts of accrued interest approximate their fair values.




52




1.
            Summary
      of Significant Accounting Policies
(continued)





Floating rate junior subordinated
deferrable interest debentures - The fair values of the Corporation’s
floating rate debentures are estimated using discounted cash flow analysis based
on the Corporation’s current incremental borrowing rates for similar types of
borrowing arrangements.





Off-balance-sheet instruments
- Fair values for off-balance-sheet lending commitments are based on fees
currently charged to enter into similar agreements, taking into account the
remaining terms of the agreements and the counter parties’ credit
standings.





Risks and Uncertainties- In the normal course of its business, the Corporation encounters two
significant types of risk: economic and regulatory. There are three main
components of economic risk: interest rate risk, credit risk and market risk.
The Corporation is subject to interest rate risk to the degree that its
interest-bearing liabilities mature or reprice at different speeds, or on
different bases, than its interest-earning assets.





Credit risk is the risk of default on
the Corporation’s loan portfolio that results from the borrowers’ inability or
unwillingness to make contractually required payments. Credit risk also applies
to investment securities and mortgage-backed securities should the issuer of the
security be unable to make principal and interest payments. Market risk reflects
changes in the value of collateral underlying loans receivable, the valuation of
real estate held by the Corporation and the valuation of investment
securities.





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





In preparing the consolidated financial
statements, management is required to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosures of contingent
assets and liabilities as of the dates of the balance sheets and revenues and
expenses for the periods covered. Actual results could differ from those
estimates and assumptions.





Reclassifications -
Certain amounts in prior years’ financial statements have been reclassified to
conform with current year classifications. These reclassifications had no effect
on previously reported net income or shareholders’ equity.





Stock-Based
Compensation - The Corporation accounts for the compensation costs
for its stock option plan under the fair value recognition provisions of Financial Accounting Standards Board FASB ASC
123(R), “Accounting for
Stock-Based Compensation”, (ASC 718-10-10).





There were no stock options granted in
2009 or 2008.





2.
            Investment
      and Mortgage-backed Securities





Held to
Maturity - Securities classified as held to maturity consisted
of the following (in thousands):




AsofDecember31,2009Amortized
                          
                          
                          Gross Unrealized
                          
                          
                          FairCost
                          
                          
                          Gains
                          
                          
                          Losses
                          
                          
                          ValueMunicipal
      Securities
                          
                          $
                          3,934
                          
                          
                          $
                          52
                          
                          
                          $
                          (10
                          )
                          
                          $
                          3,976




53





2.
            Investment
      and Mortgage-backed Securities
(continued)





Available for
Sale - Securities classified as available for sale consisted of
the following (in thousands):




AsofDecember31,2009Amortized
                    
                    
                    Gross Unrealized
                    
                    
                    FairCost
                    
                    
                    Gains
                    
                    
                    Losses
                    
                    
                    ValueInvestment
      Securities:U.S.
      Agency Obligations
                    
                    $
                    4
                    
                    
                    $
                    —
                    
                    
                    $
                    —
                    
                    
                    $
                    4Government
      Sponsored Enterprises
                    
                    
                    79,162
                    
                    
                    
                    217
                    
                    
                    
                    (908
                    )
                    
                    
                    78,471Municipal
      Securities
                    
                    
                    5,781
                    
                    
                    
                    261
                    
                    
                    
                    —
                    
                    
                    
                    6,042Trust
      Preferred Securities
                    
                    
                    8,570
                    
                    
                    
                    —
                    
                    
                    
                    (2,658
                    )
                    
                    
                    5,912Total
      Investment Securities
                    
                    
                    93,517
                    
                    
                    
                    478
                    
                    
                    
                    (3,566
                    )
                    
                    
                    90,429Mortgage-backed
      Securities:Fannie
      Mae
                    
                    
                    35,561
                    
                    
                    
                    1,162
                    
                    
                    
                    —
                    
                    
                    
                    36,723Ginnie
      Mae
                    
                    
                    16,569
                    
                    
                    
                    461
                    
                    
                    
                    —
                    
                    
                    
                    17,030Freddie
      Mac
                    
                    
                    3,068
                    
                    
                    
                    86
                    
                    
                    
                    —
                    
                    
                    
                    3,154Collateralized
      Mortgage Obligations
                    
                    
                    597
                    
                    
                    
                    —
                    
                    
                    
                    (117
                    )
                    
                    
                    480Total
      Mortgage-backed Securities
                    
                    
                    55,795
                    
                    
                    
                    1,709
                    
                    
                    
                    (117
                    )
                    
                    
                    57,387Total
      available for sale
                    
                    $
                    149,312
                    
                    
                    $
                    2,187
                    
                    
                    $
                    (3,683
                    )
                    
                    $
                    147,816





Held to
Maturity - Securities classified as held to maturity consisted
of the following (in thousands):




AsofDecember31,2008Amortized
                    
                    
                    Gross Unrealized
                    
                    
                    FairCost
                    
                    
                    Gains
                    
                    
                    Losses
                    
                    
                    ValueMunicipal
      Securities
                    
                    $
                    2,430
                    
                    
                    $
                    –
                    
                    
                    $
                    (120
                    )
                    
                    $
                    2,310





Available for
Sale - Securities classified as available for sale consisted of
the following (in thousands):




AsofDecember31,2008Amortized
                    
                    
                    Gross Unrealized
                    
                    
                    FairCost
                    
                    
                    Gains
                    
                    
                    Losses
                    
                    
                    ValueInvestment
      Securities:U.S.
      Agency Obligations
                    
                    $
                    6
                    
                    
                    $
                    –
                    
                    
                    $
                    –
                    
                    
                    $
                    6Government
      Sponsored Enterprises
                    
                    
                    27,901
                    
                    
                    
                    331
                    
                    
                    
                    (2
                    )
                    
                    
                    28,230Municipal
      Securities
                    
                    
                    6,135
                    
                    
                    
                    223
                    
                    
                    
                    –
                    
                    
                    
                    6,358Trust
      Preferred Securities
                    
                    
                    12,325
                    
                    
                    
                    –
                    
                    
                    
                    (3,933
                    )
                    
                    
                    8,392Total
      Investment Securities
                    
                    
                    46,367
                    
                    
                    
                    554
                    
                    
                    
                    (3,935
                    )
                    
                    
                    42,986Mortgage-backed
      Securities:Fannie
      Mae
                    
                    
                    31,989
                    
                    
                    
                    452
                    
                    
                    
                    (56
                    )
                    
                    
                    32,385Ginnie
      Mae
                    
                    
                    21,311
                    
                    
                    
                    567
                    
                    
                    
                    –
                    
                    
                    
                    21,878Freddie
      Mac
                    
                    
                    2,551
                    
                    
                    
                    33
                    
                    
                    
                    (10
                    )
                    
                    
                    2,574Collateralized
      Mortgage Obligations
                    
                    
                    809
                    
                    
                    
                    –
                    
                    
                    
                    (214
                    )
                    
                    
                    595Total
      Mortgage-backed Securities
                    
                    
                    56,660
                    
                    
                    
                    1,052
                    
                    
                    
                    (280
                    )
                    
                    
                    57,432Total
      available for sale
                    
                    $
                    103,027
                    
                    
                    $
                    1,606
                    
                    
                    $
                    (4,215
                    )
                    
                    $
                    100,418




54





2.
            Investment
      and Mortgage-backed Securities
(continued)





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





Less than 12 Months
                        
                        
                        12 Months or More
                        
                        
                        TotalFair
                          Value
                        
                        
                        Unrealized
                          Losses
                        
                        
                        Fair
                          Value
                        
                        
                        Unrealized
                          Losses
                        
                        
                        Fair
                          Value
                        
                        
                        Unrealized
                          LossesHeld to MaturityMunicipal
      Securities
                        
                        $
                        494
                        
                        
                        $
                        9
                        
                        
                        $
                        833
                        
                        
                        $
                        1
                        
                        
                        $
                        1,326
                        
                        
                        $
                        10Total
                        
                        $
                        494
                        
                        
                        $
                        9
                        
                        
                        $
                        833
                        
                        
                        $
                        1
                        
                        
                        $
                        1,326
                        
                        
                        $
                        10





Less than 12 Months
                  
                  
                  12 Months or More
                  
                  
                  TotalFair
                    Value
                  
                  
                  Unrealized
                    Losses
                  
                  
                  Fair
                    Value
                  
                  
                  Unrealized
                    Losses
                  
                  
                  Fair
                    Value
                  
                  
                  Unrealized
                    LossesSecuritiesAvailablefor
      SaleU.S.
      AgencyObligations
                  
                  $
                  –
                  
                  
                  $
                  –
                  
                  
                  $
                  –
                  
                  
                  $
                  –
                  
                  
                  $
                  –
                  
                  
                  $
                  –Government
      Sponsored Enterprises
                  
                  
                  41,040
                  
                  
                  
                  908
                  
                  
                  
                  –
                  
                  
                  
                  –
                  
                  
                  
                  41,040
                  
                  
                  
                  908Municipal
      Securities
                  
                  
                  –
                  
                  
                  
                  –
                  
                  
                  
                  –
                  
                  
                  
                  –
                  
                  
                  
                  –
                  
                  
                  
                  –Trust
      Preferred Securities
                  
                  
                  –
                  
                  
                  
                  –
                  
                  
                  
                  5,912
                  
                  
                  
                  2,658
                  
                  
                  
                  5,912
                  
                  
                  
                  2,658Mortgage-backedSecurities
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  532
                  
                  
                  
                  117
                  
                  
                  
                  532
                  
                  
                  
                  117Total
                  
                  $
                  41,040
                  
                  
                  $
                  908
                  
                  
                  $
                  6,444
                  
                  
                  $
                  2,775
                  
                  
                  $
                  47,484
                  
                  
                  $
                  3,683





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




Less than 12 Months
                        
                        
                        12 Months or More
                        
                        
                        TotalFair
                          Value
                        
                        
                        Unrealized
                          Losses
                        
                        
                        Fair
                          Value
                        
                        
                        Unrealized
                          Losses
                        
                        
                        Fair
                          Value
                        
                        
                        Unrealized
                          LossesHeld to MaturityMunicipal
      Securities
                        
                        $
                        1,525
                        
                        
                        $
                        70
                        
                        
                        $
                        784
                        
                        
                        $
                        50
                        
                        
                        $
                        2,309
                        
                        
                        $
                        120Total
                        
                        $
                        1,525
                        
                        
                        $
                        70
                        
                        
                        $
                        784
                        
                        
                        $
                        50
                        
                        
                        $
                        2,309
                        
                        
                        $
                        120





Less than 12 Months
                  
                  
                  12 Months or More
                  
                  
                  TotalFair
                    Value
                  
                  
                  Unrealized
                    Losses
                  
                  
                  Fair
                    Value
                  
                  
                  Unrealized
                    Losses
                  
                  
                  Fair
                    Value
                  
                  
                  Unrealized
                    LossesSecurities
      AvailableforSaleU.S.
      AgencyObligations
                  
                  $
                  –
                  
                  
                  $
                  –
                  
                  
                  $
                  –
                  
                  
                  $
                  –
                  
                  
                  $
                  –
                  
                  
                  $
                  –GovernmentSponsored
      Enterprises
                  
                  
                  3,000
                  
                  
                  
                  2
                  
                  
                  
                  –
                  
                  
                  
                  –
                  
                  
                  
                  3,000
                  
                  
                  
                  2Municipal
      Securities
                  
                  
                  –
                  
                  
                  
                  –
                  
                  
                  
                  –
                  
                  
                  
                  –
                  
                  
                  
                  –
                  
                  
                  
                  –Trust
      Preferred Securities
                  
                  
                  –
                  
                  
                  
                  –
                  
                  
                  
                  8,392
                  
                  
                  
                  3,933
                  
                  
                  
                  8,392
                  
                  
                  
                  3,933Mortgage-backedSecurities
                  
                  
                  126
                  
                  
                  
                  3
                  
                  
                  
                  8,629
                  
                  
                  
                  277
                  
                  
                  
                  8,755
                  
                  
                  
                  280Total
                  
                  $
                  3,126
                  
                  
                  $
                  5
                  
                  
                  $
                  17,021
                  
                  
                  $
                  4,210
                  
                  
                  $
                  20,147
                  
                  
                  $
                  4,215





55





2.
            Investment
      and Mortgage-backed Securities
(continued)





Management reviews securities for
other-than-temporary impairment at least on a quarterly basis, and more
frequently when economic or market concerns warrant such evaluation.
Consideration is given to (1) the length of time and the extent to which the
fair value has been less than cost, (2) the financial condition and near-term
prospects of the issuer, and (3) the intent and ability of the Corporation to
retain its investment in the issuer for a period of time sufficient to allow for
any anticipated recovery in fair value.





