** **

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-K**

 

**(Mark One)**

 

| **x** | **Annual Report Pursuant to   Section 13 or 15(d) of the Securities Exchange Act of 1934** |
|-------|------------------------------------------------------------------------------------------------------|

 

**For the fiscal year ended December 31, 2010**

 

**or**

 

| **o** | **Transition Report Pursuant to   Section 13 or 15(d) of the Securities Exchange Act of 1934** |
|-------|----------------------------------------------------------------------------------------------------------|

 

**For the transition period from            to           **

 

**Commission file number 000-52592**

 

**Congaree Bancshares, Inc.**

(Exact name of registrant as specified in its charter)

 

| **South Carolina**                       |   | **20-1734180**                       |
|------------------------------------------|--------|--------------------------------------|
| (State of Incorporation)                 |   | (I.R.S. Employer Identification No.) |
|                                     |   |                                 |
| **1201 Knox Abbott Drive, Cayce, SC**    |   | **29033**                            |
| (Address of principal executive offices) |   | (Zip Code)                           |

 

**(803) 794-2265**

(Issuer’s Telephone Number)

 

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

 

Securities registered under Section 12(g) of the Exchange Act:

 

Title of each class: **Common Stock, $0.01 par value per share**

 

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

 

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

 

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

 

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

 

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

 

The aggregate market value of the voting and nonvoting common equity held by non-affiliates of the registrant (computed by reference to the price at which the stock was most recently sold) was $6,175,536 as of the last business day of the registrant’s most recently completed second fiscal quarter.

 

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

 

| Large accelerated filer o                                              |   | Accelerated filer o         |
|-----------------------------------------------------------------------------|--------|----------------------------------|
|                                                                        |   |                             |
| Non-accelerated filer o

(Do not check if a smaller reporting company) |   | Smaller reporting company x |

 

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.

 

| **Class**                              | ** ** | **Outstanding at March 31, 2011** |
|----------------------------------------|------------|-------------------------------------------------------|
| Common Stock, $.01 par value per share |       | 1,764,439 shares                                      |

 

**DOCUMENTS INCORPORATED BY REFERENCE**

 

Proxy Statement for the Annual Meeting of Shareholders to be held on May 25, 2011 Part III (Items 10-14)

 

 

 

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**Part I**

 

**Item 1.  Business**

 

This report contains statements which constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.  Forward-looking statements may relate to our financial condition, results of operation, plans, objectives, or future performance. These statements are based on many assumptions and estimates and are not guarantees of future performance.  Our actual results may differ materially from those anticipated in any forward-looking statements, as they will depend on many factors about which we are unsure, including many factors which are beyond our control.  The words “may,” “would,” “could,” “will,” “expect,” “anticipate,” “believe,” “intend,” “plan,” and “estimate,” as well as similar expressions, are meant to identify such forward-looking statements.  Potential risks and uncertainties include, but are not limited to, those described below under “Risk Factors” and the following:

 

·                  reduced earnings due to higher credit losses generally and specifically because losses in the sectors of our loan portfolio secured by real estate are greater than expected due to economic factors, including declining real estate values, increasing interest rates, increasing unemployment, or changes in payment behavior or other factors;

·                  reduced earnings due to higher credit losses because our loans are concentrated by loan type, industry segment, borrower type, or location of the borrower or collateral;

·                  restrictions or conditions imposed by our regulators on our operations may make it more difficult for us to achieve our goals;

·                  our non-payment of dividends on preferred stock issued to the U.S. Treasury under the Capital Purchase Program component of the Troubled Asset Relief Program;

·                  our efforts to raise capital or otherwise increase our regulatory capital ratios;

·                  our ability to retain our existing customers, including our deposit relationships;

·                  changes in deposit flows;

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

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

·                  changes in political conditions or the legislative or regulatory environment, including the effect of recent financial reform legislation on the banking industry;

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

·                  changes occurring in business conditions and inflation;

·                  increased funding costs due to market illiquidity, increased competition for funding, and/or increased regulatory requirements with regard to funding;

·                  changes in technology;

·                  changes in monetary and tax policies;

·                  the adequacy of the level of our allowance for loan losses and the amount of loan loss provisions required in future periods;

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

·                  the rates of loan growth;

·                  the amount of our loan portfolio collateralized by real estate, and the weakness in the real estate market;

·                  our reliance on available secondary funding sources such as FHLB advances, Federal Reserve Discount Window borrowings, sales of securities and loans, and federal funds lines of credit from correspondent banks to meet our liquidity needs;

·                  our ability to maintain effective internal control over financial reporting;

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

·                  changes in monetary and tax policies, including confirmation of the income tax refund claims received by the Internal Revenue Service (“IRS”);

·                  loss of consumer confidence and economic disruptions resulting from terrorist activities or other military activity;

·                  changes in the securities markets; and

·                  other risks and uncertainties detailed in Part I, Item 1A of this Annual Report on Form 10-K and from time to time in our filings with the Securities and Exchange Commission (“SEC”).

 

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These risks are exacerbated by the recent developments in national and international financial markets, and we are unable to predict what impact these uncertain market conditions will have on us.  For more than three years, the capital and credit markets have experienced extended volatility and disruption.  There can be no assurance that these unprecedented developments will not continue to materially and adversely impact our business, financial condition, and results of operations, as well as our ability to raise capital or other funding for liquidity and business purposes.

 

We have based our forward-looking statements on our current expectations about future events. Although we believe that the expectations reflected in our forward-looking statements are reasonable, we cannot guarantee that these expectations will be achieved. We undertake no obligation to publicly update or otherwise revise any forward-looking statements whether as a result of new information, future events, or otherwise.

 

**General**

 

Congaree Bancshares, Inc. (the “Company”) is a South Carolina corporation organized in November 2005 to operate as a bank holding company pursuant to the Federal Bank Holding Company Act of 1956 and the South Carolina Bank Holding Company Act, and to own and control all of the capital stock of Congaree State Bank (the “Bank”).  The Bank opened for business on October 16, 2006.  The Bank currently maintains a main office at 1201 Knox Abbott Drive, Cayce, South Carolina.  We opened a second office located at 2023 Sunset Boulevard, West Columbia, South Carolina in 2009.

 

Our assets consist primarily of our investment in the Bank and liquid investments. Our primary activities are conducted through the Bank.  As of December 31, 2010, our consolidated total assets were $121,176,715, our consolidated total loans were $90,335,609, our consolidated total deposits were $106,585,992, and our consolidated total shareholders’ equity was approximately $11,176,648.

 

Our net income is dependent primarily on our net interest income, which is the difference between the interest income earned on loans, investments, and other interest-earning assets and the interest paid on deposits and other interest-bearing liabilities.  To a lesser extent, our net income also is affected by our noninterest income derived principally from service charges and fees and income from the sale and/or servicing of financial assets such as loans and investments, as well as the level of noninterest expenses such as salaries, employee benefits and occupancy costs.

 

Our operations are significantly affected by prevailing economic conditions, competition, and the monetary, fiscal, and regulatory policies of governmental agencies.  Lending activities are influenced by a number of factors, including the general credit needs of individuals and small and medium-sized businesses in our market areas, competition among lenders, the level of interest rates, and the availability of funds.  Deposit flows and costs of funds are influenced by prevailing market rates of interest, primarily the rates paid on competing investments, account maturities, and the levels of personal income and savings in our market areas.

 

**Marketing Focus**

 

Congaree State Bank is a locally-owned and operated bank organized to serve consumers and small- to medium-sized businesses and professional concerns.  A primary reason for operating the Bank lies in our belief that a community-based bank, with a personal focus, can better identify and serve local relationship banking needs than can a branch or subsidiary of larger outside banking organizations.  We believe that we can be successful by offering a higher level of customer service and a management team more focused on the needs of the community than most of our competitors.  We believe that this approach will be enthusiastically supported by the community. Our foundation is to remain true to our values.

 

**Banking Services**

 

The Bank is primarily engaged in the business of accepting demand and time deposits and providing commercial, consumer and mortgage loans to the general public.  Deposits in the Bank are insured by the Federal Deposit Insurance Corporation (the “FDIC”) up to a maximum amount, which was recently permanently increased to $250,000 under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”).  Other services which the Bank offers include online banking, commercial cash management, remote deposit capture, safe deposit boxes, bank official checks, traveler’s checks, and wire transfer capabilities.

 

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**Location and Service Area**

 

Our primary service area consists of Lexington and Richland Counties, with a primary focus on an area within a 15 mile radius of our main office in West Columbia, South Carolina.  Our Sunset office is located in West Columbia on a major artery that connects Columbia with Lexington.  We opened the Sunset office in January 2009. The site is located approximately one mile east of the Lexington Medical Center and provides excellent visibility for the Bank.

 

Our primary service area consists of Lexington and Richland Counties, South Carolina.  With its central location in the state and convenient access to I-20, I-26, and I-77, this area is considered one of the fastest growing areas in South Carolina.  Home to the state capital, the University of South Carolina, and a variety of service-based and light manufacturing companies, this area provides a growing and diverse economy.  Lexington Medical Center, Lexington County’s largest employer, has approximately 3,800 employees and continues to expand.  The other top employers in Lexington County include Michelin Tire Corporation, Allied-Signal Corporation, United Parcel Service, and NCR Corporation.  The amenities and opportunities that our primary service area offers are wide-ranging from housing, education, healthcare, shopping, recreation, and culture.  We believe these factors make the quality of life in the area attractive.

 

Our primary service area has also experienced solid population growth.  From 2000 to 2009 Lexington County’s population increased by 18.3% (an increase of 39,597 people), for a ranking of seventh among the 46 counties in South Carolina in terms of population growth over the last decade.  Based on a 2009 estimate, Lexington County ranks sixth as far as the largest counties, amongst the top ten in the State. The County added 46,377 residents for a 21.4% increase in population for a total of 262,391 residents.  As of June 30, 2010, the Bank maintained a 3.83% deposit market share in Lexington County. As of June 30, 2010, our market share in Cayce, South Carolina is 19.95% and our market share in West Columbia, South Carolina is 13.97%.

 

Despite being in what we believe is one of the best markets in South Carolina, we face the risk of being particularly sensitive to changes in the state and local economies.  South Carolina has not been immune to the economic challenges of the past two years.  Unemployment has been rising in our markets and property values have declined.  Continued higher levels of unemployment will continue to impact credit quality.  As a result, we are spending significant time on credit solutions for our customers and managing and disposing of real estate acquired in settlement of loans as effectively as possible.  The weakening in the state and local economies has impacted our loan demand and, to a lesser extent, available deposits.

 

See Item 1A. Risk Factors for a discussion regarding the material risks and uncertainties that may impact our market.

 

**Lending Activities**

 

We emphasize a range of lending services, including real estate, commercial, and equity-line and consumer loans to individuals, small- to medium-sized businesses, and professional concerns that are located in or conduct a substantial portion of their business in our Bank’s primary service area.  We compete for these loans with competitors who are well established in our service area and have greater resources and lending limits.  As a result, we may have to charge lower interest rates to attract borrowers.

 

The well established banks in our service area will likely make proportionately more loans to medium- to large-sized businesses than we will.  Many of the Bank’s anticipated commercial loans will likely be made to small- to medium-sized businesses which may be less able to withstand competitive, economic, and financial conditions than larger borrowers. At December 31, 2010, we had net loans of $88,783,548 million, representing 73.3% of our total assets.

 

*Loan Approval and Review.*  Certain credit risks are inherent in making loans.  These include prepayment risks, risks resulting from uncertainties in the future value of collateral, risks resulting from changes in economic and industry conditions, and risks inherent in dealing with individual borrowers.  We attempt to mitigate repayment risks by adhering to internal credit policies and procedures.  The Bank’s loan approval policies provide for various levels of officer lending authority.  When the amount of aggregate loans to a single borrower exceeds any individual officer’s lending authority, the loan request is considered and approved by an officer with a higher lending limit or the board of directors’ loan committee.  The Bank’s lending staff and credit administration meets on a bi-monthly basis to help identify and discuss potential problem loans.  The Bank does not make any loans to any director of the 

 

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Bank unless the loan is approved by the board of directors of the Bank and is made on terms not more favorable to the person than would be available to a person not affiliated with the Bank.  The Bank currently adheres to Federal National Mortgage Association and Federal Home Loan Mortgage Corporation guidelines in its mortgage loan review process, but may choose to alter this policy in the future.  The Bank sells residential mortgage loans that it originates in the secondary market.

 

*Allowance for Loan Losses.*  We maintain an allowance for loan losses, which we establish through a provision for loan losses charged against income.  We charge loans against this allowance when we believe that the collectibility of the principal is unlikely.  The allowance is an estimated amount that we believe is adequate to absorb losses inherent in the loan portfolio based on evaluations of its collectibility.  As of December 31, 2010, our allowance for loan losses was approximately 1.54% of the average outstanding balance of our loans, based on our consideration of several factors, including regulatory guidelines, mix of our loan portfolio, and evaluations of local economic conditions as well as peer data.  Over time, we will periodically determine the amount of the allowance based on our consideration of several factors, including:

 

·                  an ongoing review of the quality, mix, and size of our overall loan portfolio;

·                  our historical loan loss experience;

·                  evaluation of economic conditions;

·                  specific problem loans and commitments that may affect the borrower’s ability to pay;

·                  regular reviews of loan delinquencies and loan portfolio quality by our internal auditors and our bank regulators; and

·                  the amount and quality of collateral, including guarantees, securing the loans.

 

*Lending Limits.*  The Bank’s lending activities are subject to a variety of lending limits imposed by federal law.  In general, the Bank is subject to a legal limit on loans to a single borrower equal to 15% of the Bank’s capital and unimpaired surplus.  Different limits may apply based on the type of loan or the nature of the borrower, including the borrower’s relationship to the Bank.  These limits will increase or decrease as the Bank’s capital increases or decreases.  Unless the Bank is able to sell participations in its loans to other financial institutions, the Bank will not be able to meet all of the lending needs of loan customers requiring aggregate extensions of credit above these limits.

 

*Credit Risk*.  The principal credit risk associated with each category of loans is the creditworthiness of the borrower.  Borrower creditworthiness is affected by general economic conditions and the strength of the manufacturing, services, and retail market segments.  General economic factors affecting a borrower’s ability to repay include interest, inflation, and employment rates and the strength of local and national economy, as well as other factors affecting a borrower’s customers, suppliers, and employees.

 

*Real Estate Loans. *One of the primary components of our loan portfolio is loans secured by first or second mortgages on real estate.  As of December 31, 2010, loans secured by first or second mortgages on real estate made up approximately $79,701,385, or 88.2% of our loan portfolio.  These loans will generally fall into one of two categories: real estate — mortgage and real estate — construction.  These categories are discussed in more detail below, including their specific risks.  Interest rates for all categories may be fixed or adjustable, and will more likely be fixed for shorter-term loans.  The Bank will generally charge an origination fee for each loan.

 

Real estate loans are subject to the same general risks as other loans.  Real estate loans are also sensitive to fluctuations in the value of the real estate securing the loan.  On first and second mortgage loans we typically do not advance more than regulatory limits.  We will require a valid mortgage lien on all real property loans along with a title lien policy which insures the validity and priority of the lien.  We will also require borrowers to obtain hazard insurance policies and flood insurance, if applicable.  Additionally, certain types of real estate loans have specific risk characteristics that vary according to the collateral type securing the loan and the terms and repayment sources for the loan.

 

We will have the ability to originate some real estate loans for sale into the secondary market.  We can limit our interest rate and credit risk on these loans by locking the interest rate for each loan with the secondary investor and receiving the investor’s underwriting approval prior to originating the loan.

 

·                  *Real Estate - Mortgage*.  Loans secured by real estate mortgages are the principal component of our loan portfolio.  These loans generally fall into one of two categories: residential real estate loans and commercial real estate loans.

 

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·                  *Residential Real Estate Loans. *At December 31, 2010, our individual residential real estate loans ranged in size from $2,540 to $1,148,673, with an average loan size of approximately $85,721.  These loans generally have longer terms of up to 30 years.  We offer fixed and adjustable rate mortgages, and we intend to sell most, if not all, of the residential real estate loans that we generate in the secondary market soon after we originate them.  We do not intend to retain servicing rights for these loans.  Inherent in residential real estate loans’ credit risk is the risk that the primary source of repayment, the residential borrower, will be unable to service the debt.  If a real estate loan is in default, we also run the risk that the value of a residential real estate loan’s secured real estate will decrease, and thereby be insufficient to satisfy the loan.  To mitigate these risks, we will evaluate each borrower on an individual basis and attempt to determine their credit profile.  By selling these loans in the secondary market, we can significantly reduce our exposure to credit risk because the loans will be underwritten through a third party agent without any recourse against the Bank.  At December 31, 2010, residential real estate loans (other than construction loans) totaled $39,988,999, or 44.3% of our loan portfolio.

 

·                  *Commercial Real Estate Loans*.  At December 31, 2010, our individual commercial real estate loans ranged in size from $1,591 to $1,567,949, with an average loan size of approximately $240,339.  Commercial real estate loans generally have terms of five years or less, although payments may be structured on a longer amortization basis.  Inherent in commercial real estate loans’ credit risk is the risk that the primary source of repayment, the operating commercial real estate company, will be insufficient to service the debt.  If a real estate loan is in default, we also run the risk that the value of a commercial real estate loan’s secured real estate will decrease, and thereby be unable to satisfy the loan.  To mitigate these risks, we evaluate each borrower on an individual basis and attempt to determine its business risks and credit profile.  We attempt to reduce credit risk in the commercial real estate portfolio by emphasizing loans on owner-occupied office and retail buildings where the loan-to-value ratio is established by independent appraisals.  We typically review the personal financial statements of the principal owners and require their personal guarantees.  These reviews often reveal secondary sources of payment and liquidity to support a loan request.  At December 31, 2010, commercial real estate loans (other than construction loans) totaled $27,636,367, or 30.6% of our loan portfolio.

 

·                  *Real Estate - Construction. *We offer adjustable and fixed rate residential and commercial construction loans to builders and developers and to consumers who wish to build their own home.  The term of construction and development loans will generally be limited to 18 months, although payments may be structured on a longer amortization basis.  Most loans will mature and require payment in full upon the sale of the property.  Construction and development loans generally carry a higher degree of risk than long term financing of existing properties.  Repayment usually depends on the ultimate completion of the project within cost estimates and on the sale of the property.  Specific risks include:

 

·                  cost overruns;

·                  mismanaged construction;

·                  inferior or improper construction techniques;

·                  economic changes or downturns during construction;

·                  a downturn in the real estate market;

·                  rising interest rates which may prevent sale of the property; and

·                  failure to sell completed projects in a timely manner.

 

We attempt to reduce risk by obtaining personal guarantees where possible, and by keeping the loan-to-value ratio of the completed project below specified percentages.  We may also reduce risk by selling participations in larger loans to other institutions when possible.  At December 31, 2010, total construction loans amounted to $12,076,019, or 13.4% of our loan portfolio.

 

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*Commercial Loans*.  The Bank makes loans for commercial purposes in various lines of businesses.  We focus our efforts on commercial loans of less than $1,000,000.  Equipment loans will typically be made for a term of five years or less at fixed or variable rates, with the loan fully amortized over the term and secured by the financed equipment.  Working capital loans typically have terms not exceeding one year and are usually secured by accounts receivable, inventory, or personal guarantees of the principals of the business.  For loans secured by accounts receivable or inventory, principal is typically repaid as the assets securing the loan are converted into cash, and in other cases principal is typically due at maturity.  Trade letters of credit, standby letters of credit, and foreign exchange are handled through a correspondent bank as agent for the Bank.  Commercial loans primarily have risk that the primary source of repayment, the borrowing business, will be unable to service the debt.  Often this occurs as the result of changes in local economic conditions or in the industry in which the borrower operates which impact cash flow or collateral value.

 

We also offer small business loans utilizing government enhancements such as the Small Business Administration’s 7(a) and SBA’s 504 programs.  These loans are typically partially guaranteed by the government which may help to reduce the Bank’s risk.  Government guarantees of SBA loans will not exceed 80% of the loan value, and will generally be less.  At December 31, 2010, commercial loans amounted to $9,234,855, or 10.2% of our loan portfolio.

 

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

 

Consumer loans are generally considered to have greater risk than first or second mortgages on real estate because the value of the secured property may depreciate rapidly, they are often dependent on the borrower’s employment status as the sole source of repayment, and some of them are unsecured.  To mitigate these risks, we analyze selective underwriting criteria for each prospective borrower, which may include the borrower’s employment history, income history, credit bureau reports, or debt to income ratios.  If the consumer loan is secured by property, such as an automobile loan, we also attempt to offset the risk of rapid depreciation of the collateral with a shorter loan amortization period.  Despite these efforts to mitigate our risks, consumer loans have a higher rate of default than real estate loans.  For this reason, we also attempt to reduce our loss exposure to these types of loans by limiting their sizes relative to other types of loans. Consumer loans which are not secured by real estate amounted to $1,399,369 or 1.6% of our loan portfolio.

 

We also offer home equity loans.  Our underwriting criteria for and the risks associated with home equity loans and lines of credit will generally be the same as those for first mortgage loans.  Home equity lines of credit typically have terms of 15 years or less, typically carry balances less than $75,000, and may extend up to 90% of the available equity of each property. At December 31, 2010, individual home equity lines of credit, which are secured by real estate, amounted to $25,538,314, or 28.3% of our loan portfolio.

 

*Relative Risks of Loans*.  Each category of loan has a different level of credit risk.  Real estate loans are generally safer than loans secured by other assets because the value of the underlying security, real estate, is generally ascertainable and does not fluctuate as much as some other assets.  Certain real estate loans are less risky than others.  Residential real estate loans are generally the least risky type of real estate loan, followed by commercial real estate loans and construction and development loans.  Commercial loans, which can be secured by real estate or other assets, or which can be unsecured, are generally more risky than real estate loans, but less risky than consumer loans.  Finally, consumer loans, which can also be secured by real estate or other assets, or which can also be unsecured, are generally considered to be the most risky of these categories of loans.  Any type of loan which is unsecured is generally more risky than secured loans.  These levels of risk are general in nature, and many factors including the creditworthiness of the borrower or the particular nature of the secured asset may cause any type of loan to be more or less risky than another.  Additionally, these levels of risk are limited to an analysis of credit risk, and they do not take into account other risk factors associated with making loans such as the interest rate risk inherent in long-term, fixed-rate loans.

 

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**Deposit Services**

 

We offer a full range of deposit services that are typically available in most banks and savings and loan associations, including checking accounts, NOW accounts, commercial accounts, savings accounts, and other time deposits of various types, ranging from daily money market accounts to longer-term certificates of deposit.  The transaction accounts and time certificates are typically tailored to our primary service area at competitive rates.  In addition, we offer certain retirement account services, including IRAs.  We solicit these accounts from individuals, businesses, and other organizations.

 

**Other Banking Services**

 

We offer safe deposit boxes, cashier’s checks, banking by mail, direct deposit of payroll and social security checks, U.S. Savings Bonds, and traveler’s checks.  The Bank is associated****with the Intercept Switch, Pulse, MasterCard, Cirrus and Plus ATM networks that may be used by the Bank’s customers throughout the country.  We believe that by being associated with a shared network of ATMs, we are better able to serve our customers and will be able to attract customers who are accustomed to the convenience of using ATMs.  We also offer a debit card and credit card services through a correspondent bank as an agent for the Bank.  We do not expect the Bank to exercise trust powers during its initial years of operation.

 

**Competition**

 

The Columbia/West Columbia/Lexington market is highly competitive, with all of the largest banks in the state, as well as super regional banks, represented.  The competition among the various financial institutions is based upon a variety of factors, including interest rates offered on deposit accounts, interest rates charged on loans, credit and service charges, the quality of services rendered, the convenience of banking facilities and, in the case of loans to large commercial borrowers, relative lending limits.  In addition to banks and savings associations, we compete with other financial institutions including securities firms, insurance companies, credit unions, leasing companies and finance companies.  Size gives larger banks certain advantages in competing for business from large corporations.  These advantages include higher lending limits and the ability to offer services in other areas of South Carolina.  As a result, we do not generally attempt to compete for the banking relationships of large corporations, but concentrate our efforts on small- to medium-sized businesses and individuals.  We believe we will compete effectively in this market by offering quality and personal service.

 

**Employees**

 

As of December 31, 2010, we had 23 full-time employees and 5 part-time employees.

 

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**SUPERVISION AND REGULATION**

 

Both Congaree Bancshares, Inc. and Congaree State Bank are subject to extensive state and federal banking regulations that impose restrictions on and provide for general regulatory oversight of their operations.  These laws generally are intended to protect depositors and not shareholders.  The following summary is qualified by reference to the statutory and regulatory provisions discussed.  Changes in applicable laws or regulations may have a material effect on our business and prospects.  Our operations may be affected by legislative changes and the policies of various regulatory authorities.  We cannot predict the effect that fiscal or monetary policies, economic control, or new federal or state legislation may have on our business and earnings in the future.

 

The following discussion is not intended to be a complete list of all the activities regulated by the banking laws or of the impact of such laws and regulations on our operations.  It is intended only to briefly summarize some material provisions.

 

**Recent Legislative and Regulatory Initiatives to Address Financial and Economic Crisis**

 

Markets in the United States and elsewhere have experienced extreme volatility and disruption over the past three years.  These circumstances have exerted significant downward pressure on prices of equity securities and virtually all other asset classes, and have resulted in substantially increased market volatility, severely constrained credit and capital markets, particularly for financial institutions, and an overall loss of investor confidence.  Loan portfolio performances have deteriorated at many institutions resulting from, among other factors, a weak economy and a decline in the value of the collateral supporting their loans.  Dramatic slowdowns in the housing industry, due in part to falling home prices and increasing foreclosures and unemployment, have created strains on financial institutions.  Many borrowers are now unable to repay their loans, and the collateral securing these loans has, in some cases, declined below the loan balance.  In response to the challenges facing the financial services sector, several regulatory and governmental actions have been announced including:

 

·                   The Emergency Economic Stabilization Act of 2008 (“EESA”), approved by Congress and signed by President Bush on October 3, 2008, which, among other provisions, allowed the U.S. Treasury to purchase up to $700 billion of mortgages, mortgage-backed securities and certain other financial instruments from financial institutions for the purpose of stabilizing and providing liquidity to the U.S. financial markets.  EESA also temporarily raised the basic limit of FDIC deposit insurance from $100,000 to $250,000 through December 31, 2013;

 

·                   On October 7, 2008, the FDIC approved a plan to increase the rates banks pay for deposit insurance;

 

·                  On October 14, 2008, the U.S. Treasury announced the creation of a new program, the Capital Purchase Program, that encourages and allows financial institutions to build capital through the sale of senior preferred shares to the U.S. Treasury on terms that are non-negotiable;

 

·                  On October 14, 2008, the FDIC announced the creation of the Temporary Liquidity Guarantee Program (“TLGP”), which seeks to strengthen confidence and encourage liquidity in the banking system.  The TLGP has two primary components that are available on a voluntary basis to financial institutions:

 

·                  Guarantee of newly-issued senior unsecured debt; the guarantee would apply to new debt issued on or before October 31, 2009 and would provide protection until December 31, 2012; issuers electing to participate would pay a 75 basis point fee for the guarantee; and

 

·                  Unlimited deposit insurance for non-interest bearing deposit transaction accounts; financial institutions electing to participate will pay a 10 basis point premium in addition to the insurance premiums paid for standard deposit insurance.

 

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·                  On February 10, 2009, the U.S. Treasury announced the Financial Stability Plan, which earmarked $350 billion of the TARP funds authorized under EESA.

 

·                  On February 17, 2009, the American Recovery and Reinvestment Act (the “Recovery Act”) was signed into law in an effort to, among other things, create jobs and stimulate growth in the United States economy.  The Recovery Act specifies appropriations of approximately $787 billion for a wide range of Federal programs and will increase or extend certain benefits payable under the Medicaid, unemployment compensation, and nutrition assistance programs.  The Recovery Act also reduces individual and corporate income tax collections and makes a variety of other changes to tax laws.  The Recovery Act also imposes certain limitations on compensation paid by participants in the U.S. Treasury’s Troubled Asset Relief Program (“TARP”);

 

·                  On March 23, 2009, the U.S. Treasury, in conjunction with the FDIC and the Federal Reserve, announced the Public-Private Partnership Investment Program for Legacy Assets which consists of two separate plans, addressing two distinct asset groups:

 

·                    The first plan is the Legacy Loan Program, which has a primary purpose to facilitate the sale of troubled mortgage loans by eligible institutions, including FDIC-insured federal or state banks and savings associations. Eligible assets are not strictly limited to loans; however, what constitutes an eligible asset will be determined by participating banks, their primary regulators, the FDIC and the Treasury. Under the Legacy Loan Program, the FDIC has sold certain troubled assets out of an FDIC receivership in two separate transactions relating to the failed Illinois bank, Corus Bank, NA, and the failed Texas bank, Franklin Bank, S.S.B. These transactions were completed in September 2009 and October 2009, respectively.

 

·                    The second plan is the Securities Program, which is administered by the Treasury and involves the creation of public-private investment funds (“PPIFs”) to target investments in eligible residential mortgage-backed securities and commercial mortgage-backed securities issued before 2009 that originally were rated AAA or the equivalent by two or more nationally recognized statistical rating organizations, without regard to rating enhancements (collectively, “Legacy Securities”). Legacy Securities must be directly secured by actual mortgage loans, leases or other assets, and may be purchased only from financial institutions that meet TARP eligibility requirements. Treasury received over 100 unique applications to participate in the Legacy Securities PPIP and in July 2009 selected nine PPIF managers.  As of September 30, 2010, the PPIFs had completed their fundraising and have closed on approximately $7.4 billion of private sector equity capital, which was matched 100 percent by Treasury, representing $14.7 billion of total equity capital. Treasury has also provided $14.7 billion of debt capital, representing $29.4 billion of total purchasing power. As of September 30, 2010, PPIFs have drawn-down approximately $18.6 billion of total capital which has been invested in eligible assets and cash equivalents pending investment.

 

·                  On May 22, 2009, the FDIC levied a one-time special assessment on all banks due on September 30, 2009;

 

·                  On November 12, 2009, the FDIC issued a final rule to require banks to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012 and to increase assessment rates effective on January 1, 2011;

 

·                  On February 2, 2010, the U.S. President called on the U.S. Congress to create a new Small Business Lending Fund.  Under this proposal, $30 billion in TARP funds would be transferred to a new program outside of TARP to support small business lending.  As proposed, only small- and medium-sized banks would qualify to participate in the program;

 

·                  In June 2010, the Federal Reserve, the FDIC and the OCC issued a comprehensive final guidance on incentive compensation policies intended to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of such organizations by encouraging 

 

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excessive risk-taking. The guidance, which covers all employees that have the ability to materially affect the risk profile of an organization, either individually or as part of a group, is based upon the key principles that a banking organization’s incentive compensation arrangements should (i) provide incentives that do not encourage risk-taking beyond the organization’s ability to effectively identify and manage risks, (ii) be compatible with effective internal controls and risk management, and (iii) be supported by strong corporate governance, including active and effective oversight by the organization’s board of directors.

 

The Federal Reserve will review, as part of the regular, risk-focused examination process, the incentive compensation arrangements of banking organizations, such as the Company, that are not “large, complex banking organizations.” These reviews will be tailored to each organization based on the scope and complexity of the organization’s activities and the prevalence of incentive compensation arrangements. The findings of the supervisory initiatives will be included in reports of examination. Deficiencies will be incorporated into the organization’s supervisory ratings, which can affect the organization’s ability to make acquisitions and take other actions. Enforcement actions may be taken against a banking organization if its incentive compensation arrangements, or related risk-management control or governance processes, pose a risk to the organization’s safety and soundness and the organization is not taking prompt and effective measures to correct the deficiencies.

 

·                  On July 21, 2010, the U.S. President signed into law the Dodd-Frank Act, a comprehensive regulatory framework that will affect every financial institution in the U.S.  The Dodd-Frank Act will likely result in dramatic changes across the financial regulatory system, some of which become effective immediately and some of which will not become effective until various future dates. Implementation of the Dodd-Frank Act will require many new rules to be made by various federal regulatory agencies over the next several years. Uncertainty remains as to the ultimate impact of the Dodd-Frank Act until final rulemaking is complete, which could have a material adverse impact either on the financial services industry as a whole or on our business, financial condition, results of operations, and cash flows. Provisions in the legislation that affect consumer financial protection regulations, deposit insurance assessments, payment of interest on demand deposits, and interchange fees could increase the costs associated with deposits and place limitations on certain revenues those deposits may generate. The Dodd-Frank Act includes provisions that, among other things, will:

 

·                  Centralize responsibility for consumer financial protection by creating a new agency, the Bureau of Consumer Financial Protection, responsible for implementing, examining, and enforcing compliance with federal consumer financial laws.

 

·                  Create the Financial Stability Oversight Council that will recommend to the Federal Reserve increasingly strict rules for capital, leverage, liquidity, risk management and other requirements as companies grow in size and complexity.

 

·                  Provide mortgage reform provisions regarding a customer’s ability to repay, restricting variable-rate lending by requiring that the ability to repay variable-rate loans be determined by using the maximum rate that will apply during the first five years of a variable-rate loan term, and making more loans subject to provisions for higher cost loans, new disclosures, and certain other revisions.

 

·                  Change the assessment base for federal deposit insurance from the amount of insured deposits to consolidated assets less tangible capital, eliminate the ceiling on the size of the Deposit Insurance Fund (“DIF”), and increase the floor on the size of the DIF, which generally will require an increase in the level of assessments for institutions with assets in excess of $10 billion.

 

·                  Make permanent the $250,000 limit for federal deposit insurance and provide unlimited federal deposit insurance until December 31, 2012 for noninterest-bearing demand transaction accounts at all insured depository institutions.

 

·                  Implement corporate governance revisions, including with regard to executive compensation and proxy access by shareholders, which apply to all public companies, not just financial institutions.

 

·                  Repeal the federal prohibitions on the payment of interest on demand deposits, thereby permitting depository institutions to pay interest on business transactions and other accounts.

 

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·                  Amend the Electronic Fund Transfer Act (“EFTA”) to, among other things, give the Federal Reserve the authority to establish rules regarding interchange fees charged for electronic debit transactions by payment card issuers having assets over $10 billion and to enforce a new statutory requirement that such fees be reasonable and proportional to the actual cost of a transaction to the issuer.

 

·                  Internationally, both the Basel Committee on Banking Supervision (the “Basel Committee”) and the Financial Stability Board (established in April 2009 by the Group of Twenty (“G-20”) Finance Ministers and Central Bank Governors to take action to strengthen regulation and supervision of the financial system with greater international consistency, cooperation, and transparency) have committed to raise capital standards and liquidity buffers within the banking system (“Basel III”). On September 12, 2010, the Group of Governors and Heads of Supervision agreed to the calibration and phase-in of the Basel III minimum capital requirements (raising the minimum Tier 1 common equity ratio to 4.5% and minimum Tier 1 equity ratio to 6.0%, with full implementation by January 2015) and introducing a capital conservation buffer of common equity of an additional 2.5% with full implementation by January 2019. The U.S. federal banking agencies support this agreement. In December 2010, the Basel Committee issued the Basel III rules text, outlining the details and time-lines of global regulatory standards on bank capital adequacy and liquidity. According to the Basel Committee, the Framework sets out higher and better-quality capital, better risk coverage, the introduction of a leverage ratio as a backstop to the risk-based requirement, measures to promote the build-up of capital that can be drawn down in periods of stress, and the introduction of two global liquidity standards.

 

·                  On September 27, 2010, the U.S. President signed into law the Small Business Jobs and Credit Act which, among other things, creates a $30 billion fund to provide capital for banks with assets under $10 billion to increase their small-business lending. On December 21, 2010, the U.S. Treasury published the application form, term sheet and their guidance for participation in the SBLF. Under the terms of the SBLF, the Treasury will purchase shares of senior preferred stock from banks, bank holding companies, and other financial institutions that will qualify as Tier 1 capital for regulatory purposes and rank senior to a participating institution’s common stock. The application deadline for participating in the SBLF is March 31, 2011. Based on the program criteria, we do not plan to participate in the SBLF.

