** **

| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| **UNITED STATES**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| **SECURITIES AND EXCHANGE COMMISSION**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| **Washington, D.C. 20549**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| **FORM 10-Q**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| **[X] QUARTERLY REPORT  PURSUANT TO SECTION 13 OR 15(d)**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| **OF THE SECURITIES  EXCHANGE ACT OF 1934**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| For the Quarterly Period  Ended September 30, 2008                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| **OR**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| **[  ] TRANSITION REPORT  PURSUANT TO SECTION 13 OR 15 (d)**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| **OF THE SECURITIES  EXCHANGE ACT OF 1934**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| For the Transition Period  from                       to                                                                                                                                                                                                                                                                                                                                                 |
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| Commission file number  000-27719                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| **          Southern First Bancshares,	Inc.              **                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| (Exact name of registrant as  specified in its charter)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|                          South Carolina                                                                                                                                                                                                                                                                   |             58-2459561   |
| (State or other jurisdiction  of incorporation)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  | (I.R.S. Employer  Identification No.) |
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       | ** ** |
| 100 Verdae Boulevard, Suite 100                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  | ** ** |
|                          Greenville,     S.C.                                                                                                                                                                                                                                                                                                                              |              29606              |
| (Address of principal  executive offices)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        | (Zip Code) |
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|                 864-679-9000                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| (Registrant’s telephone  number, including area code)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|              Not  Applicable                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| (Former name, former  address, and former fiscal year, if changed since last report)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| Indicate by check mark  whether the registrant (1) has filed all reports required to be filed by  Section 13 or 15(d) of the                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| Exchange Act of 1934  during the preceding 12 months (or for such shorter period that the  registrant was required to file such                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| reports),  and (2) has been subject to such filing requirements for the past 90  days.  Yes [ X ]  No [  ]                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| Indicate  by check mark whether the registrant is a large accelerated filer, an  accelerated filer, a non-accelerated filer, or a                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| smaller  reporting company.  See the definitions of “large accelerated filer,” “accelerated  filer,” and “smaller reporting                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| company”  in Rule 12b-2 of the Exchange Act.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|                                                    Large  accelerated filer  [    ]            Accelerated filer                      [     ]  |
|                                                    Non-accelerated  filer    [    ]        Smaller Reporting Company [ X ]                                                                                                                                                                 |
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| Indicate  by check mark whether the registrant is a shell company (as defined in Rule  12b-2 of the Exchange Act).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| Yes [   ]  No [ X ]                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| Indicate  the number of shares outstanding of each of the issuer’s classes of common  stock, as of the latest practicable date:                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 3,044,863  shares of common stock, $.01 par value per share, were issued and outstanding  as of November 10,, 2008.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |

 

 

----

 

 

**SOUTHERN FIRST BANCSHARES,INC.PARTI.  FINANCIAL INFORMATION**

**            **

**Item 1.  Financial Statements**

 

             The financial statements of Southern FirstBancshares, Inc. and its Subsidiary are set forth in the following pages.

 