To determine which individual
securities are at risk for other-than-temporary impairment, the Corporation
considers various characteristics of each security including but not limited to
the credit rating, the duration and amount of the unrealized loss, and any
credit enhancements. The relative importance of this information varies based on
the facts and circumstances surrounding each security, as well as the economic
environment at the time of the assessment. As a result of this review, the
Corporation identifies individual securities believed to be at risk for
other-than-temporary impairment. These securities are evaluated by estimating
projected cash flows based on the structure of the security and certain
assumptions, such as prepayments, default rates, and loss severity to determine
whether the Corporation expects to receive all of the contractual cash flows as
scheduled. The Corporation recognizes an other-than-temporary impairment credit
loss when the present value of the investment security’s cash flows expected to
be collected are less than the amortized cost basis.





To determine impairment charges for the
Corporation’s collateralized debt obligations (“CDO”), we performed discounted
cash flow valuations through a static default model test. The default model used
assumed a 3.6% rate, which is three times the historic default rates, a 0%
recovery on all banks in deferral of interest payments and a 0% prepayment rate.
Cash flow valuations with a premium mark up of 300 basis points were also used
to determine the fair market values of the Corporation’s collateralized debt
obligations. Valuation documentation for the cash flow analysis is provided by
an independent third party and is reviewed each quarter by the Corporation’s
external auditor.





The following table presents the
Corporation’s investments by category and the related unrealized gains or
losses, net of tax, recognized in other comprehensive losses, credit losses
recognized in and credit ratings for each classification of security. Trust
preferred securities are divided into pooled and single issue securities. All
trust preferred pooled securities are in the mezzanine tranche. Private label
trust preferred securities are $2.0 million each and are evaluated each quarter
based on the financial stability of the institution. Agency MBS and agency
securities are government guaranteed and therefore, their risk is relatively
low. These securities have no credit rating included in the table
below.





Amounts in the following table are in
millions.


Security
                Classification
              
              Amortized
                Cost
              
              
              Fair
                Value
              
              
              OCI
              
              
              OTTI
              
              
              AAA
              
              
              AA
              
              
              A
              
              
              Baa1
              
              
              Ba3
              
              
              Not
                Rated
              
              
              Below
                Investment
                GradeSingle
      issuer trust preferred securities
              
              $
              4.0
              
              
              $
              2.8
              
              
              $
              (0.8
              )
              
              $
              —
              
              
              $
              —
              
              
              $
              —
              
              
              $
              —
              
              
              $
              —
              
              
              $
              —
              
              
              $
              2.8
              
              
              $
              —Pooled
      trust preferred securities
              
              
              4.6
              
              
              
              3.1
              
              
              
              (0.9
              )
              
              
              (3.8
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              0.8
              
              
              
              —
              
              
              
              2.3Agency
      MBS
              
              
              55.2
              
              
              
              56.9
              
              
              
              1.1
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —Private
      label CMO
              
              
              0.6
              
              
              
              0.5
              
              
              
              (0.1
              )
              
              
              —
              
              
              
              0.5
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —Treasury/Agency
              
              
              79.1
              
              
              
              78.5
              
              
              
              (0.5
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —Municipals/AFS
              
              
              5.8
              
              
              
              6.0
              
              
              
              0.2
              
              
              
              —
              
              
              
              2.4
              
              
              
              0.9
              
              
              
              1.1
              
              
              
              1.1
              
              
              
              —
              
              
              
              0.5
              
              
              
              —Municipals/HTM
              
              
              3.9
              
              
              
              4.0
              
              
              
              —
              
              
              
              —
              
              
              
              2.5
              
              
              
              0.5
              
              
              
              1.0
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —Total
              
              $
              153.2
              
              
              $
              151.8
              
              
              $
              (1.0
              )
              
              $
              (3.8
              )
              
              $
              5.4
              
              
              $
              1.4
              
              
              $
              2.1
              
              
              $
              1.1
              
              
              $
              0.8
              
              
              $
              3.3
              
              
              $
              2.3





For the
year ended December, 31, 2009, the Corporation experienced a credit-related
other-than-temporary impairment of $3.8 million on the CDO portfolio. All of
these securities are in the Corporation’s available for sale portfolio. This was
charged to earnings in non-interest income as “Other-than-temporary-impairment
write-down on securities”. The total securities impacted by credit-related
other-than-temporary impairment have a current carrying value of $3.1 million
and represent approximately 2.1% of available for sale securities. These
securities will have a negligible
impact on the Corporation’s liquidity. We do not intend to sell the remaining
debt securities and more likely than not, we will not be required to sell the
debt securities before their anticipated recovery.




56


2.
              Investment
      and Mortgage-backed Securities
(continued)




Proceeds, gross gains and gross losses
realized from the sales of available for sale securities were as follows for the
periods ended (in thousands):





Years Ended December 31,2009
                    
                    
                    2008Proceeds
                    
                    $
                    39,987
                    
                    
                    $
                    37,040Gross
      gains
                    
                    
                    775
                    
                    
                    
                    498Gross
      losses
                    
                    
                    –
                    
                    
                    
                    –Net
      gain (loss) on investmenttransactions
                    
                    $
                    775
                    
                    
                    $
                    498





The maturities of securities at
December 31, 2009 are as follows (in thousands):





Held to Maturity
                
                
                Available for SaleAmortized
                  Cost
                
                
                Fair
                  Value
                
                
                Amortized
                  Cost
                
                
                Fair
                  ValueDue
      in one year or less
                
                $
                —
                
                
                $
                —
                
                
                $
                727
                
                
                $
                728Due
      after one year through five years
                
                
                —
                
                
                
                —
                
                
                
                424
                
                
                
                429Due
      after five years through ten years
                
                
                —
                
                
                
                —
                
                
                
                18,784
                
                
                
                18,626Due
      after ten years
                
                
                3,934
                
                
                
                3,976
                
                
                
                129,377
                
                
                
                128,033Total
      investment and mortgage-backed securities
                
                $
                3,934
                
                
                $
                3,976
                
                
                $
                149,312
                
                
                $
                147,816





The
mortgage-backed securities held at December 31, 2009 mature between one and
thirty years. The actual lives of those securities may be significantly shorter
as a result of principal payments and prepayments. All mortgage-backed
securities are U.S. Government securities issued through Fannie Mae, Ginnie Mae,
or Freddie Mac.





At December 31, 2009 and 2008, $94.6
million and $80.6 million, respectively, of securities recorded at book value
were pledged as collateral for certain deposits and borrowings.





At December 31, 2009, approximately
$2.4 million of mortgage-backed securities were adjustable rate securities.
The adjustment periods range from monthly to annually and rates are adjusted
based on the movement of a variety of indices.





Investments in collateralized mortgage
obligations (“CMOs”) had a fair market value of $480,000 at December 31,
2009. These are private label CMO securities that were issued by a large
regional bank. Therefore, the fair market value is determined by the current
available broker supplied price as an estimate of the amount the Corporation
could expect to receive in the open market. These securities are not actively
traded as a result of the economic crisis.





3.
            Federal
      Home Loan Bank Capital Stock





Provident Community Bank, as a member
institution of Federal Home Loan Bank of Atlanta (“FHLB”), is required to own
capital stock in the FHLB of Atlanta based generally upon a membership-based
requirement and an activity-based requirement related to the level of advances
that the Corporation borrows from the FHLB. No ready market exists for this
stock and it has no quoted market value. However, redemption of this stock
historically has been at par value. The carrying value (which approximates fair
value) of this stock was $3.9 million at December 31, 2009 and $3.9 million at
December 31, 2008.


57
  3.
              Federal
      Home Loan Bank Capital Stock
(continued)




In
evaluating other-than-temporary impairment of the FHLB stock, the Corporation
considered the most recent financial results of the FHLB, the resumption of
paying dividends on common stock, its ability to repurchase the stock
at par value throughout the year in a timely manner based on the level of
advances that the Corporation maintains, and the baseline credit assessment
rating given by Moody’s Investors Service of AAA. The Corporation believes that
the resumption of the common stock dividend and the investment grade rating of
AAA indicate that there is no impairment in the investment in the FHLB stock as
of December 31, 2009.





4.
            Loans,
      Net





Loans
receivable consisted of the following (in thousands):




AsofDecember31,2009
                    
                    
                    2008Mortgage
      loans:Fixed-rate
      residential
                    
                    $
                    10,675
                    
                    
                    $
                    12,847Adjustable-rate
      residential
                    
                    
                    6,202
                    
                    
                    
                    7,388Commercial
      real estate
                    
                    
                    110,901
                    
                    
                    
                    110,589Construction
                    
                    
                    2,923
                    
                    
                    
                    5,867Total
      mortgage loans
                    
                    
                    130,701
                    
                    
                    
                    136,691Commercial
      loans:Commercial
      non-real estate
                    
                    
                    34,429
                    
                    
                    
                    27,946Commercial
      lines of credit
                    
                    
                    39,096
                    
                    
                    
                    66,066Total
      commercial loans
                    
                    
                    73,525
                    
                    
                    
                    94,012Consumer
      loans:Home
      equity
                    
                    
                    17,395
                    
                    
                    
                    17,371Consumer
      and installment
                    
                    
                    34,578
                    
                    
                    
                    39,301Consumer
      lines of credit
                    
                    
                    314
                    
                    
                    
                    330Total
      consumer loans
                    
                    
                    52,287
                    
                    
                    
                    57,002Total
      loans
                    
                    
                    256,513
                    
                    
                    
                    287,705Less:Undisbursed  portion
      of interim construction loans
                    
                    
                    (320
                    )
                    
                    
                    (1,926
                    )Unamortized
      loan discount
                    
                    
                    (309
                    )
                    
                    
                    (383
                    )Allowance
      for loan losses
                    
                    
                    (5,579
                    )
                    
                    
                    (6,778
                    )Net
      deferred loan origination costs
                    
                    
                    115
                    
                    
                    
                    47Total,
      net
                    
                    $
                    250,420
                    
                    
                    $
                    278,665Weighted-average
      interest rate of loans
                    
                    
                    4.87
                    %
                    
                    
                    5.47
                    %





Under OCC
regulations, the Bank may not make loans to one borrower in excess of 15% of
unimpaired capital. This limitation does not apply to loans made before August
9, 1989. At December 31, 2009, the Bank had loans outstanding to one borrower
ranging up to $5.4 million.





Adjustable-rate
residential real estate loans (approximately $6.2 million and $7.4 million at
December 31, 2009 and 2008, respectively) are subject to rate adjustments
annually and generally are adjusted based on movement of the Federal Home Loan
Bank National Monthly Median Cost of Funds rate or the Constant Maturity
Treasury index. The maximum loan rates can be adjusted is 200 basis points in
any one year with a lifetime cap of 600 basis points.





Non-refundable
deferred origination fees and cost and discount points collected at loan
closing, net of commitment fees paid, are deferred and recognized at the time of
sale of the mortgage loans. Gain or loss on sales of mortgage loans is
recognized based upon the difference between the selling price and the carrying
amount of the mortgage loans sold.  Other fees earned during the loan
origination process are also included in net gain or loss on sales of mortgage
loans.





Until
2002, the Bank originated both fixed rate and adjustable rate mortgage loans
with terms generally ranging from fifteen to thirty years and generally sold the
loans while retaining servicing on loans originated.  The Bank
discontinued the origination of loans held for sale in 2002. The underlying
value of loans serviced for others was $10.6 million and $13.0 million at
December 31, 2009 and 2008, respectively.




58




4.
            Loans,
      net (continued)




Loans
that management identifies as impaired generally will be non-performing loans.
At December 31, 2009 and 2008, loans which are accounted for on a non-accrual
basis or contractually past due ninety days or more totaled
approximately $20.9 million and $16.0 million, respectively. The amount the
Corporation will ultimately realize from these loans could differ materially
from their carrying value because of future developments affecting the
underlying collateral or the borrower’s ability to repay the loans. During the
years ended December 31, 2009 and 2008, the Corporation recognized no interest
income on loans past due 90 days or more, whereas, under the original terms of
these loans, the Corporation would have recognized additional interest income of
approximately $1.4 million and $715,000, respectively.