 

·                  In November 2010, the Federal Reserve’s monetary policymaking committee, the Federal Open Market Committee (“FOMC”), decided that further support to the economy was needed. With short-term interest rates already nearing 0%, the FOMC agreed to deliver that support by committing to purchase additional longer-term securities, as it did in 2008 and 2009. The FOMC intends to buy an additional $600 billion of longer-term U.S. Treasury securities by mid-2011 and will continue to reinvest repayments of principal on its holdings of securities, as it has been doing since August 2010.

 

·                  In November 2010, the FDIC approved two proposals that amend the deposit insurance assessment regulations. The first proposal implements a provision in the Dodd-Frank Act that changes the assessment base from one based on domestic deposits (as it has been since 1935) to one based on assets. The assessment base changes from adjusted domestic deposits to average consolidated total assets minus average tangible equity.

 

The second proposal changes the deposit insurance assessment system for large institutions in conjunction with the guidance given in the Dodd-Frank Act. Since the new base would be much larger than the current base, the FDIC will lower assessment rates, which achieves the FDIC’s goal of not significantly altering the total amount of revenue collected from the industry. Risk categories and debt ratings will be eliminated from the assessment calculation for large banks which will instead use scorecards. The scorecards will include financial measures that are predictive of long-term performance. A large financial institution will continue to be defined as an insured depository institution with at least $10 billion in assets. Both changes in the assessment system will be effective as of April 1, 2011 and will be payable at the end of September.

 

·                  In December 2010, the FDIC voted to increase the required amount of reserves for the designated reserve ratio (“DRR”) to 2.0%. The ratio is higher than the 1.35% set by the Dodd-Frank Act in July 2010 and is an integral part of the FDIC’s comprehensive, long-range management plan for the DIF.

 

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·                  On December 29, 2010, the Dodd-Frank Act was amended to include full FDIC insurance on Interest on Lawyers Trust Accounts (“IOLTAs”). IOLTAs will receive unlimited insurance coverage as noninterest-bearing transaction accounts for two years ending December 31, 2012.

 

·                  In February 2011, the FDIC approved the final rules that, as noted above, change the assessment base from domestic deposits to average assets minus average tangible equity, adopt a new scorecard-based assessment system for financial institutions with more than $10 billion in assets, and finalize the DRR target size at 2.0% of insured deposits.

 

On January 9, 2009, as part of the CPP, we entered into a CPP Purchase Agreement with the Treasury Department, pursuant to which we sold (i) 3,285 shares of our Fixed Rate Cumulative Perpetual Preferred Stock, Series A, and (ii) a warrant to purchase 164 shares of our Fixed Rate Cumulative Perpetual Preferred Stock, Series B for an aggregate purchase price of $3,285,000 in cash.  The CPP Warrant was immediately exercised.

 

We elected to voluntarily participate in the unlimited deposit insurance component of the TAGP through December 31, 2010. Throughout 2010, participating institutions paid fees of 15 to 25 basis points (annualized), depending on the Risk Category assigned to the institution, on the balance of each covered account in excess of $250,000. Coverage under the program was in addition to and separate from the basic coverage available under the FDIC’s general deposit insurance rules. As a result of the Dodd-Frank Act that was signed into law on July 21, 2010, the program ended on December 31, 2010, and all institutions are now required to provide full deposit insurance on noninterest-bearing transaction accounts until December 31, 2012. There will not be a separate assessment for this as there was for institutions participating in the deposit insurance component of the TAGP.

 

Although it is likely that further regulatory actions will arise as the Federal government attempts to address the economic situation, we cannot predict the effect that fiscal or monetary policies, economic control, or new federal or state legislation may have on our business and earnings in the future.

 

**Congaree Bancshares, Inc.**

 

We own 100% of the outstanding capital stock of the Bank, and therefore we are considered to be a bank holding company under the federal Bank Holding Company Act of 1956 (the “Bank Holding Company Act”).  As a result, we are primarily subject to the supervision, examination and reporting requirements of the Board of Governors of the Federal Reserve (the “Federal Reserve”) under the Bank Holding Company Act and its regulations promulgated thereunder.  Moreover, as a bank holding company of a bank located in South Carolina, we also are subject to the South Carolina Banking and Branching Efficiency Act.

 

***Permitted Activities.*** Under the Bank Holding Company Act, a bank holding company is generally permitted to engage in, or acquire direct or indirect control of more than 5% of the voting shares of any company engaged in, the following activities:

 

·                  banking or managing or controlling banks;

 

·                  furnishing services to or performing services for our subsidiaries; and

 

·                  any activity that the Federal Reserve determines to be so closely related to banking as to be a proper incident to the business of banking.

 

Activities that the Federal Reserve has found to be so closely related to banking as to be a proper incident to the business of banking include:

 

·                  factoring accounts receivable;

 

·                  making, acquiring, brokering or servicing loans and usual related activities;

 

·                  leasing personal or real property;

 

·                  operating a non-bank depository institution, such as a savings association;

 

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·                  trust company functions;

 

·                  financial and investment advisory activities;

 

·                  conducting discount securities brokerage activities;

 

·                  underwriting and dealing in government obligations and money market instruments;

 

·                  providing specified management consulting and counseling activities;

 

·                  performing selected data processing services and support services;

 

·                  acting as agent or broker in selling credit life insurance and other types of insurance in connection with credit transactions; and

 

·                  performing selected insurance underwriting activities.

 

As a bank holding company we also can elect to be treated as a “financial holding company,” which would allow us to engage in a broader array of activities.  In sum, a financial holding company can engage in activities that are financial in nature or incidental or complementary to financial activities, including insurance underwriting, sales and brokerage activities, providing financial and investment advisory services, underwriting services and limited merchant banking activities.  We have not sought financial holding company status, but may elect such status in the future as our business matures.  If we were to elect in writing for financial holding company status, each insured depository institution we control would have to be well capitalized, well managed and have at least a satisfactory rating under the CRA (discussed below).

 

The Federal Reserve has the authority to order a bank holding company or its subsidiaries to terminate any of these activities or to terminate its ownership or control of any subsidiary when it has reasonable cause to believe that the bank holding company’s continued ownership, activity or control constitutes a serious risk to the financial safety, soundness or stability of it or any of its bank subsidiaries.

 

***Change in Control.***  In addition, and subject to certain exceptions, the Bank Holding Company Act and the Change in Bank Control Act, together with regulations promulgated there under, require Federal Reserve approval prior to any person or company acquiring “control” of a bank holding company.  Control is conclusively presumed to exist if an individual or company acquires 25% or more of any class of voting securities of a bank holding company.  Following the relaxing of these restrictions by the Federal Reserve in September 2008, control will be rebuttably presumed to exist if a person acquires more than 33% of the total equity of a bank or bank holding company, of which it may own, control or have the power to vote not more than 15% of any class of voting securities.

 

***Source of Strength****.*  In accordance with Federal Reserve Board policy, we are expected to act as a source of financial strength to the Bank and to commit resources to support the Bank in circumstances in which we might not otherwise do so.  If the Bank were to become “under-capitalized” (see below “Congaree State Bank—Prompt Corrective Action”), we would be required to provide a guarantee of the Bank’s plan to return to capital adequacy.  Additionally, under the Bank Holding Company Act, the Federal Reserve Board may require a bank holding company to terminate any activity or relinquish control of a nonbank subsidiary, other than a nonbank subsidiary of a bank, upon the Federal Reserve Board’s determination that such activity or control constitutes a serious risk to the financial soundness or stability of any depository institution subsidiary of the bank holding company.  Further, federal bank regulatory authorities have additional discretion to require a bank holding company to divest itself of any bank or nonbank subsidiaries if the agency determines that divestiture may aid the depository institution’s financial condition.  Further, any loans by a bank holding company to a subsidiary bank are subordinate in right of payment to deposits and certain other indebtedness of the subsidiary bank.  In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank at a certain level would be assumed by the bankruptcy trustee and entitled to priority payment.

 

***Capital Requirements.***  The Federal Reserve Board imposes certain capital requirements on the bank holding company under the Bank Holding Company Act, including a minimum leverage ratio and a minimum ratio 

 

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of “qualifying” capital to risk-weighted assets. These requirements are essentially the same as those that apply to the bank and are described below under “Congaree State Bank—Prompt Corrective Action.” Subject to our capital requirements and certain other restrictions, we are able to borrow money to make a capital contribution to the Bank, and these loans may be repaid from dividends paid from the Bank to the Company. Our ability to pay dividends depends on the Bank’s ability to pay dividends to us, which is subject to regulatory restrictions as described below in “Congaree State Bank—Dividends.” We are also able to raise capital for contribution to the Bank by issuing securities without having to receive regulatory approval, subject to compliance with federal and state securities laws. Currently, the Company also has to obtain the prior written approval of the Federal Reserve Bank before declaring or paying any dividends.

 

***South Carolina State Regulation.***  As a South Carolina bank holding company under the South Carolina Banking and Branching Efficiency Act, we are subject to limitations on sale or merger and to regulation by the South Carolina Board of Financial Institutions, including a restriction on the ability to sell our Bank for at least five years from the date of its formation.  We are not required to obtain the approval of the South Carolina Board of Financial Institutions prior to acquiring the capital stock of a national bank, but we must notify them at least 15 days prior to doing so.  We must receive the Board’s approval prior to engaging in the acquisition of a South Carolina state chartered bank or another South Carolina bank holding company.

 

**Congaree State Bank**

 

The Bank operates as a state chartered bank incorporated under the laws of the State of South Carolina and is subject to examination by the South Carolina Board of Financial Institutions.  Deposits in the bank are insured by the FDIC up to a maximum amount, which is currently $250,000 for each non-retirement depositor and $250,000 for certain retirement-account depositors.

 

The South Carolina Board of Financial Institutions and the FDIC regulate or monitor virtually all areas of the Bank’s operations, including:

 

·                  security devices and procedures;

 

·                  adequacy of capitalization and loss reserves;

 

·                  loans;

 

·                  investments;

 

·                  borrowings;

 

·                  deposits;

 

·                  mergers;

 

·                  issuances of securities;

 

·                  payment of dividends;

 

·                  interest rates payable on deposits;

 

·                  interest rates or fees chargeable on loans;

 

·                  establishment of branches;

 

·                  corporate reorganizations;

 

·                  maintenance of books and records; and

 

·                  adequacy of staff training to carry on safe lending and deposit gathering practices.

 

The South Carolina Board of Financial Institutions requires the Bank to maintain specified capital ratios and imposes limitations on the Bank’s aggregate investment in real estate, bank premises, and furniture and fixtures.  The South Carolina Board of Financial Institutions also requires the Bank to prepare quarterly reports on the Bank’s financial condition in compliance with its minimum standards and procedures.

 

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All insured institutions must undergo regular on site examinations by their appropriate banking agency.  The cost of examinations of insured depository institutions and any affiliates may be assessed by the appropriate agency against each institution or affiliate as it deems necessary or appropriate.  Insured institutions are required to submit annual reports to the FDIC, their federal regulatory agency, and their state supervisor when applicable.  The FDIC has developed a method for insured depository institutions to provide supplemental disclosure of the estimated fair market value of assets and liabilities, to the extent feasible and practicable, in any balance sheet, financial statement, report of condition or any other report of any insured depository institution.  The FDIC Improvement Act also requires the federal banking regulatory agencies to prescribe, by regulation, standards for all insured depository institutions and depository institution holding companies relating, among other things, to the following:

 

·                  internal controls;

 

·                  information systems and audit systems;

 

·                  loan documentation;

 

·                  credit underwriting;

 

·                  interest rate risk exposure; and

 

·                  asset quality.

 

***Prompt Corrective Action. ***As an insured depository institution, the Bank is required to comply with the capital requirements promulgated under the Federal Deposit Insurance Act and the regulations thereunder, which set forth****five capital categories, each with specific regulatory consequences.  Under these regulations, the categories are:

 

·                                          Well Capitalized - The institution exceeds the required minimum level for each relevant capital measure.  A well capitalized institution is one (i) having a total capital ratio of 10% or greater, (ii) having a tier 1 capital ratio of 6% or greater, (iii) having a leverage capital ratio of 5% or greater and (iv) that is not subject to any order or written directive to meet and maintain a specific capital level for any capital measure.

 

·                                          Adequately Capitalized - The institution meets the required minimum level for each relevant capital measure.  No capital distribution may be made that would result in the institution becoming undercapitalized.  An adequately capitalized institution is one (i) having a total capital ratio of 8% or greater, (ii) having a tier 1 capital ratio of 4% or greater and (iii) having a leverage capital ratio of 4% or greater or a leverage capital ratio of 3% or greater if the institution is rated composite 1 under the CAMELS (Capital, Assets, Management, Earnings, Liquidity and Sensitivity to market risk) rating system.

 

·                                          Undercapitalized - The institution fails to meet the required minimum level for any relevant capital measure.  An undercapitalized institution is one (i) having a total capital ratio of less than 8% or (ii) having a tier 1 capital ratio of less than 4% or (iii) having a leverage capital ratio of less than 4%, or if the institution is rated a composite 1 under the CAMELS rating system, a leverage capital ratio of less than 3%.

 

·                                          Significantly Undercapitalized - The institution is significantly below the required minimum level for any relevant capital measure.  A significantly undercapitalized institution is one (i) having a total capital ratio of less than 6% or (ii) having a tier 1 capital ratio of less than 3% or (iii) having a leverage capital ratio of less than 3%.

 

·                                          Critically Undercapitalized - The institution fails to meet a critical capital level set by the appropriate federal banking agency.  A critically undercapitalized institution is one having a ratio of tangible equity to total assets that is equal to or less than 2%.

 

If the FDIC determines, after notice and an opportunity for hearing, that the Bank is in an unsafe or unsound condition, the regulator is authorized to reclassify the Bank to the next lower capital category (other than critically undercapitalized) and require the submission of a plan to correct the unsafe or unsound condition.

 

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If the Bank is not well capitalized, it cannot accept brokered deposits without prior FDIC approval.  Even if approved, rate restrictions apply governing the rate the bank may be permitted to pay on the brokered deposits.  In addition, a bank that is undercapitalized cannot offer an effective yield in excess of 75 basis points over the “national rate” paid on deposits (including brokered deposits, if approval is granted for the bank to accept them) of comparable size and maturity.  The “national rate” is defined as a simple average of rates paid by insured depository institutions and branches for which data are available and is published weekly by the FDIC.  Institutions subject to the restrictions that believe they are operating in an area where the rates paid on deposits are higher than the “national rate” can use the local market to determine the prevailing rate if they seek and receive a determination from the FDIC that it is operating in a high-rate area.  Regardless of the determination, institutions must use the national rate to determine conformance for all deposits outside their market area.

 

Moreover, if the Bank becomes less than adequately capitalized, it must adopt a capital restoration plan acceptable to the FDIC.  The Bank also would become subject to increased regulatory oversight, and is increasingly restricted in the scope of its permissible activities.  Each company having control over an undercapitalized institution also must provide a limited guarantee that the institution will comply with its capital restoration plan.  Except under limited circumstances consistent with an accepted capital restoration plan, an undercapitalized institution may not grow.  An undercapitalized institution may not acquire another institution, establish additional branch offices or engage in any new line of business unless determined by the appropriate Federal banking agency to be consistent with an accepted capital restoration plan, or unless the FDIC determines that the proposed action will further the purpose of prompt corrective action.  The appropriate federal banking agency may take any action authorized for a significantly undercapitalized institution if an undercapitalized institution fails to submit an acceptable capital restoration plan or fails in any material respect to implement a plan accepted by the agency.  A critically undercapitalized institution is subject to having a receiver or conservator appointed to manage its affairs and for loss of its charter to conduct banking activities.

 

An insured depository institution may not pay a management fee to a bank holding company controlling that institution or any other person having control of the institution if, after making the payment, the institution, would be undercapitalized.  In addition, an institution cannot make a capital distribution, such as a dividend or other distribution that is in substance a distribution of capital to the owners of the institution if following such a distribution the institution would be undercapitalized.  Thus, if payment of such a management fee or the making of such would cause the Bank to become undercapitalized, it could not pay a management fee or dividend to us.

 

As of December 31, 2010, the Bank’s ratios were sufficient for the Bank to be considered “well-capitalized” under the regulatory framework for prompt corrective action. As further described below, the Bank entered into a Consent Order (the “Consent Order”), effective May 14, 2010, with the FDIC and the South Carolina Board of Financial Institutions (the “Supervisory Authorities”) which, among other things, required the Bank to achieve Tier 1 capital at least equal to 8% of total assets and Total Risk-Based capital at least equal to 10% of total risk-weighted assets within 150 days from the effective date of the Consent Order. As of December 31, 2010, the Bank was in compliance with the minimum capital requirements established in the Consent Order.  Subsequently, on April 8, 2011 the Consent Order was terminated by the Supervisory Authorities but the Bank was required to maintain these higher capital ratios.

 

***Regulatory Matters -***Following the FDIC’s safety and soundness examination of the Bank in the fourth quarter of 2009, the Bank entered into the Consent Order with the FDIC and the South Carolina Board of Financial Institutions on May 11, 2010.  The Consent Order required specific actions needed to address certain findings from the FDIC’s most recent Report of Examination and to address the Bank’s financial condition, primarily related to policy and planning issues, oversight, loan concentrations and classifications, non-performing loans, liquidity/funds management, and capital planning. The Board of Directors and management of the Bank have aggressively worked to improve these practices and procedures and as of April 8, 2011 the Consent Order has been terminated although certain regulatory restrictions remain. The Supervisory Authorities have instituted certain ongoing requirements for the Bank as follows:

 

·                   The Bank shall prepare and submit a comprehensive budget and earnings forecast for the Bank which covers 2011 and include any changes made as a result of the examination. Subsequently, budgets will be prepared and submitted annually by January 1 of each year. In addition, quarterly progress reports regarding the Bank’s actual performance compared to the budget plan shall be submitted concurrently with other reporting requirements.

 

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·                   The Bank shall develop specific plans and proposals for the reduction and improvement of assets which are subject to adverse classification and past due loans.

 

·                  The Bank shall not extend, directly or indirectly, any additional credit to or for the benefit of any borrower who is obligated in any manner to the Bank or any extension of credit or portion thereof that has been charged off by the Bank or classified Loss or Doubtful in any report of examination, so long as such credit remains uncollected. In addition, the Bank shall make no additional advances to any borrower whose loan or line of credit has been adversely classified Substandard in this Report or any subsequent report without the prior approval of a majority of the Bank’s Board of Directors.

 

·                  Unless otherwise approved in writing by the Supervisory Authorities, the Bank shall charge off within 30 days of receipt of any official report of examination by either State or FDIC examiners, the remaining balance of any assets classified as Loss, and make an appropriate impairment provision to the reserve for loan losses for those classified as Doubtful.

 

·                  The Bank shall maintain an adequate reserve for loan losses and such reserve shall be established by charges to current operating earnings. The Bank shall review the adequacy of the reserve prior to the end of each calendar quarter and make appropriate provisions to the reserve. The review shall be consider the results of the Bank’s loan review, loan loss experience, trends of delinquent and nonaccrual loans, estimate of potential loss exposure of significant credits, concentrations of credit, and present and prospective economic conditions. The results of the review shall be recorded in the minutes of the Board meeting at which the review was undertaken.

 

·                  The Bank shall maintain a minimum Tier 1 Leverage Capital ratio of 8 percent (8%) and a Total Risk-Based Capital ratio of at least ten percent (10%) and maintain a “Well-Capitalized” designation, as defined in Section 325 of the FDIC Rules and Regulations. In the event that the Bank’s capital falls below these minimums, the Bank shall notify the Supervisory Authorities and shall increase capital in an amount sufficient to meet the minimum ratio required by this provision within 90 days. The Bank shall not pay dividends without prior written consent of the Supervisory Authorities.

 

·                  The Bank shall eliminate and/or correct all violations of law and regulation and contraventions of policy listed in the report issued by the Supervisory Authorities. In addition, the Bank shall take all necessary steps to ensure future compliance with all applicable laws and regulations and polity statements.

 

The Board of Directors and management of the Bank will continue to diligently work to comply the requirements set above by the Supervising Authorities.

 

***Standards for Safety and Soundness.  ***The Federal Deposit Insurance Act also requires the federal banking regulatory agencies to prescribe, by regulation or guideline, operational and managerial standards for all insured depository institutions relating to: (i) internal controls, information systems and internal audit systems; (ii) loan documentation; (iii) credit underwriting; (iv) interest rate risk exposure; and (v) asset growth.  The agencies also must prescribe standards for asset quality, earnings, and stock valuation, as well as standards for compensation, fees and benefits.  The federal banking agencies have adopted regulations and Interagency Guidelines Prescribing Standards for Safety and Soundness to implement these required standards.  These 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.  Under the regulations, if the FDIC determines that the Bank fails to meet any standards prescribed by the guidelines, the agency may require the Bank to submit to the agency an acceptable plan to achieve compliance with the standard, as required by the FDIC.  The final regulations establish deadlines for the submission and review of such safety and soundness compliance plans.

 

***Insurance of Accounts and Regulation by the FDIC.***  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 effective March 31, 2006.  As insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of and to require reporting by FDIC insured institutions.  It also may prohibit any FDIC insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious risk to the insurance fund.  The FDIC also has the authority to initiate enforcement actions against savings institutions, after giving the Office of Thrift Supervision 

 

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an opportunity to take such action, and may terminate the deposit insurance if it determines that the institution has engaged in unsafe or unsound practices or is in an unsafe or unsound condition.

 

Due to the large number of recent bank failures, and the FDIC’s new Temporary Liquidity Guarantee Program, the FDIC adopted a revised risk-based deposit insurance assessment schedule in February 2009, which raised deposit insurance premiums.  The FDIC also implemented a five basis point special assessment of each insured depository institution’s assets minus Tier 1 capital as of June 30, 2009, which special assessment amount was capped at 10 basis points times the institution’s assessment base for the second quarter of 2009.  In addition, the FDIC recently announced a rule that requires financial institutions like us to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010 through and including 2012 to re-capitalize the Deposit Insurance Fund.  The FDIC may exercise its discretion as supervisor and insurer to exempt an institution from the prepayment requirement if the FDIC determines that the prepayment would adversely affect the safety and soundness of the institution.  We requested exemption from the prepayment requirement and received such exemption from the FDIC.  During 2010, we paid $442,999 in deposit insurance, which included regular premiums and the special assessment.  The rule also provides for increasing the FDIC-assessment rates by three basis points effective January 1, 2011.

 

FDIC insured institutions are required to pay a Financing Corporation assessment, in order to fund the interest on bonds issued to resolve thrift failures in the 1980s.  For the first quarter of 2010, the Financing Corporation assessment equaled 1.14 basis points for domestic deposits.  These assessments, which may be revised based upon the level of deposits, will continue until the bonds mature in the years 2017 through 2019.

 

The FDIC may terminate the deposit insurance of any insured depository institution, including the Bank, if it determines after a hearing 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 FDIC or the OCC.  It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance, if the institution has no tangible capital.  If insurance of accounts is terminated, the accounts at the institution at the time of the termination, less subsequent withdrawals, shall continue to be insured for a period of six months to two years, as determined by the FDIC.  Management of the Bank is not aware of any practice, condition or violation that might lead to termination of the bank’s deposit insurance.

 

***Transactions with Affiliates and Insiders.***  The Company is a legal entity separate and distinct from the Bank and its other subsidiaries.  Various legal limitations restrict the Bank from lending or otherwise supplying funds to the Company or its non-bank subsidiaries.  The Company and the Bank are subject to Sections 23A and 23B of the Federal Reserve Act and Federal Reserve Regulation W.  Section 23A of the Federal Reserve Act places limits on the amount of loans or extensions of credit to, or investments in, or certain other transactions with, affiliates and on the amount of advances to third parties collateralized by the securities or obligations of affiliates.  The aggregate of all covered transactions is limited in amount, as to any one affiliate, to 10% of the Bank’s capital and surplus and, as to all affiliates combined, to 20% of the Bank’s capital and surplus.  Furthermore, within the foregoing limitations as to amount, each covered transaction must meet specified collateral requirements.  The Bank is forbidden to purchase low quality assets from an affiliate.

 

Section 23B of the Federal Reserve Act, among other things, prohibits an institution from engaging in certain transactions with certain affiliates unless the transactions are on terms substantially the same, or at least as favorable to such institution or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies.  The Bank is also subject to certain restrictions on extensions of credit to executive officers, directors, certain principal shareholders, and their related interests.  Such extensions of credit (i) must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with third parties and (ii) must not involve more than the normal risk of repayment or present other unfavorable features.

 

Regulation W generally excludes all non-bank and non-savings association subsidiaries of banks from treatment as affiliates, except to the extent that the Federal Reserve Board decides to treat these subsidiaries as affiliates. The regulation also limits the amount of loans that can be purchased by a bank from an affiliate to not more than 100% of the bank’s capital and surplus.

 

The Bank is also subject to certain restrictions on extensions of credit to executive officers, directors, certain principal shareholders, and their related interests.  Such extensions of credit (i) must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions 

 

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with third parties and (ii) must not involve more than the normal risk of repayment or present other unfavorable features.

 

***Branching****.*  Under current South Carolina law, the Bank may open branch offices throughout South Carolina with the prior approval of the South Carolina Board of Financial Institutions.  In addition, with prior regulatory approval, the Bank is able to acquire existing banking operations in South Carolina.  Furthermore, federal legislation permits interstate branching, including out-of-state acquisitions by bank holding companies, interstate branching by banks, and interstate merging by banks.  The Dodd-Frank Act removes previous state law restrictions on de novo interstate branching in states such as South Carolina.  This change permits out-of-state banks to open de novo branches in states where the laws of the state where the de novo branch to be opened would permit a bank chartered by that state to open a de novo branch.

 

***Anti-Tying Restrictions. ***Under amendments to the Bank Holding Company Act and Federal Reserve regulations, a bank is prohibited from engaging in certain tying or reciprocity arrangements with its customers.  In general, a bank may not extend credit, lease, sell property, or furnish any services or fix or vary the consideration for these on the condition that (i) the customer obtain or provide some additional credit, property, or services from or to the bank, the bank holding company or subsidiaries thereof or (ii) the customer may not obtain some other credit, property, or services from a competitor, except to the extent reasonable conditions are imposed to assure the soundness of the credit extended.  Certain arrangements are permissible: a bank may offer combined-balance products and may otherwise offer more favorable terms if a customer obtains two or more traditional bank products; and certain foreign transactions are exempt from the general rule.  A bank holding company or any bank affiliate also is subject to anti-tying requirements in connection with electronic benefit transfer services.

 

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

 

***Finance Subsidiaries.***  Under the Gramm-Leach-Bliley Act (the “GLBA”), subject to certain conditions imposed by their respective banking regulators, national and state-chartered banks are permitted to form “financial subsidiaries” that may conduct financial or incidental activities, thereby permitting bank subsidiaries to engage in certain activities that previously were impermissible.  The GLBA imposes several safeguards and restrictions on financial subsidiaries, including that the parent bank’s equity investment in the financial subsidiary be deducted from the bank’s assets and tangible equity for purposes of calculating the bank’s capital adequacy.  In addition, the GLBA imposes new restrictions on transactions between a bank and its financial subsidiaries similar to restrictions applicable to transactions between banks and non-bank affiliates.

 

***Consumer Protection Regulations.*** Activities of the Bank are subject to a variety of statutes and regulations designed to protect consumers.  Interest and other charges collected or contracted for by the Bank are subject to state usury laws and federal laws concerning interest rates.  The Bank’s loan operations are also subject to federal laws applicable to credit transactions, such as the:

 

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

 

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

 

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

 

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

 

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

 

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collection agencies; and

 

·                  The rules and regulations of the various federal agencies charged with the responsibility of implementing these federal laws.

 

The deposit operations of the Bank also are subject to:

 

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

 

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

 

***Enforcement Powers.***  The Bank and its “institution-affiliated parties,” including its management, employees, agents, independent contractors, and consultants such as attorneys and accountants and others who participate in the conduct of the financial institution’s affairs, are subject to potential civil and criminal penalties for violations of law, regulations or written orders of a government agency.  These practices can include the failure of an institution to timely file required reports or the filing of false or misleading information or the submission of inaccurate reports.  Civil penalties may be as high as $1,375,000 a day for such violations.  Criminal penalties for some financial institution crimes have been increased to 20 years.  In addition, regulators are provided with greater flexibility to commence enforcement actions against institutions and institution-affiliated parties.  Possible enforcement actions include the termination of deposit insurance.  Furthermore, banking agencies’ power to issue cease-and-desist orders were expanded.  Such orders may, among other things, require affirmative action to correct any harm resulting from a violation or practice, including restitution, reimbursement, indemnifications or guarantees against loss.  A financial institution may also be ordered to restrict its growth, dispose of certain assets, rescind agreements or contracts, or take other actions as determined by the ordering agency to be appropriate.

 

***Anti-Money Laundering. ***Financial institutions must maintain anti-money laundering programs that include established internal policies, procedures, and controls; a designated compliance officer; an ongoing employee training program; and testing of the program by an independent audit function. The Company and the Bank are also prohibited from entering into specified financial transactions and account relationships and must meet enhanced standards for due diligence and “knowing your customer” in their dealings with foreign financial institutions and foreign customers.  Financial institutions must take reasonable steps to conduct enhanced scrutiny of account relationships to guard against money laundering and to report any suspicious transactions, and recent laws provide law enforcement authorities with increased access to financial information maintained by banks.  Anti-money laundering obligations have been substantially strengthened as a result of the USA Patriot Act, enacted in 2001 and renewed in 2006.  Bank regulators routinely examine institutions for compliance with these obligations and are required to consider compliance in connection with the regulatory review of applications.  The regulatory authorities have been active in imposing “cease and desist” orders and money penalty sanctions against institutions found to be violating these obligations.

 

***USA PATRIOT Act.******* **The USA PATRIOT Act became effective on October 26, 2001, amended, in part, the Bank Secrecy Act, and provides, in part, for the facilitation of information sharing among governmental entities and financial institutions for the purpose of combating terrorism and money laundering by enhancing anti-money laundering and financial transparency laws, as well as enhanced information collection tools and enforcement mechanics for the U.S. government, including: (i) requiring standards for verifying customer identification at account opening; (ii) rules to promote cooperation among financial institutions, regulators, and law enforcement entities in identifying parties that may be involved in terrorism or money laundering; (iii) reports by nonfinancial trades and businesses filed with the Treasury Department’s Financial Crimes Enforcement Network for transactions exceeding $10,000; and (iv) filing suspicious activities reports by brokers and dealers if they believe a customer may be violating U.S. laws and regulations and requires enhanced due diligence requirements for financial institutions that administer, maintain, or manage private bank accounts or correspondent accounts for non-U.S. persons.  Bank regulators routinely examine institutions for compliance with these obligations and are required to consider compliance in connection with the regulatory review of applications.

 

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Under the USA PATRIOT Act, the Federal Bureau of Investigation (“FBI”) can send our banking regulatory agencies lists of the names of persons suspected of involvement in terrorist activities.  The Bank can be requested, to search its records for any relationships or transactions with persons on those lists.  If the Bank finds any relationships or transactions, it must file a suspicious activity report and contact the FBI.

 

The Office of Foreign Assets Control (“OFAC”), which is a division of the U.S. Department of the Treasury, is responsible for helping to insure that United States entities do not engage in transactions with “enemies” of the United States, as defined by various Executive Orders and Acts of Congress.  OFAC has sent, and will send, our banking regulatory agencies lists of names of persons and organizations suspected of aiding, harboring or engaging in terrorist acts.  If the Bank finds a name on any transaction, account or wire transfer that is on an OFAC list, it must freeze such account, file a suspicious activity report and notify the FBI.  The Bank has appointed an OFAC compliance officer to oversee the inspection of its accounts and the filing of any notifications.  The Bank actively checks high-risk OFAC areas such as new accounts, wire transfers and customer files.  The Bank performs these checks utilizing software, which is updated each time a modification is made to the lists provided by OFAC and other agencies of Specially Designated Nationals and Blocked Persons.

 

***Privacy and Credit Reporting*****. **Financial institutions are required to disclose their policies for collecting and protecting confidential information.  Customers generally may prevent financial institutions from sharing nonpublic personal financial information with nonaffiliated third parties except under narrow circumstances, such as the processing of transactions requested by the consumer or when the financial institution is jointly sponsoring a product or service with a nonaffiliated third party.  Additionally, financial institutions generally may not disclose consumer account numbers to any nonaffiliated third party for use in telemarketing, direct mail marketing or other marketing to consumers.  It is the Bank’s policy not to disclose any personal information unless required by law.

 

Like other lending institutions, the Bank utilizes credit bureau data in its underwriting activities.  Use of such data is regulated under the Federal Credit Reporting Act on a uniform, nationwide basis, including credit reporting, prescreening, sharing of information between affiliates, and the use of credit data.  The Fair and Accurate Credit Transactions Act of 2003 (the “FACT Act”) authorizes states to enact identity theft laws that are not inconsistent with the conduct required by the provisions of the FACT Act.

 

***Payment of Dividends.*** A South Carolina state bank may not pay dividends from its capital.  All dividends must be paid out of undivided profits then on hand, after deducting expenses, including reserves for losses and bad debts.  In general, the Bank is authorized to pay cash dividends up to 100% of net income in any calendar year without obtaining the prior approval of the South Carolina Board of Financial Institutions, provided that the Bank received a composite rating of one or two at the last federal or state regulatory examination.  The Bank must obtain approval from the South Carolina Board of Financial Institutions prior to the payment of any other cash dividends.  However, currently the Bank must obtain prior approval from the Supervisory Authorities prior to the payment of any cash dividends.  In addition, under the Federal Deposit Insurance Corporation Improvement Act, the Bank may not pay a dividend if, after paying the dividend, the Bank would be undercapitalized.

 

***Check 21.***  The Check Clearing for the 21st Century Act gives “substitute checks,” such as a digital image of a check and copies made from that image, the same legal standing as the original paper check.  Some of the major provisions include:

 

·                                          allowing check truncation without making it mandatory;

 

·                                          demanding that every financial institution communicate to account holders in writing a description of its substitute check processing program and their rights under the law;

 

·                                          legalizing substitutions for and replacements of paper checks without agreement from consumers;

 

·                                          retaining in place the previously mandated electronic collection and return of checks between financial institutions only when individual agreements are in place;

 

·                                          requiring that when accountholders request verification, financial institutions produce the original check (or a copy that accurately represents the original) and demonstrate that the account debit was accurate and valid; and

 

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·                                          requiring the re-crediting of funds to an individual’s account on the next business day after a consumer proves that the financial institution has erred.

 

***Effect of Governmental Monetary Policies*****.**  Our earnings are affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies.  The Federal Reserve bank’s monetary policies have had, and are likely to continue to have, an important impact on the operating results of commercial banks through its power to implement national monetary policy in order, among other things, to curb inflation or combat a recession.  The monetary policies of the Federal Reserve Board have major effects upon the levels of bank loans, investments and deposits through its open market operations in United States government securities and through its regulation of the discount rate on borrowings of member banks and the reserve requirements against member bank deposits.  It is not possible to predict the nature or impact of future changes in monetary and fiscal policies.

 

***Proposed Legislation and Regulatory Action*****.**  New regulations and statutes are regularly proposed that contain wide-ranging proposals for altering the structures, regulations, and competitive relationships of the nation’s financial institutions.  We cannot predict whether or in what form any proposed regulation or statute will be adopted or the extent to which our business may be affected by any new regulation or statute.

 

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**Item 1A.  Risk Factors.**

 

***Difficult market conditions in our market and economic trends have adversely affected our industry and our business and may continue to do so.***

 

Our business has been directly affected by market conditions, trends in industry and finance, legislative and regulatory changes, and changes in governmental monetary and fiscal policies and inflation, all of which are beyond our control.  The current economic downturn, increase in unemployment and other events that have negatively affected both household and corporate incomes, both nationally and locally, have decreased the demand for loans and our other products and services and have increased the number of customers who fail to pay interest and/or principal on their loans.  As a result, we have experienced significant declines in our real estate markets with decreasing prices and increasing delinquencies and foreclosures, which have negatively affected the credit performance of our loans and resulted in increases in the level of our nonperforming assets and charge-offs of problem loans.  At the same time, competition among depository institutions for deposits and quality loans has increased significantly.  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.  These market conditions and the tightening of credit have led to increased deficiencies in our loan portfolio, increased market volatility and widespread reduction in general business activity.