***SOUTHERN FIRST BANCSHARES, INC. AND SUBSIDIARY***

***CONSOLIDATEDBALANCE SHEETS***

*(Dollarsin thousands)*

**                                                                                        **

| ** **                    |                                                                                                  |                                                                                     | ** **                                       | **September  30,**                                                       | ** **    | **December  31,** |
|-------------------------------|-------------------------------------------------------------------------------------------------------|------------------------------------------------------------------------------------------|--------------------------------------------------|--------------------------------------------------------------------------|---------------|-------------------|
| ** **                    |                                                                                                  |                                                                                     | ** **                                       | **2008**                                                                 | ** **    | **2007**          |
| ** **                    |                                                                                                  |                                                                                     | ** **                                       | (Unaudited)                                                              |          | (Audited)         |
| **Assets**                    |                                                                                                  |                                                                                     |                                             |
| ** **                    | Cash and due from banks                                                                               |  $                                                                                  | 9,189                                       |                                                                     |  $       | 7,714        |
|                          | Federal funds sold                                                                                    | 12,003                                                                              |                                             | 9,257                                                               |
|                          | Investment securities available for sale                                                              | 68,703                                                                              |                                             | 64,010                                                              |
|                          | Investment securities held to maturity-                                                               |                                                                                     |                                             |                                                                     |
|                          |   (fair value $12,635 and $14,573)                                                               | 12,854                                                                              |                                             | 14,819                                                              |
|                          | Other investments, at cost                                                                            | 8,461                                                                               |                                             | 8,678                                                               |
|                          | Loans, net                                                                                            | 554,782                                                                             |                                             | 503,098                                                             |
|                          | Property and equipment, net                                                                           | 9,921                                                                               |                                             | 5,391                                                               |
|                          | Accrued interest receivable                                                                           | 2,931                                                                               |                                             | 3,324                                                               |
|                          | Other real estate owned                                                                               | 2,061                                                                               |                                             | 268                                                                 |
|                          | Bank owned life insurance                                                                             | 11,719                                                                              |                                             | 8,907                                                               |
|                          | Deferred income taxes                                                                                 | 3,321                                                                               |                                             | 2,003                                                               |
|                          | Other assets                                                                                          | 621                                                                                 |                                             | 660                                                                 |
|                          |                                                                                                  |                                                                                     |                                             |                                                                     |          |              |
|                          |           Total assets                                        |  $                                                                                  | 696,566                                     |                                                                     |  $       | 628,129      |
|                          |                                                                                                  |                                                                                     |                                             |                                                                     | ** **    | ** **        |
| **Liabilities**               | ** **                                                                                            | ** **                                                                               |                                             |
| ** **                    | Deposits                                                                                              |  $                                                                                  | 477,828                                     |              |  $       | 412,821      |
|                          | Official checks  outstanding                                                                          | 3,159                                                                               |                                             | 819                                                                 |
|                          | Federal Home Loan Bank advances and related debt                                                      | 161,700                                                                             |                                        | 158,520                                                             |
|                          | Junior subordinated debentures                                                                        | 13,403                                                                              |                                             | 13,403                                                              |
|                          | Accrued interest payable                                                                              | 2,064                                                                               |                                             | 2,739                                                               |
|                          | Accounts payable and accrued expenses                                                                 | 763                                                                                 |                                             | 1,549                                                               |
|                          |                                                                                                  |                                                                                     |                                             |                                                                     |          |              |
|                          |                                                                                                  |                                                                                     | Total liabilities                                | 658,917                                                             |          | 589,851      |
|                          |                                                                                                  |                                                                                     |                                             |                                                                     | ** **    | ** **        |
| **Shareholders’ equity** | ** **                                                                                            |                                                                                     |                                             |
|                          | Preferred stock, par value $.01 per share, 10,000,000 shares                                          |                                                                                     |                                             |                                                                     |
|                          |                                                                                                  | authorized, no shares issued           | -                                           |                                                                     | -        |
|                          | Common stock, par value $.01 per share                                                                |                                                                                     |                                             |                                                                     |
|                          |     10,000,000 shares authorized, 3,016,118 and 2,946,456 issued  and                  |                                                                                     |                                             |                                                                     |
|                          |       outstanding at September 30, 2008 and December 31, 2007,  respectively | 30                                                                                  |                                             | 29                                                                  |
|                          | Nonvested restricted stock                                                                            | (30)                                                                                     |                                             | (41)                                                                     |
|                          | Additional paid-in capital                                                                            | 31,504                                                                              |                                             | 31,034                                                              |
|                          | Accumulated other comprehensive income (loss)                                                         | (2,497)                                                                                  |                                             | 96                                                                  |
|                          | Retained earnings                                                                                | 8,642                                                                               |                                             | 7,160                                                               |
|                          |                                                                                                  |                                                                                     |                                             |                                                                     |          |              |
|                          |                                                                                                  |                                                                                     | Total shareholders’ equity                  | 37,649                                                              |          | 38,278       |
|                          |                                                                                                  |                                                                                     |                                             |                                                                     |          |              |
|                          |                                                                                                  |                                                                                     | Total liabilities and  shareholders’ equity |  $                                                                  | 696,566  |              |  $ | 628,129  |
|                               |                                                                                                       |                                                                                          |                                                  |                                                                          |               |                   |  |  |  |

 

Seenotes to consolidated financial statements that are an integral part of theseconsolidated statements.