Information about impaired loans as of
and for the years ended December 31, 2009 and 2008, is as follows:





Years Ended December 31,2009
                  
                  
                  2008Loans
      receivable for which there is a related allowance for credit losses
      determined in accordance with ASC 310-10/Statement No. 114
                  
                  $
                  1,829
                  
                  
                  $
                  7,774Other
      impaired loans
                  
                  
                  19,040
                  
                  
                  
                  8,227Total
      impaired loans
                  
                  $
                  20,869
                  
                  
                  $
                  16,001Average
      monthly balance of impaired loans
                  
                  $
                  20,006
                  
                  
                  $
                  7,588Specific
      allowance for credit losses
                  
                  $
                  675
                  
                  
                  $
                  3,536





Specific reserves of $6.4 million were
charged against impaired loans as partial charge-offs for the year ended
December 31, 2009.





The changes in allowance for loan
losses consisted of the following (in thousands):





Years Ended December 31,2009
                  
                  
                  2008Balance
      at beginning of Period
                  
                  $
                  6,778
                  
                  
                  $
                  3,344Provision
      for loan losses
                  
                  
                  8,695
                  
                  
                  
                  4,210Net
      charge-offs
                  
                  
                  (9,894
                  )
                  
                  
                  (776
                  )Balance
      at end of period
                  
                  $
                  5,579
                  
                  
                  $
                  6,778





Renegotiated
loans, or troubled debt restructurings, are those loans where the borrower is
experiencing financial difficulties and we have agreed to concessions of the
terms such as changes in the interest rate charged and/or other concessions.
Troubled debt restructurings increased $3.0 million from $316,000 at
December 31, 2008 to $3.3 million at December 31, 2009. The majority of this
increase relates primarily to two commercial real estate relationships totaling
$2.5 million that have been affected by the downturn in the commercial real
estate market.





Directors and officers of the
Corporation are customers of the Corporation in the ordinary course of
business.  Loans to directors and officers have terms consistent with
those offered to other customers.  Loans to officers and directors of
the Corporation are summarized as follows (in thousands):





Years Ended December 31,2009
                      
                      
                      2008Balance
      at beginning of period
                      
                      $
                      539
                      
                      
                      $
                      349Loans
      originated during the period
                      
                      
                      1,719
                      
                      
                      
                      219Loan
      repayments during the period
                      
                      
                      (78
                      )
                      
                      
                      (29
                      )Balance
      at the end of period
                      
                      $
                      2,180
                      
                      
                      $
                      539





59





5.
            Office
      Properties and Equipment





Office properties and equipment
consisted of the following (in thousands):





As of December 31,2009
                  
                  
                  2008Land
                  
                  $
                  1,656
                  
                  
                  $
                  1,656Building
      and improvements
                  
                  
                  5,269
                  
                  
                  
                  5,146Office
      furniture, fixtures and equipment
                  
                  
                  2,057
                  
                  
                  
                  2,989Total
                  
                  
                  8,982
                  
                  
                  
                  9,791Less
      accumulated depreciation
                  
                  
                  (3,535
                  )
                  
                  
                  (3,954
                  )Office
      properties and equipment, net
                  
                  $
                  5,447
                  
                  
                  $
                  5,837





Depreciation expense was $534,000 and
$652,000 for the years ended December 31, 2009 and 2008,
respectively.





6.
            Intangible
      Assets





Intangible assets consisted of the
following (in thousands):





Years Ended December 31,2009
                  
                  
                  2008Core
      Deposit PremiumBalance at beginning of
      year
                  
                  $
                  516
                  
                  
                  $
                  932Amortization
                  
                  
                  (324
                  )
                  
                  
                  (416
                  )Charge-off
      of remaining deposit premium
                  
                  
                  (192
                  )
                  
                  
                  —Balance at end of
      year
                  
                  
                  -
                  
                  
                  
                  516GoodwillBalance
      at beginning of year
                  
                  
                  2,329
                  
                  
                  
                  2,329Reclassification
      of goodwill
                  
                  
                  (1,172
                  )
                  
                  
                  —Charge-off
      of remaining goodwill
                  
                  
                  (1,157
                  )
                  
                  
                  —Balance at end of
      year
                  
                  
                  -
                  
                  
                  
                  2,329Total
                  
                  $
                  -
                  
                  
                  $
                  2,845





A reclassification of goodwill occurred
due to an adjustment to the goodwill valuation that was offset against deferred
income taxes. This adjustment resulted from our review of prior income tax
returns and the discovery of a misclassification from our business combination
in 1999.





Goodwill
is reviewed for potential impairment at least annually at the reporting unit
level. The Corporation performs its impairment testing in the fourth quarter of
each year and more frequently if circumstances exist that indicate a probable
reduction in the fair value below carrying value. An impairment loss is recorded
to the extent that the carrying amount of goodwill exceeds its implied fair
value. Other intangible assets are evaluated for impairment if events and
circumstances indicate a possible impairment. Such evaluation of other
intangible assets is based on undiscounted cash flow projections. Impairment
charges of $192,000 were recorded related to a deposit premium
impairment.





In
performing the first step (“Step 1”) of the goodwill impairment testing and
measurement process to identify possible impairment, the estimated fair value
was developed using a market valuation approach that utilizes the current stock
price as the primary indicator of fair market value. The results of this Step 1
process indicated that the estimated fair value was less than book value, thus
requiring the Corporation to perform the second step (“Step 2”) of the goodwill
impairment test.  Based on the Step 2 analysis, it was determined that
the implied fair value of goodwill was $0 as of December 31, 2009, which
resulted in a goodwill impairment charge of $1,157,000 for the year ended
December 31, 2008 that was recorded as a component of noninterest expense on the
consolidated statement of operations.





The primary factor in the determination
of goodwill impairment in 2009 was the Corporation’s relatively low stock price
and resulting market valuation. The Corporation’s stock price has been trading
below its book value throughout 2009. Management attributes its relatively low
stock price to both financial services industry-wide and Corporation specific
factors primarily related to credit quality issues. The goodwill impairment
charge is non-cash expense, and since goodwill is a non interest earning asset,
this charge will not impact the Corporation’s future operating
performance.




60




7.
            Deposit
      Accounts





Deposit accounts at December 31 were as
follows (in thousands):





2009
                    
                    
                    2008Rate
                    
                    
                    Balance
                    
                    
                    %
                    
                    
                    Rate
                    
                    
                    Balance
                    
                    
                    %Account TypeNOW
      accounts:Commercial
      non-interest-bearing
                    
                    
                    –
                    %
                    
                    $
                    18,015
                    
                    
                    
                    5.42
                    %
                    
                    
                    –
                    %
                    
                    $
                    17,002
                    
                    
                    
                    5.54
                    %Non-commercial
                    
                    
                    2.30
                    
                    
                    
                    98,274
                    
                    
                    
                    29.53
                    
                    
                    
                    2.06
                    
                    
                    
                    68,033
                    
                    
                    
                    22.18Money
      market
                    
                    
                    1.57
                    
                    
                    
                    32,239
                    
                    
                    
                    9.69
                    
                    
                    
                    2.17
                    
                    
                    
                    22,313
                    
                    
                    
                    7.27Savings
                    
                    
                    0.51
                    
                    
                    
                    13,383
                    
                    
                    
                    4.02
                    
                    
                    
                    0.57
                    
                    
                    
                    12,407
                    
                    
                    
                    4.04Total
      demand and time deposits
                    
                    
                    1.74
                    
                    
                    
                    161,911
                    
                    
                    
                    48.66
                    
                    
                    
                    1.92
                    
                    
                    
                    119,755
                    
                    
                    
                    39.03Time deposits:Up to 3.00%
                    
                    
                    
                    
                    
                    
                    135,064
                    
                    
                    
                    40.59
                    
                    
                    
                    
                    
                    
                    
                    41,720
                    
                    
                    
                    13.603.01% - 4.00%
                    
                    
                    
                    
                    
                    
                    20,885
                    
                    
                    
                    6.27
                    
                    
                    
                    
                    
                    
                    
                    79,176
                    
                    
                    
                    25.804.01% - 5.00%
                    
                    
                    
                    
                    
                    
                    13,744
                    
                    
                    
                    4.13
                    
                    
                    
                    
                    
                    
                    
                    58,962
                    
                    
                    
                    19.225.01% - 6.00%
                    
                    
                    
                    
                    
                    
                    1,130
                    
                    
                    
                    0.34
                    
                    
                    
                    
                    
                    
                    
                    7,180
                    
                    
                    
                    2.346.01% - 7.00%
                    
                    
                    
                    
                    
                    
                    28
                    
                    
                    
                    0.01
                    
                    
                    
                    
                    
                    
                    
                    28
                    
                    
                    
                    0.01Total
      time deposits
                    
                    
                    2.27
                    
                    
                    
                    170,851
                    
                    
                    
                    51.34
                    
                    
                    
                    3.56
                    
                    
                    
                    187,066
                    
                    
                    
                    60.97Total
      deposit accounts
                    
                    
                    2.02
                    %
                    
                    $
                    332,762
                    
                    
                    
                    100.00
                    %
                    
                    
                    2.91
                    %
                    
                    $
                    306,821
                    
                    
                    
                    100.00
                    %





As of December 31, 2009 and 2008, total
deposit accounts include approximately $2.0 million and $2.0 million,
respectively, of deposits from the Corporation’s officers, directors, employees
or parties related to them.





At December 31, 2009 and 2008, time
deposit accounts with balances of $100,000 and over totaled approximately $68.2
million and $74.9 million, respectively.





Time deposits by maturity were as
follows (in thousands):





As of December 31,2009
                    
                    
                    2008Maturity DateWithin
      1
      year
                    
                    $
                    119,737
                    
                    
                    $
                    141,904After
      1 but within 2
      years
                    
                    
                    48,695
                    
                    
                    
                    40,462After
      2 but within 3
      years
                    
                    
                    2,069
                    
                    
                    
                    2,354After
      3 but within 4
      years
                    
                    
                    287
                    
                    
                    
                    1,854Thereafter
                    
                    
                    63
                    
                    
                    
                    492Total
      time
      deposits
                    
                    $
                    170,851
                    
                    
                    $
                    187,066





Interest
expense on deposits consisted of the following (in thousands):





Years Ended December 31,2009
                                
                                
                                2008Account TypeNOW
      accounts and money market deposit accounts
                                
                                $
                                2,385
                                
                                
                                $
                                2,147Passbook
      and statement savingsAccounts
                                
                                
                                69
                                
                                
                                
                                83Certificate
      accounts
                                
                                
                                5,572
                                
                                
                                
                                6,758Early
      withdrawal penalties
                                
                                
                                (31
                                )
                                
                                
                                (29
                                )Total
                                
                                $
                                7,995
                                
                                
                                $
                                8,959





61





8.
            Advances
      from the Federal Home Loan Bank





At December 31, 2009 and 2008, the Bank
had $64.5 million and $69.5 million, respectively, of advances outstanding from
the FHLB.  The maturity of the advances from the FHLB is as follows
(in thousands):





As of December 31,2009
                
                
                Weighted
                  Average Rate
                
                
                2008
                
                
                Weighted
                  Average RateContractual
      Maturity:Within
      one year – fixed rate
                
                $
                5,000
                
                
                
                4.93
                
                
                $
                5,000
                
                
                
                2.93
                %After
      one but within three years – fixed rate
                
                
                —
                
                
                
                —
                
                
                
                5,000
                
                
                
                4.93After
      one but within three years – adjustable rate
                
                
                22,000
                
                
                
                4.58
                
                
                
                22,000
                
                
                
                4.58Greater
      than five years – adjustable rate
                
                
                37,500
                
                
                
                3.89
                
                
                
                37,500
                
                
                
                3.89Total
      advances
                
                $
                64,500
                
                
                
                4.20
                %
                
                $
                69,500
                
                
                
                4.11
                %





The Bank
pledges as collateral to the advances their FHLB stock, investment securities
and has entered into a blanket collateral agreement with the FHLB whereby the
Bank maintains, free of other encumbrances, qualifying loans (as defined) with
unpaid principal balances equal to, when discounted at 50% to 80% of the unpaid
principal balances, 100% of total advances. The amount of qualifying loans was
$52.8 million and $48.5 million, respectively, at December 31, 2009 and 2008. In
addition to qualifying loans, the Corporation also pledges investment
securities. The amount of investment securities pledged for advances was $46.5
million and $36.1 million, respectively, at December 31, 2009 and 2008. Advances
are subject to prepayment penalties and to calls at the option of the FHLB of
Atlanta. The advances callable in fiscal 2010 are $59.5 million with a weighted
average rate of 4.15%. During fiscal years 2009 and 2008, the FHLB did not
exercise any of the call provisions related to the advances.