 

Our future success significantly depends upon the growth in population, income levels, deposits and housing starts in our market areas.  Unlike many larger institutions, we are not able to spread the risks of unfavorable economic conditions across a large number of diversified economies and geographic locations.  If the markets in which we operate do not recover and grow as anticipated or if prevailing economic conditions locally or nationally do not improve, our business may continue to be negatively impacted.

 

***A significant portion of our loan portfolio is secured by real estate, and events that negatively affect the real estate market could hurt our business.***

 

Beginning in the second half of 2007 and continuing through 2010, the financial markets were beset by significant volatility associated with subprime mortgages, including adverse impacts on credit quality and liquidity within the financial markets.  The volatility has been exacerbated by a significant decline in the value of real estate.  As of December 31, 2010, approximately 88.2% of our loans were secured by real estate mortgages.  The real estate collateral for these loans provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended.  We do not generally originate traditional long term residential mortgages, but we do issue traditional second mortgage residential real estate loans and home equity lines of credit.  A further weakening of the real estate market in our market areas could result in an increase in the number of borrowers who default on their loans and a reduction in the value of the collateral securing their loans, which in turn could have an adverse effect on our profitability and asset quality.  If we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, our earnings and shareholder’s equity could be adversely affected.  Acts of nature, including hurricanes, tornados, earthquakes, fires and floods, which may cause uninsured damage and other loss of value to real estate that secures these loans, may also negatively impact our financial condition.

 

***We are exposed to higher credit risk by commercial real estate, construction, and commercial lending.***

 

Commercial real estate, commercial, and construction lending usually involves higher credit risks than that of single-family residential lending.  As of December 31, 2010, the following loan types accounted for the stated percentages of our total loan portfolio: commercial real estate — 30.6%; construction and development and land— 13.4%; and commercial — 10.2%.  These types of loans involve larger loan balances to a single borrower or groups of related borrowers.  Commercial real estate loans may be affected to a greater extent than residential loans by adverse conditions in real estate markets or the economy because commercial real estate borrowers’ ability to repay their loans depends on successful development of their properties, in addition to the factors affecting residential real estate borrowers.  These loans also involve greater risk because they generally are not fully amortizing over the loan period, but have a balloon payment due at maturity.  A borrower’s ability to make a balloon payment typically will depend on being able to either refinance the loan or sell the underlying property in a timely manner.

 

Risk of loss on a construction loan depends largely upon whether our initial estimate of the property’s value at completion of construction equals or exceeds the cost of the property construction (including interest), the 

 

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availability of permanent take-out financing, and the builder’s ability to ultimately sell the property.  During the construction phase, a number of factors can result in delays and cost overruns.  If estimates of value are inaccurate or if actual construction costs exceed estimates, the value of the property securing the loan may be insufficient to ensure full repayment when completed through a permanent loan or by seizure of collateral.

 

Commercial and industrial loans are typically based on the borrowers’ ability to repay the loans from the cash flow of their businesses.  These loans may involve greater risk because the availability of funds to repay each loan depends substantially on the success of the business itself.  In addition, the collateral securing the loans have the following characteristics: (a) they depreciate over time, (b) they are difficult to appraise and liquidate, and (c) they fluctuate in value based on the success of the business.

 

Commercial real estate, construction, and commercial loans are more susceptible to a risk of loss during a downturn in the business cycle.  Our underwriting, review and monitoring cannot eliminate all of the risks related to these loans.  The banking regulators are giving commercial real estate lending greater scrutiny, and may require banks with higher levels of commercial real estate loans to implement improved underwriting, internal controls, risk management policies and portfolio stress testing, as well as possibly higher levels of allowances for losses and capital levels as a result of commercial real estate lending growth and exposures.

 

***Our decisions regarding credit risk and reserves for loan losses may materially and adversely affect our business.***

 

Making loans and other extensions of credit is an essential element of our business.  Although we seek to mitigate risks inherent in lending by adhering to specific underwriting practices, our loans and other extensions of credit may not be repaid.  The risk of nonpayment is affected by a number of factors, including:

 

·                  the duration of the credit;

·                  credit risks of a particular customer;

·                  changes in economic and industry conditions; and

·                  in the case of a collateralized loan, risks resulting from uncertainties about the future value of the collateral.

 

We attempt to maintain an appropriate allowance for loan losses to provide for probable losses in our loan portfolio.  We periodically determine the amount of the allowance based on consideration of several factors, including:

 

·                  an ongoing review of the quality, mix, and size of our overall loan portfolio;

·                  our historical loan loss experience;

·                  evaluation of economic conditions;

·                  regular reviews of loan delinquencies and loan portfolio quality; and

·                  the amount and quality of collateral, including guarantees, securing the loans.

 

There is no precise method of predicting credit losses since any estimate of loan losses is necessarily subjective and the accuracy of the estimate depends on the outcome of future events.  Therefore, we face the risk that charge-offs in future periods will exceed our allowance for loan losses and that additional increases in the allowance for loan losses will be required.  Additions to the allowance for loan losses would result in an increase of our net loss, and possibly a decrease in our capital.

 

While we generally underwrite the loans in our portfolio in accordance with our own internal underwriting guidelines and regulatory supervisory guidelines, in certain circumstances we have made loans which exceed either our internal underwriting guidelines, supervisory guidelines, or both.  As of December 31, 2010, we had $7,215,251 in loans that had loan-to-value ratios that exceeded regulatory supervisory guidelines.  In addition, supervisory limits on commercial loan to value exceptions are set at 30% of our Bank’s capital.  At December 31, 2010, we had $3,838,990 in commercial loans that exceeded the supervisory loan to value ratio.  The number of loans in our portfolio with loan-to-value ratios in excess of supervisory guidelines, our internal guidelines, or both could increase the risk of delinquencies and defaults in our portfolio.

 

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***Lack of seasoning of our loan portfolio may increase the risk of credit defaults in the future.***

 

Due to our short operating history, all of the loans in our loan portfolio and of our lending relationships are of relatively recent origin.  In general, loans do not begin to show signs of credit deterioration or default until they have been outstanding for some period of time, a process we refer to as “seasoning.”  As a result, a portfolio of older loans will usually behave more predictably than a newer portfolio.  Because our loan portfolio is relatively new, the current level of delinquencies and defaults may not be representative of the level that will prevail when the portfolio becomes more seasoned, which may be higher than current levels.  If delinquencies and defaults increase, we may be required to increase our provision for loan losses, which would adversely affect our results of operations and financial condition.

 

***Our net interest income could be negatively affected by the lower level of short-term interest rates, recent developments in the credit and real estate markets and competition in our market area.***

 

As a financial institution, our earnings significantly depend upon our net interest income, which is the difference between the income that we earn on interest-earning assets, such as loans and investment securities, and the expense that we pay on interest-bearing liabilities, such as deposits and borrowings.  Therefore, any change in general market interest rates, including changes resulting from changes in the Federal Reserve’s fiscal and monetary policies, affects us more than non-financial institutions and can have a significant effect on our net interest income and net income.

 

The Federal Reserve reduced interest rates on three occasions in 2007 by a total of 100 basis points, to 4.25%, and by another 400 basis points, to a range of 0% to 0.25%, during 2009.  Rates remained steady for 2010.  On March 18, 2010, the Federal Reserve announced its decision to purchase as much as $300 billion of long-term treasuries in an effort to maintain low interest rates.  Approximately 53.6% of our loans were variable rate loans at December 31, 2010.  The interest rates on a significant segment of these loans decrease when the Federal Reserve reduces interest rates, while the interest that we earn on our assets may not change in the same amount or at the same rates.  Accordingly, increases in interest rates may reduce our net interest income.  In addition, an increase in interest rates may decrease the demand for loans.  Furthermore, increases in interest rates will add to the expenses of our borrowers, which may adversely affect their ability to repay their loans with us.

 

Increased nonperforming loans and the decrease in interest rates reduced our net interest income during 2010 and could cause additional pressure on net interest income in future periods.  This reduction in net interest income may also be exacerbated by the high level of competition that we face in our primary market areas.  Any significant reduction in our net interest income could negatively affect our business and could have a material adverse effect on our capital, financial condition and results of operations.

 

***Continuation of the economic downturn could reduce our customer base, our level of deposits, and demand for financial products such as loans.***

 

Our success significantly depends upon the growth in population, income levels, deposits, and housing starts in our markets.  The current economic downturn has negatively affected the markets in which we operate and, in turn, the quality of our loan portfolio.  If the communities in which we operate do not grow or if prevailing economic conditions locally or nationally remain unfavorable, our business may not succeed.  A continuation of the economic downturn or prolonged recession would likely result in the continued deterioration of the quality of our loan portfolio and reduce our level of deposits, which in turn would hurt our business.  Interest received on loans represented approximately 88.3% of our interest income for the year ended December 31, 2010.  If the economic downturn continues or a prolonged economic recession occurs in the economy as a whole, borrowers will be less likely to repay their loans as scheduled.  Moreover, in many cases the value of real estate or other collateral that secures our loans has been adversely affected by the economic conditions and could continue to be negatively affected.  Unlike many larger institutions, we are not able to spread the risks of unfavorable local economic conditions across a large number of diversified economies.  A continued economic downturn could, therefore, result in losses that materially and adversely affect our business.

 

***Recent legislation and administrative actions authorizing the U.S. government to take direct actions within the financial services industry may not stabilize the U.S. financial system.***

 

Under the EESA, which was enacted on October 3, 2008, the U.S. Treasury has the authority to, among other things, invest in financial institutions and purchase up to $700 billion of troubled assets and mortgages from 

 

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financial institutions for the purpose of stabilizing and providing liquidity to the U.S. financial markets. Under the CPP, the U.S. Treasury committed to purchase up to $250 billion of preferred stock and warrants in eligible institutions. The EESA also temporarily increased FDIC deposit insurance coverage to $250,000 per depositor through December 31, 2009, which was recently permanently increased to $250,000 under the Dodd-Frank Act.

 

On February 10, 2009, the U.S. Treasury announced the Financial Stability Plan which, among other things, provides a forward-looking supervisory capital assessment program that is mandatory for banking institutions with over $100 billion of assets and makes capital available to financial institutions qualifying under a process and criteria similar to the CPP. In addition, the American Recovery and Reinvestment Act of 2009 (the “ARRA”) was signed into law on February 17, 2009, and includes, among other things, extensive new restrictions on the compensation and governance arrangements of financial institutions.

 

On July 21, 2010, the President signed into law the Dodd-Frank Act, a comprehensive regulatory framework that will affect every financial institution in the U.S. The Dodd-Frank Act includes, among other measures, changes to the deposit insurance and financial regulatory systems, enhanced bank capital requirements and provisions designed to protect consumers in financial transactions. Regulatory agencies will implement new regulations in the future which will establish the parameters of the new regulatory framework and provide a clearer understanding of the legislation’s effect on banks. The changes resulting from the Dodd-Frank Act may impact the profitability of our business activities, require changes to certain of our business practices, impose upon us more stringent capital, liquidity, and leverage requirements or otherwise adversely affect our business. In particular, the potential impact of the Dodd-Frank Act on our operations and activities, both currently and prospectively, include, among others:

 

· a reduction in our ability to generate or originate revenue-producing assets as a result of compliance with heightened capital standards;

 

· increased cost of operations due to greater regulatory oversight, supervision and examination of banks and bank holding companies, and higher deposit insurance premiums;

 

· the limitation on our ability to raise capital through the use of trust preferred securities as these securities may no longer be included as Tier 1 capital going forward; and

 

· the limitation on our ability to expand consumer product and service offerings due to anticipated stricter consumer protection laws and regulations.

 

Numerous actions have been taken by the U.S. Congress, the Federal Reserve, the U.S. Treasury, the FDIC, the SEC and others to address the current liquidity and credit crisis that followed the sub-prime mortgage crisis that commenced in 2007, including the Financial Stability Program adopted by the U.S. Treasury. We cannot predict the actual effects of EESA, ARRA, the Dodd-Frank Act, and various other governmental, regulatory, monetary and fiscal initiatives which have been and may be enacted on the economy, the financial markets, or on us. The terms and costs of these activities, or the failure of these actions to help stabilize the financial markets, asset prices, market liquidity and a continuation or worsening of current financial market and economic conditions, could materially and adversely affect our business, financial condition, results of operations, and the price of our common stock.

 

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

 

Negative developments in the global credit and securitization markets have resulted in uncertainty in the financial markets in general with the expectation of continued uncertainty in 2011. As a result of this “credit crunch,” commercial as well as consumer loan portfolio performances have deteriorated at many institutions and the competition for deposits and quality loans has increased significantly. In addition, the values of real estate collateral supporting many commercial loans and home mortgages have declined and may continue to decline. Global securities markets, and bank holding company stock prices in particular, have been negatively affected, as has the ability of banks and bank holding companies to raise capital or borrow in the debt markets. Bank regulatory agencies are expected to be active in responding to concerns and trends identified in examinations, including the expected issuance of many formal enforcement orders.

 

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These initiatives may increase our expenses or decrease our income by, among other things, making it harder for us to foreclose on mortgages.  Further, the overall effects of these and other legislative and regulatory efforts on the financial markets remain uncertain, and they may not have the intended stabilization results.  These efforts may even have unintended harmful consequences on the U.S. financial system and our business.  Should these or other legislative or regulatory initiatives have unintended effects, our business, financial condition, results of operations and prospects could be materially and adversely affected.

 

In addition, we may need to modify our strategies and business operations in response to these changes.  We may also incur increased capital requirements and constraints or additional costs to satisfy new regulatory requirements.  Given the volatile nature of the current market and the uncertainties underlying efforts to mitigate or reverse disruptions, we may not timely anticipate or manage existing, new or additional risks, contingencies or developments in the current or future environment.  Our failure to do so could materially and adversely affect our business, financial condition, results of operations and prospects.

 

***We could experience an unexpected inability to obtain needed liquidity.***

 

Liquidity measures the ability to meet current and future cash flow needs as they become due.  The liquidity of a financial institution reflects its ability to meet loan requests, to accommodate possible outflows in deposits, and to take advantage of interest rate market opportunities.  The ability of a financial institution to meet its current financial obligations is a function of its balance sheet structure, its ability to liquidate assets and its access to alternative sources of funds.  We seek to ensure our funding needs are met by maintaining a level of liquidity through asset/liability management as well as through, among other things, our ability to borrow funds from the Federal Home Loan Bank and the Federal Reserve Bank.  As December 31, 2010, our borrowing capacity with the Federal Home Loan Bank was $13,290,000 of which $9,850,000 is available.  Both institution specific events such as deterioration in our credit ratings resulting from a weakened capital position or from lack of earnings and industry-wide events such as a collapse of credit markets may result in a reduction of available funding sources sufficient to cover the liquidity demands.  If we are unable to obtain funds when needed, it could materially adversely affect our business, financial condition and results of operations.

 

***Because of our participation in the Treasury Department’s Capital Purchase Program, we are subject to several restrictions including restrictions on compensation paid to our executives.***

 

Pursuant to the terms of the CPP Purchase Agreement between us and the Treasury, we adopted certain standards for executive compensation and corporate governance for the period during which the Treasury holds the equity issued pursuant to the CPP Purchase Agreement, including the common stock which may be issued pursuant to the CPP Warrant.  These standards generally apply to our Chief Executive Officer, Chief Financial Officer and the three next most highly compensated senior executive officers.  The standards include (1) ensuring that incentive compensation for senior executives does not encourage unnecessary and excessive risks that threaten the value of the financial institution; (2) required clawback of any bonus or incentive compensation paid to a senior executive based on statements of earnings, gains or other criteria that are later proven to be materially inaccurate; (3) prohibition on making golden parachute payments to senior executives; and (4) agreement not to deduct for tax purposes executive compensation in excess of $500,000 for each senior executive.  In particular, the change to the deductibility limit on executive compensation will likely increase the overall cost of our compensation programs in future periods and may make it more difficult to attract suitable candidates to serve as executive officers.

 

***Legislation or regulatory changes could cause us to seek to repurchase the preferred stock that we sold to the U.S. Treasury pursuant to the Capital Purchase Program.***

 

Legislation that has been adopted after we closed on our sale of Series A and Series B Preferred Stock to the Treasury for approximately $3.3 million pursuant to the CPP on January 9, 2009, or any legislation or regulations that may be implemented in the future, may have a material impact on the terms of our CPP transaction with the Treasury.  If we determine that any such legislation or any regulations, in whole or in part, alter the terms of our CPP transaction with the Treasury in ways that we believe are adverse to our ability to effectively manage our business, then it is possible that we may seek to unwind, in whole or in part, the CPP transaction by repurchasing some or all of the preferred stock that we sold to the Treasury pursuant to the CPP.  If we were to repurchase all or a portion of such preferred stock, then our capital levels could be materially reduced.

 

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***The securities purchase agreement between us and the Treasury limits our ability to pay dividends on and repurchase our common stock.***

 

The securities purchase agreement between us and the Treasury provides that prior to January 9, 2012, unless we have redeemed the Series A Preferred Stock and Series B Preferred Stock or the Treasury has transferred the Series A Preferred Stock or Series B Preferred Stock to a third party, the consent of the Treasury will be required for us to declare or pay any dividend or make any distribution on our common stock.  The purchase agreement further provides that prior to January 9, 2019, unless we have redeemed the Series A Preferred Stock and Series B Preferred Stock or the Treasury has transferred the Series A Preferred Stock or Series B Preferred Stock to a third party, the consent of the Treasury will be required for us to redeem, purchase or acquire any shares of our common stock or other equity or capital securities, other than in connection with benefit plans consistent with past practice and certain other circumstances specified in the purchase agreement.  These restrictions could have a negative effect on the value of our common stock.

 

***Higher FDIC Deposit Insurance premiums and assessments that we are required to pay could have an adverse effect on our earnings and our ability to pay our liabilities as they come due.***

 

As a member institution of the FDIC, we are required to pay quarterly deposit insurance premium assessments to the FDIC. Due to the large number of recent bank failures, and the FDIC’s new Temporary Liquidity Guarantee Program, the FDIC adopted a revised risk-based deposit insurance assessment schedule in February 2009, which raised deposit insurance premiums. The FDIC also implemented a five basis point special assessment of each insured depository institution’s assets minus Tier 1 capital as of June 30, 2009, which special assessment amount was capped at 10 basis points times the institution’s assessment base for the second quarter of 2009. In addition, the FDIC required financial institutions like us to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010 through and including 2012 to re-capitalize the Deposit Insurance Fund, unless the FDIC exempted the institution from the prepayment requirement upon a determination that the prepayment would adversely affect the safety and soundness of the institution. We did request exemption from the prepayment requirement. During 2010, we expensed $417,758 in deposit insurance.

 

In February 2011, the FDIC approved two rules that amend the deposit insurance assessment regulations. The first rule implements a provision in the Dodd-Frank Act that changes the assessment base from one based on domestic deposits to one based on assets. The assessment base changes from adjusted domestic deposits to average consolidated total assets minus average tangible equity. The second rule changes the deposit insurance assessment system for large institutions in conjunction with the guidance given in the Dodd-Frank Act. Since the new base would be much larger than the current base, the FDIC will lower assessment rates, which achieves the FDIC s goal of not significantly altering the total amount of revenue collected from the industry. Risk categories and debt ratings will be eliminated from the assessment calculation for large banks which will instead use scorecards. The scorecards will include financial measures that are predictive of long-term performance. A large financial institution will continue to be defined as an insured depository institution with at least $10 billion in assets. Both changes in the assessment system will be effective as of April 1, 2011 and will be payable at the end of September.

 

Although we cannot predict what the insurance assessment rates will be in the future, further deterioration in either risk-based capital ratios or adjustments to the base assessment rates could have a material adverse impact on our business, financial condition, results of operations, and cash flows.

 

***Our small-l to medium-sized business target markets may have fewer financial resources to weather a downturn in the economy.***

 

We target the banking and financial services needs of small- and medium-sized business.  These businesses generally have fewer financial resources in terms of capital borrowing capacity than larger entities.  If general economic conditions continue to negatively impact these businesses in the markets in which we operate, our business, financial condition and results of operations may be adversely affected.

 

***We depend on the accuracy and completeness of information about clients and counterparties and our financial condition could be adversely affected if we rely on misleading information.***

 

In deciding whether to extend credit or to enter into other transactions with clients and counterparties, we may rely on information furnished to us by or on behalf of clients and counterparties, including financial statements and other financial information.  We also may rely on representations of clients and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors.  

 

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For example, in deciding whether to extend credit to clients, we may assume that a customer’s audited financial statements conform with GAAP and present fairly, in all material respects, the financial condition, results of operations and cash flows of the customer.  Our financial condition and results of operations could be negatively affected to the extent we rely on financial statements that do not comply with GAAP or are materially misleading.

 

***The costs of being an SEC registered company are proportionately higher for smaller companies like us because of the requirements imposed by the Sarbanes-Oxley Act.***

 

The Sarbanes-Oxley Act of 2002 and the related rules and regulations promulgated by the SEC have increased the scope, complexity and cost of corporate governance, reporting and disclosure practices.  These regulations are applicable to our company.  We have experienced, and expect to continue to experience, increasing compliance costs, including costs related to internal controls, as a result of the Sarbanes-Oxley Act.  These necessary costs are proportionately higher for a company of our size and will affect our profitability more than that of some of our larger competitors.

 

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

 

We are required by regulatory authorities to maintain adequate levels of capital to support our operations.  To support our continued operations, including any additional growth, we may need to raise additional capital.  In addition, we intend to redeem the Series A Preferred Stock that we issued to the Treasury under the CPP before the dividends on the Series A Preferred Stock increase from 5% per annum to 9% per annum in 2014, as we may need to raise additional capital to do so.  Our ability to raise additional capital will depend in part on conditions in the capital markets at that time, which are outside our control, and our financial performance.  Accordingly, we may be unable to raise additional capital, if and when needed, on terms acceptable to us, or at all.  If we cannot raise additional capital when needed, our ability to continue our current operations or further expand our operations through internal growth and acquisitions could be materially impaired.  In addition, if we decide to raise additional equity capital, your interest could be diluted.

 

***We face strong competition for clients, which could prevent us from obtaining clients and may cause us to pay higher interest rates to attract deposits.***

 

The banking business is highly competitive, and we experience competition in our market from many other financial institutions.  We compete with commercial banks, credit unions, savings and loan associations, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market funds, and other mutual funds, as well as other super-regional, national, and international financial institutions that operate offices in our primary market areas and elsewhere.  We compete with these institutions both in attracting deposits and in making loans.  In addition, we have to attract our client base from other existing financial institutions and from new residents.  Many of our competitors are well-established, larger financial institutions.  These institutions offer some services, such as extensive and established branch networks, that we do not provide.  There are also a number of other relatively new community banks in our market that share our general marketing focus on small- to medium-sized businesses and individuals.  There is a risk that we will not be able to compete successfully with other financial institutions in our market, and that we may have to pay higher interest rates to attract deposits, resulting in reduced profitability.  In addition, competitors that are not depository institutions are generally not subject to the extensive regulations that apply to us.

 

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

 

Although we do not have any current plans to do so, we may seek to acquire other financial institutions or parts of those institutions.  We may also expand into new markets or lines of business or offer new products or services.  These activities would involve a number of risks, including:

 

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

 

·                  the time and costs of evaluating new markets, hiring or retaining experienced local management, and opening new offices and the time lags between these activities and the generation of sufficient assets and deposits to support the costs of the expansion;

 

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

 

·                  the risk of loss of key employees and customers.

 

We have never acquired another institution before, so we lack experience in handling any of these risks.  There is the risk that any expansion effort will not be successful.

 

***We are exposed to the possibility of technology failure and a disruption in our operations may adversely affect our business.***

 

We rely on our computer systems and the technology of outside service providers.  Our daily operations depend on the operational effectiveness of their technology.  We rely on our systems to accurately track and record our assets and liabilities.  If our computer systems or outside technology sources become unreliable, fail, or experience a breach of security, our ability to maintain accurate financial records may be impaired, which could materially affect our business operations and financial condition.  In addition, a disruption in our operations resulting from failure of transportation and telecommunication systems, loss of power, interruption of other utilities, natural disaster, fire, global climate changes, computer hacking or viruses, failure of technology, terrorist activity or the domestic and foreign response to such activity or other events outside of our control could have an adverse impact on the financial services industry as a whole and/or on our business. Our business recovery plan may not be adequate and may not prevent significant interruptions of our operations or substantial losses.

 

**Item 1B.  Unresolved Staff Comments.**

 

Not applicable.

 

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**Item 2.   Properties.**

 

Our Sunset office, which opened in January, 2009 is located at the intersection of Sunset Boulevard and Kim Street approximately one mile east of the Lexington Medical Center.  Our address is 2023 Sunset Boulevard, West Columbia, South Carolina 29169.  The building is approximately 4,100 square feet on a site that is approximately 1.5 acres in size and is a full service banking facility with 3 drive-thru lanes and a drive-thru ATM.  The Sunset office is subject to a 15 year lease, with the option to extend the lease for two consecutive renewal terms of five years each.

 

We also occupy another branch and administration office located at 1201 Knox Abbot Drive, Cayce, South Carolina.  This building is approximately 7,500 square feet in administration area and approximately 2,100 square feet branch office with a drive in facility.  In December 2009, we entered into a sale-lease back agreement for a portion of this property.  The lease is for a period of 15 years, with the option to extend the lease for three consecutive renewal terms of five years each.  This property is approximately 5,674 square feet which the Bank leases to other tenants. In June 2010, the Company entered into a sale-lease back agreement for a branch and office building located at 1201 Knox Abbot Drive in Cayce, South Carolina. The lease is for a period of 15 years, with the option to extend the lease for two consecutive renewal terms of five years each.

 

**Item 3.   Legal Proceedings****.**

 

In the ordinary course of operations, we may be a party to various legal proceedings from time to time.  We are not aware of any pending or threatened proceeding against us which we expect to have a material effect on our business, results of operations, or financial condition.

 

**Item 4.   (Removed and Reserved)****.**

 

**PART II**

 

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

 

Since February 2, 2009, our common stock has been quoted on the OTC Bulletin Board under the symbol “CNRB.”  Quotations on the OTC Bulletin Board reflect inter-dealer prices, without retail mark-up, mark-down, or commissions, and may not represent actual transactions.  Transactions of our common stock did not begin to occur on the OTC Bulletin Board until February 4, 2009.

 

The following is a summary of the high and low bid prices for our common stock reported by the OTC Bulletin Board for the periods indicated:

 
| **2010**       | ** ** | **High** | ** ** | **Low** | ** ** |
|----------------|------------|----------|------------|---------|------------|
| First Quarter  |       | $        | 4.00       |    | $          | 2.50 |   |
| Second Quarter |       | 3.50     |       | 2.50    |       |
| Third Quarter  |       | 3.50     |       | 2.50    |       |
| Fourth Quarter |       | 2.75     |       | 1.80    |       |
|                |            |          |            |         |            |  |  |

 
| **2009**       | ** ** | **High** | ** ** | **Low** | ** ** |
|----------------|------------|----------|------------|---------|------------|
| First Quarter  |       | $        | 10.00      |    | $          | 1.00 |   |
| Second Quarter |       | 10.00    |       | 3.50    |       |
| Third Quarter  |       | 5.00     |       | 3.50    |       |
| Fourth Quarter |       | 6.75     |       | 2.05    |       |
|                |            |          |            |         |            |  |  |

 

As of April 10, 2011, there were 1,764,439 shares of common stock outstanding held by approximately 1,824 shareholders of record.  All of our currently issued and outstanding common stock was issued in our initial public offering which was completed on October 16, 2006.

 

We have not declared or paid any cash dividends on our common stock since our inception.  For the foreseeable future we do not intend to declare cash dividends.  We intend to retain earnings to grow our business and strengthen our capital base.  Our ability to pay dividends depends on the ability of our subsidiary, Congaree State 

 

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Bank, to pay dividends to us.  As a South Carolina state bank, our Bank may only pay dividends out of its net profits, after deducting expenses, including losses and bad debts.  In addition, our Bank is prohibited from declaring a dividend on its shares of common stock until its surplus equals its stated capital.  In addition, the Bank currently must obtain prior approval from the Supervisory Authorities prior to the payment of any cash dividends.

 

In addition, on January 9, 2009, as part of the Capital Purchase Program established by the Treasury under the EESA, we entered into the CPP Purchase Agreement with Treasury, pursuant to which we issued and sold to Treasury (i) 3,285 shares of our Series A Preferred Stock, and (ii) a ten-year warrant to purchase 164 shares of our Series B Preferred Stock, for an aggregate purchase price of $3,285,000 in cash.  Pursuant to the CPP Purchase Agreement, prior to January 9, 2012, unless we have redeemed the Series A Preferred Stock and the Series B Preferred Stock or the Treasury has transferred the Series A Preferred Stock and the Series B Preferred Stock to a third party, the consent of the Treasury will be required for us to declare or pay any dividend or make any distribution on our common stock.

 

The following table sets forth equity compensation plan information at December 31, 2010.

 

**Equity Compensation Plan Information**

 
| **Plan Category**                                                 | ** ** | **Number of securities********to be issued********upon exercise of   outstanding options,   warrants and rights (a)** | ** ** | **Weighted-average********exercise price of   outstanding options,   warrants and rights   (b)** | ** ** | **Number of securities********remaining available for********future issuance under********equity compensation   plans (c)********(excluding securities********reflected in column(a))** | ** ** |
|------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Equity compensation plans approved by security   holders (1)           |       | 82,391                                                                                                                                                                  |       | $                                                                                                                         | 10.00      |                                                                                                                                                                                                                                           | 183,909    |   |
|                                                                   |       |                                                                                                                                                                    |       |                                                                                                                      |       |                                                                                                                                                                                                                                           |       |
| Equity compensation plans not approved by security   holders (2)  |       | 120,000                                                                                                                                                                 |       | $                                                                                                                         | 10.00      |                                                                                                                                                                                                                                           | —     |   |
| Total                                                                  |       | 202,391                                                                                                                                                                 |       | $                                                                                                                         | 10.00      |                                                                                                                                                                                                                                           | 183,909    |   |

 

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(1)                                At our annual meeting in 2007, we adopted the Congaree Bancshares, Inc. 2007 Stock Incentive Plan.

 

(2)                                Each of our organizers received, for no additional consideration, a warrant to purchase one share of common stock for $10.00 per share for each share purchased during our initial public offering up to a maximum of 10,000 warrants.  The warrants are represented by separate warrant agreements.  The warrants will vest over a three year period beginning October 16, 2007, and they will be exercisable in whole or in part during the 10 year period ending October 16, 2016.  If the South Carolina Board of Financial Institutions or the FDIC issues a capital directive or other order requiring the Bank to obtain additional capital, the warrants will be forfeited, if not immediately exercised.

 

**Item 6.  Selected Financial Data.**

 

Not applicable.

 

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

 

**General**

 

Our Bank opened for business on October 16, 2006.  All activities of the Company prior to that date relate to the organization of the Bank.  The following discussion describes our results of operations for the years ended December 31, 2010 and 2009 and also analyzes our financial condition as of December 31, 2010. The following discussion and analysis also identifies significant factors that have affected our financial position and operating results during the periods included in the accompanying financial statements. We encourage you to read this discussion and analysis in conjunction with our financial statements and the other statistical information included in this report.

 

Like most community banks, we derive the majority of our income from interest we receive on our loans and investments.  Our primary source of funds for making these loans and investments is our deposits, on which we pay interest.  Consequently, one of the key measures of our success is our amount of net interest income, or the difference between the income on our interest-earning assets, such as loans and investments, and the expense on our interest-bearing liabilities, such as deposits, also known as net interest margin.  Another key measure is the spread between the yield we earn on these interest-earning assets and the rate we pay on our interest-bearing liabilities, which is referred to as net interest spread.

 

We have included a number of tables to assist in our description of these measures.  For example, the “Average Balances, Income and Expenses, and Rates” tables show for the periods indicated the average balance for each category of our assets and liabilities, as well as the average yield we earned or the average rate we paid with respect to each category.  A review of these tables show that our loans historically have provided higher interest yields than our other types of interest-earning assets, which is why we have invested a substantial percentage of our earning assets into our loan portfolio.  Similarly, the “Rate/Volume Analysis” table helps demonstrate the impact of changing interest rates and changing volume of assets and liabilities during the periods shown.  We also track the sensitivity of our various categories of assets and liabilities to changes in interest rates, and we have included “Interest Sensitivity Analysis” tables to help explain this.  Finally, we have included a number of tables that provide detail about our investment securities, our loans, our deposits and other borrowings.

 

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

 

In addition to earning interest on our loans and investments, we earn income through fees and other expenses we charge to our clients.  We describe the various components of this non-interest income, as well as our non-interest expense, in the following discussion.

 

**Current Economic Environment**

 

Markets in the United States and elsewhere have experienced extreme volatility and disruption for more than three years.  These circumstances have exerted significant downward pressure on prices of equity securities and virtually all other asset classes, and have resulted in substantially increased market volatility, severely constrained credit and capital markets, particularly for financial institutions, and an overall loss of investor confidence.  Loan portfolio performances have deteriorated at many institutions resulting from, among other factors, a weak economy and a decline in the value of the collateral supporting their loans.  Dramatic slowdowns in the housing industry, due in part to falling home prices and increasing foreclosures and unemployment, have created strains on financial institutions.  Many borrowers are now unable to repay their loans, and the collateral securing these loans has, in some cases, declined below the loan balance.  As discussed above in the section titled “Supervision and Regulation” under the heading “Recent Legislative and Regulatory Initiatives to Address Financial and Economic Crisis,” the United States government has taken unprecedented actions in response to the challenges facing the financial services sector.

 

**The Effect of the Current Economic Environment on our Bank**

 

Like many financial institutions across the United States and in South Carolina, our operations have been 

 

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adversely affected by the current economic crisis.  Beginning in 2008 and continuing through 2010, we recognized that construction, acquisition, and development real estate projects were slowing, guarantors were becoming financially stressed, and increasing credit losses were surfacing.  Portfolio-wide delinquencies remained at an elevated level over the first two quarters of 2010. Declines in the Bank’s past due rates in the third and fourth quarters of 2010 were attributed to the Bank’s management of the delinquent borrowers. Delinquencies were evenly distributed across portfolios and non-accruing loans were primarily concentrated in commercial real estate loans.

 

As of December 31, 2010, approximately 88.2% of our loans had real estate as a primary or secondary component of collateral.  Included in our loans secured by real estate, we have approximately $12,076,019 of construction and development loans as of December 31, 2010, most of which are on properties located within the Columbia MSA and consist primarily of loans to individuals or closely held real estate holding companies where the borrower was holding property for current and/or future personal use.  Additionally, $1,050,190 of all construction and development loans are single family residence construction loans to the individual who intends on using the constructed house as their primary residence.  Over the last three years, the Bank has experienced minimal loss from its construction and development portfolio and believes that the loans we have made to date do not carry the same risks associated with a typical bank’s construction and development portfolio.

 

The result of the above was a significant increase in the level of our non-performing assets during 2010.  As of December 31, 2010, our non-performing assets equaled $4.7 million, or 3.88% of assets, as compared to $2.7 million, or 1.94% of assets, as of December 31, 2009.  For the year ended December 31, 2010, we recorded a provision for loan losses of $853,109 and net loan charge-offs of $799,985, or 0.85% of average loans, as compared to a $717,937 provision for loan losses and net loan charge-offs of $907,840, or 0.83% of average loans, for the year ended December 31, 2009.  In general, the provision for loan losses for 2010 was attributed to overall strain in the economy.  Specifically, one charge off accounted for 32.1% of all total charge offs during the year. The overall level of the Bank’s net losses to average loans was .80% which was superior to its UBPR Peer Group Average of 1.20%. We believe that active management of delinquent borrowers was the primary factor for the Bank’s favorable performance.  In addition, our net interest margin increased to 3.29% for the year ended December 31, 2010 from 2.97% for the year ended December 31, 2009.