 

| 2 |
|---|

----

***SOUTHERN FIRST BANCSHARES, INC. AND SUBSIDIARYCONSOLIDATED STATEMENTS OF INCOME***

*(Dollarsin thousands, except share data)*

*** ***

| *** ***                                   | *** ***                                             | *** ***                            | *** *** | *** ***    | **For  the three months ended** | ** **      | **For  the nine months ended** |
|------------------------------------------------|----------------------------------------------------------|-----------------------------------------|--------------|-----------------|---------------------------------|-----------------|--------------------------------|
| *** ***                                   | *** ***                                             | *** ***                            | *** *** | *** ***    | **September  30,**              | ** **      | **September  30,**             |
| *** ***                                   | *** ***                                             | *** ***                            | *** *** | *** ***    | **2008**                        | ** **      | **2007**                       | ** ** | **2008** | ** ** | **2007** |
| *** ***                                   | *** ***                                             | *** ***                            | *** *** | *** ***    | (Unaudited)                     |
| **Interest income**                            |                                                     |                                    |         |            |                            |            |                           |
| *** ***                                   | Loans                                                    |  $                                 | 8,720   |            |  $                         | 9,096      |                           |  $ | 26,630  |   |  $ | 25,315  |
| *** ***                                   | Investment securities                                    | 1,282                              |         | 1,107      |                            | 3,837      |                           | 3,228  |
| *** ***                                   | Federal funds sold                                       | 57                                 |         | 77         |                            | 238        |                           | 441  |
| *** ***                                   | *** ***                                             | *** ***                            | *** *** | *** ***    |                            |            |                           |   |   |   |   |
| *** ***                                   | *** ***                                             | Total interest income                   | 10,059  |            | 10,280                     |            | 30,705                    |   | 28,984  |
| *** ***                                   | *** ***                                             | *** ***                            | *** *** | *** ***    |                            |            |                           |   |   |   |   |
| **Interest expense**                           |                                                     |                                    |         |            |                            |            |                           |
| *** ***                                   | Deposits                                                 | 3,531                              |         | 4,015      |                            | 11,495     |                           | 11,533  |
| *** ***                                   | Borrowings                                               | 1,685                              |         | 1,842      |                            | 5,195      |                           | 5,094  |
| *** ***                                   | *** ***                                             | Total interest expense                  | 5,216   |            | 5,857                      |            | 16,690                    |   | 16,627  |
| *** ***                                   | *** ***                                             | *** ***                            | *** *** | *** ***    |                            |            |                           |   |   |   |   |
| *** ***                                   | Net interest income                                      | 4,843                              |         | 4,423      |                            | 14,015     |                           | 12,357  |
| *** ***                                   | Provision for loan losses                                | 650                                |         | 450        |                            | 1,950      |                           | 1,290  |
| *** ***                                   | *** ***                                             | *** ***                            | *** *** | *** ***    |                            |            |                           |   |   |   |   |
| *** ***                                   | Net interest income after provision for loan losses      | 4,193                              |         | 3,973      |                            | 12,065     |                           | 11,067  |
| *** ***                                   | *** ***                                             | *** ***                            | *** *** | *** ***    |                            |            |                           |   |   |   |   |
| **Noninterest income**                         |                                                     |                                    |         |            |                            |            |                           |
| *** ***                                   | Loan fee income                                          | 38                                 |         | 45         |                            | 126        |                           | 121  |
| *** ***                                   | Service fees on deposit accounts                         | 177                                |         | 111        |                            | 468        |                           | 293  |
| *** ***                                   | Income from bank owned life insurance                    | 114                                |         | 96         |                            | 312        |                           | 278  |
| *** ***                                   | Gain on sale of securities                               | 7                                  |         | -     |                            | 7          |                           | -   |
| *** ***                                   | Other than temporary impairment on investment securities | (1,841)                                 |         | -     |                            | (1,841)         |                           | -   |
| *** ***                                   | Real estate owned activity                               | (7)                                     |         | (70)            |                            | (58)            |                           | 109  |