9.
            Securities
      Sold Under Agreements to Repurchase





The
Company had $18,520,000 and $19,005,000 borrowed under agreements to repurchase
at December 31, 2009 and 2008, respectively. The amortized cost of the
securities underlying the agreements to repurchase at December 31, 2009 was
$19,142,000 and $22,188,000 at December 31, 2008. The maximum amount outstanding
at any month end during 2009 was $20,411,000 and $23,389,000 for 2008. The
average amount of outstanding agreements for 2009 was $18,134,000 and
$21,588,000 for 2008 and the approximate weighted average interest rate was
1.56% in 2009 and 2.53% in 2008.





10.
            Floating
      Rate Junior Subordinated Deferrable Interest
  Debentures





On July
18, 2006, the Corporation sponsored the creation of Provident Community
Bancshares Capital Trust I (“Capital Trust I”). The Corporation is the
owner of all of the common securities of Capital Trust I.  On July 21,
2006, Capital Trust I issued $4,000,000 in the form of floating/fixed rate
capital securities through a pooled trust preferred securities
offering.  The proceeds from this issuance, along with the
Corporation’s $124,000 capital contribution for Capital Trust I’s common
securities, were used to acquire $4,124,000 aggregate principal amount of
the Corporation’s floating rate junior subordinated deferrable interest
debentures due October 1, 2036 (the “Debentures”), which constitute the sole
asset of Capital Trust I.  The interest rate on the Debentures and the
capital securities will be equal to 7.393% for the first five
years.  Thereafter, the interest rate is variable and adjustable
quarterly at 1.74% over the three-month LIBOR.  The Corporation has,
through the Trust Agreement establishing Capital Trust I, the Guarantee
Agreement, the notes and the related Debenture, taken together, fully
irrevocably and unconditionally guaranteed all of the Capital Trust I
obligations under the capital securities. The stated maturity of the Debentures
is October 1, 2036.  In addition, the Debentures are subject to
redemption at par at the option of the Corporation, subject to prior regulatory
approval, in whole or in part on any interest payment date after October 1,
2011. The Debentures are also subject to redemption prior to October 1, 2011 at
up to 103.7% of par after the occurrence of certain events that would either
have a negative tax effect on Capital Trust I or the Corporation or would result
in Capital Trust I being treated as an investment company that is required to be
registered under the Investment Company Act of 1940.  The Corporation
has the right, at one or more times, to defer interest payments on the
Debentures for up to twenty consecutive quarterly periods.  The
Corporation paid $305,000 and $305,000 in interest for the years ended December
31, 2009 and 2008, respectively, for the Capital Trust I
debentures.





62





10.
              Floating
      Rate Junior Subordinated Deferrable Interest Debentures
      (continued)





On
November 28, 2006, the Corporation sponsored the creation of Provident Community
Bancshares Capital Trust (“Capital Trust II”). The Corporation is the owner
of all of the common securities of the Trust. On December 15, 2006, the Trust
issued $8,000,000 in the form of floating rate capital securities through a
pooled trust preferred securities offering. The proceeds of Capital Trust
II were utilized for the redemption of Union Financial Bancshares Statutory
Trust (the “Trust”) issued on December 18, 2001. The proceeds from this
issuance, along with the Corporation’s $247,000 capital contribution for the
Trust’s common securities, were used to acquire $8,247,000 aggregate principal
amount of the Corporation’s floating rate junior subordinated deferrable
interest debentures due March 1, 2037 (the “Debentures”), which constitute the
sole asset of the Trust.  The interest rate on the Debentures and the
capital securities is variable and adjustable quarterly at 1.74% over the
three-month LIBOR, with a rate at December 31, 2008 of 3.92%. The
Corporation has, through the Trust agreement establishing the Trust, the
Guarantee Agreement, the notes and the related Debenture, taken together, fully
irrevocably and unconditionally guaranteed all of the Trust’s obligations under
the capital securities. The stated maturity of the Debentures is March 1, 2037.
In addition, the Debentures are subject to redemption at par at the option of
the Corporation, subject to prior regulatory approval, in whole or in part on
any interest payment date after March 1, 2012. The Debentures are also subject
to redemption prior to March 1, 2012 at 103.5% of par after the occurrence of
certain events that would either have a negative tax effect on the Trust or the
Corporation or would result in the Trust being treated as an investment company
that is required to be registered under the Investment Company Act of
1940.  The Corporation has the right, at one or more times, to defer
interest payments on the Debentures for up to twenty consecutive quarterly
periods.  The Corporation paid $225,000 and $416,000 in interest to
the Capital Trust II in 2009 and 2008, respectively.





11.
            Income
      Taxes





Income tax expense is summarized as
follows (in thousands):





Years Ended December 31,2009
                  
                  
                  2008Current
                  
                  $
                  (1,057
                  )
                  
                  $
                  744Deferred
                  
                  
                  (2,954
                  )
                  
                  
                  (1,340
                  )Total
      income tax benefit
                  
                  $
                  (4,011
                  )
                  
                  $
                  ( 596
                  )





The
provision for income taxes differed from amounts computed by applying the
statutory federal rate of 34% to income before income taxes as follows (in
thousands):





Years Ended December 31,2009
                  
                  
                  2008Tax
      at federal income tax rate
                  
                  $
                  (3,877
                  )
                  
                  $
                  (337
                  )Increase
      (decrease) resulting from:State
      income taxes, net of federalbenefit
                  
                  
                  —
                  
                  
                  
                  12Interest on municipal
      bonds
                  
                  
                  (146
                  )
                  
                  
                  (160
                  )Non-taxable life insurance
      income
                  
                  
                  (136
                  )
                  
                  
                  (136
                  )Impairment of
      goodwill
                  
                  
                  393
                  
                  
                  
                  —Other,
      net
                  
                  
                  (245
                  )
                  
                  
                  25Total
                  
                  $
                  (4,011
                  )
                  
                  $
                  (596
                  )





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





63





11.
            Income
      Taxes (continued)





The tax effects of significant items
comprising the Corporation’s deferred taxes as of December 31, 2009 and 2008 are
as follows (in thousands):




December31,2009
                    
                    
                    2008Deferred
      tax assets:Book
      reserves in excess of tax basis bad debt reserves
                    
                    $
                    1,516
                    
                    
                    $
                    2,305Deferred
      compensation
                    
                    
                    527
                    
                    
                    
                    453Net
      operating loss
                    
                    
                    1,630
                    
                    
                    
                    –Other-than-temporary-impairment
                    
                    
                    1,277
                    
                    
                    
                    –SFAS
      No. 115 mark-to-market adjustment
                    
                    
                    553
                    
                    
                    
                    913Charitable
      contribution limitation
                    
                    
                    6
                    
                    
                    
                    –Other
      real estate owned
                    
                    
                    355
                    
                    
                    
                    106Core
      deposit intangible
                    
                    
                    232
                    
                    
                    
                    131Loan
      discount amortization
                    
                    
                    105
                    
                    
                    
                    –Other
                    
                    
                    535
                    
                    
                    
                    165Total
      deferred tax asset
                    
                    
                    6,736
                    
                    
                    
                    4,073Deferred
      tax liabilities:Difference
      between book and tax property basis
                    
                    
                    80
                    
                    
                    
                    97Difference
      between book and tax Federal Home Loan Bank stock
                    
                    
                    85
                    
                    
                    
                    85Deferred
      loan fees
                    
                    
                    41
                    
                    
                    
                    17Partnership
      pass-through differences
                    
                    
                    51
                    
                    
                    
                    –Prepaid
      expenses
                    
                    
                    81
                    
                    
                    
                    70Total
      deferred tax liability
                    
                    
                    338
                    
                    
                    
                    269Net
      deferred tax asset
                    
                    $
                    6,398
                    
                    
                    $
                    3,804





The deferred tax assets of $6.4 million
and $3.8 million at December 31, 2009 and 2008 are included in other assets in
the balance sheet.





Deferred
tax assets or liabilities are initially recognized for differences between the
financial statement carrying amount and the tax basis of asset and liabilities
which will result in future deductible or taxable amounts and operating loss and
tax credit carry-forwards. A valuation allowance is then established, as
applicable, to reduce the deferred tax asset to the level at which it is “more
likely than not” that the tax benefits will be realized. Realization of tax
benefits of deductible temporary differences and operating loss or credit
carry-forwards depends on having sufficient taxable income of an appropriate
character within the carry-back and carry-forward periods. Sources of taxable
income that may allow for the realization of tax benefits include (1) taxable
income in the current year orprior years that is available through carry-back,
(2) future taxable income that will result from the reversal of existing taxable
temporary differences, and (3) taxable income generated by future operations.
There is no valuation allowance for deferred tax assets as of December 31, 2009
and 2008. It is management’s belief that realization of the deferred tax asset
is more likely than not.





Retained
earnings at December 31, 2009 includes approximately $1.6 million representing
pre-1988 tax bad debt base year reserve amounts for which no deferred income tax
liability has been provided since these reserves are not expected to reverse
until indefinite future periods and may never reverse. Circumstances that would
require an accrual of a portion or all of this unrecorded tax liability are
failure to meet the definition of a bank, dividend payments in excess of current
year or accumulated tax earnings and profits, or other distributions in
dissolutions, liquidations or redemption of the Bank’s stock.





64





12.
            Employee
      Benefits





The
Corporation has a contributory profit-sharing plan which is available to all
eligible employees.  Annual employer contributions to the plan consist
of an amount which matches participant contributions up to a maximum of 5% of a
participant’s compensation and a discretionary amount determined annually by the
Corporation’s Board of Directors.  The annual contributions to the plan
will be 5% of a participant’s compensation. Employer expensed contributions to
the plans were $150,000 and $147,500 for the years ended December 31, 2009 and
2008, respectively.





13.
            Financial
      Instruments with Off Balance Sheet
Risk





The
Corporation is a party to financial instruments with off-balance-sheet risk in
the normal course of business to meet the financing needs of its customers and
to reduce its own exposure to fluctuations in interest rates. These financial
instruments are commitments to extend credit. They involve, to varying degrees,
elements of credit risk in excess of the amount recognized in the balance
sheets. The contract or notional amounts of those instruments reflect the extent
of involvements the Corporation has in particular classes of financial
instruments.





The
Corporation’s exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit is
represented by the contractual amount of those instruments. The Corporation uses
the same credit policies in making commitments and conditional obligations as
they do for on-balance-sheet instruments.





Commitments
to extend credit are agreements to lend to a customer as long as there is no
violation of any condition established in the contract.  Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since many of the commitments are expected to expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements.  The Corporation evaluates each
customer’s creditworthiness on a case-by-case basis. The amount of collateral
obtained, if it is deemed necessary by the Corporation upon extension of credit,
is based on management’s credit evaluation of the counter-party. Collateral held
varies but may include accounts receivable, inventory, property, plant, and
equipment and income-producing commercial properties.





The Corporation had loan commitments as
follows (in thousands):


As of December 31,2009
                  
                  
                  2008Fixed/variable
      interest rate commitments to fund residential credit
                  
                  $
                  1,519
                  
                  
                  $
                  4,539Commitments
      to fund commercial and construction loans
                  
                  
                  320
                  
                  
                  
                  1,926Unused
      portion of credit lines (principally variable-rate consumerlines
      secured by real estate)
                  
                  
                  38,292
                  
                  
                  
                  49,380Total
                  
                  $
                  40,131
                  
                  
                  $
                  55,845





The Corporation has no additional
financial instruments with off-balance sheet risk.





The Corporation did not incur any
losses on its commitments in the years ended December 31, 2009 and
2008.