 

**Critical Accounting Policies**

 

We have adopted various accounting policies that govern the application of accounting principles generally accepted in the United States of America and with general practices within the banking industry in the preparation of our financial statements. Our significant accounting policies are described in footnote 1 to our audited consolidated financial statements as of December 31, 2010, included herein.  Management has discussed these critical accounting policies with the audit committee.

 

Certain accounting policies involve significant judgments and assumptions by us that have a material impact on the carrying value of certain assets and liabilities.  We consider these accounting policies to be critical accounting policies.  The judgment and assumptions we use are based on historical experience and other factors, which we believe to be reasonable under the circumstances.  Because of the nature of the judgment and assumptions we make, actual results could differ from these judgments and estimates that could have a material impact on the carrying values of our assets and liabilities and our results of operations.

 

*Allowance for Loan Losses*

 

We believe the allowance for loan losses is the critical accounting policy that requires the most significant judgment and estimates used in preparation of our consolidated financial statements.  Some of the more critical judgments supporting the amount of our allowance for loan losses include judgments about the creditworthiness of borrowers, the estimated value of the underlying collateral, the assumptions about cash flow, determination of loss factors for estimating credit losses, the impact of current events, and conditions, and other factors impacting the level of probable inherent losses.

 

Under different conditions or using different assumptions, the actual amount of credit losses incurred by us may be different from management’s estimates provided in our consolidated financial statements.  Refer to the portion of this discussion that addresses our allowance for loan losses for a more complete discussion of our processes and methodology for determining our allowance for loan losses.

 

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*Income Taxes*

 

We use assumptions and estimates in determining income taxes payable or refundable for the current year, deferred income tax liabilities and assets for events recognized differently in our financial statements and income tax returns, and income tax expense.  Determining these amounts requires analysis of certain transactions and interpretation of tax laws and regulations.  Management exercises judgment in evaluating the amount and timing of recognition of resulting tax liabilities and assets.  These judgments and estimates are reevaluated on a continual basis as regulatory and business factors change.  No assurance can be given that either the tax returns submitted by us or the income tax reported on the financial statements will not be adjusted by either adverse rulings by the United States Tax Court, changes in the tax code, or assessments made by the Internal Revenue Service.  We are subject to potential adverse adjustments, including, but not limited to, an increase in the statutory federal or state income tax rates, the permanent nondeductibility of amounts currently considered deductible either now or in future periods, and the dependency on the generation of future taxable income, including capital gains, in order to ultimately realize deferred income tax assets.

 

**Results of Operations**

 

*General*

 

Our net loss was $298,557 and $1,142,922 for the years ended December 31, 2010 and 2009, respectively. Net loss before income taxes was $298,557 for the year ended December 31, 2010, a decrease of $844,365, or 73.9%, compared to $1,142,922 for the year ended December 31, 2009.  The decrease in net loss before income taxes resulted from a $229,142 decrease in noninterest expense and increases of $416,119 in net interest income and $334,276 in noninterest income.  Noninterest income increased from $336,302 for the year ended December 31, 2009, to $670,578 for the year ended December 31, 2010.  We also recorded a provision for loan losses of $853,109 and $717,937 for the years ended December 31, 2010 and 2009, respectively.

 

*Net Interest Income*

 

Our primary source of revenue is net interest income.  Net interest income is the difference between income earned on interest-earning assets and interest paid on deposits and borrowings used to support such assets. The level of net interest income is determined by the balances of interest-earning assets and interest-bearing liabilities and corresponding interest rates earned and paid on those assets and liabilities, respectively.  In addition to the volume of and corresponding interest rates associated with these interest-earning assets and interest-bearing liabilities, net interest income is affected by the timing of the repricing of these interest-earning assets and interest-bearing liabilities.

 

Net interest income was $4,202,204 for the year ended December 31, 2010, an increase of $416,119 or 11.0%, over net interest income of $3,786,085 for the year ended December 31, 2009.  Interest income of $6,241,309 for the year ended December 31, 2010, included $5,510,062 on loans, $714,752 on investment securities and $16,495 on federal funds sold.  Loan interest and related fees decreased $474,654, or 7.9%, over 2009, due to a decrease in the loan portfolio volume. Total interest expense of $2,039,105 for the year ended December 31, 2010, included $1,950,960 related to deposit accounts and $88,145 on federal funds purchased and Federal Home Loan Bank borrowings.  Interest expense on deposits decreased $831,453, or 29.9%, due to the decrease in deposit rates during 2010.

 

The following table sets forth information related to our average balance sheet, average yields on assets, and average costs of liabilities. We derived these yields by dividing income or expense by the average balance of the corresponding assets or liabilities. We derived average balances from the daily balances throughout the periods indicated. The net amount of capitalized loan fees is amortized into interest income over the life of the loans.

 

35

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**Average Balances, Income and Expenses, and Rates**

 
| ** **                                         | ** ** | **For the Year Ended   December 31, 2010** | ** ** | **For the Year Ended   December 31, 2009** | ** ** | **For the Year Ended   December 31, 2008** | ** ** |
|----------------------------------------------------|------------|---------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                                         | ** ** | **Average   Balance**                                               | ** ** | **Income/   Expense**                                               | ** ** | **Yield/   Rate**                                                   | ** ** | **Average   Balance** | ** ** | **Income/   Expense** | ** ** | **Yield/   Rate** | ** ** | **Average   Balance** | ** ** | **Income/   Expense** | ** ** | **Yield/   Rate** | ** ** |
| ** **                                         | ** ** | **(dollars   in thousands)**                                        | ** ** |
| Earning   assets:                                  |       |                                                                |       |                                                                |       |                                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Federal   funds sold                               |       | $                                                                   | 6,482      |                                                                | $          | 17                                                                  |       | 0.25 | % | $ | 5,561 |   | $ | 20 |   | 0.38 | % | $ | 1,085 |   | $ | 38 |   | 3.49 | % |
| Investment   securities andFHLB stock              |       | 21,030                                                              |       | 715                                                                 |       | 3.40                                                                | %          | 13,035 |   | 649 |   | 4.98 | % | 14,137 |   | 745 |   | 5.27 | % |
| Loans   receivable(1)                              |       | 100,457                                                             |       | 5,510                                                               |       | 5.48                                                                | %          | 108,870 |   | 5,985 |   | 5.50 | % | 87,391 |   | 5,496 |   | 6.29 | % |
|                                               |       |                                                                |       |                                                                |       |                                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total   earning assets                             |       | 127,969                                                             |       | 6,242                                                               |       | 4.88                                                                | %          | 127,466 |   | 6,654 |   | 5.22 | % | 102,613 |   | 6,279 |   | 6.1 | % |
| Noninterest-earning   assets                       |       | 6,358                                                               |       |                                                                |       |                                                                |       | 6,751 |   |   |   |   |   | 4,869 |   |   |   |   |   |
|                                               |       |                                                                |       |                                                                |       |                                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total   assets                                     |       | $                                                                   | 134,327    |                                                                |       |                                                                |       |   | $ | 134,217 |   |   |   |   |   | $ | 107,482 |   |   |   |   |   |
|                                               |       |                                                                |       |                                                                |       |                                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing   liabilities:                    |       |                                                                |       |                                                                |       |                                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest   bearing transaction accounts            |       | $                                                                   | 4,471      |                                                                | 15         |                                                                | 0.33       | % | $ | 4,395 |   | 13 |   | 0.29 | % | $ | 4,310 |   | 33 |   | 0.76 | % |
| Savings &   money market                  |       | 43,326                                                              |       | 676                                                                 |       | 1.56                                                                | %          | 29,338 |   | 595 |   | 2.03 | % | 23,914 |   | 686 |   | 2.87 | % |
| Time   deposits                                    |       | 62,024                                                              |       | 1,260                                                               |       | 2.03                                                                | %          | 73,340 |   | 2,175 |   | 2.97 | % | 55,966 |   | 2,268 |   | 4.05 | % |
| Advances   from FHLB                               |       | 3,000                                                               |       | 81                                                                  |       | 2.69                                                                | %          | 3,000 |   | 79 |   | 2.63 | % | 2,509 |   | 67 |   | 2.68 | % |
| Federal   funds purchased and repurchase agreement |       | 332                                                                 |       | 7                                                                   |       | 2.17                                                                | %          | 1,172 |   | 7 |   | 0.61 | % | 2,009 |   | 52 |   | 2.61 | % |
|                                               |       |                                                                |       |                                                                |       |                                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total   interest-bearing liabilities               |       | 113,153                                                             |       | 2,039                                                               |       | 1.80                                                                | %          | 111,245 |   | 2,869 |   | 2.58 | % | 88,708 |   | 3,106 |   | 3.50 | % |
|                                               |       |                                                                |       |                                                                |       |                                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Noninterest-bearing   liabilities                  |       | 10,282                                                              |       |                                                                |       |                                                                |       | 10,810 |   |   |   |   |   | 8,473 |   |   |   |   |   |
| Shareholders’   equity                        |       | 10,892                                                              |       |                                                                |       |                                                                |       | 12,162 |   |   |   |   |   | 10,301 |   |   |   |   |   |
|                                               |       |                                                                |       |                                                                |       |                                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total   liabilities and shareholders’ equity  |       | $                                                                   | 134,327    |                                                                |       |                                                                |       |   | $ | 134,217 |   |   |   |   |   | $ | 107,482 |   |   |   |   |   |
|                                               |       |                                                                |       |                                                                |       |                                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net   interest spread                              |       |                                                                |       |                                                                |       | 3.08                                                                | %          |   |   |   |   | 2.64 | % |   |   |   |   | 2.62 | % |
|                                               |       |                                                                |       |                                                                |       |                                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net   interest margin                              |       |                                                                |       | 4,203                                                               |       | 3.29                                                                | %          |   |   | 3,785 |   | 2.97 | % |   |   | 3,173 |   | 3.09 | % |
|                                                    |            |                                                                     |            |                                                                     |            |                                                                     |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(1)  Loan fees, which are immaterial, are included in interest income.  There were $1,417,289 in nonaccrual loans for 2010 and $2,020,974 nonaccrual loans in 2009. Nonaccrual loans are included in the average balances, and income on nonaccrual loans is included on the cash basis for yield computation purposes.

 

Our consolidated net interest margin for the year ended December 31, 2010 was 3.29%, an increase of 32 basis points from the net interest margin of 2.97% for the year ended December 31, 2009.  The net interest margin is calculated by dividing net interest income by year-to-date average earning assets.  This increase can be attributed to the costs of our funding sources.  We rely on a higher volume of money market and time deposits to fund our loan portfolio and, as they mature, these deposits are being replaced at lower interest rates.  Earning assets averaged $127,969,697 for the year ended December 31, 2010, increasing from $127,466,494 for the year ended December 31, 2009. Our net interest spread was 3.08% for the year ended December 31, 2010. The net interest spread is the difference between the yield we earn on our interest-earning assets and the rate we pay on our interest-bearing liabilities. In pricing deposits, we consider our liquidity needs, the direction and levels of interest rates and local market conditions. As such, higher rates than local competitors have been paid initially to attract deposits.

 

36

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*Rate/Volume Analysis*

 

Net interest income can be analyzed in terms of the impact of changing interest rates and changing volume. The following table sets forth the effect which the varying levels of interest-earning assets and interest-bearing liabilities and the applicable rates had on changes in net interest income for the comparative periods presented.  Changes attributed to both rate and volume, have been allocated on a pro rata basis.

* *
| ** **                                         | ** ** | **2010 Compared to 2009** | ** ** | **2009 Compared to 2008** | ** ** |
|----------------------------------------------------|------------|------------------------------------------|------------|------------------------------------------|------------|
| ** **                                         | ** ** | **Total   Change**                       | ** ** | **Change in   Volume**              | ** ** | **Change in   Rate** | ** ** | **Total   Change** | ** ** | **Change in   Volume** | ** ** | **Change in   Rate** | ** ** |
| **Interest-earning assets:**                       | ** ** | ** **                               | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Federal funds sold                                 |       | $                                        | (4,422     | )                                        | $          | 2,578 |   | $ | (7,000 | ) | $ | (16,995 | ) | $ | (51,718 | ) | $ | (34,723 | ) |
| Investment securities   and FHLB stock             |       | 66,004                                   |       | 343,986                                  |       | (277,982 | ) | (96,401 | ) | (133,158 | ) | (36,757 | ) |
| Loans                                              |       | (474,654                                 | )          | (682,393                                 | )          | 207,739 |   | 488,351 |   | (193,296 | ) | (681,647 | ) |
| **Total interest income**                          |       | (413,072                                 | )          | (335,829                                 | )          | (77,243 | ) | 374,955 |   | (378,172 | ) | (753,127 | ) |
|                                               |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |
| **Interest-bearing liabilities:**                  | ** ** | ** **                               | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest-bearing   deposits                        |       | (831,453                                 | )          | (53,345                                  | )          | (778,108 | ) | (204,379 | ) | (1,037,502 | ) | (833,123 | ) |
| FHLB advances                                      |       | 2,166                                    |       | —                                   |       | 2,166 |   | 11,439 |   | 10,194 |   | (1,245 | ) |
| Federal funds purchased   and repurchase agreement |       | 96                                       |       | 333                                      |       | (237 | ) | (45,249 | ) | (85,430 | ) | (40,181 | ) |
| **Total interest expense**                         |       | (829,191                                 | )          | (53,012                                  | )          | (776,179 | ) | (238,189 | ) | (1,112,738 | ) | (874,549 | ) |
| **Net interest income**                            |       | $                                        | 416,119    |                                     | $          | (282,817 | ) | $ | 698,936 |   | $ | 613,144 |   | $ | 734,566 |   | $ | (121,422 | ) |

 

*Provision for Loan Losses*

 

We have established an allowance for loan losses through a provision for loan losses charged as a non-cash expense to our statement of operations. We review our loan portfolio periodically to evaluate our outstanding loans and to measure both the performance of the portfolio and the adequacy of the allowance for loan losses.  Please see the discussion below under “Provision and Allowance for Loan Losses” for a description of the factors we consider in determining the amount of the provision we expense each period to maintain this allowance.

 

Our provision for loan losses for the year ended December 31, 2010 was $853,109, an increase of $135,172, or 18.8%, over our provision of $717,937, for the year ended December 31, 2009.  The allowance as a percentage of gross loans has been increased from approximately 1.4% to 1.7% as of December 31, 2009 and 2010, respectively, due to management’s evaluation of the adequacy of the reserve for possible loan losses given the size, mix, and quality of the current loan portfolio. Management also relies on our limited history of past-dues and charge-offs, as well as peer data to determine our loan loss allowance.

 

*Noninterest Income*

 

Noninterest income for the year ended December 31, 2010 was $670,578 compared to $336,302 for the year ended December 31, 2009.  Service charges and other fees on deposit accounts were $304,723 for the year ended December 31, 2010, an improvement of $166,165 over the year ended December 31, 2009, due to an increase in deposit accounts.  For the year ended December 31, 2010, mortgage loan origination fees were $76,011, a decrease of $22,166, or 22.6%, from 2009, due to the decrease in the volume of mortgage loans originated.  We expect this trend to continue and then increase as market conditions improve.  Noninterest income included gains on sales of securities available-for-sale of $439,130 for the year ended December 31, 2010, compared to $114,571 in 2009.  However, these gains were offset by the loss on sale of the administrative building and related improvements of $174,047.

 

37

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*Noninterest Expenses*

 

The following table sets forth information related to our noninterest expenses for the year ended December 31, 2010 and 2009.

 
| ** **                                              | ** ** | **2010**  | ** ** | **2009**  | ** ** |
|---------------------------------------------------------|------------|-----------|------------|-----------|------------|
| Compensation and benefits                               |       | 1,820,278 |       | 2,361,927 |       |
| Occupancy and equipment                                 |       | 838,949   |       | 811,777   |       |
| Data processing and related costs                       |       | 383,287   |       | 286,827   |       |
| Marketing, advertising and shareholder   communications |       | 63,164    |       | 118,292   |       |
| Legal and audit                                         |       | 271,283   |       | 390,359   |       |
| Other professional fees                                 |       | 118,279   |       | 71,570    |       |
| Supplies and postage                                    |       | 58,945    |       | 65,972    |       |
| Insurance                                               |       | 30,037    |       | 32,406    |       |
| Credit related expenses                                 |       | 28,632    |       | 31,894    |       |
| Regulatory fees and FDIC insurance                      |       | 442,999   |       | 290,845   |       |
| Other real estate owned expense                         |       | 165,478   |       | 25,531    |       |
| Other                                                   |       | 96,899    |       | 59,972    |       |
| Total noninterest expense                               |       | $         | 4,318,230  |      | $          | 4,547,372 |   |
|                                                         |            |           |            |           |            |  |  |

 

Noninterest expense was $4,318,230 for the year ended December 31, 2010, compared to $4,547,372 for the year ended December 31, 2009.  The most significant component of noninterest expense is compensation and benefits, which totaled $1,820,278 for the year ended December 31, 2010, compared to $2,361,927 for the year ended December 31, 2009. The decrease is primarily related to staff reductions.  Occupancy and equipment expense of $838,949 in 2010 increased from $811,777 in 2009.  Data processing and related expense increased from $286,827 in 2009 to $383,287 in 2010, primarily due to an increase in our core processor charges compared to prior year. Legal and audit fees decreased from $390,359 in 2009 to $271,283 in 2010, as a result of reduction in fees and performing several internal audit functions in-house.  Other professional fees increased from $71,570 in 2009 to $118,279 in 2010.  Supplies and postage related expenses decreased from $65,972 in 2009 to $58,945 in 2010, as a result of the efforts to reduce expenses.  Other real estate expenses increased from $25,531 in 2009 to $165,478 in 2010 as a result of increase in the number of real estate owned during the year.  Regulatory fees and FDIC insurance increased from $290,845 in 2009 to $442,999 in 2010, primarily due to an increase in FDIC insurance assessments in the fourth quarter of 2009 and all of 2010. The increase in other expenses from $59,972 in 2009 to $96,899 was due to an increase in operational expenses.

 

*Income Taxes*

 

The Company had no currently taxable income for the years ended December 31, 2010 and 2009.  The Company has recorded a valuation allowance equal to the net deferred tax asset as the realization of this asset is dependent on the Company’s ability to generate future taxable income during the periods in which temporary differences become deductible.

 

***Balance Sheet Review***

 

*General*

 

At December 31, 2010, total assets were $121,176,715 compared to $140,036,471 at December 31, 2009, for a decrease of $18,859,756, or 13.5%.  The decrease in assets resulted from decreases in our loan portfolio and federal funds sold and related decreases in our funding sources of deposits.  Interest-earning assets comprised approximately 93.7% and 92.9% of total assets at December 31, 2010 and December 31, 2009.  Gross loans totaled $90,335,609 at December 31, 2010, a decrease of $15,808,117, or 14.9%, from $106,143,726 at December 31, 2009.  The reduction in gross loans was the result of our plan to reduce our overall risk profile, specifically to reduce the overall size of the balance sheet. Accordingly, we are actively seeking to reduce our real estate mortgage loan portfolio to improve our credit quality and preserve capital. In addition, we transferred loans in the amount of $3,260,032 to other real estate owned during the year ended December 31, 2010. Investment securities were $22,394,206 at December 31, 2010, an increase of $3,954,245, or 21.4%, from $18,439,961 at December 31, 2009.  Investment in overnight federal funds decreased $2,915,000 to $2,280,000 at December 31, 2010.

 

Deposits totaled $106,585,992 at December 31, 2010, a $18,010,718, or 14.5%, decrease from $124,596,710 at December 31, 2009.  Shareholders’ equity was $11,176,648 and $12,196,323 at December 31, 2010 and December 31, 2009, respectively.

 

38

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*Investments*

 

At December 31, 2010, our available for sale investment securities portfolio was $20,776,657 and represented approximately 17.1% of our total assets. Available for sale investment securities increased $2,810,996 from $17,965,661 at December 31, 2009.  Our portfolio consisted of U.S. government sponsored agencies of $15,843,864, mortgage-backed agencies of $2,118,254 and state, county and municipal investment securities of $2,814,539.

 

Contractual maturities and yields on our investment securities available for sale at December 31, 2010 are shown in the following table.  Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

 
| ** **                         | ** ** | **Less than** | ** ** | **One year to** | ** ** | **Five years**        | ** ** | ** **                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------------------------------|------------|--------------------|------------|---------------------------|------------|----------------------------|------------|------------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                         | ** ** | **one year**  | ** ** | **five years**       | ** ** | **to ten years** | ** ** | **Over ten years** | ** ** | **Total**  | ** ** |
| ** **                         | ** ** | **Amount**         | ** ** | **Yield**                 | ** ** | **Amount**                 | ** ** | **Yield**                    | ** ** | **Amount** | ** ** | **Yield**  | ** ** | **Amount** | ** ** | **Yield** | ** ** | **Amount** | ** ** | **Yield** | ** ** |
|                               |       |               |       |                      |       |                       |       |                         |       |       |       |       |       |       |       |   |   |   |   |   |   |
| U.S. Government sponsored agencies |       | —             |       | —                    |       | $                          | 131,622    |                         | 5.12       | %          | $          | 11,587,102 |       | 2.87       | %          | $ | 4,125,140 |   | 2.65 | % | $ | 15,843,864 |   | 2.83 | % |
|                               |       |               |       |                      |       |                       |       |                         |       |       |       |       |       |       |       |   |   |   |   |   |   |
| Mortgage-backed agencies           |       | —             |       | —                    |       | —                     |       | —                       |       | 2,118,254  |       | 3.15       | %          | —     |       | — |   | 2,118,254 |   | 3.15 | % |
|                               |       |               |       |                      |       |                       |       |                         |       |       |       |       |       |       |       |   |   |   |   |   |   |
| State, county and municipal        |       | —             |       | —                    |       | —                     |       | —                       |       | —     |       | —     |       | 2,814,539  |       | 4.77 | % | 2,814,539 |   | 4.77 | % |
|                               |       |               |       |                      |       |                       |       |                         |       |       |       |       |       |       |       |   |   |   |   |   |   |
| **Total**                          |       | —             |       | —                    |       | $                          | 131,622    |                         | 5.12       | %          | $          | 13,705,356 |       | 2.91       | %          | $ | 6,939,679 |   | 3.51 | % | $ | 20,776,657 |   | 3.13 | % |

 

At December 31, 2010, our held to maturity investment securities portfolio was $1,143,249 and represented approximately 0.9% of our total assets. There was no investment securities classified as held to maturity at December 31, 2009.  Our held to maturity portfolio consisted of state, county and municipal investment securities of $1,143,249.

 

Contractual maturities and yields on our investment securities held to maturity at December 31, 2010 are shown in the following table.  Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

 
| ** **                  | ** ** | **Less than** | ** ** | **One year to** | ** ** | **Five years**        | ** ** | ** **                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-----------------------------|------------|--------------------|------------|---------------------------|------------|----------------------------|------------|------------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                  | ** ** | **one year**  | ** ** | **five years**       | ** ** | **to ten years** | ** ** | **Over ten years** | ** ** | **Total**  | ** ** |
| ** **                  | ** ** | **Amount**         | ** ** | **Yield**                 | ** ** | **Amount**                 | ** ** | **Yield**                    | ** ** | **Amount** | ** ** | **Yield**  | ** ** | **Amount** | ** ** | **Yield** | ** ** | **Amount** | ** ** | **Yield** | ** ** |
|                        |       |               |       |                      |       |                       |       |                         |       |       |       |       |       |       |       |   |   |   |   |   |   |
| State, county and municipal |       | —             |       | —                    |       | —                     |       | —                       |       | $          | 447,275    |       | 4.75       | %          | $          | 695,974 |   | 4.81 | % | $ | 1,143,249 |   | 4.79 | % |
|                        |       |               |       |                      |       |                       |       |                         |       |       |       |       |       |       |       |   |   |   |   |   |   |
| **Total**                   |       | —             |       | —                    |       | —                     |       | —                       |       | $          | 447,275    |       | 4.75       | %          | $          | 695,974 |   | 4.81 | % | $ | 1,143,249 |   | 4.79 | % |
|                             |            |                    |            |                           |            |                            |            |                              |            |            |            |            |            |            |            |  |  |  |  |  |  |  |  |  |  |  |

 

The amortized costs and the fair value of our investment securities available-for-sale at December 31, 2010 and 2009 are shown in the following table.

 
| ** **                         | ** ** | **2010**             | ** **     | **2009**               | ** ** |
|------------------------------------|------------|----------------------|----------------|------------------------|------------|
| ** **                         | ** ** | **Amortized   Cost** | ** **     | **Fair    Value** | ** ** | **Amortized   Cost** | ** ** | **Fair   Value** | ** ** |
| ** **                         | ** ** | ** **           | ** **     | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Available for Sale**             | ** ** | ** **           | ** **     | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                         | ** ** | ** **           | ** **     | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** |
| U.S. Government sponsored agencies |       | $                    | 16,240,270     |                   | $          | 15,843,864 |   | $ | 10,603,783 |   | $ | 10,749,191 |   |
| Mortgage-backed agencies           |       | 2,151,089            |           | 2,118,254              |       | 6,662,003 |   | 6,786,659 |   |
| State, county and municipal        |       | 2,999,285            |           | 2,814,539              |       | 449,666 |   | 429,811 |   |
|                               |       |                 |           |                   |       |   |   |   |   |
| **Total**                          | ** ** | **$**                | **21,390,644** | ** **             | **$**      | **20,776,657** | ** ** | **$** | **17,715,452** | ** ** | **$** | **17,965,661** | ** ** |

 

39

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The amortized costs and the fair value of our investment securities held-to-maturity at December 31, 2010 are shown in the following table.

 
| ** **                  | ** ** | **2010**             | ** **    |
|-----------------------------|------------|----------------------|---------------|
| ** **                  | ** ** | **Amortized   Cost** | ** **    | **Fair    Value** | ** ** |
| **Held to Maturity**        | ** ** | ** **           | ** **    | ** ** | ** ** |
| ** **                  | ** ** | ** **           | ** **    | ** ** | ** ** |
| State, county and municipal |       | $                    | 1,143,249     |   | $ | 1,133,220 |   |
|                        |       |                 |          |   |   |
| **Total**                   | ** ** | **$**                | **1,143,249** | ** ** | **$** | **1,133,220** | ** ** |

 

There were no investment securities classified as held-to-maturity as of December 31, 2009.

 

We believe, based on industry analyst reports and credit ratings, the deterioration in fair values of individual investment securities available-for-sale is attributed to changes in market interest rates and not in the credit quality of the issuer and therefore, these losses are not considered other-than-temporary.  We have the ability and intent to hold these securities until such time as the value recovers or the securities mature.

 

Investment securities with market values of approximately $3,212,762 and $3,783,988 at December 31, 2010 and 2009, respectively, were pledged to secure public deposits and to secure the borrowings from the FHLB, as required by law.

 

Proceeds from sales of available-for-sale securities during 2010 and 2009 were $11,368,953 and $3,530,088, respectively.  Gross gains of $439,130 and $114,571 were recognized on these sales in 2010 and 2009, respectively.

 

We held non-marketable equity securities, which consisted of Federal Home Loan Bank stock of $372,300 and Pacific Coast Bankers Bank stock of $102,000 at December 31, 2010.  These investments are carried at cost, which approximates fair market value.  During 2009, we recognized an other-than-temporary impairment charge on the remaining Silverton Bank stock balance of $60,352.

 

Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation.  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 Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.

 

In analyzing an issuer’s financial condition, management considers whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, and industry analysts’ reports.  As management has the ability to hold debt securities until maturity, or for the foreseeable future if classified as available for sale, no declines are deemed to be other than temporary.

 

*Loans*

 

Since loans typically provide higher interest yields than other interest-earning assets, it is our goal to ensure that the highest percentage of our earning assets is invested in our loan portfolio. Gross loans outstanding at December 31, 2010 were $90,335,609, or 79.5% of interest-earning and 74.5% of total assets, compared to $106,143,726, or 81.6% % of interest-earning and 75.8% of total assets at December 31, 2009.  Due to the economic environment, the Bank made selective decisions related to originating loans in 2010.  In addition, as the Bank moved into its fourth year of operations it experienced the attrition of loans due to refinancing and/or payoffs from borrowers.

 

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Loans secured by real estate mortgages comprised approximately 88.2% of loans outstanding at December 31, 2010 and 86.8% at December 31, 2009.  Most of our real estate loans are secured by residential and commercial properties.  We do not generally originate traditional long term residential mortgages, but we do issue traditional second mortgage residential real estate loans and home equity lines of credit.  We obtain a security interest in real estate whenever possible, in addition to any other available collateral.  This collateral is taken to increase the likelihood of the ultimate repayment of the loan. Generally, we limit the loan-to-value ratio on loans we make to 80%.

 

Commercial loans and lines of credit represented approximately 10.2% and 11.1% of our loan portfolio at December 31, 2010 and 2009, respectively.

 

Our construction and development, and land loan portfolio represented approximately 13.4% and 15.5% at December 31, 2010 and 2009, respectively.

 

The following table summarizes the composition of our loan portfolio as of December 31, 2010 and 2009:

 
| ** **                            | ** ** | **2010**   | ** ** | **2009**                       | ** ** |
|---------------------------------------|------------|------------|------------|--------------------------------|------------|
| ** **                            | ** ** | **Amount** | ** ** | **Percentage   of Total** | ** ** | **Amount** | ** ** | **Percentage   of Total** | ** ** |
| Real Estate:                          | ** ** | ** ** | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Construction and development and land |       | $          | 12,076,019 |                           | 13.37      | % | $ | 16,454,132 |   | 15.50 | % |
| Commercial                            |       | 27,636,367 |       | 30.59                          |       | 31,926,392 |   | 30.08 |   |
| Residential mortgages                 |       | 14,450,685 |       | 16.00                          |       | 16,375,098 |   | 15.43 |   |
| Home equity lines                     |       | 25,538,314 |       | 28.27                          |       | 27,425,120 |   | 25.83 |   |
| Total real estate                     |       | 79,701,385 |       | 88.23                          |       | 92,180,742 |   | 86.84 |   |
|                                  |       |       |       |                           |       |   |   |   |   |
| Commercial                            |       | 9,234,855  |       | 10.22                          |       | 11,738,295 |   | 11.06 |   |
| Consumer                              |       | 1,399,369  |       | 1.55                           |       | 2,224,689 |   | 2.10 |   |
| Gross loans                           |       | 90,335,609 |       | 100                            | %          | 106,143,726 |   | 100 | % |
| Less allowance for loan losses        |       | (1,552,061 | )          |                           |       | (1,498,937 | ) |   |   |
| Total loans, net                      |       | $          | 88,783,548 |                           |       |   | $ | 104,644,789 |   |   |   |

 

*Maturities and Sensitivity of Loans to Changes in Interest Rates*

 

The information in the following table is based on the contractual maturities of individual loans, including loans which may be subject to renewal at their contractual maturity.  Renewal of such loans is subject to review and credit approval, as well as modification of terms upon maturity.  Actual repayments of loans may differ from the maturities reflected below because borrowers have the right to prepay obligations with or without prepayment penalties.

 

The following table summarizes the loan maturity distribution by composition and interest rate types at December 31, 2010.

 
| ** **                                   | ** ** | ** **                            | ** ** | **After one**                         | ** ** | ** **                       | ** ** | ** ** | ** ** |
|----------------------------------------------|------------|---------------------------------------|------------|--------------------------------------------|------------|----------------------------------|------------|------------|------------|
| ** **                                   | ** ** | **One year********or less** | ** ** | **but within********five years** | ** ** | **After five********years** | ** ** | **Total**  | ** ** |
| Real estate- mortgage                        |       | $                                     | 6,214,387  |                                       | $          | 45,057,331                       |       | $          | 27,299,477 |   | $ | 78,571,195 |   |
| Real estate- construction                    |       | 846,273                               |       | 283,917                                    |       | —                           |       | 1,130,190  |       |
| Total real estate                            |       | 7,060,660                             |       | 45,341,248                                 |       | 27,299,477                       |       | 79,701,385 |       |
|                                         |       |                                  |       |                                       |       |                             |       |       |       |
| Commercial                                   |       | 4,024,814                             |       | 4,954,638                                  |       | 255,403                          |       | 9,234,855  |       |
| Consumer- other                              |       | 462,499                               |       | 936,870                                    |       | —                           |       | 1,399,369  |       |
| Total gross loans, net of deferred loan fess |       | $                                     | 11,547,973 |                                       | $          | 51,232,756                       |       | $          | 27,554,880 |   | $ | 90,335,609 |   |
|                                         |       |                                  |       |                                       |       |                             |       |       |       |
| Gross loans maturing after one year with     |       |                                  |       |                                       |       |                             |       |       |       |
| Fixed interest rates                         |       |                                  |       |                                       |       |                             |       | $          | 37,112,695 |   |
| Floating interest rates                      |       |                                  |       |                                       |       |                             |       | $          | 41,674,941 |   |
| Total                                        |       |                                  |       |                                       |       |                             |       | $          | 78,787,636 |   |

 

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*Provision and Allowance for Loan Losses*

 

We have established an allowance for loan losses through a provision for loan losses charged to expense on our consolidated statement of operations. The allowance for loan losses was $1,552,061 and $1,498,937 as of December 31, 2010 and December 31, 2009, respectively, and represented 1.7% of outstanding loans at December 31, 2010 and 1.4% of outstanding loans at December 31, 2009. The allowance for loan losses represents an amount which we believe will be adequate to absorb probable losses on existing loans that may become uncollectible. Our judgment as to the adequacy of the allowance for loan losses is based on a number of assumptions about future events, which we believe to be reasonable, but which may or may not prove to be accurate. Our determination of the allowance for loan losses is based on evaluations of the collectability of loans, including consideration of factors such as the balance of impaired loans, the quality, mix, and size of our overall loan portfolio, economic conditions that may affect the borrower’s ability to repay, the amount and quality of collateral securing the loans, our historical loan loss experience, and a review of specific problem loans. We also consider subjective issues such as changes in the lending policies and procedures, changes in the local/national economy, changes in volume or type of credits, changes in volume/severity of problem loans, quality of loan review and board of director oversight, concentrations of credit, and peer group comparisons. We adjust the amount of the allowance periodically based on changing circumstances as a component of the provision for loan losses.

 

We calculate the allowance for loan losses for specific types of loans and evaluate the adequacy on an overall portfolio basis utilizing our credit grading system which we apply to each loan.  We combine our estimates of the reserves needed for each component of the portfolio, including loans analyzed on a pool basis and loans analyzed individually.  The allowance is divided into two portions: (1) an amount for specific allocations on significant individual credits and (2) a general reserve amount.

 

*Specific Reserve*

 

We analyze individual loans within the portfolio and make allocations to the allowance based on each individual loan’s specific factors and other circumstances that affect the collectability of the credit. Significant individual credits classified as doubtful or substandard/special mention within our credit grading system require both individual analysis and specific allocation, if necessary.

 

Loans in the substandard category are characterized by deterioration in quality exhibited by any number of well-defined weaknesses requiring corrective action such as declining or negative earnings trends and declining or inadequate liquidity.  Loans in the doubtful category exhibit the same weaknesses found in the substandard loan; however, the weaknesses are more pronounced.  These loans, however, are not yet rated as loss because certain events may occur which could salvage the debt such as injection of capital, alternative financing, or liquidation of assets.

 

In these situations where a loan is determined to be impaired (primarily because it is probable that all principal and interest due according to the terms of the loan agreement will not be collected as scheduled), the loan is excluded from the general reserve calculations described below and is assigned a specific reserve.  These reserves are based on a thorough analysis of the most probable source of repayment which is usually the liquidation of the underlying collateral, but may also include discounted future cash flows or, in rare cases, the market value of the loan itself.

 

Generally, for larger collateral dependent loans, current market appraisals are ordered to estimate the current fair value of the collateral.  However, in situations where a current market appraisal is not available, management uses the best available information (including recent appraisals for similar properties, communications with qualified real estate professionals, information contained in reputable trade publications and other observable market data) to estimate the current fair value.  The estimated costs to sell the subject property are then deducted

 

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from the estimated fair value to arrive at the “net realizable value” of the loan and to determine the specific reserve on each impaired loan reviewed.  The credit risk management group periodically reviews the fair value assigned to each impaired loan and adjusts the specific reserve accordingly.