65





14.
            Fair
      Value of Financial Instruments





The estimated fair values of the
Corporation’s financial instruments were as follows at December 31, 2009 (in
thousands):


December 31, 2009Carrying
                          Amount
                        
                        
                        Fair
                          ValueFinancial assetsCash
      and due from banks
                        
                        $
                        15,631
                        
                        
                        $
                        15,631Securities
      available for sale
                        
                        
                        147,816
                        
                        
                        
                        147,816Securities
      held to maturity
                        
                        
                        3,934
                        
                        
                        
                        3,976Federal
      Home Loan Bank stock, at cost
                        
                        
                        3,947
                        
                        
                        
                        3,947Federal
      Reserve Bank stock, at cost
                        
                        
                        832
                        
                        
                        
                        832Loans,
      net
                        
                        
                        250,420
                        
                        
                        
                        250,455Accrued
      interest receivable
                        
                        
                        2,238
                        
                        
                        
                        2,238Cash
      surrender value of life insurance
                        
                        
                        9,332
                        
                        
                        
                        9,332Financial liabilitiesDeposits
                        
                        $
                        332,762
                        
                        
                        $
                        323,113Advances
      from FHLB and other borrowings
                        
                        
                        64,500
                        
                        
                        
                        67,457Securities
      sold under agreement to repurchase
                        
                        
                        18,520
                        
                        
                        
                        18,544Floating
      rate junior subordinated deferrable interest debentures
                        
                        
                        12,372
                        
                        
                        
                        10,758Accrued
      interest payable
                        
                        
                        581
                        
                        
                        
                        581Off-balance-sheet assets
      (liabilities)Commitments
      to extend credit
                        
                        $
                        (40,131
                        )
                        
                        $
                        (0
                        )





The
estimated fair values of the Corporation’s financial instruments were as follows
at December 31, 2008 (in thousands):


December 31, 2008Carrying
                          Amount
                        
                        
                        Fair
                          ValueFinancial assetsCash
      and due from banks
                        
                        $
                        21,370
                        
                        
                        $
                        21,370Securities
      available for sale
                        
                        
                        100,418
                        
                        
                        
                        100,418Securities
      held to maturity
                        
                        
                        2,430
                        
                        
                        
                        2,310Federal
      Home Loan Bank stock, at cost
                        
                        
                        3,929
                        
                        
                        
                        3,929Federal
      Reserve Bank stock, at cost
                        
                        
                        599
                        
                        
                        
                        599Loans,
      net
                        
                        
                        278,665
                        
                        
                        
                        286,004Accrued
      interest receivable
                        
                        
                        2,087
                        
                        
                        
                        2,087Cash
      surrender value of life insurance
                        
                        
                        9,577
                        
                        
                        
                        9,577Financial liabilitiesDeposits
                        
                        $
                        306,821
                        
                        
                        $
                        315,542Advances
      from FHLB and other borrowings
                        
                        
                        69,500
                        
                        
                        
                        70,394Securities
      sold under agreement to repurchase
                        
                        
                        19,005
                        
                        
                        
                        19,232Floating
      rate junior subordinated deferrable interest debentures
                        
                        
                        12,372
                        
                        
                        
                        11,636Accrued
      interest payable
                        
                        
                        701
                        
                        
                        
                        701Off-balance-sheet assets
      (liabilities)Commitments
      to extend credit
                        
                        $
                        (55,845
                        )
                        
                        $
                        (0
                        )





The
Corporation utilizes fair value measurements to record fair value adjustments to
certain assets and liabilities and to determine fair value disclosures.
Effective January 1, 2008, the Corporation adopted FASB 157 (ASC 820-10-15) Fair
Value Measurements which provides a framework for measuring and disclosing fair
value under generally accepted accounting principles. This standard requires
disclosures about the  fair value of assets andliabilities
recognized in the balance sheet in periods subsequent to initial recognition,
whether the measurements are made on a recurring basis (for example,
available-for-sale investment  securities) or on a nonrecurring basis
(for example, impaired loans).





66





14.
            Fair
      Value of Financial Instruments
(continued)


Fair Value
Hierarchy





ASC
820-10-15 defines fair value as the exchange price that would be received for an
asset or paid to transfer a liability (an exit price) in the principal or most
advantageous market for the asset or liability in an orderly transaction between
market participants on the measurement date. ASC 820-10-15 also establishes a
fair value hierarchy which requires an entity to maximize the use of observable
inputs and minimize the use of unobservable inputs when measuring fair value.
The standard describes three levels of inputs that may be used to measure fair
value:





Level
      1
                      
                      Valuation
      is based upon quoted prices in active markets for identical assets or
      liabilities.Level
      2
                      
                      Valuation
      is based upon 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
      3
                      
                      Valuation
      is based upon quoted prices for similar assets or liabilities; quoted
      prices in markets that are not active; and model-based techniques whose
      value is determined using pricing models, discounted cash flow
      methodologies and similar
techniques.




Following
is a description of valuation methodologies used for assets and liabilities
recorded at fair value.





Investment Securities
Available for Sale





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





Loans





The
Corporation is predominantly an asset based lender with real estate serving as
collateral on a substantial majority of loans. The Corporation does not record
loans at fair value on a recurring basis. However, from time to time, a loan is
considered impaired and the related impairment is charged against the allowance
or a specific allowance is established. Loans for which it is probable that
payment of interest and principal will not be made in accordance with the
contractual terms of the loan agreement are considered impaired. Loans which are
deemed to be impaired are primarily valued at the fair values of the underlying
real estate collateral. Such fair values are obtained using collateral net
liquidation value, market value of similar debt, enterprise value, and
discounted cash flows. Those impaired loans not requiring a specific allowance
represent loans for which the fair value of the expected repayment or collateral
meet or exceed the recorded investment in such loans. The Corporation considers
all non-accrual loans and troubled debt restructurings to be impaired.
Therefore, at December 31, 2009, loans classified as impaired totaled $20.9
million. Based on recommendations from our primary bank regulator, specific
reserves of $6.4 million were charged off against the outstanding loans at
December 31, 2009. When the fair value of the collateral is based on an
observable market price or a current appraised value, the Corporation records
the impaired loan as nonrecurring Level 2. When an appraised value is not
available or management determines the fair value of the collateral is further
impaired below the appraised value and there is not observable market price, the
Corporation records the impaired loans as nonrecurring Level 3.




67





14.
            Fair
      Value of Financial Instruments
(continued)





Real Estate Acquired Through
Foreclosure





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





Goodwill and Other
Intangible Assets





Goodwill
and other intangible assets are subject to impairment testing. Goodwill and
other intangible assets measured at fair value on a nonrecurring basis relate to
intangible assets (deposit premium intangible) that were acquired in connection
with acquisitions and were valued at their fair market values at the time of
acquisition. As such, the Corporation classifies goodwill and other intangible
assets subjected to nonrecurring value adjustments as Level 3. The Corporation
evaluated its goodwill and intangibles in 2009 and determined the entire amounts
to be impaired. Therefore, the Corporation did not have any goodwill or other
intangible assets at December 31, 2009.


Assets and Liabilities
Recorded at Fair Value on a Recurring Basis





Assets
measured at fair value on a recurring basis at December 31, 2009 are as
follows:





Total
                    
                    
                    (Level 1)
                    
                    
                    (Level 2)
                    
                    
                    (Level 3)Available
      for Sale Securities
                    
                    $
                    147,816,000
                    
                    
                    $
                    78,474,000
                    
                    
                    $
                    66,232,000
                    
                    
                    $
                    3,110,000





Assets
and liabilities measured at fair value on a recurring basis at December 31, 2008
are as follows:





Total
                  
                  
                  (Level 1)
                  
                  
                  (Level 2)
                  
                  
                  (Level 3)Available
      for Sale Securities
                  
                  $
                  100,418,000
                  
                  
                  $
                  28,236,000
                  
                  
                  $
                  67,337,000
                  
                  
                  $
                  4,845,000





The
following is a reconciliation of the beginning and ending balances for assets
measured at fair value on a recurring basis using significant unobservable
inputs (Level 3) for the period ended December 31, 2009.




Fair Value Measurements Using SignificantUnobservable Inputs (Level 3)Investment
      SecuritiesAvailable-for-SaleBeginning
      balance at December 31, 2008
                      
                      $
                      4,845,000Transfers
      in of Level 3
                      
                      
                      —Gain/(Loss)
      for the year
                      
                      
                      (1,735,000
                      )Purchases,
      sales, issuances and settlements, net
                      
                      
                      —Ending
      balance at December 31, 2009
                      
                      $
                      3,110,000





68





14.
            Fair
      Value of Financial Instruments
(continued)





Assets and Liabilities
Recorded at Fair Value on a Nonrecurring Basis





The
Corporation may be required, from time to time, to measure certain assets at
fair value on a nonrecurring basis in accordance with U.S. generally accepted
accounting principles. These include assets that are measured at the lower of
cost or market that were recognized at fair value below cost at the end of the
period.





Assets  and
liabilities measured at fair value on a nonrecurring basis at December 31, 2009
are as follows:





Total
                  
                  
                  (Level 1)
                  
                  
                  (Level 2)
                  
                  
                  (Level 3)Non
      performing loans
                  
                  $
                  20,869,000
                  
                  
                  $
                  —
                  
                  
                  $
                  20,869,000
                  
                  
                  $
                  —Other
      real estate owned
                  
                  
                  5,917,000
                  
                  
                  
                  —
                  
                  
                  
                  5,917,000
                  
                  
                  
                  —Total
      assets at fair value
                  
                  $
                  26,786,000
                  
                  
                  $
                  —
                  
                  
                  $
                  26,786,000
                  
                  
                  $
                  —





Assets
and liabilities measured at fair value on a nonrecurring basis at December 31,
2008 are as follows:





Total
                
                
                (Level 1)
                
                
                (Level 2)
                
                
                (Level 3)Non
      performing loans
                
                $
                16,001,000
                
                
                $
                —
                
                
                $
                16,001,000
                
                
                $
                —Other
      real estate owned
                
                
                667,000
                
                
                
                —
                
                
                
                667,000
                
                
                
                —Goodwill
      and intangible assets
                
                
                2,845,000
                
                
                
                —
                
                
                
                2,845,000
                
                
                
                —Total
      assets at fair value
                
                $
                19,513,000
                
                
                $
                —
                
                
                $
                19,513,000
                
                
                $
                —





15.
            Preferred
      Stock





On March
13, 2009, as part of the United States Department of the Treasury’s Capital
Purchase Program, the Corporation issued 9,266 shares of Fixed Rate Cumulative
Perpetual Preferred Stock, Series A, $1,000 per share liquidation preference,
and a warrant to purchase up to 178,880 shares of the Corporation’s common stock
for a period of ten years at an exercise price of $7.77 per share, in exchange
for $9,266,000 in cash from the United States Department of the
Treasury.  The proceeds, net of issuance costs consisting primarily of
legal fees, were allocated between the preferred stock and the warrant on a pro
rata basis, based upon the estimated market values of the preferred stock and
the warrant.  As a result, $25,000 of the proceeds was allocated to
the warrant. The amount allocated to the warrant is considered a discount on the
preferred stock and will be amortized using the level yield method over a
five-year period through a charge to retained earnings. Such amortization will
not reduce net income, but will reduce income available to common sharesholders.
Fair market value of the preferred stock was determined by using a discounted
cash flow model that assumed a market dividend yield for similar preferred
stock.





The
preferred stock pays cumulative dividends of 5% per year for the first five
years and 9% per year thereafter.  The Corporation may redeem the
preferred stock at its liquidation preference plus accrued and unpaid dividends
at any time with the prior regulatory approval.  The securities
purchase agreement between the Corporation and the United States Department of
the Treasury limits, for three years, the rate of dividend payments on the
Corporation’s common stock to the amount of its last quarterly cash dividend
before participation in the program of $0.03 per share unless an increase is
approved by the Department of the Treasury, limits the Corporation’s ability to
repurchase its common stock for three years and subjects the Corporation to
certain executive compensation limitations included in the Emergency Economic
Stabilization Act of 2008, as amended by the American Recovery and Reinvestment
Act of 2009. The Corporation plans to remain in the program for the initial
three-year period and evaluate alternative sources of capital after that
point.