 

*General Reserve*

 

We calculate our general reserve based on a percentage allocation for each of the effective categories of unclassified loan types.  We apply our historical trend loss factors to each category and adjust these percentages for qualitative or environmental factors, as discussed below.  The general estimate is then added to the specific allocations made to determine the amount of the total allowance for loan losses.

 

We also maintain a general reserve in accordance with December 2006 regulatory interagency guidance in our assessment of the loan loss allowance.  This general reserve considers qualitative or environmental factors that are likely to cause estimated credit losses including, but not limited to:  changes in delinquent loan trends, trends in risk grades and net charge offs, concentrations of credit, trends in the nature and volume of the loan portfolio, general and local economic trends, collateral valuations, the experience and depth of lending management and staff, lending policies and procedures, the quality of loan review systems, and other external factors.

 

In addition, the current downturn in the real estate market has resulted in an increase in loan delinquencies, defaults and foreclosures, and we believe these trends are likely to continue.  In some cases, this downturn has resulted in a significant impairment to the value of our collateral and our ability to sell the collateral upon foreclosure, and there is a risk that this trend will continue.  The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended.  If real estate values continue to decline, it is also more likely that we would be required to increase our allowance for loan losses.  Based on present information and an ongoing evaluation, management considers the allowance for loan losses to be adequate to meet presently known and inherent losses in the loan portfolio.  Management’s judgment about the adequacy of the allowance is based upon a number of assumptions about future events which it believes to be reasonable but which may or may not be accurate.  Thus, there can be no assurance that charge-offs in future periods will not exceed the allowance for loan losses or that additional increases in the allowance for loan losses will not be required, especially considering the overall weakness in the commercial real estate market in our market areas.  Management believes estimates of the level of allowance for loan losses required have been appropriate and our expectation is that the primary factors considered in the provision calculation will continue to be consistent with prior trends.

 

The Company identifies impaired loans through its normal internal loan review process.  Loans on the Company’s potential problem loan list are considered potentially impaired loans.  These loans are evaluated in determining whether all outstanding principal and interest are expected to be collected.  Loans are not considered impaired if a minimal payment delay occurs and all amounts due, including accrued interest at the contractual interest rate for the period of delay, are expected to be collected. Management has determined that the Company had $2,251,261 and $5,015,580 in impaired loans at December 31, 2010 and December 31, 2009, respectively.  At December 31, 2009, most of the impaired loans identified by management are collateral dependent loans and therefore the valuation allowance amounts on such loans were recorded as a charge-off.  Our valuation allowance related to impaired loans totaled $224,935 and $107,822 at December 31, 2010 and December 31, 2009, respectively.

 

We have retained an independent consultant to review our loan files on a test basis to assess the grading of samples of loans.  In addition, various regulatory agencies review our allowance for loan losses through periodic examinations, and they may require us to record additions to the allowance for loan losses based on their judgment about information made available to them at the time of their examination.  Our losses may vary from our estimates, and there is the possibility that charge-offs in future periods will exceed the allowance for loan losses that we have estimated.

 

The following table presents a summary related to our allowance for loan losses for the years ended December 31, 2010 and 2009:

 

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| ** **                                    | ** ** | **For the years ended December 31,** | ** **  |
|-----------------------------------------------|------------|---------------------------------------------------------------|-------------|
| ** **                                    | ** ** | **2010**                                                      | ** **  | **2009** | ** ** |
|                                          |       |                                                          |        |   |   |
| Balance at the beginning of period            |       | $                                                             | 1,498,937   |   | $ | 1,688,840 |   |
| Charge-offs:                                  |       |                                                          |        |   |   |
| Commercial, financial and agricultural        |       | 183,814                                                       |        | 401,588 |   |
| Real estate - mortgage                        |       | 509,844                                                       |        | 539,851 |   |
| Real estate -   construction                  |       | 111,155                                                       |        | — |   |
| Consumer                                      |       | 4,525                                                         |        | — |   |
| Total Charged-off                             |       | $                                                             | 809,338     |   | $ | 941,439 |   |
|                                          |       |                                                          |        |   |   |
| Recoveries:                                   |       |                                                          |        |   |   |
| Commercial, financial and agricultural        |       | 6,000                                                         |        | 32,599 |   |
| Real estate - mortgage                        |       | —                                                        |        | 1,000 |   |
| Consumer                                      |       | 3,353                                                         |        | — |   |
| Total Recoveries                              |       | $                                                             | 9,353       |   | $ | 33,599 |   |
|                                          |       |                                                          |        |   |   |
| Net Charge-offs                               |       | $                                                             | 799,985     |   | $ | 907,840 |   |
| Provision for Loan Loss                       |       | $                                                             | 853,109     |   | $ | 717,937 |   |
|                                          |       |                                                          |        |   |   |
| Balance at end of period                      |       | $                                                             | 1,552,061   |   | $ | 1,498,937 |   |
|                                          |       |                                                          |        |   |   |
| Total loans at end of period                  |       | $                                                             | 90,335,609  |   | $ | 106,143,726 |   |
|                                          |       |                                                          |        |   |   |
| Average loans outstanding                     |       | $                                                             | 100,457,328 |   | $ | 108,869,938 |   |
|                                          |       |                                                          |        |   |   |
| As a percentage of average loans:             |       |                                                          |        |   |   |
| Net loans charged-off                         |       | .80                                                           | %           | .83 | % |
| Provision for loan losses                     |       | .85                                                           | %           | .66 | % |
|                                          |       |                                                          |        |   |   |
| Allowance for loan losses as a percentage of: |       |                                                          |        |   |   |
| Year end loans                                |       | 1.72                                                          | %           | 1.41 | % |

 

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*Non-Performing Assets*

 

The following table summarizes non-performing assets and the income that would have been reported on non-accrual loans as of December 31, 2010 and 2009:

 
| ** **                                | ** ** | **December 31,** | ** ** |
|-------------------------------------------|------------|-----------------------|------------|
| ** **                                | ** ** | **2010**              | ** ** | **2009** | ** ** |
|                                      |       |                  |       |   |   |
| Other real estate and   repossessions     |       | $                     | 3,293,167  |   | $ | 501,037 |   |
|                                      |       |                  |       |   |   |   |   |
| Non-accrual loans                         |       | $                     | 1,417,289  |   | $ | 2,020,974 |   |
|                                      |       |                  |       |   |   |   |   |
| Accruing loans 90 days or   more past due |       | $                     | —     |   | $ | 196,373 |   |
|                                      |       |                  |       |   |   |
| Total non-performing   assets             |       | $                     | 4,710,456  |   | $ | 2,718,384 |   |
|                                      |       |                  |       |   |   |
| As a percentage of gross   loans:         |       | 5.21                  | %          | 2.56 | % |

 

The Bank had net charge offs on loans in the amount of $799,985 for the year ended December 31, 2010, compared to $907,840 charged off in 2009.  Approximately $339,000 of the charge-offs in 2010 relates to loans identified as impaired in 2009****and approximately $461,000 of the charge-offs in 2010 are the result of loans identified as impaired loans during 2010. At December 31, 2010, there were 13 loans in non-accrual status totaling $1,417,289 compared to 13 loans in nonaccrual status that totaling $2,020,974 at December 31, 2009.  There was one loan totaling $196,373 that was contractually past due 90 days or more still accruing interest at December 31, 2009 and none at December 31, 2010.  In addition, there were 4 loans restructured or otherwise impaired totaling $843,060 not already included in nonaccrual status at December 31, 2010.  There were 10 loans restructured or otherwise impaired totaling $2,994,606 not already included in nonaccrual status at December 31, 2009.  At December 31, 2010 and 2009, impaired loans totaled $2,251,261 and $5,015,580, respectively. The decrease in impaired loans compared to prior year is the result of charge-offs and foreclosures on these impaired loans during 2010.  The Bank also currently is prohibited from extending any additional credit to a borrower which has a credit that has been charged off by the Bank or classified as Loss or Doubtful in any report of examination, so long as such credit remains uncollected. Management is concerned about the changes in the nonperforming assets but believes that the allowance has been appropriately funded for additional losses on existing loans, based on currently available information.  The Company will continue to monitor nonperforming assets closely and make changes to the allowance for loan losses when necessary.

 

Generally, a loan will be placed on nonaccrual status when it becomes 90 days past due as to principal or interest, or when management believes, after considering economic and business conditions and collection efforts, that the borrower’s financial condition is such that collection of the loan is doubtful. A payment of interest on a loan that is classified as nonaccrual is applied against the principal balance. During the year ended December 31, 2010 and 2009, we received approximately $13,513 and $65,716 in interest income in relation to loans on non-accrual status and forgone interest income related to loans on non-accrual status was approximately $38,323 and $23,066, respectively.

 

Management believes that the amount of nonperforming assets could continue to have a negative effect on the Company’s condition if current economic conditions do not improve.  As was seen in the 2010 financial results, the effect would be lower earnings caused by larger contributions to the loan loss provision arising from a larger impairment in the loan portfolio and a higher level of loan charge-offs.  Management believes the Company has credit quality review processes in place to identify problem loans quickly.  Management will work with customers that are having difficulties meeting their loan payments.  The last resort is foreclosure.

 

*Potential Problem Loans*

 

Potential problem loans consist of loans that are generally performing in accordance with contractual terms but for which we have concerns about the ability of the borrower to continue to comply with repayment terms because of the borrower’s potential operating or financial difficulties.  Management monitors these loans closely and reviews performance on a regular basis.  As of December 31, 2010 and 2009, potential problem loans that were not

 

45

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already categorized as nonaccrual totaled $843,060 and $2,994,606, respectively.  These loans are considered in determining management’s assessment of the adequacy of the allowance for loan losses.

 

*Deposits*

 

Our primary source for our loans and investments is our deposits.  Total deposits as of the years ended December 31, 2010 and 2009 were $106,585,992 and $124,596,710, respectively.  It has become more difficult to attract local deposits as national and local market trends over the past several years suggest that consumers have moved an increasing percentage of discretionary savings funds into investments such as annuities, stocks and mutual funds. Accordingly, our deposit balances have decreased compared to prior year. The following table shows the average balance outstanding and the average rates paid on deposits during 2010 and 2009.

 
| ** **                           | ** ** | **2010**             | ** **  | **2009** | ** ** |
|--------------------------------------|------------|----------------------|-------------|----------|------------|
| ** **                           | ** ** | **Average   Amount** | ** **  | **Rate** | ** ** | **Average   Amount** | ** ** | **Rate** | ** ** |
| Non-interest bearing demand deposits |       | $                    | 9,954,508   |     | —     | % | $ | 10,460,441 |   | — | % |
| Interest-bearing checking            |       | 4,471,063            |        | 0.33     |       | 4,395,267 |   | 0.30 |   |
|                                 |       |                 |        |     |       |   |   |   |   |
| Money market                         |       | 42,431,506           |        | 1.58     |       | 28,665,265 |   | 2.06 |   |
| Savings                              |       | 894,561              |        | 0.45     |       | 673,106 |   | 0.79 |   |
| Time deposits less than $100,000     |       | 28,234,323           |        | 2.03     |       | 30,911,199 |   | 2.90 |   |
| Time deposits $100,000 and over      |       | 33,789,178           |        | 2.03     |       | 42,428,929 |   | 3.06 |   |
| Total                                |       | $                    | 119,775,139 |     | 1.78       | % | $ | 117,534,207 |   | 2.60 | % |

 

Core deposits, which exclude time deposits of $100,000 or more and brokered certificates of deposit, provide a relatively stable funding source for our loan portfolio and other earning assets.  Our core deposits were $85,189,016 at December 31, 2010, compared to $81,529,139 at December 31, 2009.  Our loan-to-deposit ratio was 84.75% and 85.19% at December 31, 2010 and 2009, respectively.  Due to the competitive interest rate environment in our market, we utilized brokered certificates of deposit as a funding source when we were able to procure these certificates at interest rates less than those in the local market.  Brokered certificates of deposit purchased outside our primary market totaled $2,217,000 at December 31, 2010, compared to $5,295,000 at December 31, 2009.  We expect to continue to decrease our reliance on brokered deposits as our core deposits continue to grow.

 

The maturity distribution of our time deposits of $100,000 or more and brokered time deposits at December 31, 2010 was as follows:

 
| Three months or less           |   | $         | 5,765,137  |   |
|--------------------------------|--------|-----------|------------|--------|
| Over three through six months  |   | 2,805,827 |       |
| Over six through twelve months |   | 7,313,196 |       |
| Over twelve months             |   | 5,512,816 |       |
| Total                          |   | $         | 21,396,976 |   |

 

*Borrowings and lines of credit*

 

At December 31, 2010, the Bank had short-term lines of credit with correspondent banks to purchase a maximum of $5,800,000 in unsecured federal funds on a one to fourteen day basis and $3,300,000 in unused federal funds on a one to twenty day basis for general corporate purposes.  The interest rate on borrowings under these lines is the prevailing market rate for federal funds purchased.  These accommodation lines of credit are renewable annually and may be terminated at any time at the correspondent banks’ sole discretion.  At December 31, 2010 and 2009, we had no borrowings outstanding on these lines.

 

We are also a member of the Federal Home Loan Bank.  At December 31, 2010 and 2009, we had $3,000,000 outstanding at an interest rate of 2.62%, with a maturity date of February 25, 2013.  The Bank borrowed the funds to reduce the cost of funds on money used to fund loans.  The Bank has remaining credit availability of $9,850,000 at the Federal Home Loan Bank.  Although we expect to continue using Federal Home Loan Bank advances as a secondary funding source, core deposits will continue to be our primary funding source.

 

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**Capital Resources**

 

Total shareholders’ equity was $11,176,648 at December 31, 2010, a decrease of $1,019,675 from $12,196,323 at December 31, 2009.  The decrease is primarily due to the $571,492 in unrealized loss on investment securities available for sale and dividends accrued on preferred stock for $179,010 during 2010.  In addition, shareholder’s equity was reduced by our net loss of $298,557 for the year ended December 31, 2010. Capital surplus increased due to stock compensation expense of $29,384 in 2010.

 

The Federal Reserve and bank regulatory agencies require bank holding companies and financial institutions to maintain capital at adequate levels based on a percentage of assets and off-balance sheet exposures, adjusted for risk weights ranging from 0% to 100%.  The Federal Reserve guidelines contain an exemption from the capital requirements for “small bank holding companies”, which in 2006 were amended to cover most bank holding companies with less than $500 million in total assets that do not have a material amount of debt or equity securities outstanding registered with the SEC.  Although our class of common stock is registered under Section 12 of the Securities Exchange Act, we believe that because our stock is not listed on any exchange or otherwise actively traded, the Federal Reserve will interpret its new guidelines to mean that we qualify as a small bank holding company.  Nevertheless, our Bank remains subject to these capital requirements.  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 Bank’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 classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

 

Under the capital adequacy guidelines, regulatory capital is classified into two tiers.  These guidelines require an institution to maintain a certain level of Tier 1 and Tier 2 capital to risk-weighted assets.  Tier 1 capital consists of common shareholders’ equity, excluding the unrealized gain or loss on securities available for sale, minus certain intangible assets.  In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, are multiplied by a risk-weight factor of 0% to 100% based on the risks believed to be inherent in the type of asset.  Tier 2 capital consists of Tier 1 capital plus the general reserve for loan losses, subject to certain limitations.  We are also required to maintain capital at a minimum level based on total average assets, which is known as the Tier 1 leverage ratio.

 

At the Bank level, we are subject to various regulatory capital requirements administered by the federal banking agencies.  Under the regulations adopted by the federal regulatory authorities, a bank will be categorized as:

 

·                  Well capitalized if the institution has a total risk-based capital ratio of 10.0% or greater, a Tier 1 risk-based capital ratio of 6.0% or greater, a leverage ratio of 5.0% or greater, and is not subject to any order or written directive by any such regulatory authority to meet and maintain a specific capital level for any capital measure.

·                  Adequately capitalized if the institution has a total risk-based capital ratio of 8.0% or greater, a Tier 1 risk-based capital ratio of 4.0% or greater, a leverage ratio of 4.0% or greater, and is not categorized as well capitalized.

·                  Undercapitalized if the institution has a total risk-based capital ratio that is less than 8.0%, a Tier 1 risk-based capital ratio of less than 4.0%, or a leverage ratio of less than 4.0%.

·                  Significantly undercapitalized if the institution has a total risk-based capital ratio of less than 6.0%, a Tier 1 risk-based capital ratio of less than 3.0%, or a leverage ratio of less than 3.0%.

·                  Critically undercapitalized if the institution’s tangible equity is equal to or less than 2.0% of average quarterly tangible assets.

 

In addition, an institution may be downgraded to, or deemed to be in, a capital category that is lower than indicated by its capital ratios if it is determined to be in an unsafe or unsound condition or if it receives an unsatisfactory examination rating with respect to certain matters.  A bank’s capital category is determined solely for the purpose of applying prompt corrective action regulations, and the capital category may not constitute an accurate representation of a bank’s overall financial condition or prospects for other purposes.

 

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The following table sets forth the Bank’s capital ratios at December 31, 2010 and 2009.  As of December 31, 2010 and 2009, the Bank was considered “well capitalized” and within compliance with the minimum capital requirements specifically established for the Bank by its Supervisory Authorities.

 
| ** **                | ** ** | **2010** | ** ** | **2009** | ** ** |
|---------------------------|------------|----------|------------|----------|------------|
|                      |       |     |       |     |       |   |   |   |   |
| Total risk-based capital  |       | $        | 12,538     |     | 14.09      | % | $ | 10,836 |   | 10.57 | % |
| Tier 1 risk-based capital |       | 11,421   |       | 12.84    | %          | 9,542 |   | 9.30 | % |
| Leverage capital          |       | 11,421   |       | 9.16     | %          | 9,542 |   | 6.99 | % |
|                           |            |          |            |          |            |  |  |  |  |  |  |

 

On January 9, 2009, we entered into the CPP Purchase Agreement with the Treasury, pursuant to which the company issued and sold to Treasury (i) 3,285 shares of our Series A Preferred Stock, and (ii) a ten-year warrant to purchase 164 shares of our Series B Preferred Stock, for an aggregate purchase price of $3,285,000 in cash.  The Series A and Series B Preferred Stock qualifies as Tier 1 capital under Federal Reserve guidelines.

 

**Return on Equity and Assets**

 

The following table shows the return on average assets (net income (loss) divided by average total assets), return on average equity (net income (loss) divided by average equity), and equity to assets ratio (average equity divided by average total assets) for the years ended December 31, 2010 and 2009.

 
| ** **               | ** ** | **2010** | ** ** | **2009** | ** ** |
|--------------------------|------------|----------|------------|----------|------------|
| Return on average assets |       | (0.22    | )%         | (0.85    | )%         |
|                     |       |     |       |     |       |
| Return on average equity |       | (2.74    | )%         | (9.40    | )%         |
|                     |       |     |       |     |       |
| Equity to assets ratio   |       | 8.11     | %          | 9.06     | %          |

 

**Effect of Inflation and Changing Prices**

 

The effect of relative purchasing power over time due to inflation has not been taken into account in our consolidated financial statements.  Rather, our financial statements have been prepared on an historical cost basis in accordance with accounting principles generally accepted in the United States of America.

 

Unlike most industrial companies, our assets and liabilities are primarily monetary in nature.  Therefore, the effect of changes in interest rates will have a more significant impact on our performance than will the effect of changing prices and inflation in general.  In addition, interest rates may generally increase as the rate of inflation increases, although not necessarily in the same magnitude.  We attempt to manage the relationships between interest-sensitive assets and liabilities in order to protect against wide rate fluctuations, including those resulting from inflation.

 

**Off-Balance Sheet Risk**

 

Through the Bank, we have made contractual commitments to extend credit in the ordinary course of our business activities.  These commitments are legally binding agreements to lend money to our clients at predetermined interest rates for a specified period of time.  We evaluate each client’s creditworthiness on a case-by-case basis.  The amount of collateral obtained, if deemed necessary by us upon extension of credit, is based on our credit evaluation of the borrower.  Collateral varies but may include accounts receivable, inventory, property, plant and equipment, commercial and residential real estate.  We manage the credit risk on these commitments by subjecting them to normal underwriting and risk management processes.  At December 31, 2010, we had issued commitments to extend credit of approximately $11,091,000 through various types of lending arrangements.  There were two standby letters of credit included in the commitments for $125,000.  Fixed rate commitments were $516,085 and variable rate commitments were $10,574,915.  At December 31, 2009, commitments to extend credit amounted to $13,940,000, which included letters of credit of $125,000.

 

Commitments generally have fixed expiration dates or other termination clauses and may require the payment of a fee. A significant portion of the unfunded commitments relate to consumer equity lines of credit and

 

48

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commercial lines of credit.  Based on historical experience, we anticipate that a portion of these lines of credit will not be funded.

 

Except as disclosed in this document, we are not involved in off-balance sheet contractual relationships, unconsolidated related entities that have off-balance sheet arrangements or transactions that could result in liquidity needs or other commitments that significantly impact earnings.

 

**Liquidity**

 

Liquidity represents the ability of a company to convert assets into cash or cash equivalents without significant loss, and the ability to raise additional funds by increasing liabilities.  Liquidity management involves monitoring our sources and uses of funds in order to meet our day-to-day cash flow requirements while maximizing profits.  Liquidity management is made more complicated because different balance sheet components are subject to varying degrees of management control.  For example, the timing of maturities of our investment portfolio is fairly predictable and subject to a high degree of control at the time investment decisions are made.  However, net deposit inflows and outflows are far less predictable and are not subject to the same degree of control.

 

At December 31, 2010, our liquid assets, consisting of cash and due from banks and federal funds sold, amounted to $5,051,515, or approximately 4.2% of total assets.  Our investment securities available for sale at December 31, 2010 amounted to $20,776,657, or approximately 17.1% of total assets.  Unpledged investment securities traditionally provide a secondary source of liquidity since they can be converted into cash in a timely manner.  At December 31, 2010, $3,212,762 of our investment securities were pledged to secure public entity deposits and as collateral for advances from the Federal Home Loan Bank (“FHLB”).

 

Our ability to maintain and expand our deposit base and borrowing capabilities serves as our primary source of liquidity.  We plan to meet our future cash needs through the liquidation of temporary investments and the generation of deposits. In addition, we will receive cash upon the maturities and sales of loans and maturities, calls and prepayments on investment securities.  We maintain federal funds purchased lines of credit with correspondent banks totaling $9,100,000.  Availability on these lines of credit was $9,100,000 at December 31, 2010.  We are a member of the FHLB, from which applications for borrowings can be made.  The FHLB requires that investment securities or qualifying mortgage loans be pledged to secure advances from them. We are also required to purchase FHLB stock in a percentage of each advance.  At December 31, 2010, we had borrowed $3,000,000 from FHLB.

 

We believe that our existing stable base of core deposits and borrowing capabilities will enable us to successfully meet our long-term liquidity needs.

 

**Market Risk**

 

Market risk is the risk of loss from adverse changes in market prices and rates, which principally arise from interest rate risk inherent in our lending, investing, deposit gathering, and borrowing activities.  Other types of market risks, such as foreign currency exchange rate risk and commodity price risk, do not generally arise in the normal course of our business.

 

We actively monitor and manage our interest rate risk exposure principally by measuring our interest sensitivity “gap,” which is the positive or negative dollar difference between assets and liabilities that are subject to interest rate repricing within a given period of time.  Interest rate sensitivity can be managed by repricing assets or liabilities, selling securities available for sale, replacing an asset or liability at maturity, or adjusting the interest rate during the life of an asset or liability.  Managing the amount of assets and liabilities repricing in this same time interval helps to hedge the risk and minimize the impact on net interest income of rising or falling interest rates.  We generally would benefit from increasing market rates of interest when we have an asset-sensitive gap position and generally would benefit from decreasing market rates of interest when we are liability-sensitive.  The Company is cumulatively liability sensitive over the three-month to twelve month period and asset sensitive over all periods greater than one year. The analysis presents only a static view of the timing of maturities and repricing opportunities, without taking into consideration that changes in interest rates do not affect all assets and liabilities equally.  For example, rates paid on a substantial portion of core deposits may change contractually within a relatively short time frame, but those rates are viewed by us as significantly less interest-sensitive than market-based rates such as those paid on noncore deposits.  Net interest income may be affected by other significant factors in a given interest rate environment, including changes in the volume and mix of interest-earning assets and interest-bearing liabilities.

 

49

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**Interest Rate Sensitivity**

 

Asset-liability management is the process by which we monitor and control the mix and maturities of our assets and liabilities.  The essential purposes of asset-liability management are to ensure adequate liquidity and to maintain an appropriate balance between interest sensitive assets and liabilities in order to minimize potentially adverse impacts on earnings from changes in market interest rates.  Our asset-liability management committee monitors and considers methods of managing exposure to interest rate risk.  The asset-liability management committee is responsible for maintaining the level of interest rate sensitivity of our interest sensitive assets and liabilities within board-approved limits.

 

The following table sets forth information regarding our rate sensitivity, as of December 31, 2010 at each of the time intervals.  The information in the table may not be indicative of our rate sensitivity position at other points in time.  In addition, the repricing distribution indicated in the table differs from the contractual maturities of certain interest-earning assets and interest-bearing liabilities presented due to consideration of prepayment speeds under various interest rate change scenarios in the application of the interest rate sensitivity methods described above.

 
| ** **                                                 | ** ** | ** **                     | ** ** | **After three**                          | ** ** | **After one but**       | ** ** | ** **                  | ** ** | ** ** | ** ** |
|------------------------------------------------------------|------------|--------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-----------------------------|------------|------------|------------|
| **December 31, 2010**                            | ** ** | **Within three   months** | ** ** | **But within********twelve months** | ** ** | **within five********years** | ** ** | **After five   years** | ** ** | **Total**  | ** ** |
| Interest-earning assets:(in thousands)                     |       |                           |       |                                          |       |                              |       |                        |       |       |       |
| Federal funds sold                                         |       | $                              | 2,280      |                                          | $          | —                            |       | $                           | —     |       | $          | — |   | $ | 2,280 |   |
| Investment securities                                      |       | 1,411                          |       | 471                                           |       | 2,539                             |       | 18,113                      |       | 22,534     |       |
| Loans                                                      |       | 51,700                         |       | 7,525                                         |       | 30,782                            |       | 329                         |       | 90,336     |       |
| Total interest-earning assets                              |       | $                              | 55,391     |                                          | $          | 7,996                             |       | $                           | 33,321     |       | $          | 18,442 |   | $ | 115,150 |   |
|                                                       |       |                           |       |                                          |       |                              |       |                        |       |       |       |
| Interest-bearing liabilities:(in thousands)                |       |                           |       |                                          |       |                              |       |                        |       |       |       |
| Interest-bearing checking                                  |       | $                              | 4,053      |                                          | $          | —                            |       | $                           | —     |       | $          | — |   | $ | 4,053 |   |
| Money market and savings                                   |       | 46,281                         |       | —                                        |       | —                            |       | —                      |       | 46,281     |       |
| Time deposits                                              |       | 11,373                         |       | 24,084                                        |       | 11,503                            |       | —                      |       | 46,960     |       |
| Federal funds purchased                                    |       | —                         |       | —                                        |       | —                            |       | —                      |       | —     |       |
| FHLB Advances                                              |       | —                         |       | —                                        |       | 3,000                             |       |                        |       | 3,000      |       |
| Total interest-bearing Liabilities                         |       | $                              | 61,707     |                                          | $          | 24,084                            |       | $                           | 14,503     |       | $          | — |   | $ | 100,294 |   |
|                                                       |       |                           |       |                                          |       |                              |       |                        |       |       |       |
| Period gap (in thousands)                                  |       | $                              | (6,316     | )                                             | $          | (16,088                           | )          | $                           | 18,818     |       | $          | 18,442 |   | 14,856 |   |
| Cumulative gap (in thousands)                              |       | $                              | (6,316     | )                                             | $          | (22,404                           | )          | $                           | (3,586     | )          | $          | 14,856 |   |   |   |
| Ratio of cumulative gap to total interest-earning   assets |       | (5.49                          | )%         | (19.46                                        | )%         | (3.11                             | )%         | 12.90                       | %          |       |       |

 

**Item 7A.  Quantitative and Qualitative Disclosures About Market Risk.**

 

Not applicable.

 

50

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**Item 8.  Financial Statements and Supplementary Data**

 

**INDEX TO AUDITED FINANCIAL STATEMENTS**

 

**CONGAREE BANCSHARES, INC. AND SUBSIDIARY**

 

**Table of Contents**

 
| ** **                                                                               | **Page No.** |
|------------------------------------------------------------------------------------------|-------------------|
|                                                                                     |              |
| Report of   Independent Registered Public Accounting Firm                                | 52                |
| Consolidated Balance   Sheets                                                            | 53                |
| Consolidated   Statements of Operations                                                  | 54                |
| Consolidated   Statements of Changes in Shareholders’ Equity and Comprehensive Loss | 55                |
| Consolidated   Statements of Cash Flows                                                  | 56                |
| Notes to Consolidated Financial Statements                                               | 57-80             |

 

51

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**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

 

The Board of Directors

Congaree Bancshares, Inc. and Subsidiary

Cayce, South Carolina

 

We have audited the accompanying consolidated balance sheets of Congaree Bancshares, Inc. and Subsidiary (the Company) as of December 31, 2010 and 2009, and the related consolidated statements of operations, changes in shareholders’ equity and comprehensive loss, and cash flows for the years then ended.  These financial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our audit included consideration of internal controls over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Congaree Bancshares, Inc. and Subsidiary, as of December 31, 2010 and 2009, and the results of their operations and cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles.

 

 
| /s/   Elliott Davis, LLC   |   |
|----------------------------|--------|
| Columbia,   South Carolina |   |
| April   12, 2011           |   |

 

52

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**CONGAREE BANCSHARES, INC. AND SUBSIDIARY**

**Consolidated Balance Sheets**

 
| ** **                                                                                            | ** ** | **December 31,** | ** **      |
|-------------------------------------------------------------------------------------------------------|------------|-----------------------|-----------------|
| ** **                                                                                            | ** ** | **2010**              | ** **      | **2009** | ** ** |
| **Assets:**                                                                                           |       |                  |            |   |   |
| Cash and cash   equivalents:                                                                          |       |                  |            |   |   |
| Cash and due from banks                                                                               |       | $                     | 2,771,515       |   | $ | 7,006,281 |   |
| Federal funds sold                                                                                    |       | 2,280,000             |            | 5,195,000 |   |
| Certificates of deposit   with other banks                                                            |       | —                |            | 250,210 |   |
|                                                                                                  |       |                  |            |   |   |
| Total cash and cash   equivalents                                                                     |       | 5,051,515             |            | 12,451,491 |   |
|                                                                                                  |       |                  |            |   |   |
| Securities   available-for-sale                                                                       |       | 20,776,657            |            | 17,965,661 |   |
| Securities held-to-maturity (estimated fair value   of $1,133,220)                                    |       | 1,143,249             |            | — |   |
| Nonmarketable equity   securities                                                                     |       | 474,300               |            | 474,300 |   |
|                                                                                                  |       |                  |            |   |   |
| Loans receivable                                                                                      |       | 90,335,609            |            | 106,143,726 |   |
| Less allowance for loan   losses                                                                      |       | 1,552,061             |            | 1,498,937 |   |
|                                                                                                  |       |                  |            |   |   |
| Loans receivable, net                                                                                 |       | 88,783,548            |            | 104,644,789 |   |
|                                                                                                  |       |                  |            |   |   |
| Premises, furniture and   equipment, net                                                              |       | 753,709               |            | 3,410,687 |   |
| Accrued interest   receivable                                                                         |       | 503,753               |            | 479,112 |   |
| Other real estate owned                                                                               |       | 3,293,167             |            | 501,037 |   |
| Other assets                                                                                          |       | 396,817               |            | 109,394 |   |
|                                                                                                  |       |                  |            |   |   |
| Total assets                                                                                          | ** ** | **$**                 | **121,176,715** | ** ** | **$** | **140,036,471** | ** ** |
|                                                                                                  | ** ** | ** **            | ** **      | ** ** | ** ** |
| **Liabilities:**                                                                                      |       |                  |            |   |   |
| Deposits:                                                                                             |       |                  |            |   |   |
| Noninterest-bearing   transaction accounts                                                            |       | $                     | 9,291,900       |   | $ | 11,719,046 |   |
| Interest-bearing   transaction accounts                                                               |       | 4,053,594             |            | 4,756,331 |   |
| Savings and money market                                                                              |       | 46,281,198            |            | 33,706,925 |   |
| Time deposits $100,000   and over                                                                     |       | 21,396,976            |            | 43,067,571 |   |
| Other time deposits                                                                                   |       | 25,562,324            |            | 31,346,837 |   |
|                                                                                                  |       |                  |            |   |   |
| Total deposits                                                                                        |       | 106,585,992           |            | 124,596,710 |   |
|                                                                                                  |       |                  |            |   |   |
| Federal Home Loan Bank   advances                                                                     |       | 3,000,000             |            | 3,000,000 |   |
| Accrued interest payable                                                                              |       | 44,059                |            | 70,436 |   |
| Other liabilities                                                                                     |       | 370,016               |            | 173,002 |   |
|                                                                                                  |       |                  |            |   |   |
| Total liabilities                                                                                     |       | 110,000,067           |            | 127,840,148 |   |
|                                                                                                  |       |                  |            |   |   |
| Commitments and   contingencies (Notes 13, 14 and 19)                                                 |       |                  |            |   |   |
|                                                                                                  |       |                  |            |   |   |
| **Shareholders’ equity:**                                                                        |       |                  |            |   |   |
| Preferred stock, $.01   par value, 10,000,000 shares authorized:                                      |       |                  |            |   |   |
| Series A cumulative   perpetual preferred stock; 3,285 shares issued and outstanding             |       | 3,167,722             |            | 3,135,530 |   |
| Series B cumulative   perpetual preferred stock; 164 shares issued and outstanding               |       | 175,538               |            | 178,599 |   |
| Common stock, $.01 par   value, 10,000,000 shares authorized; 1,764,439 shares issued and outstanding |       | 17,644                |            | 17,644 |   |
| Capital surplus                                                                                       |       | 17,688,324            |            | 17,658,940 |   |
| Retained deficit                                                                                      |       | (9,466,226            | )               | (8,959,528 | ) |
| Accumulated other   comprehensive income (loss)                                                       |       | (406,354              | )               | 165,138 |   |
|                                                                                                  |       |                  |            |   |   |
| Total shareholders’   equity                                                                     |       | 11,176,648            |            | 12,196,323 |   |
|                                                                                                  |       |                  |            |   |   |
| Total liabilities and   shareholders’ equity                                                     | ** ** | **$**                 | **121,176,715** | ** ** | **$** | **140,036,471** | ** ** |

 

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

 

53

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**CONGAREE BANCSHARES, INC. AND SUBSIDIARY**