69





16.
            Real
      Estate Acquired in Settlement of
Loans





Real estate acquired in settlement of
loans through foreclosure is summarized as follows:





Years Ended December 31,2009
                  
                  
                  2008Balance
      at beginning of period
                  
                  $
                  667
                  
                  
                  $
                  856Foreclosures
      added during the period
                  
                  
                  5,890
                  
                  
                  
                  163Provision
      charged as a write-down
                  
                  
                  (640
                  )
                  
                  
                  (352
                  )Balance
      at the end of period
                  
                  $
                  5,917
                  
                  
                  $
                  667





Net real
estate operations expense was $787,000 and $409,000 for the years ended December
31, 2009 and 2008, respectively.





17.
            Supplemental
      Cash Flow Disclosures





Years Ended December 31,2009
                  
                  
                  2008Cash
      paid for:Income taxes
                  
                  $
                  —
                  
                  
                  $
                  680Interest
                  
                  
                  11,713
                  
                  
                  
                  13,247Non-cash
      transactions:Loans foreclosed
                  
                  
                  5,890
                  
                  
                  
                  163Unrealized
      gain (loss) on securitiesavailable
      for sale
                  
                  $
                  (1,495
                  )
                  
                  $
                  (2,609
                  )





18.
            Commitments
      and Contingencies





Lease commitments
- The Corporation leases certain Bank facilities under rental agreements
that have expiration dates between 2018 and 2025. Future minimum rental payments
due under these leases are as follows:





Years Ended2010
                        
                        $
                        469,4642011
                        
                        
                        469,4642012
                        
                        
                        469,4642013
                        
                        
                        469,4642014
                        
                        
                        469,464Thereafter
                        
                        
                        2,370,192





Total rent expense for the years ended
December 31, 2009 and 2008 was $484,000 and $446,000,
respectively.





Lines of credit - At
December 31, 2009, the Corporation had unused short-term secured lines of
credit to purchase federal funds from unrelated banks totaling $4.0 million and
the ability to borrow an additional $54.0 million from secured borrowing lines.
Lines of credit are available on a one-to-ten day basis for general purposes of
the Corporation.  All of the lenders have reserved the right to
withdraw these lines at their option.





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





The Corporation makes loans to
individuals and small businesses for various personal and commercial purposes
primarily in the Piedmont region of South Carolina and North
Carolina.  The Corporation’s loan portfolio is not concentrated in
loans to any single borrower or a relatively small number of
borrowers.  Additionally, management is not aware of any
concentrations of loans to classes of borrowers or industries that would be
similarly affected by economic conditions.  Management has identified
a concentration of a type of lending that it is
monitoring.  Commercial non-mortgage loans totaled $73.5 million at
December 31, 2009 representing 281% of total equity and 29% of loans
receivable.  At December 31, 2008, this concentration totaled $94.0
million representing 392% of
total equity and 34% of net loans receivable. Commercial loans are of higher
risk and typically are made on the basis of the borrower’s ability to make
repayment from the cash flow of the borrower’s business and are generally
secured by a variety of collateral types, primarily accounts receivable,
inventory and equipment.




70




18.
              Commitments
      and Contingencies (continued)




In
addition to monitoring potential concentrations of loans to particular borrowers
or groups of borrowers, industries, geographic regions and loan types,
management monitors exposure to credit risk from other lending practices such as
loans that subject borrowers to substantial payment increases (e.g. principal
deferral periods, loans with initial interest-only periods, etc.) and loans with
high loan-to-value ratios.  Management has determined that the
Corporation has a concentration of loans that exceed one of the regulatory
guidelines for loan-to-value ratios.  This particular guideline states
that the total amount by which commercial, agricultural, and multifamily and
other non-residential properties exceed the regulatory maximum loan-to-value
ratio limits should not exceed 30% of a bank’s total risk-based
capital.  The excess over regulatory guidelines for these types of
loans totaled $19.9 million at December 31, 2009 representing 52% of the Bank’s
total risk-based capital.  These amounts exceeded
regulatory guidelines by $7.2 million and 18.6%, respectively.





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





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





The
Corporation places its deposits and correspondent accounts with and sells its
federal funds to high quality institutions. Management believes credit risk
associated with correspondent accounts is not significant.





Litigation - The
Corporation is involved in legal actions in the normal course of business. In
the opinion of management, based on the advice of its general counsel, the
resolution of these matters will not have a material adverse impact on future
results of operations or the financial position of the Corporation.





Potential Impact of Changes
in Interest Rates - The Corporation’s profitability depends to a large
extent on its net interest income, which is the difference between interest
income from loans and investments and interest expense on deposits and
borrowings.  Like most financial institutions, the Corporation’s
interest income and interest expense are significantly affected by changes in
market interest rates and other economic factors beyond its control. Management
seeks to manage the relationships between interest-sensitive assets and
liabilities in order to protect against wide interest rate
fluctuations.





The
Corporation has more interest-rate sensitive assets than liabilities. Thus, it
enjoys an increasing net interest rate spread during periods of rising interest
rates. The Corporation experiences a shrinking net interest spread in a falling
interest rate environment.





71





19.
            Stock
      Option Plans





At December 31, 2009, the Corporation
had the following stock options outstanding.





Grant
      Date
                        
                        
                        Shares
                          Granted
                        
                        
                        Average
                          Exercise
                          Price Per
                          Share
                        
                        
                        Average
                          Intrinsic
                          Value(1)
                        
                        
                        Expiration Date
                        
                        Earliest Date
                          ExercisableOctober,
      2000
                        
                        
                        
                        1,700
                        
                        
                        $
                        8.75
                        
                        
                        $
                        –
                        
                        
                        October,
      2010
                        
                        October,
      2000January,
      2001
                        
                        
                        
                        15,840
                        
                        
                        
                        9.06
                        
                        
                        
                        –
                        
                        
                        January,
      2011
                        
                        January,
      2001January,
      2002
                        
                        
                        
                        13,573
                        
                        
                        
                        10.36
                        
                        
                        
                        –
                        
                        
                        January
      2012
                        
                        January,
      2002April,
      2002
                        
                        
                        
                        750
                        
                        
                        
                        13.00
                        
                        
                        
                        –
                        
                        
                        April,
      2012
                        
                        April,
      2002December,
      2003
                        
                        
                        
                        36,500
                        
                        
                        
                        16.75
                        
                        
                        
                        –
                        
                        
                        December,
      2013
                        
                        December,
      2003January,
      2005
                        
                        
                        
                        1,000
                        
                        
                        
                        16.60
                        
                        
                        
                        –
                        
                        
                        January,
      2015
                        
                        January,
      2005March,
      2005
                        
                        
                        
                        21,500
                        
                        
                        
                        17.26
                        
                        
                        
                        –
                        
                        
                        March,
      2015
                        
                        March,
      2005Total
      shares granted
                        
                        
                        
                        90,863
                        
                        
                        
                        
                        
                        
                        $
                        –





(1) The
aggregate intrinsic value of a stock option in the table above represents the
total pre-tax intrinsic value (the amount by which the current market value of
the underlying stock exceeds the exercise price of the option) that would have
been received by the option holders had all option holders exercised their
options on December 31, 2009.  This amount changes based on changes in
the market value of the Corporation’s stock.





At
December 31, 2009, the Corporation had the following options
exercisable:




Fiscal
                              Year
                            
                            
                            Range
      of
                              exercise
      price
                            
                            
                            Weighted
      Average
                              Remaining
                              Contractual
      Life
                            
                            
                            Number
      Options
                              Exercisable
                            
                            
                            Average
                              Exercise
                              Price2000
                            
                            
                            $
                            8.75
                            
                            
                            0.8
      years
                            
                            
                            
                            1,700
                            
                            
                            $
                            8.752001
                            
                            
                            
                            9.06
                            
                            
                            2
      years
                            
                            
                            
                            15,840
                            
                            
                            
                            9.062002
                            
                            
                            
                            10.36-13.00
                            
                            
                            2.6
      years
                            
                            
                            
                            13,573
                            
                            
                            
                            10.502003
                            
                            
                            
                            16.75
                            
                            
                            4
      years
                            
                            
                            
                            750
                            
                            
                            
                            16.752005
                            
                            
                            
                            16.60
                            
                            
                            5
      years
                            
                            
                            
                            36,500
                            
                            
                            
                            16.602005
                            
                            
                            
                            17.26
                            
                            
                            4.9
      years
                            
                            
                            
                            1,000
                            
                            
                            
                            17.2621,500$
                            8.75-$17.26
                            
                            
                            3.8 years
                            
                            
                            
                            90,863
                            
                            
                            $
                            14.44




Options for the two previous fiscal
years were forfeited and exercised as follows:




Stock
                      options
                    
                    
                    Weighted
                      average
                      exerciseOutstanding
      at December 31, 2007
                    
                    
                    110,693
                    
                    
                    $
                    14.59Granted
                    
                    
                    –
                    
                    
                    
                    –Forfeited
                    
                    
                    (9,036
                    )
                    
                    
                    15.64Exercised
                    
                    
                    (7,544
                    )
                    
                    
                    15.57Outstanding
      at December 31, 2008
                    
                    
                    94,113
                    
                    
                    $
                    14.44Granted
                    
                    
                    –
                    
                    
                    
                    –Forfeited
                    
                    
                    (3,250
                    )
                    
                    
                    16.02Exercised
                    
                    
                    –
                    
                    
                    
                    –Outstanding
      at December 31, 2009
                    
                    
                    90,863
                    
                    
                    $
                    14.44




The
intrinsic value of options exercised for the years ended December 31, 2009 and
2008 was $0 and $24,108, respectively.





20.
            Liquidation
      Account, Dividend Restrictions and Regulatory
  Matters





On August
7, 1987, the Bank completed its conversion from a federally chartered mutual
savings and loan association to a federally chartered stock savings and loan
association.  A special liquidation account was established by the
Bank for the pre-conversion retained earnings of approximately $3,718,000. The
liquidation account is maintained for the benefit of depositors who held a
savings or demand account as of the March 31, 1986 eligibility or the June 30,
1987 supplemental eligibility record dates who continue to maintain their
deposits at the Bank after the
conversion.  In the event of a future liquidation (and only in such an
event), each eligible and supplemental eligible account holder who continues to
maintain his or her deposit account will be entitled to receive a
distribution from the liquidation account.  The total amount of
the liquidation account will be decreased in an amount proportionately
corresponding to decreases in the deposit account balances of eligible and
supplemental eligible account holders on each subsequent annual determination
date.  Except for payment of dividends by the Bank to Provident
Community Bancshares and repurchase of the Bank’s stock, the existence of the
liquidation account will not restrict the use or application of such net
worth.


72
  20.
              Liquidation
      Account, Dividend Restrictions and Regulatory Matters
      (continued)




The Bank
is prohibited from declaring cash dividends on its common stock or repurchasing
its common stock if the effect thereof would cause its net worth to be reduced
below either the amount required for the liquidation account or the minimum
regulatory capital requirement.  In addition, the Bank is also
prohibited from declaring cash dividends and repurchasing its own stock without
prior regulatory approval if the total amount of all dividends and stock
repurchases (including any proposed dividends and stock repurchases) for the
applicable calendar year exceeds its current year’s net income plus its retained
net income for the preceding two years. Under current OCC regulations the Bank
is limited in the amount it may loan to affiliates, including the Corporation.
Loans to a single affiliate may not exceed 10%, and the aggregate of loans to
all affiliates may not exceed 20% of bank capital and surplus.





The Bank
and the Corporation are subject to various regulatory capital requirements
administered by banking regulators. Failure to meet minimum capital requirements
can initiate certain mandatory - and possibly additional discretionary - actions
by regulators that, if undertaken, could have a direct material effect on the
Corporation’s financial statements.





Under
capital adequacy guidelines and the regulatory framework for prompt corrective
action, the Bank must meet specific capital guidelines that involve quantitative
measures of the bank’s assets, liabilities, and certain off-balance-sheet items
as calculated under regulatory accounting practices. The Bank’s capital amounts
and classification are also subject to qualitative judgments by the regulators
about components, risk weightings and other factors.





Quantitative
measures established by regulations to ensure capital adequacy require the Bank
and the Corporation to maintain minimum amounts and ratios of total and Tier 1
capital to risk-weighted assets, and of Tier 1 capital to average assets (as
defined in the regulations). Management believes, as of December 31, 2009, that
the Bank and the Corporation meet the capital adequacy requirements to which
they are subject.





As of
December 31, 2009 and 2008, the Bank was “well capitalized” under the regulatory
framework for prompt corrective action based on its capital ratio calculations.
In order to be “well capitalized”, the Bank must maintain minimum total
risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the
following table. There are no conditions or events since December 31, 2009 that
management believes have changed the Bank’s classification.




Under
present regulations of the OCC, the Bank must have core capital (leverage
requirement) equal to 4.0% of assets, of which 1.5% must be tangible capital,
excluding intangible assets.  The Bank must also maintain risk-based
regulatory capital as a percent of risk weighted assets at least equal to 8.0%.
In measuring compliance with capital standards, certain adjustments must be made
to capital and total assets.


73





20.
            Liquidation Account, Dividend
      Restrictions and Regulatory Matters(continued)





The following tables present the total
risk-based, Tier 1 risk-based and Tier 1 leverage requirements for the
Corporation and the Bank (in thousands).





December 31, 2009Actual
                
                
                RegulatoryMinimum
                
                
                “WellCapitalized”Amount
                
                
                Ratio
                
                
                Amount
                
                
                Ratio
                
                
                Amount
                
                
                RatioLeverage
    ratioCorporation
                
                $
                31,511
                
                
                
                6.91
                %
                
                $
                18,234
                
                
                
                4.00
                %
                
                $
                n/a
                
                
                
                n/a
                %Bank
                
                
                32,924
                
                
                
                7.17
                
                
                
                18,364
                
                
                
                4.00
                
                
                
                22,955
                
                
                
                5.00Tier 1 capital
      ratioCorporation
                
                
                31,511
                
                
                
                10.38
                
                
                
                12,140
                
                
                
                4.00
                
                
                
                n/a
                
                
                
                n/aBank
                
                
                32,924
                
                
                
                10.86
                
                
                
                12,125
                
                
                
                4.00
                
                
                
                18,188
                
                
                
                6.00Total risk-based capital
      ratioCorporation
                
                
                38,259
                
                
                
                12.61
                
                
                
                24,279
                
                
                
                8.00
                
                
                
                n/a
                
                
                
                n/aBank
                
                
                36,703
                
                
                
                12.11
                
                
                
                24,251
                
                
                
                8.00
                
                
                
                30,314
                
                
                
                10.00





December 31, 2008Actual
                
                
                RegulatoryMinimum
                
                
                “WellCapitalized”Amount
                
                
                Ratio
                
                
                Amount
                
                
                Ratio
                
                
                Amount
                
                
                RatioLeverage
    ratioCorporation
                
                $
                31,710
                
                
                
                7.46
                %
                
                $
                16,786
                
                
                
                4.00
                %
                
                $
                n/a
                
                
                
                n/a
                %Bank
                
                
                33,698
                
                
                
                8.04
                
                
                
                16,772
                
                
                
                4.00
                
                
                
                20,965
                
                
                
                5.00Tier 1 capital
      ratioCorporation
                
                
                31,710
                
                
                
                10.02
                
                
                
                12,494
                
                
                
                4.00
                
                
                
                n/a
                
                
                
                n/aBank
                
                
                33,698
                
                
                
                10.80
                
                
                
                12,480
                
                
                
                4.00
                
                
                
                18,720
                
                
                
                6.00Total risk-based capital
      ratioCorporation
                
                
                38,710
                
                
                
                12.39
                
                
                
                24,989
                
                
                
                8.00
                
                
                
                n/a
                
                
                
                n/aBank
                
                
                37,634
                
                
                
                12.06
                
                
                
                24,961
                
                
                
                8.00
                
                
                
                31,201
                
                
                
                10.00





Under current Federal Reserve
guidelines, the Corporation includes trust preferred securities in Tier 1
capital.




The Bank is required to maintain
reserves, in the form of cash and balances with the Federal Reserve Bank,
against its deposit liabilities. The amounts of such reserves totaled
$4.8 millionat December 31, 2009and $2.5 million at December 31,
2008.





21.
            Recently Issued Accounting
      Standards





The following is a summary of recent
authoritative pronouncements thatmayaffect accounting, reporting, and
disclosure of financial information by the Corporation:





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





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




74




21.
              Recently Issued Accounting
      Standards (continued)




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





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





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




75




22.
            Provident Community Bancshares,
      Inc.Financial
      Information


(Parent Corporation
Only)





Condensed financial information forProvident Community
Bancsharesis presented as
follows (in thousands):


As of December 31,2009
                                      
                                      
                                      2008Condensed
      Balance SheetsAssets:Cash and due from
      banks
                                      
                                      $
                                      1,638
                                      
                                      
                                      $
                                      1,173Investment in
      subsidiary
                                      
                                      
                                      36,565
                                      
                                      
                                      
                                      34,849Other
                                      
                                      
                                      380
                                      
                                      
                                      
                                      379Total
assets
                                      
                                      $
                                      38,583
                                      
                                      
                                      $
                                      36,401Liabilities and Shareholders’
      Equity:Accrued interest
      payable
                                      
                                      $
                                      90
                                      
                                      
                                      $
                                      105Floating rate junior subordinated
      deferrable interest debentures
                                      
                                      
                                      12,372
                                      
                                      
                                      
                                      12,372Shareholders’
      equity
                                      
                                      
                                      26,121
                                      
                                      
                                      
                                      23,924Total liabilities and
      shareholders’ equity
                                      
                                      $
                                      38,583
                                      
                                      
                                      $
                                      36,401





Years Ended December 31,2009
                          
                          
                          2008Condensed Statements of
      Income(Loss)Equity in undistributed earnings
      (losses) of subsidiary
                          
                          $
                          (6,774
                          )
                          
                          $
                          412Interest
      expense
                          
                          
                          (530
                          )
                          
                          
                          (721
                          )Other expense,
      net
                          
                          
                          (87
                          )
                          
                          
                          (88
                          )Net loss
                          
                          $
                          (7,391
                          )
                          
                          $
                          (397
                          )Condensed Statements of Cash
      FlowsOperating
      Activities:Net loss
                          
                          $
                          (7,391
                          )
                          
                          $
                          (397
                          )Adjustments to reconcile net loss
      to net cash used in operating activities:Equity in undistributed earnings
      (losses) of subsidiary
                          
                          
                          6,774
                          
                          
                          
                          (412
                          )Increase (decrease)  in
      other assets and liabilities, net
                          
                          
                          (16
                          )
                          
                          
                          (10
                          )Net cash used in operating
      activities
                          
                          
                          (633
                          )
                          
                          
                          (819
                          )Investing
      Activities:Capital contribution to
      subsidiary
                          
                          
                          (7,766
                          )
                          
                          
                          —Net cash used in investing
      activities
                          
                          
                          (7,766
                          )
                          
                          
                          —Financing
      Activities:Dividends received from
      subsidiary
                          
                          
                          —
                          
                          
                          
                          2,900Dividend reinvestment plan
      contributions
                          
                          
                          16
                          
                          
                          
                          120Issuance of preferred
      stock
                          
                          
                          9,240
                          
                          
                          
                          —Issuance of common stock
      warrants
                          
                          
                          25
                          
                          
                          
                          —Preferred stock dividends
      paid
                          
                          
                          (310
                          )
                          
                          
                          —Cash dividends
      paid
                          
                          
                          (107
                          )
                          
                          
                          (821
                          )Share repurchase
      program
                          
                          
                          —
                          
                          
                          
                          (345
                          )Proceeds from the exercise of
      stock options
                          
                          
                          —
                          
                          
                          
                          2Net cash provided by financing
      activities
                          
                          
                          8,864
                          
                          
                          
                          1,856Net increase  in cash
      and due from banks
                          
                          
                          465
                          
                          
                          
                          1,037Cash and due from banks at
      beginning of  period
                          
                          
                          1,173
                          
                          
                          
                          136Cash and due from banks at end of
      period
                          
                          $
                          1,638
                          
                          
                          $
                          1,173




76




23.
            Quarterly Financial
      Data(unaudited)




The tables set forth below summarize
selected financial data regarding results of operations for the periods
indicated (in thousands, except common share data).





FortheyearendedDecember31,2009<
;/f
    ont>First
                  quarter
                
                
                Second
                  Quarter
                
                
                Third
                  Quarter
                
                
                Fourth
                  quarter
                
                
                TotalInterest
    income
                
                $
                5,138
                
                
                $
                5,344
                
                
                $
                5,352
                
                
                $
                5,065
                
                
                $
                20,899Interest
      expense
                
                
                3,027
                
                
                
                3,003
                
                
                
                2,898
                
                
                
                2,665
                
                
                
                11,593Net interest
      income
                
                
                2,111
                
                
                
                2,341
                
                
                
                2,454
                
                
                
                2,400
                
                
                
                9,306Provision for loan
      losses
                
                
                2,700
                
                
                
                925
                
                
                
                1,425
                
                
                
                3,645
                
                
                
                8,695Non-interest
      income
                
                
                480
                
                
                
                270
                
                
                
                413
                
                
                
                (1,129
                )
                
                
                34Non-interest
      expense
                
                
                2,516
                
                
                
                2,617
                
                
                
                2,480
                
                
                
                4,434
                
                
                
                12,047Provision(benefit)for income
      taxes
                
                
                (930
                )
                
                
                (364
                )
                
                
                (402
                )
                
                
                (2,315
                )
                
                
                (4,011
                )Preferred stock dividends and
      accretion
                
                
                25
                
                
                
                118
                
                
                
                119
                
                
                
                120
                
                
                
                382(Loss) income available to common
      shareholders
                
                $
                (1,720
                )
                
                $
                (685
                )
                
                $
                (755
                )
                
                $
                (4,613
                )
                
                $
                (7,773
                )Netloss incomeper common
      share—Basic
                
                $
                (0.95
                )
                
                $
                (0.32
                )
                
                $
                (0.42
                )
                
                $
                (2.65
                )
                
                $
                (4.34
                )Netloss incomeper common
      share—Diluted
                
                $
                (0.95
                )
                
                $
                (0.32
                )
                
                $
                (0.42
                )
                
                $
                (2.65
                )
                
                $
                (4.34
                )





For the year ended December 31,
      2008First
                  quarter
                
                
                Second
                  Quarter
                
                
                Third
                  Quarter
                
                
                Fourth
                  quarter
                
                
                TotalInterest
    income
                
                $
                6,175
                
                
                $
                5,700
                
                
                $
                5,533
                
                
                $
                5,377
                
                
                $
                22,785Interest
      expense
                
                
                3,673
                
                
                
                3,236
                
                
                
                3,137
                
                
                
                3,160
                
                
                
                13,206Net interest
      income
                
                
                2,502
                
                
                
                2,464
                
                
                
                2,396
                
                
                
                2,217
                
                
                
                9,579Provision for loan
      losses
                
                
                310
                
                
                
                365
                
                
                
                615
                
                
                
                2,920
                
                
                
                4,210Non-interest
      income
                
                
                885
                
                
                
                850
                
                
                
                1,062
                
                
                
                887
                
                
                
                3,684Non-interest
      expense
                
                
                2,522
                
                
                
                2,550
                
                
                
                2,456
                
                
                
                2,518
                
                
                
                10,046Provision(benefit)for income
      taxes
                
                
                134
                
                
                
                83
                
                
                
                81
                
                
                
                (894
                )
                
                
                (596
                )Net income(loss)
                
                $
                421
                
                
                $
                316
                
                
                $
                306
                
                
                $
                (1,440
                )
                
                $
                (397
                )Net income(loss)per common
      share—Basic
                
                $
                0.24
                
                
                $
                0.18
                
                
                $
                0.17
                
                
                $
                (0.81
                )
                
                $
                (0.22
                )Net income(loss)per common
      share—Diluted
                
                $
                0.23
                
                
                $
                0.18
                
                
                $
                0.17
                
                
                $
                (0.81
                )
                
                $
                (0.22
                )





24.
            Subsequent
      Events





The Corporation has evaluated events
and transactions through the filing date for potential recognition or disclosure
in the consolidated financial statements and has determined there are no
subsequent events to disclose.




Item 9.  Changes
In and Disagreements With Accountants on Accounting and Financial
Disclosure





Not applicable.