**Consolidated Statements of Operations**

 
| ** **                                                | ** ** | **For the years ended** | ** **   |
|-----------------------------------------------------------|------------|----------------------------------------|--------------|
| ** **                                                | ** ** | **December 31,**                  | ** **   |
| ** **                                                | ** ** | **2010**                               | ** **   | **2009** | ** ** |
| **Interest income:**                                      |       |                                   |         |   |   |
| Loans, including fees                                     |       | $                                      | 5,510,062    |   | $ | 5,984,716 |   |
| Investment securities, taxable                            |       | 653,903                                |         | 648,748 |   |
| Investment securities, non-taxable                        |       | 60,849                                 |         | — |   |
| Federal funds sold and other                              |       | 16,495                                 |         | 20,917 |   |
|                                                      |       |                                   |         |   |   |
| Total                                                     |       | 6,241,309                              |         | 6,654,381 |   |
|                                                      |       |                                   |         |   |   |
| **Interest expense:**                                     |       |                                   |         |   |   |
| Time deposits $100,000 and over                           |       | 686,430                                |         | 1,228,896 |   |
| Other deposits                                            |       | 1,264,530                              |         | 1,553,517 |   |
| Other borrowings                                          |       | 88,145                                 |         | 85,883 |   |
|                                                      |       |                                   |         |   |   |
| Total                                                     |       | 2,039,105                              |         | 2,868,296 |   |
|                                                      |       |                                   |         |   |   |
| **Net interest income**                                   |       | 4,202,204                              |         | 3,786,085 |   |
| ** **                                                |       |                                   |         |   |   |
| Provision for loan losses                                 |       | 853,109                                |         | 717,937 |   |
|                                                      |       |                                   |         |   |   |
| **Net interest income after   provision for loan losses** |       | 3,349,095                              |         | 3,068,148 |   |
| ** **                                                |       |                                   |         |   |   |
| **Noninterest income:**                                   |       |                                   |         |   |   |
| Service charges on deposit accounts                       |       | 304,723                                |         | 138,558 |   |
| Residential mortgage origination fees                     |       | 76,011                                 |         | 98,177 |   |
| Gain on sales of securities available-for-sale            |       | 439,130                                |         | 114,571 |   |
| Gain (loss) on sale of assets                             |       | (174,047                               | )            | 3,423 |   |
| Impairment loss on nonmarketable equity securities        |       | —                                 |         | (60,352 | ) |
| Other                                                     |       | 24,761                                 |         | 41,925 |   |
|                                                      |       |                                   |         |   |   |
| Total noninterest income                                  |       | 670,578                                |         | 336,302 |   |
|                                                      |       |                                   |         |   |   |
| **Noninterest expenses:**                                 |       |                                   |         |   |   |
| Salaries and employee benefits                            |       | 1,820,278                              |         | 2,361,927 |   |
| Net occupancy                                             |       | 441,349                                |         | 420,116 |   |
| Furniture and equipment                                   |       | 397,600                                |         | 391,661 |   |
| Professional fees                                         |       | 387,717                                |         | 397,060 |   |
| Regulatory fees and FDIC assessment                       |       | 442,999                                |         | 290,845 |   |
| Other real estate owned expense                           |       | 165,478                                |         | 25,531 |   |
| Other operating                                           |       | 662,809                                |         | 660,232 |   |
|                                                      |       |                                   |         |   |   |
| Total noninterest expense                                 |       | 4,318,230                              |         | 4,547,372 |   |
|                                                      |       |                                   |         |   |   |
| **Loss before income taxes**                              |       | (298,557                               | )            | (1,142,922 | ) |
| ** **                                                |       |                                   |         |   |   |
| Income tax benefit                                        |       | —                                 |         | — |   |
|                                                      |       |                                   |         |   |   |
| **Net loss**                                              | ** ** | **$**                                  | **(298,557** | **)** | **$** | **(1,142,922** | **)** |
| ** **                                                | ** ** | ** **                             | ** **   | ** ** | ** ** |
| Net accretion of preferred stock to redemption   value    |       | $                                      | 29,131       |   | $ | 29,129 |   |
| Preferred dividends accrued                               |       | 179,010                                |         | 174,546 |   |
|                                                      |       |                                   |         |   |   |
| **Net loss available to common   shareholders**           | ** ** | **$**                                  | **(506,698** | **)** | **$** | **(1,346,597** | **)** |
| ** **                                                | ** ** | ** **                             | ** **   | ** ** | ** ** |
| **Loss per common share**                                 |       |                                   |         |   |   |
| Basic loss per share                                      | ** ** | **$**                                  | **(0.29**    | **)** | **$** | **(0.76** | **)** |
|                                                      | ** ** | ** **                             | ** **   | ** ** | ** ** |
| Average common shares outstanding                         | ** ** | **1,764,439**                          | ** **   | **1,764,439** | ** ** |

 

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

 

54

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**CONGAREE BANCSHARES, INC. AND SUBSIDIARY**

**Consolidated Statements of Changes in Shareholders’ Equity and Comprehensive Loss**

**For the years ended December 31, 2010 and 2009**

 
| ** **                                                 | ** ** | ** **               | ** ** | ** **            | ** **    | ** **  | ** **    | ** **   | ** ** | ** **        | ** ** | ** **  | ** **     | **Accumulated** | ** ** | ** **     | ** ** |
|------------------------------------------------------------|------------|--------------------------|------------|-----------------------|---------------|-------------|---------------|--------------|------------|-------------------|------------|-------------|----------------|-----------------|------------|----------------|------------|
| ** **                                                 | ** ** | ** **               | ** ** | ** **            | ** **    | ** **  | ** **    | ** **   | ** ** | ** **        | ** ** | ** **  | ** **     | **Other**       | ** ** | ** **     | ** ** |
| ** **                                                 | ** ** | **Preferred Stock** | ** ** | **Common Stock** | ** **    | **Capital** | ** **    | **Retained** | ** ** | **Comprehensive** | ** ** | ** **  | ** **     |
| ** **                                                 | ** ** | **Shares**               | ** ** | **Amount**            | ** **    | **Shares**  | ** **    | **Amount**   | ** ** | **Surplus**       | ** ** | **Deficit** | ** **     | **Income**      | ** ** | **Total**      | ** ** |
| **Balance, December 31, 2008**                        |       | —                   |       | $                     | —        |        | 1,764,439     |         | $          | 17,644            |       | $           | 17,436,270     |            | $          | (7,612,931     | )          | $ | 222,116 |   | $ | 10,063,099 |   |
| Issuance of Series A preferred stock                  |       | 3,285                    |       | 3,103,339             |          |        |          |         |       |              |       |        |           |            |       | 3,103,339      |       |
| Issuance of Series B preferred stock                  |       | 164                      |       | 181,661               |          |        |          |         |       |              |       |        |           |            |       | 181,661        |       |
| Accretion of Series A discount on preferred   stock   |       |                     |       | 32,191                |          |        |          |         |       |              |       | (32,191     | )              |            |       | —         |       |
| Amortization of Series B premium on preferred   stock |       |                     |       | (3,062                | )             |        |          |         |       |              |       | 3,062       |           |            |       | —         |       |
| Dividends paid on preferred stock                          |       |                     |       |                  |          |        |          |         |       |              |       | (174,546    | )              |            |       | (174,546       | )          |
| Net loss                                                   |       |                     |       |                  |          |        |          |         |       |              |       | (1,142,922  | )              |            |       | (1,142,922     | )          |
| Other comprehensive loss, net of taxes of $29,355          |       |                     |       |                  |          |        |          |         |       |              |       |        |           | (56,978         | )          | (56,978        | )          |
|                                                       |       |                     |       |                  |          |        |          |         |       |              |       |        |           |            |       |           |       |
| Comprehensive loss                                         |       |                     |       |                  |          |        |          |         |       |              |       |        |           |            |       | (1,199,900     | )          |
| Stock and warrant compensation expense                     |       |                     |       |                  |          |        |          |         |       | 222,670           |       |        |           |            |       | 222,670        |       |
|                                                       |       |                     |       |                  |          |        |          |         |       |              |       |        |           |            |       |           |       |
| **Balance, December 31, 2009**                        |       | 3,449                    |       | $                     | 3,314,129     |        | 1,764,439     |         | $          | 17,644            |       | $           | 17,658,940     |            | $          | (8,959,528     | )          | $ | 165,138 |   | $ | 12,196,323 |   |
| Accretion of Series A discount on preferred   stock   |       |                     |       | 32,191                |          |        |          |         |       |              |       | (32,191     | )              |            |       | —         |       |
| Amortization of Series B premium on preferred   stock |       |                     |       | (3,060                | )             |        |          |         |       |              |       | 3,060       |           |            |       | —         |       |
| Dividends accrued on preferred stock                       |       |                     |       |                  |          |        |          |         |       |              |       | (179,010    | )              |            |       | (179,010       | )          |
| Net loss                                                   |       |                     |       |                  |          |        |          |         |       |              |       | (298,557    | )              |            |       | (298,557       | )          |
| Other comprehensive loss, net of taxes of $292,705         |       |                     |       |                  |          |        |          |         |       |              |       |        |           | (571,492        | )          | (571,492       | )          |
|                                                       |       |                     |       |                  |          |        |          |         |       |              |       |        |           |            |       |           |       |
| Comprehensive loss                                         |       |                     |       |                  |          |        |          |         |       |              |       |        |           |            |       | (870,049       | )          |
| Stock and warrant compensation expense                     |       |                     |       |                  |          |        |          |         |       | 29,384            |       |        |           |            |       | 29,384         |       |
|                                                       |       |                     |       |                  |          |        |          |         |       |              |       |        |           |            |       |           |       |
| **Balance, December 31, 2010**                        | ** ** | **3,449**                | ** ** | **$**                 | **3,343,260** | ** **  | **1,764,439** | ** **   | **$**      | **17,644**        | ** ** | **$**       | **17,688,324** | ** **      | **$**      | **(9,466,226** | **)**      | **$** | **(406,354** | **)** | **$** | **11,176,648** | ** ** |

 

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

 

55

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**CONGAREE BANCSHARES, INC. AND SUBSIDIARY**

**Consolidated Statements of Cash Flows**

 
| ** **                                                                               | ** ** | **For the years ended** | ** **    |
|------------------------------------------------------------------------------------------|------------|----------------------------------------|---------------|
| ** **                                                                               | ** ** | **December 31,**                  | ** **    |
| ** **                                                                               | ** ** | **2010**                               | ** **    | **2009** | ** ** |
| **Cash flows from operating   activities:**                                              |       |                                   |          |   |   |
| Net loss                                                                                 |       | $                                      | (298,557      | ) | $ | (1,142,922 | ) |
| Adjustments to reconcile   net loss to net cash provided (used) by operating activities: |       |                                   |          |   |   |
| Provision for loan   losses                                                              |       | 853,109                                |          | 717,937 |   |
| Depreciation and   amortization expense                                                  |       | 220,995                                |          | 256,213 |   |
| Discount accretion and   premium amortization                                            |       | 78,537                                 |          | (23,336 | ) |
| Stock and warrant   compensation expense                                                 |       | 29,384                                 |          | 222,670 |   |
| Increase in accrued   interest receivable                                                |       | (24,641                                | )             | (6,232 | ) |
| Decrease in accrued   interest payable                                                   |       | (26,377                                | )             | (153,998 | ) |
| Gain on sale of   securities available-for-sale                                          |       | (439,130                               | )             | (114,571 | ) |
| (Gain) loss from sale of premises, furniture and   equipment                             |       | 174,047                                |          | (3,423 | ) |
| Losses and writedowns on sales of other real   estate                                    |       | 135,330                                |          | — |   |
| Other-than-temporary   impairment on nonmarketable equity securities                     |       | —                                 |          | 60,352 |   |
| Decrease in other assets                                                                 |       | 5,282                                  |          | 21,780 |   |
| Increase (decrease) in   other liabilities                                               |       | 18,004                                 |          | (31,396 | ) |
|                                                                                     |       |                                   |          |   |   |
| Net cash provided   (used) by operating activities                                       |       | 725,983                                |          | (196,926 | ) |
|                                                                                     |       |                                   |          |   |   |
| **Cash flows from investing   activities:**                                              |       |                                   |          |   |   |
| Purchase of   nonmarketable equity securities                                            |       | —                                 |          | (98,700 | ) |
| Proceeds from   maturities/calls of securities available-for-sale                        |       | 9,027,457                              |          | 3,122,852 |   |
| Proceeds from sales of   securities available-for-sale                                   |       | 11,368,953                             |          | 3,530,088 |   |
| Purchases of securities   available-for-sale                                             |       | (24,155,029                            | )             | (10,723,808 | ) |
| Purchase of securities held-to-maturity                                                  |       | (699,230                               | )             | — |   |
| Net (increase)   decrease in loans receivable                                            |       | 11,748,100                             |          | (4,947 | ) |
| Purchase of premises,   furniture and equipment                                          |       | (46,355                                | )             | (87,243 | ) |
| Proceeds from sales of   other real estate owned                                         |       | 332,572                                |          | — |   |
| Proceeds from sales of   premises, furniture and equipment                               |       | 2,308,291                              |          | 90,865 |   |
|                                                                                     |       |                                   |          |   |   |
| Net cash provided (used)   by investing activities                                       |       | 9,884,759                              |          | (4,170,893 | ) |
|                                                                                     |       |                                   |          |   |   |
| **Cash flows from financing   activities:**                                              |       |                                   |          |   |   |
| Increase (decrease) in   noninterest-bearing deposits                                    |       | (2,427,146                             | )             | 528,414 |   |
| Increase (decrease) in   interest-bearing deposits                                       |       | (15,583,572                            | )             | 5,533,736 |   |
| Proceeds from issuance   of preferred stock                                              |       | —                                 |          | 3,285,000 |   |
| Dividends paid on   preferred stock                                                      |       | —                                 |          | (152,159 | ) |
|                                                                                     |       |                                   |          |   |   |
| Net cash provided (used)   by financing activities                                       |       | (18,010,718                            | )             | 9,194,991 |   |
|                                                                                     |       |                                   |          |   |   |
| **Net increase (decrease) in cash   and cash equivalents**                               |       | (7,399,976                             | )             | 4,827,172 |   |
| ** **                                                                               |       |                                   |          |   |   |
| **Cash and cash equivalents,   beginning of period**                                     |       | 12,451,491                             |          | 7,624,319 |   |
| ** **                                                                               |       |                                   |          |   |   |
| **Cash and cash equivalents, end of   period**                                           | ** ** | **$**                                  | **5,051,515** | ** ** | **$** | **12,451,491** | ** ** |

 

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

 

56

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**CONGAREE BANCSHARES, INC. AND SUBSIDIARY**

 

**Notes to Consolidated Financial Statements**

 

**NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

**Organization** - Congaree Bancshares, Inc. and Subsidiary (the Company) was incorporated to serve as a bank holding company for its subsidiary, Congaree State Bank (the Bank).  Congaree State Bank commenced business on October 16, 2006.  The principal business activity of the Bank is to provide banking services to domestic markets, principally in West Columbia and Cayce, South Carolina.  The Bank is a state-chartered commercial bank, and its deposits are insured by the Federal Deposit Insurance Corporation.  The consolidated financial statements include the accounts of the parent company and its wholly-owned subsidiary after elimination of all significant intercompany balances and transactions.

 

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

 

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

 

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

 

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

 

The Company makes loans to individuals and small businesses for various personal and commercial purposes primarily in the Lexington County region of South Carolina.  The Company’s loan portfolio is not concentrated in loans to any single borrower or a relatively small number of borrowers.  Additionally, Management is not aware of any concentrations of loans to classes of borrowers or industries that would be similarly affected by economic conditions.

 

In addition to monitoring potential concentrations of loans to particular borrowers or groups of borrowers, industries and geographic regions, Management monitors exposure to credit risk from concentrations of lending products and practices such as loans that subject borrowers to substantial payment increases (e.g. principal deferral periods, loans with initial interest-only periods, etc.) and loans with high loan-to-value ratios.  Management has determined that there is no concentration of credit risk associated with its lending policies or practices.  Additionally, there are industry practices that could subject the Company to increased credit risk should economic conditions change over the course of a loan’s life. For example, the Company makes variable rate loans and fixed rate principal-amortizing loans with maturities prior to the loan being fully paid (i.e. balloon payment loans).  These loans are underwritten and monitored to manage the associated risks.  Therefore, management believes that these particular practices do not subject the Company to unusual credit risk.

 

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

 

57

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**CONGAREE BANCSHARES, INC. AND SUBSIDIARY**

 

**Notes to Consolidated Financial Statements**

 

**NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES***- continued*

 

**Investment Securities**- Securities are classified in one of three categories: trading, available for sale, or held to maturity. Trading securities are bought and held principally for the purpose of selling them in the near term. Held to maturity securities are those securities for which the Bank has the ability and intent to hold the securities until maturity. All other securities not included in trading or held to maturity are classified as available for sale. At December 31, 2010 and 2009, the Bank had no trading securities.

 

Held-to-maturity securities are recorded at cost, adjusted for the amortization or accretion of premiums or discounts. Securities available-for-sale are carried at amortized cost and adjusted to estimated market value by recognizing the aggregate unrealized gains or losses in a valuation account.  Aggregate market valuation adjustments are recorded in shareholders’ equity net of deferred income taxes.  Management evaluates investment securities for other-than-temporary impairment on a quarterly basis. A decline in the market value of any investment below cost that is deemed other-than-temporary is charged to earnings for the decline in value deemed to be credit related and a new cost basis in the security is established. The decline in value attributed to non-credit related factors is recognized in other comprehensive income.  The adjusted cost basis of investments available-for-sale is determined by specific identification and is used in computing the gain or loss upon sale.

 

**Nonmarketable Equity Securities** - Nonmarketable equity securities include the cost of the Company’s investment in the stock of the Federal Home Loan Bank, Pacific Coast Bankers Bank, and Silverton Bank.  These stocks have no quoted market value and no ready market exists.  The Company’s investment in Federal Home Loan Bank stock at December 31, 2010 and 2009 was $372,300.  The Company’s investment in Pacific Coast Bankers Bank stock at December 31, 2010 and 2009 was $102,000. During 2009, the Bank recognized an impairment charge on the remaining Silverton Bank stock balance of $60,352.

 

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

 

When serious doubt exists as to the collectibility of a loan or when a loan becomes contractually 90 days past due as to principal or interest, interest income is generally discontinued unless the estimated net realizable value of collateral exceeds the principal balance and accrued interest.  When interest accruals are discontinued, income earned but not collected is reversed.

 

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

 

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

 

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

 

Management’s judgment in determining the adequacy of the allowance is based on evaluations of the probability of collection of loans. These evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, current economic conditions that may affect the borrower’s ability to pay, overall portfolio quality, and review of specific problem loans.

 

58

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**CONGAREE BANCSHARES, INC. AND SUBSIDIARY**

 

**Notes to Consolidated Financial Statements**

 

**NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES*****-****continued*

 

**Allowance for Loan Losses***(continued)* - Management uses an outsourced independent loan review specialist on an annual basis to corroborate and challenge the internal loan grading system and methods used to determine the adequacy of the allowance for loan losses.

 

Management believes the allowance for loan losses is adequate. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the allowance for loan losses. Such regulators may require additions to the allowance based on their judgments of information available to them at the time of their examination.

 

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

 

**Other Real Estate Owned** - Other real estate owned represents properties acquired through or in lieu of loan foreclosure and is initially recorded at fair market value less estimated disposal costs.  Costs of improvements are capitalized, whereas costs relating to holding other real estate and valuation adjustments are expensed.  Revenue and expenses from operations and changes in valuation allowance are included in other real estate owned expense.

 

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

 

**Advertising Expense** - Advertising and public relations costs are generally expensed as incurred.  External costs incurred in producing media advertising are expensed the first time the advertising takes place.  External costs relating to direct mailing costs are expensed in the period in which the direct mailings are sent.

 

**Loss Per Share** - Basic loss per share represents income available to shareholders divided by the weighted-average number of common shares outstanding during the period.  Dilutive loss per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued.  The only potential common share equivalents are those related to stock options and warrants.  Stock options and warrants which are antidilutive are excluded from the calculation of diluted net income per share.  Since the Company is in a net loss position for the years ended December 31, 2010 and 2009, potential dilutive common shares were not included, because to do so would be antidilutive.

 

**Stock-Based Compensation** - The Company accounts for its stock compensation plans using a fair value based method whereby compensation cost is measured at the grant date based on the value of the award and is recognized over the service period, which is usually the vesting period.

 

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

 

59

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**CONGAREE BANCSHARES, INC. AND SUBSIDIARY**

 

**Notes to Consolidated Financial Statements**

 

**NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES*****-****continued*

 

**Comprehensive Income***(continued)* - The components of other comprehensive income and related tax effects are as follows for the years ended December 31, 2010 and 2009.

 
| ** **                                                            | ** ** | **2010** | ** **   | **2009** | ** ** |
|-----------------------------------------------------------------------|------------|----------|--------------|----------|------------|
|                                                                  |       |     |         |     |       |
| Unrealized gains (losses) on securities   available-for-sale          |       | $        | (425,067     | )        | $          | 28,238 |   |
| Reclassification adjustment for gains realized in   net income (loss) |       | (439,130 | )            | (114,571 | )          |
|                                                                  |       |     |         |     |       |
| Net unrealized losses on securities                                   |       | (864,197 | )            | (86,333  | )          |
|                                                                  |       |     |         |     |       |
| Tax effect                                                            |       | 292,705  |         | 29,355   |       |
|                                                                  |       |     |         |     |       |
| Net-of-tax amount                                                     | ** ** | **$**    | **(571,492** | **)**    | **$**      | **(56,978** | **)** |

 

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

 

Interest paid on deposits and other borrowings totaled $2,065,482 and $3,022,294 for the years ended December 31, 2010 and 2009, respectively.  Changes in the valuation account for securities available-for-sale, including deferred tax effects, are considered non-cash transactions for purposes of the statement of cash flows and are presented in detail in the notes to the financial statements.  In addition, transfers of loans to other real estate owned and changes in dividends payable are also considered non-cash transactions.  The Bank transferred loans in the amount of $3,260,032 and $501,037 to other real estate owned during the years ended December 31, 2010 and 2009, respectively.  The change in dividends payable was $179,010 and $22,387 during the years ended December 31, 2010 and 2009, respectively.  Investments securities with a book value of $448,672 were transferred from the available-for-sale category to held-to-maturity during the year ended December 31, 2010. The Bank did not transfer any investment securities between categories during the year ended December 31, 2009.

 

There were no income tax payments during the years ended December 31, 2010 and 2009.

** **

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

** **

**Fair Values of Financial Instruments** - Fair values of financial instruments are estimated using relevant market value information and other assumptions, as more fully disclosed in a separate note. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates.

 

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

 

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

 

60

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**CONGAREE BANCSHARES, INC. AND SUBSIDIARY**

 

**Notes to Consolidated Financial Statements**

 

**NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES*****-****continued*

 

**Recent Accounting Pronouncements** - The following is a summary of recent authoritative pronouncements that may affect accounting, reporting, and disclosure of financial information by the Company:

 

In January 2010, fair value guidance was amended to require disclosures for significant amounts transferred in and out of Levels 1 and 2 and the reasons for such transfers and to require that gross amounts of purchases, sales, issuances and settlements be provided in the Level 3 reconciliation.  Disaggregation of classes of assets and liabilities is also required. The new disclosures are effective for the Company for the current year and have been reflected in a separate note.

 

In July 2010, the Receivables topic of the ASC was amended to require expanded disclosures related to a company’s allowance for credit losses and the credit quality of its financing receivables. The amendments will require the allowance disclosures to be provided on a disaggregated basis.  The Company is required to begin to comply with the disclosures in its financial statements for the year ending December 31, 2010.

 

On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), which significantly changes the regulation of financial institutions and the financial services industry.  The Dodd-Frank Act includes several provisions that will affect how community banks, thrifts, and small bank and thrift holding companies will be regulated in the future.  Among other things, these provisions abolish the Office of Thrift Supervision and transfer its functions to the other federal banking agencies, relax rules regarding interstate branching, allow financial institutions to pay interest on business checking accounts, change the scope of federal deposit insurance coverage, and impose new capital requirements on bank and thrift holding companies.  The Dodd-Frank Act also establishes the Bureau of Consumer Financial Protection as an independent entity within the Federal Reserve, which will be given the authority to promulgate consumer protection regulations applicable to all entities offering consumer financial services or products, including banks.  Additionally, the Dodd-Frank Act includes a series of provisions covering mortgage loan origination standards affecting originator compensation, minimum repayment standards, and pre-payments.  Management is actively reviewing the provisions of the Dodd-Frank Act and assessing its probable impact on our business, financial condition, and results of operations.

 

In August 2010, two updates were issued to amend various SEC rules and schedules pursuant to Release No. 33-9026: Technical Amendments to Rules, Forms, Schedules and Codification of Financial Reporting Policies and based on the issuance of SEC Staff Accounting Bulletin 112.  The amendments related primarily to business combinations and removed references to “minority interest” and added references to “controlling” and “noncontrolling interest”.  The updates were effective upon issuance but had no impact on the Company’s financial statements.

 

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

 

**Reclassifications** - Certain captions and amounts in the 2009 consolidated financial statements were reclassified to conform with the 2010 presentation.  The reclassifications did not have an impact on the net loss or shareholders’ equity.

 

**NOTE 2 - CASH AND DUE FROM BANKS**

 

The Company is required to maintain cash balances with its correspondent banks to cover all cash letter transactions.  At December 31, 2010 and 2009, the requirement was met by the cash balance in the vault.

 

61

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**CONGAREE BANCSHARES, INC. AND SUBSIDIARY**

 

**Notes to Consolidated Financial Statements**

 

**NOTE 3 - INVESTMENT SECURITIES**

 

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

 
| ** **                       | ** ** | **Amortized** | ** **     | **Gross Unrealized** | ** ** | **Estimated** | ** ** |
|----------------------------------|------------|---------------|----------------|---------------------------|------------|---------------|------------|
| ** **                       | ** ** | **Costs**     | ** **     | **Gains**                 | ** ** | **Losses**    | ** ** | **Fair Value** | ** ** |
| **December 31, 2010**       |       |          |           |                      |       |          |       |   |   |
| Government sponsored enterprises |       | $             | 16,240,270     |                      | $          | 14,333        |       | $ | 410,739 |   | $ | 15,843,864 |   |
| Mortgage-backed securities       |       | 2,151,089     |           | 8,107                     |       | 40,942        |       | 2,118,254 |   |
| State, county and municipal      |       | 2,999,285     |           | 75                        |       | 184,821       |       | 2,814,539 |   |
|                             |       |          |           |                      |       |          |       |   |   |
| ** **                       | ** ** | **$**         | **21,390,644** | ** **                | **$**      | **22,515**    | ** ** | **$** | **636,502** | ** ** | **$** | **20,776,657** |   |
| ** **                       |       |          |           |                      |       |          |       |   |   |
| **December 31, 2009**       |       |          |           |                      |       |          |       |   |   |
| Government sponsored enterprises |       | $             | 10,603,783     |                      | $          | 251,076       |       | $ | 105,668 |   | $ | 10,749,191 |   |
| Mortgage-backed securities       |       | 6,662,003     |           | 176,778                   |       | 52,122        |       | 6,786,659 |   |
| State, county and municipal      |       | 449,666       |           | —                    |       | 19,855        |       | 429,811 |   |
| ** **                       | ** ** | **$**         | **17,715,452** | ** **                | **$**      | **427,854**   | ** ** | **$** | **177,645** | ** ** | **$** | **17,965,661** |   |

 

The amortized cost and estimated fair values of securities held-to-maturity were:

** **
| ** **                  | ** ** | **Amortized** | ** **    | **Gross Unrealized** | ** ** | **Estimated** | ** ** |
|-----------------------------|------------|---------------|---------------|---------------------------|------------|---------------|------------|
| ** **                  | ** ** | **Costs**     | ** **    | **Gains**                 | ** ** | **Losses**    | ** ** | **Fair Value** | ** ** |
| **December 31, 2010**  |       |          |          |                      |       |          |       |   |   |
| State, county and municipal |       | $             | 1,143,249     |                      | $          | —        |       | $ | 10,029 |   | $ | 1,133,220 |   |
|                        |       |          |          |                      |       |          |       |   |   |   |   |   |   |
| ** **                  | ** ** | **$**         | **1,143,249** | ** **                | **$**      | **—**    | ** ** | **$** | **10,029** | ** ** | **$** | **1,133,220** |   |

 

There were no securities classified as held-to-maturity at December 31, 2009.

 

Proceeds from sales of available-for-sale securities during 2010 and 2009 were $11,368,953 and $3,530,088, respectively. Gross gains of $439,130 and $114,571 were recognized on those sales in 2010 and 2009, respectively.  The amortized costs and fair values of investment securities at December 31, 2010, by contractual maturity, are shown in the following chart. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.  Callable securities and mortgage-backed securities are included in the year of their contractual maturity date.

 

In May 2010, management transferred securities with a book value of $447,875 from the available-for-sale category to held-to-maturity. Management intends to hold these investments to maturity and reasonably believes it has the capacity to do so.

 
| ** **                       | ** ** | **Securities**         | ** **     | **Securities**       | ** ** |
|----------------------------------|------------|------------------------|----------------|----------------------|------------|
| ** **                       | ** ** | **Available-for-Sale** | ** **     | **Held-to-Maturity** | ** ** |
| ** **                       | ** ** | **Amortized**          | ** **     | **Estimated**        | ** ** | **Amortized** | ** ** | **Estimated** | ** ** |
| ** **                       | ** ** | **Cost**               | ** **     | **Fair   Value**     | ** ** | **Cost** | ** ** | **Fair   Value** |   |
| ** **                       | ** ** | ** **             | ** **     | ** **           | ** ** | ** ** | ** ** | ** ** |   |
| Due after one through five years |       | $                      | 123,986        |                 | $          | 131,622 |   | $ | — |   | $ | — |   |
| Due after five through ten years |       | 13,968,231             |           | 13,705,357           |       | 447,275 |   | 438,392 |   |
| Due after ten years              |       | 7,298,427              |           | 6,939678             |       | 695,974 |   | 694,828 |   |
|                             |       |                   |           |                 |       |   |   |   |   |
| Total securities                 | ** ** | **$**                  | **21,390,644** | ** **           | **$**      | **20,776,657** | ** ** | **$** | **1,143,249** | ** ** | **$** | **1,133,220** | ** ** |

 

62

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**CONGAREE BANCSHARES, INC. AND SUBSIDIARY**

 

**Notes to Consolidated Financial Statements**

 

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

 

The following table shows gross unrealized losses and fair value of securities available-for-sale, aggregated by investment category, and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2010.

 
| ** **                       | ** ** | **Less than 12 months** | ** **     | **12 months or more** | ** ** | **Total**   | ** ** |
|----------------------------------|------------|----------------------------------------|----------------|--------------------------------------|------------|-------------|------------|
| ** **                       | ** ** | **Fair**                               | ** **     | **Unrealized**                       | ** ** | **Fair**    | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| ** **                       | ** ** | **Value**                              | ** **     | **Losses**                           | ** ** | **Value**   | ** ** | **Losses** | ** ** | **Value** | ** ** | **Losses** | ** ** |
| Government sponsored enterprises |       | $                                      | 13,454,861     |                                 | $          | 410,739     |       | $ | — |   | $ | — |   | $ | 13,454,861 |   | 410,739 |   |
| Mortgage-backed securities       |       | 1,165,950                              |           | 40,942                               |       | —      |       | — |   | 1,165,950 |   | 40,942 |   |
| State, county and municipal      |       | 1,936,006                              |           | 184,821                              |       | —      |       | — |   | 1,936,006 |   | 184,821 |   |
|                             |       |                                   |           |                                 |       |        |       |   |   |   |   |   |   |
|                             | ** ** | **$**                                  | **16,556,817** | ** **                           | **$**      | **636,502** | ** ** | **$** | **—** | ** ** | **$** | **—** | ** ** | **$** | **16,556,817** | ** ** | **$** | **636,502** |   |
|                                  |            |                                        |                |                                      |            |             |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

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.

 
| ** **                       | ** ** | **Less than 12 months** | ** **    | **12 months or more** | ** ** | **Total**   | ** ** |
|----------------------------------|------------|----------------------------------------|---------------|--------------------------------------|------------|-------------|------------|
| ** **                       | ** ** | **Fair**                               | ** **    | **Unrealized**                       | ** ** | **Fair**    | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| ** **                       | ** ** | **Value**                              | ** **    | **Losses**                           | ** ** | **Value**   | ** ** | **Losses** | ** ** | **Value** | ** ** | **Losses** | ** ** |
| Government sponsored enterprises |       | $                                      | 5,718,617     |                                 | $          | 105,668     |       | $ | — |   | $ | — |   | $ | 5,718,617 |   | 105,668 |   |
| Mortgage-backed securities       |       | 2,477,725                              |          | 52,122                               |       | —      |       | — |   | 2,477,725 |   | 52,122 |   |
| State, county and municipal      |       | 429,811                                |          | 19,855                               |       | —      |       | — |   | 429,811 |   | 19,855 |   |
|                             |       |                                   |          |                                 |       |        |       |   |   |   |   |   |   |
|                             | ** ** | **$**                                  | **8,626,153** | ** **                           | **$**      | **177,645** | ** ** | **$** | **—** | ** ** | **$** | **—** | ** ** | **$** | **8,626,153** | ** ** | **$** | **177,645** |   |
|                                  |            |                                        |               |                                      |            |             |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

Securities classified as available-for-sale are recorded at fair market value.  There were no securities in a continuous unrealized loss position for more than twelve months at December 31, 2010 or 2009.

 

The following table shows gross unrealized losses and fair value of securities held-to-maturity, aggregated by investment category, and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2010.

 
| ** **                  | ** ** | **Less than 12 months** | ** **    | **12 months or more** | ** ** | **Total**  | ** ** |
|-----------------------------|------------|----------------------------------------|---------------|--------------------------------------|------------|------------|------------|
| ** **                  | ** ** | **Fair**                               | ** **    | **Unrealized**                       | ** ** | **Fair**   | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| ** **                  | ** ** | **Value**                              | ** **    | **Losses**                           | ** ** | **Value**  | ** ** | **Losses** | ** ** | **Value** | ** ** | **Losses** | ** ** |
| State, county and municipal |       | $                                      | 1,133,220     |                                 | $          | 10,029     |       | $ | — |   | $ | — |   | $ | 1,133,220 |   | 10,029 |   |
|                        |       |                                   |          |                                 |       |       |       |   |   |   |   |   |   |
|                        | ** ** | **$**                                  | **1,133,220** | ** **                           | **$**      | **10,029** | ** ** | **$** | **—** | ** ** | **$** | **—** | ** ** | **$** | **1,133,220** | ** ** | **$** | **10,029** |   |
|                             |            |                                        |               |                                      |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation.  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 Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.

 

63

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**CONGAREE BANCSHARES, INC. AND SUBSIDIARY**

** **

**Notes to Consolidated Financial Statements**

 

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

 

In analyzing an issuer’s financial condition, management considers whether the securities are issued by the federal government or its agencies whether downgrades by bond rating agencies have occurred, and industry analysts’ reports. As management has the ability to hold debt securities until maturity, or for the foreseeable future if classified as available-for-sale, no declines are deemed to be other-than-temporary.

 

At December 31, 2010 and 2009, securities with estimated fair value of $3,212,762 and $3,783,988, respectively, were pledged to secure public deposits and to secure the borrowings from the FHLB, as required by law.

 

**NOTE 4 - LOANS RECEIVABLE**

 

Major classifications of loans receivable at December 31 are summarized as follows:

 
| ** **                 | ** ** | **2010**   | ** **     | **2009**   | ** ** |
|----------------------------|------------|------------|----------------|------------|------------|
|                       |       |       |           |       |       |
| Real estate - mortgage     |       | $          | 67,625,366     |       | $          | 75,726,610 |   |
| Real estate - construction |       | 12,076,019 |           | 16,454,132 |       |
| Commercial and industrial  |       | 9,234,855  |           | 11,738,295 |       |
| Consumer and other         |       | 1,399,369  |           | 2,224,689  |       |
|                       |       |       |           |       |       |
| Total gross loans          | ** ** | **$**      | **90,335,609** | ** ** | **$**      | **106,143,726** | ** ** |

 

The credit quality indicator utilized by the Company to internally analyze the loan portfolio is the internal risk rating. Loans classified as pass credits have no material weaknesses and are performing as agreed. Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date. Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

 

The following is an analysis of our loan portfolio by credit quality indicators at December 31, 2010:

 
| ** **           | ** ** | ** **     | ** **    | **Commercial**       | ** ** | ** **                   | ** ** | ** **            | ** **     | ** **      | ** ** |
|----------------------|------------|----------------|---------------|----------------------|------------|------------------------------|------------|-----------------------|----------------|-----------------|------------|
| ** **           | ** ** | ** **     | ** **    | **Real Estate** | ** ** | **Commercial Real**     | ** ** | ** **            | ** **     | **Residential** | ** ** |
| ** **           | ** ** | **Commercial** | ** **    | **Construction**     | ** ** | **Estate - Other** | ** ** | **Residential-Prime** | ** **     | **Subprime**    | ** ** |
| **Grade:**           |       |           |          |                 |       |                         |       |                  |           |            |       |
| Pass                 |       | $              | 7,374,129     |                 | $          | 7,860,668                    |       | $                     | 22,834,938     |            | $          | 27,731,483 |   | $ | 8,417,454 |   |
| Special mention      |       | 1,011,261      |          | 1,125,410            |       | 2,756,133                    |       | 163,430               |           | 1,650,840       |       |
| Substandard or worse |       | 849,465        |          | 3,089,941            |       | 2,045,296                    |       | 1,184,031             |           | 841,761         |       |
| Total                | ** ** | **$**          | **9,234,855** | ** **           | **$**      | **12,076,019**               | ** ** | **$**                 | **27,636,367** | ** **      | **$**      | **29,078,944** | ** ** | **$** | **10,910,055** | ** ** |

 
| ** **    | ** ** | **Consumer-** | ** **  | ** **        | ** ** |
|---------------|------------|---------------|-------------|-------------------|------------|
| ** **    | ** ** | **Other**     | ** **  | **Consumer-Auto** | ** ** |
|          |       |          |        |              |       |
| Performing    |       | $             | 840,124     |              | $          | 559,245 |   |
| Nonperforming |       | —        |        | —            |       |
|          |       |          |        |              |       |
| Total         | ** ** | **$**         | **840,124** | ** **        | **$**      | **559,245** | ** ** |

 

64

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**CONGAREE BANCSHARES, INC. AND SUBSIDIARY**

** **

**Notes to Consolidated Financial Statements**

 

**NOTE 4 - LOANS RECEIVABLE** - *continued*

 

The following is an aging analysis of our loan portfolio:

 
| ** **              | ** ** | ** **          | ** **  | ** **          | ** ** | ** **            | ** ** | ** **        | ** **  | ** **  | ** ** | ** **           | ** ** | **Recorded**          | ** **     |
|-------------------------|------------|---------------------|-------------|---------------------|------------|-----------------------|------------|-------------------|-------------|-------------|------------|----------------------|------------|-----------------------|----------------|
| ** **              | ** ** | ** **          | ** **  | ** **          | ** ** | ** **            | ** ** | ** **        | ** **  | ** **  | ** ** | ** **           | ** ** | **Investment**        | ** **     |
| ** **              | ** ** | **30-59 Days** | ** **  | **60-89 Days** | ** ** | **Greater Than** | ** ** | **Total**         | ** **  | ** **  | ** ** | **Total Loans** | ** ** | **90 Days**      | ** **     |
| ** **              | ** ** | **Past Dues**  | ** **  | **Past Dues**  | ** ** | **90 Days**      | ** ** | **Past Due** | ** **  | **Current** | ** ** | **Receivable**       | ** ** | **and Accruing** | ** **     |
| ** **              | ** ** | ** **          | ** **  | ** **          | ** ** | ** **            | ** ** | ** **        | ** **  | ** **  | ** ** | ** **           | ** ** | ** **            | ** **     |
| Commercial              |       | $                   | 18,430      |                | $          | 93,797                |       | $                 | 48,836      |        | $          | 161,063              |       | $                     | 9,073,797      |   | $ | 9,234,855 |   | $ | — |   |
| Commercial real estate: |       |                |        |                |       |                  |       |              |        |        |       |                 |       |                  |           |
| Construction            |       | —              |        | —              |       | 269,730               |       | 269,730           |        | 11,806,289  |       | 12,076,019           |       | —                |           |
| Other                   |       | 236,270             |        | —              |       | 70,769                |       | 307,039           |        | 27,329,328  |       | 27,636,367           |       | —                |           |
| Consumer:               |       |                |        |                |       |                  |       |              |        |        |       |                 |       |                  |           |
| Other                   |       | 123,835             |        | 2,567               |       | —                |       | 126,402           |        | 1,272,967   |       | 1,399,369            |       | —                |           |
| Residential             |       | 370,661             |        | 201,090             |       | 18,691                |       | 590,442           |        | 39,398,557  |       | 39,988,999           |       | —                |           |
|                    |       |                |        |                |       |                  |       |              |        |        |       |                 |       |                  |           |
| Total                   | ** ** | **$**               | **749,196** | ** **          | **$**      | **297,454**           | ** ** | **$**             | **408,026** | ** **  | **$**      | **1,454,676**        | ** ** | **$**                 | **88,880,933** | ** ** | **$** | **90,335,609** | ** ** | **$** | **—** | ** ** |

 

The following is an analysis of loans receivables on nonaccrual status as of December 31, 2010:

 
| Commercial                            |       | $       | 210,532       |       |
|---------------------------------------|------------|---------|---------------|------------|
| Commercial real estate:               |       |    |          |
| Commercial real estate   construction |       | 781,629 |          |
| Commercial real estate -   other      |       | 70,769  |          |
|                                  |       |    |          |
| Consumer                              |       | —  |          |
| Residential:                          |       |    |          |
| Residential - prime                   |       | 326,580 |          |
| Residential - subprime                |       | 27,779  |          |
|                                  |       |    |          |
| Total                                 | ** ** | **$**   | **1,417,289** | ** ** |

 

Transactions in the allowance for loan losses during 2010 and 2009 are summarized below:

 
| ** **                                 | ** ** | **2010** | ** **    | **2009**   | ** ** |
|--------------------------------------------|------------|----------|---------------|------------|------------|
|                                       |       |     |          |       |       |
| Balance, beginning of year                 |       | $        | 1,498,937     |       | $          | 1,688,840 |   |
| Provision charged to operations            |       | 853,109  |          | 717,937    |       |
| Loans charged-off                          |       | (809,338 | )             | (941,439   | )          |
| Recoveries of loans previously charged-off |       | 9,353    |          | 33,599     |       |
|                                       |       |     |          |       |       |
| Balance, end of year                       | ** ** | **$**    | **1,552,061** | ** ** | **$**      | **1,498,937** | ** ** |

 

65

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**CONGAREE BANCSHARES, INC. AND SUBSIDIARY**

** **

**Notes to Consolidated Financial Statements**

** **

**NOTE 4 - LOANS RECEIVABLE** - *continued*

 

The following table summarizes the allowance for loan losses and recorded investment in gross loans, by portfolio segment, at and for the period ended December 31, 2010:

 
| ** **                            | ** ** | ** **     | ** **    | **Commercial**       | ** ** | ** **     | ** ** | ** **      | ** **    | ** **      | ** ** | ** **     | ** ** |
|---------------------------------------|------------|----------------|---------------|----------------------|------------|----------------|------------|-----------------|---------------|-----------------|------------|----------------|------------|
| ** **                            | ** ** | **Commercial** | ** **    | **Real Estate** | ** ** | **Consumer**   | ** ** | **Residential** | ** **    | **Unallocated** | ** ** | **Total**      | ** ** |
| Beginning balance                     |       | $              | 300,192       |                 | $          | 436,855        |       | $               | 17,467        |            | $          | 744,423        |       | $ | — |   | $ | 1,498,937 |   |
| Charge-offs                           |       | (183,814       | )             | (500,474             | )          | (4,525         | )          | (120,525        | )             | —          |       | (809,338       | )          |
| Recoveries                            |       | 6,000          |          | —               |       | 1,100          |       | 2,253           |          | —          |       | 9,353          |       |
| Provisions                            |       | 284,733        |          | 507,814              |       | 5,169          |       | 20,301          |          | 35,092          |       | 853,109        |       |
|                                  |       |           |          |                 |       |           |       |            |          |            |       |           |       |
| Ending balance                        | ** ** | **$**          | **407,111**   | ** **           | **$**      | **444,195**    | ** ** | **$**           | **19,211**    | ** **      | **$**      | **646,452**    | ** ** | **$** | **35,092** | ** ** | **$** | **1,552,061** | ** ** |
|                                  | ** ** | ** **     | ** **    | ** **           | ** ** | ** **     | ** ** | ** **      | ** **    | ** **      | ** ** | ** **     | ** ** |
| Ending balances:                      |       |           |          |                 |       |           |       |            |          |            |       |           |       |
| Individually evaluated for impairment |       | **$**          | **162,956**   |                 | **$**      | **14,667**     |       | **$**           | **16,423**    |            | **$**      | **30,889**     |       | **$** | **—** |   | **$** | **224,935** |   |
|                                  | ** ** | ** **     | ** **    | ** **           | ** ** | ** **     | ** ** | ** **      | ** **    | ** **      | ** ** | ** **     | ** ** |
| Collectively evaluated for impairment |       | **$**          | **244,155**   |                 | **$**      | **429,528**    |       | **$**           | **2,788**     |            | **$**      | **615,563**    |       | **$** | **35,092** |   | **$** | **1,327,126** |   |
|                                  | ** ** | ** **     | ** **    | ** **           | ** ** | ** **     | ** ** | ** **      | ** **    | ** **      | ** ** | ** **     | ** ** |
| **Loans receivable:**                 |       |           |          |                 |       |           |       |            |          |            |       |           |       |
| Ending balance - total                | ** ** | **$**          | **9,234,855** | ** **           | **$**      | **39,712,386** | ** ** | **$**           | **1,399,369** | ** **      | **$**      | **39,988,999** | ** ** | **$** | **—** | ** ** | **$** | **90,335,609** | ** ** |
|                                  | ** ** | ** **     | ** **    | ** **           | ** ** | ** **     | ** ** | ** **      | ** **    | ** **      | ** ** | ** **     | ** ** |
| Ending balances:                      |       |           |          |                 |       |           |       |            |          |            |       |           |       |
| Individually evaluated for impairment |       | **$**          | **248,858**   |                 | **$**      | **1,640,710**  |       | **$**           | **16,423**    |            | **$**      | **345,270**    |       | **$** | **—** |   | **$** | **2,251,261** |   |
|                                  | ** ** | ** **     | ** **    | ** **           | ** ** | ** **     | ** ** | ** **      | ** **    | ** **      | ** ** | ** **     | ** ** |
| Collectively evaluated for impairment |       | **$**          | **8,985,997** |                 | **$**      | **38,071,676** |       | **$**           | **1,382,946** |            | **$**      | **39,643,729** |       | **$** | **—** |   | **$** | **88,084,348** |   |

 

The Company considers a loan to be impaired when it is probable that it will be unable to collect all amounts due according to the original terms of the loan agreement.  The Company measures impairment of a loan on a loan-by-loan basis. Impaired loans and related amounts included in the allowance for loan losses at December 31, 2010 and 2009 are as follows:

 
| ** **                                                 | ** ** | **December 31,** | ** **    |
|------------------------------------------------------------|------------|-----------------------|---------------|
| ** **                                                 | ** ** | **2010**              | ** **    | **2009** | ** ** |
| ** **                                                 | ** ** | ** **            | ** **    | ** ** | ** ** |
| Impaired loans without a valuation allowance               |       | $                     | 1,090,441     |   | $ | 3,894,891 |   |
| Impaired loans with a valuation allowance                  |       | 1,160,820             |          | 1,120,689 |   |
|                                                       |       |                  |          |   |   |
| Total impaired loans                                       | ** ** | **$**                 | **2,251,261** | ** ** | **$** | **5,015,580** | ** ** |
|                                                       |       |                  |          |   |   |
| Valuation allowance related to impaired loans              |       | $                     | 224,935       |   | $ | 107,822 |   |
| Average of impaired loans during the year                  |       | $                     | 2,395,149     |   | $ | 3,593,707 |   |
| Total nonaccrual loans                                     |       | $                     | 1,417,289     |   | $ | 2,020,974 |   |
| Total loans past due 90 days and still accruing   interest |       | $                     | —        |   | $ | 196,373 |   |

 

At December 31, 2010, the Company had 12 impaired loans totaling $1,408,201 or 1.56% of gross loans, in nonaccrual status.  At December 31, 2009, the Company had 13 impaired loans totaling $2,020,974 or 1.90% of gross loans, in nonaccrual status. There were no loans  that were contractually past due 90 days or more still accruing interest at December 31, 2010.  There was one loan totaling $196,373 that was contractually past due 90 days or more still accruing interest at December 31, 2009.  In addition, there were 4 loans restructured or otherwise impaired totaling $843,060 not already included in nonaccrual status at December 31, 2010.  There were 10 loans restructured or otherwise impaired totaling $2,994,606 not already included in nonaccrual status at December 31, 2009.

 

66

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** **

**CONGAREE BANCSHARES, INC. AND SUBSIDIARY**

** **

**Notes to Consolidated Financial Statements**

** **

**NOTE 4 - LOANS RECEIVABLE** - *continued*

 

The Company’s analysis under generally accepted accounting principles indicates that the level of the allowance for loan losses is appropriate to cover estimated credit losses on individually evaluated loans as well as estimated credit losses inherent in the remainder of the portfolio.  We recognized $88,250 and $264,640 in interest income on loans that are impaired during the years ended December 31, 2010 and 2009.

 

The following is an analysis of our impaired loan portfolio detailing the related allowance recorded at December 31, 2010:

 
| ** **                            | ** ** | **Current**  | ** **    | **Unpaid**    | ** ** | ** **    | ** ** | **Average**    | ** **  | **Interest**   | ** ** |
|---------------------------------------|------------|--------------|---------------|---------------|------------|---------------|------------|----------------|-------------|----------------|------------|
| ** **                            | ** ** | **Carrying** | ** **    | **Principal** | ** ** | **Related**   | ** ** | **Recorded**   | ** **  | **Income**     | ** ** |
| ** **                            | ** ** | **Balance**  | ** **    | **Amount**    | ** ** | **Allowance** | ** ** | **Investment** | ** **  | **Recognized** | ** ** |
|                                  |       |         |          |          |       |          |       |           |        |           |       |
| With no related allowance recorded:   |       |         |          |          |       |          |       |           |        |           |       |
| Commercial                            |       | $            | 9,241         |          | $          | 9,241         |       | $              | —      |           | $          | 16,998 |   | $ | 560 |   |
| Commercial real estate - construction |       | 1,050,819    |          | 1,050,819     |       | —        |       | 1,029,206      |        | 43,535         |       |
| Commercial real estate - other        |       | —       |          | —        |       | —        |       | —         |        | —         |       |
| Consumer                              |       | —       |          | —        |       | —        |       | —         |        | —         |       |
| Residential -prime                    |       | —       |          | —        |       | —        |       | —         |        | —         |       |
| Residential- subprime                 |       | 30,381       |          | 30,381        |       | —        |       | 30,574         |        | 1,548          |       |
|                                  |       |         |          |          |       |          |       |           |        |           |       |
| With an allowance recorded:           |       |         |          |          |       |          |       |           |        |           |       |
| Commercial                            |       | 239,617      |          | 266,518       |       | 162,956       |       | 278,112        |        | 12,585         |       |
| Commercial real estate - construction |       | 519,121      |          | 520,507       |       | 9,897         |       | 525,284        |        | 8,283          |       |
| Commercial real estate - other        |       | 70,769       |          | 199,942       |       | 4,769         |       | 196,659        |        | 1,107          |       |
| Consumer                              |       | 16,423       |          | 16,423        |       | 16,423        |       | 7,208          |        | 613            |       |
| Residential -prime                    |       | 18,691       |          | 18,691        |       | 18,691        |       | 18,679         |        | 692            |       |
| Residential- subprime                 |       | 296,199      |          | 296,199       |       | 12,199        |       | 292,430        |        | 19,327         |       |
|                                  |       |         |          |          |       |          |       |           |        |           |       |
| Total:                                |       |         |          |          |       |          |       |           |        |           |       |
| Commercial                            |       | 248,858      |          | 275,759       |       | 162,956       |       | 295,110        |        | 13,145         |       |
| Commercial real estate - construction |       | 1,569,940    |          | 1,571,326     |       | 9,897         |       | 1,554,490      |        | 51,818         |       |
| Commercial real estate - other        |       | 70,769       |          | 199,942       |       | 4,769         |       | 196,659        |        | 1,107          |       |
| Consumer                              |       | 16,423       |          | 16,423        |       | 16,423        |       | 7,208          |        | 613            |       |
| Residential -prime                    |       | 18,691       |          | 18,691        |       | 18,691        |       | 18,679         |        | 692            |       |
| Residential- subprime                 |       | 326,580      |          | 326,580       |       | 12,199        |       | 323,004        |        | 20,875         |       |
|                                  |       |         |          |          |       |          |       |           |        |           |       |
| Total                                 | ** ** | **$**        | **2,251,261** | ** **    | **$**      | **2,408,721** | ** ** | **$**          | **224,935** | ** **     | **$**      | **2,395,150** | ** ** | **$** | **88,250** | ** ** |

 

67

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**CONGAREE BANCSHARES, INC. AND SUBSIDIARY**

 

**Notes to Consolidated Financial Statements**

 

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

 

Premises, furniture and equipment consisted of the following:

 
| ** **                             | ** ** | **December 31,** | ** **  |
|----------------------------------------|------------|-----------------------|-------------|
| ** **                             | ** ** | **2010**              | ** **  | **2009** | ** ** |
| ** **                             | ** ** | ** **            | ** **  | ** ** | ** ** |
| Land                                   |       | $                     | —      |   | $ | 1,015,000 |   |
| Building and improvements              |       | 284,953               |        | 1,902,901 |   |
| Furniture and equipment                |       | 1,054,566             |        | 1,052,653 |   |
| Automobiles                            |       | 98,496                |        | 98,496 |   |
|                                   |       |                  |        |   |   |
| Total                                  |       | 1,438,015             |        | 4,069,050 |   |
|                                   |       |                  |        |   |   |
| Less, accumulated depreciation         |       | 684,306               |        | 658,363 |   |
|                                   |       |                  |        |   |   |
| Premises, furniture and equipment, net | ** ** | **$**                 | **753,709** | ** ** | **$** | **3,410,687** | ** ** |

 

Depreciation expense was $ 221,655 and $256,213 for the years ended 2010 and 2009, respectively.

 

During 2010 the Company sold the administrative building and related improvements, with a book value of $2,482,338, for $2,308,291 million cash in a sale-leaseback transaction. The resulting $174,047 loss on sale was recognized in 2010.

 

**NOTE 6 - OTHER REAL ESTATE OWNED**

 

Transactions in other real estate owned for the years ended December 31, 2010 and 2009 are summarized below:

** **
| ** **                 | ** ** | **2010**   | ** **    | **2009**   | ** ** |
|----------------------------|------------|------------|---------------|------------|------------|
| ** **                 | ** ** | ** ** | ** **    | ** ** | ** ** |
| Balance, beginning of year |       | $          | 501,037       |       | $          | — |   |
| Additions                  |       | 3,260,032  |          | 501,037    |       |
| Sales                      |       | (332,572   | )             | —     |       |
| Write downs                |       | (135,330   | )             | —     |       |
|                       |       |       |          |       |       |
| Balance, end of year       | ** ** | **$**      | **3,293,167** | ** ** | **$**      | **501,037** | ** ** |

 

 

**NOTE 7 - DEPOSITS**

 

At December 31, 2010, the scheduled maturities of certificates of deposit were as follows:

 
| **Maturing In:** | ** ** | **Amount** | ** **     |
|-----------------------|------------|------------|----------------|
| ** **            | ** ** | ** ** | ** **     |
| 2011                  |       | $          | 35,263,113     |   |
| 2012                  |       | 8,407,854  |           |
| 2013                  |       | 950,359    |           |
| 2014                  |       | 420,100    |           |
| 2015                  |       | 1,917,874  |           |
|                  |       |       |           |
| Total                 | ** ** | **$**      | **46,959,300** | ** ** |

 

At December 31, 2010 and 2009, the Company had approximately $2,217,000 and $5,295,000, respectively, in time deposits obtained through third party brokers.

 

68

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**CONGAREE BANCSHARES, INC. AND SUBSIDIARY**

 

**Notes to Consolidated Financial Statements**

** **

**NOTE 8 - FHLB ADVANCES**

 

Advances outstanding at December 31, 2010 and 2009 consisted of:

 
| **Interest Basis ** | ** ** | **Current Rate** | ** ** | **Maturity**           | ** ** | **Outstanding   Balance** | ** ** |
|-------------------------------|------------|-----------------------|------------|------------------------|------------|---------------------------|------------|
|                          |       |                  |       |                   |       |                      |       |
| Fixed                         |       | 2.62                  | %          | February 25, 2013 |       | $                         | 3,000,000  |   |
|                               |            |                       |            |                        |            |                           |            |  |

 

**NOTE 9 - STOCK COMPENSATION PLAN**

 

Under the terms of employment agreements with the Chief Executive Officer (CEO) and President, Chief Business Development Officer and Chief Financial Officer (CFO), stock options were granted to each as part of their compensation and benefits package.  Under these agreements, the CEO and President was granted 79,399 stock options, the Chief Business Development Officer 61,755 options and the CFO 44,110 options.  The CEO and President resigned on January 21, 2009 at which time 79,399 options were forfeited.  All options granted to the executive officers vest over five years.  The options have an exercise price of $10.00 per share and terminate ten years after the date of grant.

 

The Company also established the 2007 Stock Incentive Plan (the Plan) which provides for the granting of options to employees of the Company.  The Company did not grant any options during 2010 or 2009.

 

The Company recognized $29,384 and $127,942 of stock-based employee compensation expense during 2010 and 2009, respectively, associated with its stock option grants.  The Company is recognizing the compensation expense for stock option grants with graded vesting schedules on a straight-line basis over the requisite service period of the award.  As of December 31, 2010, all the compensation cost related to stock option grants have been recognized.

 

A summary of the activity under the stock option plan for the year ended December 31, 2010 and 2009 are as follows:

 
| ** **                       | ** ** | **2010**               | ** ** | **2009**     | ** ** |
|----------------------------------|------------|------------------------|------------|--------------|------------|
| ** **                       | ** ** | ** **             | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                       | ** ** | ** **             | ** ** | **Average**  | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                       | ** ** | ** **             | ** ** | **Exercise** | ** ** | ** ** | ** ** | **Exercise** | ** ** |
| ** **                       | ** ** | **Shares  ** | ** ** | **Price**    | ** ** | **Shares** | ** ** | **Price** | ** ** |
| ** **                       | ** ** | ** **             | ** ** | ** **   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Outstanding, beginning of period |       | 138,237                |       | $            | 10.00      |   | 225,636 |   | $ | 10.00 |   |
| Granted during the period        |       | —                 |       | —       |       |   |   |   |   |
| Exercised during the period      |       | —                 |       | —       |       |   |   |   |   |
| Forfeited during the period      |       | (55,846                | )          | 10.00        |       | (87,399 | ) | 10.00 |   |
|                             |       |                   |       |         |       |   |   |   |   |
| Outstanding, end of period       | ** ** | **82,391**             | ** ** | **$**        | **10.00**  | ** ** | **138,237** | ** ** | **$** | **10.00** | ** ** |
|                             | ** ** | ** **             | ** ** | ** **   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Options exercisable at year end  | ** ** | **82,391**             | ** ** | **$**        | **10.00**  | ** ** | **65,661** | ** ** | **$** | **10.00** | ** ** |

 

The weighted average contractual life of the options outstanding as of December 31, 2010 is 6.09 years.  There was no aggregate intrinsic value of options outstanding or exercisable at December 31, 2010. All of the options outstanding as of December 31, 2010 are fully vested.

 

69

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**CONGAREE BANCSHARES, INC. AND SUBSIDIARY**

 

**Notes to Consolidated Financial Statements**

 

**NOTE 9 - STOCK COMPENSATION PLAN** - *continued*

 

A summary of the status of the Company’s nonvested shares as of December 31, 2010 is presented below:

 
| ** **                          | ** ** | ** ** | ** ** | **Weighted**        | ** ** |
|-------------------------------------|------------|------------|------------|---------------------|------------|
| ** **                          | ** ** | ** ** | ** ** | **Average**         | ** ** |
| ** **                          | ** ** | ** ** | ** ** | **Grant Date** | ** ** |
| ** **                          | ** ** | **Shares** | ** ** | **Fair Value** | ** ** |
| Nonvested at January 1, 2010   |       | 55,012     |       | $                   | 3.34       |   |
| Granted                             |       | —     |       | —              |       |
| Forfeited                           |       | (44,218    | )          | 3.33                |       |
| Vested                              |       | (10,794    | )          | 3.33                |       |
|                                |       |       |       |                |       |
| Nonvested at December 31, 2010 |       | —     | ** ** | **$**               | **—** | ** ** |

 

**NOTE 10 - STOCK WARRANTS**

 

The organizers of the Company received stock warrants giving them the right to purchase one share of common stock for every share they purchased in the initial offering of the Company’s common stock up to 10,000 shares at a price of $10 per share.  The warrants vest over three years and expire on October 16, 2016.  Warrants held by directors of the Company will expire 90 days after the director ceases to be a director or officer of the Bank (365 days if due to death or disability).  Upon resignation of the CEO and President, 10,000 warrants were forfeited.

 

At December 31, 2010 all of the outstanding warrants were exercisable.

 

In calculating the expense for warrants, the fair value of warrants is estimated as of the grant date using the Black-Scholes option pricing model with the following weighted-average assumptions: dividend yield of 0 percent based on the Company’s expectation of dividend payouts; expected volatility of 9.77 percent based on peer group data; risk-free interest rate of 4.76 percent based on the grant date and expected term of the options and expected life of 3 years based on factors such as the vesting period and the option’s contractual term.  There was no compensation expense related to warrants for the year ended December 31, 2010. Total compensation expense related to warrants was $94,728 for the year ended December 31, 2009.

 

**NOTE 11 - INCOME TAXES**

 

The Company had no income tax expense for the years ended December 31, 2010 or 2009 as it recorded a full valuation allowance against its deferred tax asset.

 

The gross amounts of deferred tax assets and deferred tax liabilities are as follows:

 
| ** **                                       | ** ** | **Years ended December 31,** | ** ** |
|--------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                       | ** ** | **2010**                                    | ** ** | **2009** | ** ** |
| Deferred tax assets:                             |       |                                        |       |   |   |
| Allowance for loan losses                        |       | $                                           | 419,224    |   | $ | 401,162 |   |
| Net operating loss carryforward                  |       | 2,285,285                                   |       | 2,226,893 |   |
| Organization and start-up costs                  |       | 212,488                                     |       | — |   |
| Unrealized loss on securities available for sale |       | 207,634                                     |       | 232,102 |   |
| Other                                            |       | 186,306                                     |       | 137,659 |   |
|                                             |       |                                        |       |   |   |
| Deferred tax assets                              |       | 3,310,937                                   |       | 2,997,816 |   |
|                                             |       |                                        |       |   |   |
| Valuation allowance                              |       | (2,909,693                                  | )          | (2,767,796 | ) |
|                                             |       |                                        |       |   |   |
| Net deferred tax assets                          |       | 401,244                                     |       | 230,020 |   |
|                                                  |            |                                             |            |  |  |  |  |

 

70

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**CONGAREE BANCSHARES, INC. AND SUBSIDIARY**

 

**Notes to Consolidated Financial Statements**

 

**NOTE 11 - INCOME TAXES** - *continued*

 
| ** **                                       | ** ** | **Years ended December 31,** | ** **  |
|--------------------------------------------------|------------|---------------------------------------------|-------------|
| ** **                                       | ** ** | **2010**                                    | ** **  | **2009** | ** ** |
| Deferred tax liabilities:                        |       |                                        |        |   |   |
| Unrealized gain on securities available for sale |       | —                                      |        | 85,071 |   |
| Accumulated depreciation                         |       | 96,775                                      |        | 125,199 |   |
| Prepaid expenses                                 |       | 44,567                                      |        | 40,702 |   |
| Loan origination costs                           |       | 52,268                                      |        | 64,119 |   |
|                                             |       |                                        |        |   |   |
| Total deferred tax liabilities                   |       | 193,610                                     |        | 315,091 |   |
|                                             |       |                                        |        |   |   |
| Net deferred tax asset (liability)               | ** ** | **$**                                       | **207,634** | ** ** | **$** | **(85,071** | **)** |
|                                                  |            |                                             |             |  |  |  |  |

 

Deferred tax assets represent the future tax benefit of deductible differences and, if it is more likely than not that a tax asset will not be realized, a valuation allowance is required to reduce the recorded deferred tax assets to net realizable value.  As of December 31, 2010 and 2009, in consideration of the lack of an established earnings history, management has provided a valuation allowance of 100% to reflect its net realizable value.

 

The Company has a net operating loss for income tax purposes of $6,639,382 and $6,492,495 as of December 31, 2010 and 2009, respectively.  These net operating losses expire in the years 2026 through 2030.

 

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

 
| ** **                      | ** ** | **2010**   | ** ** | **2009**   | ** ** |
|---------------------------------|------------|------------|------------|------------|------------|
| ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Tax (benefit) at statutory rate |       | $          | (101,509   | )          | $          | (388,593 | ) |
| Stock compensation expense      |       | 9,991      |       | 75,708     |       |
| Change in valuation allowance   |       | 141,897    |       | 342,173    |       |
| Other                           |       | (50,379    | )          | (29,288    | )          |
|                            |       |       |       |       |       |
| Income tax benefit              | ** ** | **$**      | **—** | ** ** | **$**      | **—** | ** ** |

 

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

 

**NOTE 12 - RELATED PARTY TRANSACTIONS**

 

Certain parties (principally certain directors and executive officers of the Company, their immediate families and business interests) were loan customers of and had other transactions in the normal course of business with the Company.  Related party loans are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons and do not involve more than the normal risk of collectibility.  The following table summarizes the Bank’s related party loan activity for the year ended December 31, 2010 and 2009:

 
| ** **                 | ** ** | **2010**   | ** **    | **2009**   | ** ** |
|----------------------------|------------|------------|---------------|------------|------------|
| ** **                 | ** ** | ** ** | ** **    | ** ** | ** ** |
| Balance, January 1    |       | $          | 3,947,014     |       | $          | 3,211,211 |   |
| Disbursements              |       | 215,521    |          | 1,293,807  |       |
| Repayments                 |       | (861,073   | )             | (558,004   | )          |
|                       |       |       |          |       |       |
| Balance, December 31, | ** ** | **$**      | **3,301,462** | ** ** | **$**      | **3,947,014** | ** ** |

 

Deposits by directors, including their affiliates and executive officers, at December 31, 2010 and 2009 were $940,657 and $1,106,064, respectively.

 

71

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**CONGAREE BANCSHARES, INC. AND SUBSIDIARY**

 

**Notes to Consolidatede Financial Statements**

 

**NOTE 13 - LEASES**

 

The Company has entered into an agreement to lease an office facility under a noncancellable operating lease agreement expiring in 2023.  The Company may, at its option, extend the lease of its office facility at 2023 Sunset Boulevard in West Columbia, South Carolina, for two additional five year periods.  The Company also entered into a sale-leaseback agreement in December 2009 for a portion of the property located in Cayce, South Carolina.  The lease is for a period of fifteen years. The Company may, at its option, extend the lease for three consecutive renewal terms of five years each. In June 2010, the Company entered into a sale-leaseback agreement for the branch and office building located at 1201 Knox Abbot Drive in Cayce, South Carolina. The lease is for a period of fifteen years. The Company may, at its option, extend the lease for two consecutive renewal terms of five years each.  Minimum rental commitments as of December 31, 2010 are as follows:

 
| 2011                |       | $         | 390,435       |       |
|---------------------|------------|-----------|---------------|------------|
| 2012                |       | 398,249   |          |
| 2013                |       | 406,213   |          |
| 2014                |       | 414,333   |          |
| 2015 and thereafter |       | 4,435,303 |          |
|                |       |      |          |
| Total               | ** ** | **$**     | **6,044,533** | ** ** |

 

The leases have various renewal options and require increased rentals under cost of living escalation clauses.  Rental expenses charged to occupancy and equipment expense in 2010 and 2009 were $266,981 and $172,518, respectively.

 

**NOTE 14 - COMMITMENTS AND CONTINGENCIES**

 

The Company is subject to claims and lawsuits which arise primarily in the ordinary course of business.  Management is not aware of any legal proceedings which would have a material adverse effect on the financial position or operating results of the Company.

 

**NOTE 15 - LOSS PER SHARE**

 

Basic loss per share is computed by dividing net loss available to common shareholders by the weighted-average number of common shares outstanding.  Diluted loss per share is computed by dividing net loss available to common shareholders by the weighted-average number of common shares outstanding and dilutive common share equivalents using the treasury stock method.  There were no dilutive common share equivalents outstanding during 2010 and 2009 due to the net loss; therefore, basic and diluted loss per share were the same.

 
| ** **                                    | ** ** | **2010**   | ** **    | **2009**   | ** ** |
|-----------------------------------------------|------------|------------|---------------|------------|------------|
| **Net loss per share - basic   computation:** |       |       |          |       |       |
| ** **                                    |       |       |          |       |       |
| Net loss available to common shareholders     | ** ** | **$**      | **(506,698**  | **)**      | **$**      | **(1,346,597** | **)** |
|                                          | ** ** | ** ** | ** **    | ** ** | ** ** |
| Average common shares outstanding - basic     | ** ** | **$**      | **1,764,439** | ** ** | **$**      | **1,764,439** | ** ** |
|                                          | ** ** | ** ** | ** **    | ** ** | ** ** |
| **Basic loss per share**                      | ** ** | **$**      | **(0.29**     | **)**      | **$**      | **(0.76** | **)** |

 

**NOTE 16 - REGULATORY MATTERS**

 

The Bank is subject to various regulatory capital requirements administered by the federal banking agencies.  Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary actions by regulators that, if undertaken, could have a direct adverse material effect on the Bank’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.

 

72

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**CONGAREE BANCSHARES, INC. AND SUBSIDIARY**

 

**Notes to Consolidated Financial Statements**

 

**NOTE 16 - REGULATORY MATTERS** - *continued*

 

Following the FDIC’s safety and soundness examination of the Bank in the fourth quarter of 2009, the Bank entered into a Consent Order with the FDIC and the South Carolina Board of Financial Institutions on May 11, 2010.  The Consent Order conveys specific actions needed to address certain findings from the FDIC’s Report of Examination and to address the Bank’s current financial condition, primarily related to capital planning, liquidity/funds management, policy and planning issues, management oversight, loan concentrations and classifications, and non-performing loans. The Board of Directors and management of the Bank have aggressively worked to improve these practices and procedures and as of April 8, 2011 the Consent Order has been terminated although certain regulatory restrictions remain. Additionally, the Board of Directors and management intend to continue to take all actions necessary to enable the Bank to comply with the requirements of the regulatory restrictions.

 

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum ratios of Tier 1 and total capital as a percentage of assets and off-balance-sheet exposures, adjusted for risk weights ranging from 0% to 100%.  Tier 1 capital consists of common shareholders’ equity, excluding the unrealized gain or loss on securities available-for-sale, minus certain intangible assets.  Tier 2 capital consists of the allowance for loan losses subject to certain limitations.  Total capital for purposes of computing the capital ratios consists of the sum of Tier 1 and Tier 2 capital.  The regulatory minimum requirements are 4% for Tier 1 and 8% for total risk-based capital.

 

The Bank is also required to maintain capital at a minimum level based on total assets, which is known as the leverage ratio.  Only the strongest banks are allowed to maintain capital at the minimum requirement of 3%.  All others are subject to maintaining ratios 1% to 2% above the minimum.

 

The following table summarizes the capital amounts and ratios of the Bank and the regulatory minimum requirements at December 31:

 
| ** **                               | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** | **To Be Well-**  | ** ** |
|------------------------------------------|------------|------------|------------|----------------------------|------------|----------------------------|------------|----------------------------|------------|----------------------------|------------|
| ** **                               | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** | **Capitalized Under** | ** ** |
| ** **                               | ** ** | ** ** | ** ** | ** **                 | ** ** | **For Capital**       | ** ** | **Prompt Corrective** | ** ** |
| ** **                               | ** ** | **Actual** | ** ** | **Adequacy Purposes** | ** ** | **Action Provisions** | ** ** |
| **(Dollars in thousands)**     | ** ** | **Amount** | ** ** | **Ratio**                  | ** ** | **Amount**                 | ** ** | **Ratio**                  | ** ** | **Amount**                 | ** ** | **Ratio** | ** ** |
| **December 31, 2010**               |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| Total capital (to risk-weighted assets)  |       | $          | 12,538     |                       | 14.09      | %                          | $          | 7,117                      |       | 8.00                       | %          | $ | 8,896 |   | 10.00 | % |
| Tier 1 capital (to risk-weighted assets) |       | 11,421     |       | 12.84                      | %          | 3,558                      |       | 4.00                       | %          | 5,338                      |       | 6.00 | % |
| Tier 1 capital (to average assets)       |       | 11,421     |       | 9.16                       | %          | 4,989                      |       | 4.00                       | %          | 6,237                      |       | 5.00 | % |
|                                     |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| **December 31, 2009**               |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| Total capital (to risk-weighted assets)  |       | $          | 10,836     |                       | 10.57      | %                          | $          | 8,204                      |       | 8.00                       | %          | $ | 10,255 |   | 10.00 | % |
| Tier 1 capital (to risk-weighted assets) |       | 9,542      |       | 9.30                       | %          | 4,102                      |       | 4.00                       | %          | 6,153                      |       | 6.00 | % |
| Tier 1 capital (to average assets)       |       | 9,542      |       | 6.99                       | %          | 5,459                      |       | 4.00                       | %          | 6,824                      |       | 5.00 | % |

 

Under the Bank’s current regulatory restrictions the Bank is required to achieve and maintain Total Risk Based capital at least equal to 10% of risk-weighted assets and Tier 1 capital at least equal to 8% of total assets. As of December 31, 2010, the Bank was considered to be in compliance with the minimum capital requirements established in the regulatory restrictions.