Item
9A(T).   Controls and Procedures





(a)
            Disclosure
      Controls and Procedures





The Company’s management, including the
Company’s principal executive officer and principal financial officer, have
evaluated the effectiveness of the Company’s “disclosure controls and
procedures,” as such term is defined in Rule 13a-15(e) promulgated under the
Securities Exchange Act of 1934, as amended, (the “Exchange
Act”).  Based upon their evaluation, the principal executive officer
and principal financial officer concluded that, as of the end of the period
covered by this report, the Company’s disclosure controls and procedures were
effective for the purpose of ensuring that the information required to be
disclosed in the reports that the Company files or submits under the Exchange
Act with the Securities and Exchange Commission (the “SEC”) (1) is recorded,
processed, summarized and reported within the time periods specified in the
SEC’s rules and forms, and (2) is accumulated and communicated to the Company’s
management, including its principal executive and principal financial officers,
as appropriate to allow timely decisions regarding required
disclosure.




77




(b)
            Internal
      Controls Over Financial Reporting





Management’s annual report on internal
control over financial reporting is incorporated herein by reference to the
Company’s audited Consolidated Financial Statements in this Annual Report on
Form 10-K.





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





(c)
            Changes
      to Internal Control Over Financial
Reporting





Except as indicated herein, there were
no changes in the Company’s internal control over financial reporting during the
three months ended December 31, 2009 that have materially affected, or are
reasonable likely to materially affect, the Company’s internal control over
financial reporting.





(See Item
8. Financial Statements and Supplementary Data for additional information
regarding management’s report on internal control over financial
reporting.)





Item
9B.   Other Information





None.


PART
III





Item
10.  Directors, Executive Officers and Corporate
Governance





Directors





For information concerning the Board of
Directors of Provident Community Bancshares, the information contained under the
section captioned “Items to be Voted on By Shareholders — Item 1 — Election of
Directors” in the Proxy Statement is incorporated herein by
reference.





Compliance
with Section 16(a) of the Exchange Act





Reference is made to the cover page of
this Form 10-K and to the section captioned “Other Information Relating to
Directors and Executive Officers — Section 16(a) Beneficial Ownership
Reporting Compliance” for information regarding compliance with section 16(a) of
the Exchange Act.





Code
of Ethics





For information concerning the
Corporation’s code of ethics, the information contained under the section
captioned “Corporate Governance — Code of Ethics and Business Conduct” in the
Proxy Statement is incorporated herein by reference. A copy of the code of
ethics is available, in the Investor Relations Section of our website at
www.providentonline.com.





Executive
Officers of the Registrant





Certain executive officers of the Bank
also serve as executive officers of Provident Community
Bancshares.  The day-to-day management duties of the executive
officers of Provident Community Bancshares and the Bank relate primarily to
their duties as to the Bank.  The executive officers of Provident
Community Bancshares currently are as follows:




78




Name
              
              Age(1)
              
              Position as of
                December 31, 2009Dwight
      V. Neese
              
              59
              
              President,
      Chief Executive Officer and DirectorRichard
      H. Flake
              
              61
              
              Executive
      Vice President – Chief Financial OfficerLud
      W. Vaughn
              
              59
              
              Executive
      Vice President – Chief Operating
Officer





(1)
            At
      December 31, 2009.





Dwight V. Neese was appointed
as President and Chief Executive Officer of the Bank effective September 5,
1995.





Richard H. Flake joined the
Company in September 1995.





Lud W. Vaughnjoined the
Company in April 2003. Prior to joining the Company, Mr. Vaughn was Senior Vice
President for Bank of America in Rock Hill, South Carolina.





Corporate
Governance





Information concerning the audit
committee and the audit committee financial expert and other corporate
governance matters is incorporated herein by reference to the section titled
“Corporate Governance — Committees of the Board of Directors” and “— Audit
Committee” in the Proxy Statement.





Item 
11.  Executive Compensation





The information contained under the
sections captioned “Executive Compensation” and “Corporate Governance-Director
Compensation” in the Proxy Statement is incorporated herein by
reference.





Item 12.  Security
Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters





(a)            Security
Ownership of Certain Beneficial Owners





Information required by this item is
incorporated herein by reference to the section captioned “Stock Ownership” in
the Proxy Statement.





(b)           Security
Ownership of Management





Information required by this item is
incorporated herein by reference to the section captioned “Stock Ownership” in
the Proxy Statement.





(c)           Management
of Provident Community Bancshares knows of no arrangements, including any pledge
by any person of securities of Provident Community Bancshares, the operation of
which may at a subsequent date result in a change in control of the
registrant.




79




(d)           Equity
Compensation Plan Information





The following table sets forth
information about the Company common stock that may be issued upon the exercise
of stock options, warrants and rights under all of the Company’s equity
compensation plans as of December 31, 2009.





(a)
                            
                            
                            (b)
                            
                            
                            (c)Plan category
                            
                            Number of securities
                              to be issued upon exercise
                              of outstanding options,
                              warrants and rights
                            
                            
                            Weighted-average
                              exercise price of
                              outstanding options,
                              warrants and rights
                            
                            
                            Number of securities
                              remaining available for
                              future issuance under
                              equity compensation
                              plans (excluding securities
                              reflected in column (a))Equity
      compensation plans approved by security holders
                            
                            
                            90,863
                            
                            
                            $
                            14.39
                            
                            
                            
                            157,373Equity
      compensation plans not approved by security holdersTotal
                            
                            
                            90,863
                            
                            
                            $
                            14.39
                            
                            
                            
                            157,273





Item 13.  Certain
Relationships and Related Transactions, and Director
Independence





Transactions
with Related Persons





The information required by this item
is incorporated herein by reference to the sections captioned “Other Information
Relating to Director and Executive Officers—Policies and Procedures for Approval
of Related Person Transactions” and “—Transactions with Related Persons” in the
Proxy Statement.





Director
Independence





Information concerning director
independence is incorporated herein by reference to the section titled
“Corporate Governance—Director Independence” in the Proxy
Statement.





Item
14.   Principal Accountant Fees and Services





The information required by this Item
is incorporated herein by reference to the section captioned “Items to be Voted
On By Stockholders—Item 3—Ratification of the Appointment of the Independent
Registered Public Accounting Firm” in the Proxy Statement.




80




PART
IV





Item
15.   Exhibits





Exhibit
                No.
              
              Description
              
              Incorporated by Reference to3(a)
              
              Amended
      and Restated Certificate of Incorporation
              
              Form
      10-Q for the quarterly period ended June 30, 2006, as filed on August 9,
      20063(b)
              
              Bylaws
              
              Form
      10-K for the year ended December 31, 2008, as filed on March 26,
      20094(a)
              
              Certificate
      of Designations establishing Fixed Rate Cumulative Perpetual Preferred
      Stock, Series A, of Provident Community Bancshares
              
              Form
      8-K as filed on March 3, 20094(b)
              
              Form
      of stock certificate for Fixed Rate Cumulative Perpetual Preferred Stock,
      Series A
              
              Form
      8-K as filed on March 3, 20094(c)
              
              Warrant
      to purchase 179,100 Share of Common Stock of Provident Community
      Bancshares, Inc.
              
              Form
      8-K as filed on March 3, 200910(a)
              
              Employment
      Agreement with Dwight V. Neese
              
              Form
      10-KSB for the year ended September 30, 2003, as filed on December 19,
      200310(b)
              
              Employment
      Agreement with Richard H. Flake
              
              Form
      10-KSB for the year ended September 30, 2003, as filed on December 19,
      200310(c)
              
              (Form
      of First Amendment to the Employment Agreement by and between Provident
      Community Bancshares, Inc., Provident Community Bank and each of Dwight V.
      Neese and Richard R. Flake
              
              Form
      10-K for the year ended December 31, 2008, as filed on March 26,
      200910(d)
              
              Provident
      Community Bancshares, Inc. 1995 Stock Option Plan
              
              Definitive
      Proxy Statement as filed on December 22, 199510(e)
              
              Provident
      Community Bancshares, Inc. 2001 Stock Option Plan
              
              Definitive
      Proxy Statement as filed on December 22, 200010(f)
              
              Provident
      Community Bancshares, Inc. 2006 Stock Option Plan
              
              Definitive
      Proxy Statement as filed on March 20, 200610(g)
              
              Amended
      and Restated Change in Control Agreement by and among Lud W. Vaughn,
      Provident Community Bank, N.A. and Provident Community Bancshares,
      Inc.
              
              Form
      10-Q for the quarterly period ended June 30, 2007, as filed on August 13,
      200710(h)
              
              Form
      of First Amendment to the Amended and Restated Change in Control Agreement
      by and between Provident Community Bancshares, Inc., Provident Community
      Bank and Lud W. Vaughn
              
              Form
      10-K for the year ended December 31, 2008, as filed on March 26,
      200910(i)
              
              Supplemental
      Executive Retirement Plan, by and between Dwight V. Neese and Provident
      Community Bank
              
              Form
      10-Q for the quarterly period ended March 31, 2007, as filed on May 14,
      200710(j)
              
              Supplemental
      Executive Retirement Plan #2, by and between Dwight V. Neese and Provident
      Community Bank
              
              Form
      10-Q for the quarterly period ended March 31, 2007, as filed on May 14,
      200710(k)
              
              Supplemental
      Executive Retirement Plan, by and between Richard H. Flake and Provident
      Community Bank
              
              Form
      10-Q for the quarterly period ended March 31, 2007, as filed on May 14,
      200710(l)
              
              Supplemental
      Executive Retirement Plan #2, by and between Richard H. Flake and
      Provident Community Bank
              
              Form
      10-Q for the quarterly period ended March 31, 2007, as filed on May 14,
      200710(m)
              
              Supplemental
      Executive Retirement Plan, by and between Lud W. Vaughn and Provident
      Community Bank
              
              Form
      10-Q for the quarterly period ended June 30, 2007, as filed on August 13,
      2007




81




10(n)
              
              Form
      of Second Amendment to the Employment Agreement by and between Provident
      Community Bancshares, Inc., (formerly Union Financial Bancshares, Inc.)
      Provident Community Bank and each of Dwight V. Neese and Richard R.
      Flake
              
              Form
      10-K for the year ended December 31, 2008, as filed on March 26,
      200910(o)
              
              Form
      of First Amendment to the Amended and Restated Change in Control Agreement
      by and between Provident Community Bancshares, Inc., (formerly Union
      Financial Bancshares, Inc.) Provident Community Bank and Lud W.
      Vaughn
              
              Form
      10-K for the year ended December 31, 2008, as filed on March 26,
      200921
              
              Subsidiaries
      of the Registrant23
              
              Consent
      of Independent Auditor31(a)
              
              Rule
      13a-14(a)/15d-14(a) Certification of Chief Executive
    Officer31(b)
              
              Rule
      13a-14(a)/15d-14(a) Certification of Chief Financial
    Officer32
              
              Section
      1350 Certifications99(a)
              
              Principal
      Executive Officer Certification Regarding TARP99(b)
              
              Principal
      Financial Officer Certification Regarding TARP




82




SIGNATURES





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





PROVIDENT
      COMMUNITY BANCSHARES, INC.Date:
              March
      16, 2010
              
              By:
              /s/ Dwight V. NeeseDwight
      V. NeesePresident
      and Chief Executive Officer





In accordance with the Exchange Act,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.





By:
                  /s/ Dwight V. Neese
                  
                  By:
                  /s/ Russell H. SmartDwight
      V. Neese
                  
                  
                  Russell
      H. Smart(Principal
      Executive Officer)
                  
                  
                  DirectorDate:
                  March
      16, 2010
                  
                  Date:
                  March
      16, 2010By:
                  /s/ Richard H. Flake
                  
                  By:
                  /s/ Phillip C. WilkinsRichard
      H. Flake
                  
                  
                  Phillip
      C. Wilkins(Principal
      Financial and
                  
                  
                  DirectorAccounting
      Officer)Date:
                  March
      16, 2010
                  
                  Date:
                  March
      16, 2010By:
                  /s/ Robert H. BreakfieldRobert
      H. BreakfieldDirectorDate:
                  March
      16, 2010By:
                  /s/ William M. GrahamWilliam
      M. GrahamDirectorDate:
                  March
      16, 2010By:
                  /s/ Carl L. MasonCarl
      L. MasonDirectorDate:
                  March
      16, 2010




83