 

73

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**CONGAREE BANCSHARES, INC. AND SUBSIDIARY**

 

**Notes to Consolidated Financial Statements**

 

**NOTE 17 - UNUSED LINES OF CREDIT**

 

As of December 31, 2010 and 2009, the Company had unused lines of credit to purchase federal funds from unrelated banks totaling $9,100,000 and $7,600,000, respectively.  These lines of credit are available on a one to twenty day basis for general corporate purposes.  The Company also has a credit line to borrow funds from the FHLB.  The remaining credit availability as of December 31, 2010 was $9,850,000.

 

**NOTE 18 - RESTRICTIONS ON DIVIDENDS, LOANS, OR ADVANCES**

 

The ability of the Company to pay cash dividends to shareholders is dependent upon receiving cash in the form of dividends from its banking subsidiary.  However, certain restrictions exist regarding the ability of the subsidiary to transfer funds in the form of cash dividends to the Company.  State chartered banks are authorized to pay cash dividends up to 100% of net income in any calendar year without obtaining the prior approval of the State Board of Financial Institutions or the Commissioner of Banking provided that the Bank received a composite rating of one or two at the last examination conducted by the State or Federal regulatory authority.  Otherwise, the Bank must file an income and expense report and obtain the specific approval of the State Board.

 

Under Federal Reserve Board regulations, the amount of loans or advances from the banking subsidiary to the parent company are also restricted.

 

**NOTE 19 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK**

 

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers.  These financial instruments include commitments to extend credit and standby letters of credit.  Those instruments involve, to varying degrees, elements of credit, interest rate, and liquidity risk.  The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is essentially the same as that involved in extending loan facilities to customers.  The Company uses the same credit policies in making commitments and conditional obligations as it does 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 amount of collateral obtained if deemed necessary by the Company upon extension of credit is based on management’s credit evaluation of the borrower. Collateral held varies, but may include accounts receivable, negotiable instruments, inventory, property, plant and equipment, and real estate.  Commitments to extend credit, including unused lines of credit, amounted to $10,965,617 and $13,814,784 at December 31, 2010 and 2009, respectively.

 

Standby letters of credit represent an obligation of the Company to a third party contingent upon the failure of the Company’s customer to perform under the terms of an underlying contract with the third party or obligates the Company to guarantee or stand as surety for the benefit of the third party.  The underlying contract may entail either financial or nonfinancial obligations and may involve such things as the shipment of goods, performance of a contract, or repayment of an obligation.  Under the terms of a standby letter, generally drafts will be drawn only when the underlying event fails to occur as intended.  The Company can seek recovery of the amounts paid from the borrower.  The majority of these standby letters of credit are unsecured.  Commitments under standby letters of credit are usually for one year or less.  At December 31, 2010 and 2009, the Company has recorded no liability for the current carrying amount of the obligation to perform as a guarantor; as such amounts are not considered material. The Company had approximately $125,000 in letters of credit outstanding as of December 31, 2010 and 2009.

 

74

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**CONGAREE BANCSHARES, INC. AND SUBSIDIARY**

 

**Notes to Consolidated Financial Statements**

 

**NOTE 20 - PREFERRED STOCK**

 

On January 9, 2009, as part of the Capital Purchase Program established by the U.S. Department of the Treasury (“Treasury”) under the Emergency Economic Stabilization Act of 2009 (the “EESA”),  the Company entered into a Letter Agreement with Treasury dated January 9, 2010, pursuant to which the Company issued and sold to Treasury 3,285 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A, having a liquidation preference of $1,000 per share (the “Series A Preferred Stock”), and a ten-year warrant to purchase 164 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series B, (the “Series B Preferred Stock”), having a liquidation preference of $1,000 per share, at an initial exercise price of $0.01 per share (the “Warrant”), for an aggregate purchase price of $3,285,000 in cash.  The Warrant was immediately exercised.  The Preferred Stock, Series A, has a dividend rate of 5% for the first five years and 9% thereafter.  The Preferred Stock, Series B, has a dividend rate of 9% per year.  The Preferred Stock may not be redeemed for a period of three years from the date of the original investment unless certain conditions are met through a qualified equity offering.

 

**NOTE 21 - FAIR VALUE OF FINANCIAL INSTRUMENTS**

 

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

 

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

 

***Cash, Due from Banks and Certificates of Deposit*** - The carrying amount is a reasonable estimate of fair value, due to the short-term nature of such items.

 

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

 

***Securities Available-for-Sale*** - Investment securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available.  If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions.

 

***Nonmarketable Equity Securities*** - The carrying value of these securities approximates the fair value since no ready market exists for the stocks.

 

***Loans Receivable*******- For certain categories of loans, such as variable rate loans which are repriced frequently and have no significant change in credit risk, fair values are based on the carrying amounts.  The fair value of other types of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.  However, from time to time, a loan is considered impaired and an allowance for loan losses is established.  Loans for which it is probable that payment of interest and principal will not be made in accordance with contractual terms of the loan agreement are considered impaired.  The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows.  Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans.

 

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

 

***FHLB Advances -*** For disclosure purposes, the fair value of the FHLB fixed rate borrowing is estimated using discounted cash flows, based on the current incremental borrowing rates for similar types of borrowing arrangements.

 

75

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**CONGAREE BANCSHARES, INC. AND SUBSIDIARY**

 

**Notes to Consolidated Financial Statements**

 

**NOTE 21 - FAIR VALUE OF FINANCIAL INSTRUMENTS** - *continued*

 

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

 

***Off-Balance Sheet Financial Instruments*** - In the ordinary course of business, the Company enters into off-balance sheet financial instruments consisting of commitments to extend credit and letters of credit.  Because these commitments are made using variable rates and have short maturities, the carrying value and the fair value are immaterial for disclosure.

 

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

 
| ** **                                                           | ** ** | **December 31, 2010** | ** ** | **December 31, 2009** | ** ** |
|----------------------------------------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **                                                           | ** ** | **Carrying**                    | ** ** | **Estimated**                   | ** ** | **Carrying** | ** ** | **Estimated** | ** ** |
| ** **                                                           | ** ** | **Amount**                      | ** ** | **Fair Value**             | ** ** | **Amount** | ** ** | **Fair Value** | ** ** |
| **Financial Assets:**                                                |       |                            |       |                            |       |   |   |   |   |
| Cash and due from banks                                              |       | $                               | 2,771,515  |                            | $          | 2,771,515 |   | $ | 7,006,281 |   | $ | 7,006,281 |   |
| Federal funds sold                                                   |       | 2,280,000                       |       | 2,280,000                       |       | 5,195,000 |   | 5,195,000 |   |
| Certificates of deposit                                              |       | —                          |       | —                          |       | 250,210 |   | 250,210 |   |
| Securities available-for-sale                                        |       | 20,776,657                      |       | 20,776,657                      |       | 17,965,661 |   | 17,965,661 |   |
| Securities held-to-maturity                                          |       | 1,143,249                       |       | 1,133,220                       |       | — |   | — |   |
| Nonmarketable equity securities                                      |       | 474,300                         |       | 474,300                         |       | 474,300 |   | 474,300 |   |
| Loans receivable, net                                                |       | 88,783,548                      |       | 88,091,769                      |       | 104,644,789 |   | 104,758,655 |   |
| Accrued interest receivable                                          |       | 503,753                         |       | 503,753                         |       | 479,112 |   | 479,112 |   |
|                                                                 |       |                            |       |                            |       |   |   |   |   |
| **Financial Liabilities:**                                           |       |                            |       |                            |       |   |   |   |   |
| Demand deposit, interest-bearing transaction, and   savings accounts |       | 59,626,692                      |       | 59,626,692                      |       | 50,182,302 |   | 50,182,302 |   |
| Certificates of deposit and other time deposits                      |       | 46,959,300                      |       | 47,362,426                      |       | 74,414,408 |   | 74,577,405 |   |
| Federal Home Loan Bank advances                                      |       | 3,000,000                       |       | 2,892,056                       |       | 3,000,000 |   | 3,001,890 |   |
| Accrued interest payable                                             |       | 44,059                          |       | 44,059                          |       | 70,436 |   | 70,436 |   |
|                                                                      |            |                                 |            |                                 |            |  |  |  |  |  |  |  |  |

 
| ** **                                     | ** ** | **Notional** | ** ** | **Estimated**       | ** ** | **Notional** | ** ** | **Estimated**       | ** ** |
|------------------------------------------------|------------|--------------|------------|---------------------|------------|--------------|------------|---------------------|------------|
| ** **                                     | ** ** | **Amount**   | ** ** | **Fair Value** | ** ** | **Amount**   | ** ** | **Fair Value** | ** ** |
| **Off-Balance Sheet Financial   Instruments:** |       |         |       |                |       |         |       |                |       |
| Commitments to extend credit                   |       | $            | 10,965,617 |                | $          | —       |       | $                   | 13,814,784 |   | $ | — |   |
| Financial standby letters of credit            |       | 125,000      |       | —              |       | 125,000      |       | —              |       |
|                                                |            |              |            |                     |            |              |            |                     |            |  |  |  |  |

 

**Fair Value Measurements**

 

The Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine the fair value. These levels are:

 

Level 1 - Valuation is based upon quoted prices for identical instruments traded in active markets.

 

Level 2 - Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.

 

Level 3 - Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include the use of option pricing models, discounted cash flow models and similar techniques.

 

76

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**CONGAREE BANCSHARES, INC. AND SUBSIDIARY**

 

**Notes to Consolidated Financial Statements**

 

**NOTE 21 - FAIR VALUE OF FINANCIAL INSTRUMENTS***- continued*

 

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

 

***Investment Securities Available for Sale***

 

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

 

***Loans***

 

The Company does not record loans at fair value on a recurring basis, however, from time to time, a loan is considered impaired and an allowance for loan loss 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 are considered impaired. Once a loan is identified as individually impaired, management measures impairment. The fair value of impaired loans is estimated using one of several methods, including the collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring a specific allowance represent loans for which the fair value of expected repayments or collateral exceed the recorded investment in such loans. At December 31, 2010 and 2009, substantially all of the impaired loans were evaluated based upon the fair value of the collateral. Impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the loan as nonrecurring Level 3.

 

***Other Real Estate Owned***

 

Foreclosed assets are adjusted to fair value upon transfer of the loans to other real estate owned. Real estate acquired in settlement of loans is recorded initially at estimated fair value of the property less estimated selling costs at the date of foreclosure. The initial recorded value may be subsequently reduced by additional allowances, which are charges to earnings if the estimated fair value of the property less estimated selling costs declines below the initial recorded value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the foreclosed asset as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the foreclosed asset as nonrecurring Level 3.

 

77

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**CONGAREE BANCSHARES, INC. AND SUBSIDIARY**

 

**Notes to Consolidated Financial Statements**

 

**NOTE 21 - FAIR VALUE OF FINANCIAL INSTRUMENTS***- continued*

 

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

 
| ** **                        | ** ** | **December 31, 2010** | ** **     |
|-----------------------------------|------------|---------------------------------|----------------|
| ** **                        | ** ** | **Total**                       | ** **     | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
| **Securities available-for-sale** |       |                            |           |   |   |   |   |   |   |
| Government sponsored enterprises  |       | $                               | 15,843,864     |   | $ | — |   | $ | 15,843,864 |   | $ | — |   |
| Mortgage-backed securities        |       | 2,118,254                       |           | — |   | 2,118,254 |   | — |   |
| State, county and municipals      |       | 2,814,539                       |           | — |   | 2,814,539 |   | — |   |
|                              |       |                            |           |   |   |   |   |   |   |
| Total assets                      | ** ** | **$**                           | **20,776,657** | ** ** | **$** | **—** | ** ** | **$** | **20,776,657** | ** ** | **$** | **—** | ** ** |

 
| ** **                        | ** ** | **December 31, 2009** | ** **     |
|-----------------------------------|------------|---------------------------------|----------------|
| ** **                        | ** ** | **Total**                       | ** **     | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
| **Securities available-for-sale** |       |                            |           |   |   |   |   |   |   |
| Government sponsored enterprises  |       | $                               | 10,749,191     |   | $ | — |   | $ | 10,749,191 |   | $ | — |   |
| Mortgage-backed securities        |       | 6,786,659                       |           | — |   | 6,786,659 |   | — |   |
| State, county and municipals      |       | 429,811                         |           | — |   | 429,811 |   | — |   |
|                              |       |                            |           |   |   |   |   |   |   |
| Total assets                      | ** ** | **$**                           | **17,965,661** | ** ** | **$** | **—** | ** ** | **$** | **17,965,661** | ** ** | **$** | **—** | ** ** |

 

There were no liabilities measured at fair value on a recurring basis at December 31, 2010 and 2009, respectively.

 

Certain assets and liabilities are measured at fair value on a nonrecurring basis; that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment).  The following table presents the assets and liabilities measured at fair value on a nonrecurring basis as of December 31, 2010 and 2009, aggregated by level in the fair value hierarchy within which those measurements fall.

 
| ** **              | ** ** | **December 31, 2010** | ** **    |
|-------------------------|------------|---------------------------------|---------------|
| ** **              | ** ** | **Total**                       | ** **    | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
| Impaired loans          |       | $                               | 2,026,326     |   | $ | — |   | $ | 2,026,326 |   | $ | — |   |
| Other real estate owned |       | 3,293,167                       |          | — |   | 3,293,167 |   | — |   |
|                    |       |                            |          |   |   |   |   |   |   |
| Total assets            | ** ** | **$**                           | **5,319,493** | ** ** | **$** | **—** | ** ** | **$** | **5,319,493** | ** ** | **$** | **—** | ** ** |

 
| ** **              | ** ** | **December 31, 2009** | ** **    |
|-------------------------|------------|---------------------------------|---------------|
| ** **              | ** ** | **Total**                       | ** **    | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
| Impaired loans          |       | $                               | 4,907,758     |   | $ | — |   | $ | 4,907,758 |   | $ | — |   |
| Other real estate owned |       | 501,037                         |          | — |   | 501,037 |   | — |   |
|                    |       |                            |          |   |   |   |   |   |   |
| Total assets            | ** ** | **$**                           | **5,408,795** | ** ** | **$** | **—** | ** ** | **$** | **5,408,795** | ** ** | **$** | **—** | ** ** |

 

There were no liabilities measured at fair value on a nonrecurring basis at December 31, 2010 and 2009, respectively.

 

Impaired loans which are measured for impairment using the fair value of collateral for collateral dependent loans, had a carrying value of $2,251,261 at December 31, 2010 with a valuation allowance of $224,935.  Impaired loans had a carrying value of $5,015,580 at December 31, 2009, with a valuation allowance of $107,822.

 

Other real estate owned, which is measured at the lower of carrying or fair value less costs to sell, had a net carrying value of $3,293,167 at December 31, 2010 and $501,037 at December 31, 2009.  There was approximately $135,330 in writedowns of other real estate owned during the year ended December 31, 2010 and there were no writedowns of other real estate owned during the year ended December 31, 2009.

 

The Company has no assets or liabilities whose fair values are measured using level 3 inputs.

 

78

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**CONGAREE BANCSHARES, INC. AND SUBSIDIARY**

 

**Notes to Consolidated Financial Statements**

 

**NOTE 22 - CONGAREE BANCSHARES, INC. (PARENT COMPANY ONLY)**

 

Presented below are the condensed financial statements for Congaree Bancshares, Inc. (Parent Company Only).

 

**Condensed Balance Sheets**

 
| ** **                                        | ** ** | **December 31,** | ** **     |
|---------------------------------------------------|------------|-----------------------|----------------|
| ** **                                        | ** ** | **2010**              | ** **     | **2009** | ** ** |
| **Assets:**                                       |       |                  |           |   |   |
| Cash                                              |       | $                     | 372,682        |   | $ | 48,365 |   |
| Premises and equipment,   net                     |       | —                |           | 2,463,904 |   |
| Investment in banking   subsidiary                |       | 11,010,241            |           | 9,706,441 |   |
|                                              |       |                  |           |   |   |
| Total assets                                      | ** ** | **$**                 | **11,382,923** | ** ** | **$** | **12,218,710** | ** ** |
|                                              | ** ** | ** **            | ** **     | ** ** | ** ** | ** ** | ** ** |
| **Liabilities and shareholders’   equity:**  |       |                  |           |   |   |
| Accrued interest payable                          |       | $                     | 4,856          |   | $ | — |   |
| Other liabilities                                 |       | 201,419               |           | 22,387 |   |
|                                              |       |                  |           |   |   |
| Total liabilities                                 |       | 206,275               |           | 22,387 |   |
|                                              |       |                  |           |   |   |
| Shareholders’ equity                         |       | 11,176,648            |           | 12,196,323 |   |
|                                              |       |                  |           |   |   |
| Total liabilities and   shareholders’ equity | ** ** | **$**                 | **11,382,923** | ** ** | **$** | **12,218,710** | ** ** |

 

**Condensed Statements of Operations**

 
| ** **                                                                                | ** ** | **For the years ended** | ** **   |
|-------------------------------------------------------------------------------------------|------------|----------------------------------------|--------------|
| ** **                                                                                | ** ** | **December 31,**                  | ** **   |
| ** **                                                                                | ** ** | **2010**                               | ** **   | **2009** | ** ** |
|                                                                                      |       |                                   |         |   |   |
| **Income**                                                                                |       | $                                      | 8,000        |   | $ | 18,000 |   |
| ** **                                                                                |       |                                   |         |   |   |   |   |
| **Expenses:**                                                                             |       |                                   |         |   |   |
| Interest                                                                                  |       | 4,856                                  |         | — |   |
| Stock based compensation   expense                                                        |       | 29,384                                 |         | 222,670 |   |
| Loss on sale of assets                                                                    |       | 174,047                                |         | 222,670 |   |
| Other expenses                                                                            |       | 35,562                                 |         | 141,232 |   |
|                                                                                      |       |                                   |         |   |   |
| Total expense                                                                             |       | 243,849                                |         | 363,902 |   |
|                                                                                      |       |                                   |         |   |   |
| **Loss before income taxes and   equity in undistributed earnings of banking subsidiary** |       | (235,849                               | )            | (345,902 | ) |
| ** **                                                                                |       |                                   |         |   |   |
| Equity in undistributed   losses of banking subsidiary                                    |       | (62,708                                | )            | (797,020 | ) |
|                                                                                      |       |                                   |         |   |   |
| **Net loss**                                                                              | ** ** | **$**                                  | **(298,557** | **)** | **$** | **(1,142,922** | **)** |

 

79

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**CONGAREE BANCSHARES, INC. AND SUBSIDIARY**

 

**Notes to Consolidated Financial Statements**

 

**NOTE 22 - CONGAREE BANCSHARES, INC. (PARENT COMPANY ONLY)** - *continued*

 

**Condensed Statements of Cash Flows**

 
| ** **                                                                    | ** ** | **For the years ended** | ** **  |
|-------------------------------------------------------------------------------|------------|----------------------------------------|-------------|
| ** **                                                                    | ** ** | **December 31,**                  | ** **  |
| ** **                                                                    | ** ** | **2010**                               | ** **  | **2009** | ** ** |
| **Cash flows from operating   activities:**                                   |       |                                   |        |   |   |
| Net loss                                                                      |       | $                                      | (298,557    | ) | $ | (1,142,922 | ) |
| Adjustments to reconcile   net loss to net cash used by operating activities: |       |                                   |        |   |   |
| Depreciation expense                                                          |       | 24,304                                 |        | 58,319 |   |
| Equity in undistributed   net loss of banking subsidiary                      |       | 62,708                                 |        | 797,020 |   |
| Loss on sale of assets                                                        |       | 174,047                                |        | — |   |
| Increase in accrued   interest payable                                        |       | 4,856                                  |        | — |   |
| Increase in other   liabilities                                               |       | 22                                     |        | — |   |
| Stock and warrant   compensation expense                                      |       | 29,384                                 |        | 222,670 |   |
|                                                                          |       |                                   |        |   |   |
| Net cash used by   operating activities                                       |       | (3,236                                 | )           | (64,913 | ) |
|                                                                          |       |                                   |        |   |   |
| **Cash flows from investing   activities:**                                   |       |                                   |        |   |   |
| Purchase of premises and   equipment                                          |       | —                                 |        | (39,935 | ) |
| Sale of premises and   equipment                                              |       | 2,265,553                              |        | — |   |
| Capital contribution to   Bank                                                |       | (1,938,000                             | )           | (3,000,000 | ) |
|                                                                          |       |                                   |        |   |   |
| Net cash provided (used)   by investing activities                            |       | 327,553                                |        | (3,039,935 | ) |
|                                                                          |       |                                   |        |   |   |
| **Cash flows from financing   activities:**                                   |       |                                   |        |   |   |
| Proceeds from issuance   of preferred stock                                   |       | —                                 |        | 3,285,000 |   |
| Dividends paid on   preferred stock                                           |       | —                                 |        | (152,159 | ) |
|                                                                          |       |                                   |        |   |   |
| Net cash provided by   financing activities                                   |       | —                                 |        | 3,132,841 |   |
| **Net increase in cash and cash   equivalents**                               |       | 324,317                                |        | 27,993 |   |
| ** **                                                                    |       |                                   |        |   |   |
| **Cash and cash equivalents,   beginning of period**                          |       | 48,365                                 |        | 20,372 |   |
| ** **                                                                    |       |                                   |        |   |   |
| **Cash and cash equivalents, end of   period**                                | ** ** | **$**                                  | **372,682** | ** ** | **$** | **48,365** | ** ** |

 

**NOTE 23 — SUBSEQUENT EVENTS**

 

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

 

80

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**Item 9.  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.**

 

None.

 

**Item 9A.  Controls and Procedures.**

 

**Evaluation of Disclosure Controls and Procedures**

 

As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as defined in Exchange Act Rule 13a-15(e).  Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our current disclosure controls and procedures are effective as of December 31, 2010.  There have been no significant changes in our internal controls over financial reporting during the fourth fiscal quarter ended December 31, 2010 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

 

The design of any system of controls and procedures is based in part upon certain assumptions about the likelihood of future events.  There can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.

 

**Management’s Report on Internal Control Over Financial Reporting**

 

Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in the Exchange Act Rules 13a-15(f).  A system of internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.

 

Under the supervision and with the participation of management, including the principal executive officer and the principal financial officer, our management has evaluated the effectiveness of our internal control over financial reporting as of December 31, 2010 based on the criteria established in a report entitled “Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission” and the interpretive guidance issued by the Commission in Release No. 34-55929.  Based on this evaluation, our management has evaluated and concluded that our internal control over financial reporting was effective as of December 31, 2010.

 

We are continuously seeking to improve the efficiency and effectiveness of our operations and of our internal controls.  This results in modifications to our processes throughout the company.  However, there has been no change in our internal control over financial reporting that occurred during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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 rules of the Securities and Exchange Commission that permit the company to provide only management’s report in this annual report.

 

**Item 9B.  Other Information.**

 

None.

 

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**PART III**

 

**Item 10.  Directors, Executive Officers and Corporate Governance.**

 

Information required by Item 10 is hereby incorporated by reference from our proxy statement for our 2011 annual meeting of shareholders to be held on May 25, 2011.

 

**Item 11.  Executive Compensation.**

 

Information required by Item 11 is hereby incorporated by reference from our proxy statement for our 2011 annual meeting of shareholders to be held on May 25, 2011.

 

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

 

Information required by Item 12 is hereby incorporated by reference from our proxy statement for our 2011 annual meeting of shareholders to be held on May 25, 2011.

 

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

 

Information required by Item 13 is hereby incorporated by reference from our proxy statement for our 2011 annual meeting of shareholders to be held on May 25, 2011.

 

**Item 14.  Principal Accountant and Fees.**

 

Information required by Item 14 is hereby incorporated by reference from our proxy statement for our 2011 annual meeting of shareholders to be held on May 25, 2011.

 

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**PART IV**

 

**Item 15.  Exhibits.**

 
| 3.1.   |   | Articles   of Incorporation (incorporated by reference to Exhibit 3.1 of the   Company’s Form SB-2, File No. 333-131931)                                                                                                                                                     |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                             |
| 3.2    |   | Articles   of Amendment to Articles of Incorporation (incorporated by reference to   Exhibit 3.2 of the Company’s Form SB-2, File No. 333-131931).                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                             |
| 3.3    |   | Articles of Amendment to the Company’s Restated   Articles of Incorporation establishing the terms of the Series A   Preferred Stock (incorporated by reference to Exhibit 3.1 of the   Company’s Form 8-K filed on January 12, 2009).                             |
|   |   |                                                                                                                                                                                                                                                                                             |
| 3.4    |   | Articles of Amendment to the Company’s Restated   Articles of Incorporation establishing the terms of the Series B   Preferred Stock (incorporated by reference to Exhibit 3.2 of the   Company’s Form 8-K filed on January 12, 2009).                             |
|   |   |                                                                                                                                                                                                                                                                                             |
| 3.5    |   | Bylaws   (incorporated by reference to Exhibit 3.3 of the Company’s   Form SB-2, File No. 333-131931).                                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                             |
| 4.1.   |   | See   Exhibits 3.1 and 3.2 for provisions in Congaree Bancshares, Inc.’s   Articles of Incorporation and Bylaws defining the rights of holders of the   common stock (incorporated by reference to Exhibit 4.1 of the Company’s   Form SB-2, File No. 333-131931). |
|   |   |                                                                                                                                                                                                                                                                                             |
| 4.2.   |   | Form of   certificate of common stock (incorporated by reference to Exhibit 4.2 of   the Company’s Form SB-2, File No. 333-131931).                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                             |
| 4.3    |   | Warrant to Purchase up to 164 shares of Preferred Stock (incorporated by   reference to Exhibit 4.1 of the Company’s Form 8-K filed on   January 12, 2010).                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                             |
| 4.4    |   | Form of Series A Preferred Stock Certificate   (incorporated by reference to Exhibit 4.2 of the Company’s Form 8-K   filed on January 12, 2019).                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                             |
| 4.5    |   | Form of Series B Preferred Stock   Certificate (incorporated by reference to Exhibit 4.3 of the Company’s   Form 8-K filed on January 12, 2019).                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                             |
| 10.1   |   | Employment   Agreement between Congaree Bancshares, Inc. and Charlie T. Lovering   dated September 14, 2006 (incorporated by reference to Exhibit 10.1   of the Company’s Form 8-K filed September 14, 2006).*                                                     |
|   |   |                                                                                                                                                                                                                                                                                             |
| 10.2   |   | Employment   Agreement between Congaree Bancshares, Inc. and Stephen P. Nivens dated   February 15, 2006 (incorporated by reference to Exhibit 10.2 of the   Company’s Form SB-2, File No. 333-121485).*                                                           |
|   |   |                                                                                                                                                                                                                                                                                             |
| 10.3   |   | Employment   Agreement by and between Charles A. Kirby, Congaree Bancshares, Inc. and   Congaree State Bank dated October 20, 2010. (incorporated by reference   to Exhibit 10.1 of the Company’s Form 8-K filed October 26,   2010).*                             |
|   |   |                                                                                                                                                                                                                                                                                             |
| 10.4   |   | Letter   Amendment by and between Congaree Bancshares, Inc. and Charles A. Kirby,   dated October 20, 2010. (incorporated by reference to Exhibit 10.2   of the Company’s Form 8-K filed October 26, 2010).*                                                       |
|   |   |                                                                                                                                                                                                                                                                                             |
| 10.5   |   | Amendment   to the Amended and Restated Employment Agreement of Stephen P. Nivens, dated   October 20, 2010. (incorporated by reference to Exhibit 10.3 of the   Company’s Form 8-K filed October 26, 2010).*                                                           |
|   |   |                                                                                                                                                                                                                                                                                             |
| 10.6   |   | Amendment   to the Amended and Restated Employment Agreement of Charlie T. Lovering,   dated October 20, 2010. (incorporated by reference to Exhibit 10.4   of the Company’s Form 8-K filed October 26,                                                                 |

 

83

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|   |   | 2010).*                                                                                                                                                                                                                                                                                                                                                                          |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                             |
| 10.7   |   | Form of   Stock Warrant Agreement (incorporated by reference to Exhibit 10.5 of   the Company’s Form SB-2, File No. 333-131931).*                                                                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                             |
| 10.8   |   | Congaree   Bancshares, Inc. 2007 Stock Incentive Plan (incorporated by reference to   Exhibit 10.5 of the Company’s Form 10-KSB for the period ended   December 31, 2007).*                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                             |
| 10.9   |   | Amendment   No. 1 to the Congaree Bancshares, Inc. 2007 Stock Incentive Plan   adopted October 15, 2008 (incorporated by reference to the Company’s   Form 10-Q as Exhibit 10.1 for the period ended September 30,   2008).*                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                             |
| 10.10  |   | Letter Agreement, dated January 9, 2009,   including the Side Letter Agreement and Securities Purchase Agreement —   Standard Terms incorporated by reference therein, between the Company and the   United States Department of the Treasury (incorporated by reference to   Exhibit 10.1 of the Company’s Form 8-K filed on January 12,   2009). |
|   |   |                                                                                                                                                                                                                                                                                                                                                                             |
| 21.1   |   | Subsidiaries   of the Company.                                                                                                                                                                                                                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                                                                             |
| 24.1   |   | Power   of Attorney (filed as part of the signature page herewith).                                                                                                                                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                             |
| 31.1   |   | Rule 13a-14(a) Certification   of the Principal Executive Officer.                                                                                                                                                                                                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                             |
| 31.2   |   | Rule 13a-14(a) Certification   of the Principal Financial Officer.                                                                                                                                                                                                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                             |
| 32     |   | Section 1350   Certifications.                                                                                                                                                                                                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                             |
| 99.1   |   | Certification   of the Chief Executive Officer Pursuant to Section 111(b)(4) of the   Emergency Economic Stabilization Act of 2009.                                                                                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                             |
| 99.2   |   | Certification   of the Chief Financial Officer Pursuant to Section 111(b)(4) of the   Emergency Economic Stabilization Act of 2009.                                                                                                                                                                                                                                    |

 

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| *      |   | Management   contract of compensatory plan or arrangement required to be filed as an   Exhibit to this Annual Report on Form 10-K.                             |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                     |
| *      |   | Copies   of exhibits are available upon written request to Corporate Secretary,   Congaree Bancshares, Inc., 1201 Knox Abbott Drive, Cayce, South Carolina   29033. |

 

84

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**SIGNATURES**

 

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

 
|                                   |   | **CONGAREE BANCSHARES, INC.**             |
|----------------------------------------|--------|------------------------------------------------|
|                                   |   |                                           |
| Date:  March 31,   2011 | By:    | /s/     Charles A. Kirby                  |
|                                   |   | Charles   A. Kirby                             |
|                                   |   | President   and Chief Executive Officer        |
|                                   |   | (Principal   Executive Officer)                |
|                                   |   |                                           |
|                                   |   |                                           |
| Date:  March 31,   2011 | By:    | /s/     Charlie T. Lovering               |
|                                   |   | Charlie   T. Lovering                          |
|                                   |   | Chief   Financial Officer                      |
|                                   |   | (Principal   Financial and Accounting Officer) |

 

KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Charles A. Kirby, his true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto attorney-in-fact and agent full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that attorney-in-fact and agent, or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.

 

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

 
| **Signature**                 | ** ** | **Title**                                                             | ** ** | **Date**              |
|-------------------------------|------------|-----------------------------------------------------------------------|------------|-----------------------|
|                          |       |                                                                  |       |                  |
| /s/   Thomas Hal Derrick      |       | Director                                                              |       | March 31,   2011 |
| Thomas   Hal Derrick          |       |                                                                  |       |                  |
|                          |       |                                                                  |       |                  |
| /s/     Charles A. Kirby |       | President and Chief Executive Officer   (Principal Executive Officer) |       | March 31,   2011 |
| Charles   A. Kirby            |       |                                                                  |       |
|                          |       |                                                                  |       |                  |
| /s/   Stephen P. Nivens       |       | Senior Vice President, Director                                       |       | March 31,   2011 |
| Stephen   P. Nivens           |       |                                                                  |       |                  |
|                          |       |                                                                  |       |                  |
| /s/   E. Daniel Scott         |       | Director                                                              |       | March 31,   2011 |
| E.   Daniel Scott             |       |                                                                  |       |                  |
|                          |       |                                                                  |       |                  |
| /s/   Nitin C. Shah           |       | Director                                                              |       | March 31,   2011 |
| Nitin   C. Shah               |       |                                                                  |       |                  |
|                          |       |                                                                  |       |                  |
| /s/   J. Larry Stroud         |       | Director                                                              |       | March 31,   2011 |
| J.   Larry Stroud             |       |                                                                  |       |                  |

 

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| /s/   Donald E. Taylor    |   | Director                                                                |   | March 31,   2011 |
|---------------------------|--------|-------------------------------------------------------------------------|--------|-----------------------|
| Donald   E. Taylor        |   |                                                                    |   |                  |
|                      |   |                                                                    |   |                  |
| /s/   John D. Thompson    |   | Director                                                                |   | March 31,   2011 |
| John   D. Thompson        |   |                                                                    |   |                  |
|                      |   |                                                                    |   |                  |
| /s/   Charlie T. Lovering |   | Chief Financial Officer,   (Principal Financial and Accounting Officer) |   | March 31,   2011 |
| Charlie   T. Lovering     |   |                                                                    |   |
|                      |   |                                                                    |   |                  |
| /s/   Harry Michael White |   | Director                                                                |   | March 31,   2011 |
| Harry   Michael White     |   |                                                                    |   |                  |
|                      |   |                                                                    |   |                  |
| /s/   Samuel M. Corley    |   | Director                                                                |   | March 31,   2011 |
| Samuel   M. Corley        |   |                                                                    |   |                  |
|                      |   |                                                                    |   |                  |
| /s/   J. Kevin Reeley     |   | Director                                                                |   | March 31,   2011 |
| J.   Kevin Reeley         |   |                                                                    |   |                  |

 

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**EXHIBIT INDEX**

 
| **Exhibit** | ** ** | **Description**                                                                                                                               |
|-------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------|
|        |       |                                                                                                                                          |
| 21.1        |       | Subsidiaries   of the Company.                                                                                                                |
|        |       |                                                                                                                                          |
| 24.1        |       | Power   of Attorney (filed as part of the signature page herewith).                                                                      |
|        |       |                                                                                                                                          |
| 31.1        |       | Rule 13a-14(a) Certification   of the Principal Executive Officer.                                                                  |
|        |       |                                                                                                                                          |
| 31.2        |       | Rule 13a-14(a) Certification   of the Principal Financial Officer.                                                                  |
|        |       |                                                                                                                                          |
| 32          |       | Section 1350   Certifications.                                                                                                           |
|        |       |                                                                                                                                          |
| 99.1        |       | Certification   of the Chief Executive Officer Pursuant to Section 111(b)(4) of the   Emergency Economic Stabilization Act of 2009. |
|        |       |                                                                                                                                          |
| 99.2        |       | Certification   of the Chief Financial Officer Pursuant to Section 111(b)(4) of the   Emergency Economic Stabilization Act of 2009. |

 

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