| *** ***                                   | Other income                                             | 85                                 |         | 65         |                            | 245        |                           | 188  |
| *** ***                                   | *** ***                                             | *** ***                            | *** *** | *** ***    |                            |            |                           |   |   |   |   |
| *** ***                                   | *** ***                                             | Total noninterest income (loss)         | (1,427)      |            | 247                        |            | (741)                          |   | 989  |
| *** ***                                   | *** ***                                             | *** ***                            | *** *** | *** ***    |                            |            |                           |   |   |   |   |
| **Noninterest expenses**                       |                                                     |                                    |         |            |                            |            |                           |
| *** ***                                   | Compensation and benefits                                | 1,625                              |         | 1,547      |                            | 5,149      |                           | 4,479  |
| *** ***                                   | Professional fees                                        | 127                                |         | 131        |                            | 368        |                           | 416  |
| *** ***                                   | Marketing                                                | 154                                |         | 139        |                            | 450        |                           | 387  |
| *** ***                                   | Insurance                                                | 141                                |         | 116        |                            | 413        |                           | 328  |
| *** ***                                   | Occupancy                                                | 437                                |         | 337        |                            | 1,134      |                           | 1,081  |
| *** ***                                   | Data processing and related costs                        | 347                                |         | 310        |                            | 1,012      |                           | 865  |
| *** ***                                   | Telephone                                                | 50                                 |         | 29         |                            | 126        |                           | 97  |
| *** ***                                   | Other                                                    | 159                                |         | 176        |                            | 560        |                           | 459  |
| *** ***                                   | *** ***                                             | *** ***                            | *** *** | *** ***    |                            |            |                           |   |   |   |   |
| *** ***                                   | *** ***                                             | Total noninterest expenses              | 3,040   |            | 2,785                      |            | 9,212                     |   | 8,112  |
| *** ***                                   | *** ***                                             | *** ***                            | *** *** | *** ***    |                            |            |                           |   |   |   |   |
| *** ***                                   | *** ***                                             | Income (loss) before income tax expense | (274)        |            | 1,435                      |            | 2,112                     |   | 3,944  |
| *** ***                                   | *** ***                                             | *** ***                            | *** *** | *** ***    |                            |            |                           |   |   |   |   |
| **Income tax expense (benefit)**               | (148)                                                    |                                    | 478     |            | 630                        |            | 1,278                     |
| *** ***                                   | *** ***                                             | *** ***                            | *** *** | *** ***    |                            |            |                           |   |   |   |   |
| **Net income (loss)**                          |  $                                                  | (126)                                   |         |  $         | 957                        |            |  $                        | 1,482  |   |  $ | 2,666  |
| *** ***                                   | *** ***                                             | *** ***                            | *** *** | *** ***    |                            |            |                           |   |   |   |   |
| **Earnings (loss) per common share**           |                                                     |                                    |         |            |                            |            |                           |
| *** ***                                   | Basic                                                    |  $                                 | (0.04)       |            |  $                         | .32        |                           |  $ | .50  |   |  $ | .91  |
| *** ***                                   | Diluted                                                  |  $                                 | (0.04)       |            |  $                         | .30        |                           |  $ | .47  |   |  $ | .82  |
| *** ***                                   | *** ***                                             | *** ***                            | *** *** | *** ***    |                            |            |                           |   |   |   |   |
| **Weighted average common shares outstanding** |                                                     |                                    |         |            |                            |            |                           |
| *** ***                                   | Basic                                                    | 3,002,205                          |         | 2,946,456  |                            | 2,984,947  |                           | 2,941,007  |
| *** ***                                   | Diluted                                                  | 3,002,205                          |         | 3,235,959  |                            | 3,175,274  |                           | 3,241,437  |
|                                                |                                                          |                                         |              |                 |                                 |                 |                                |  |  |  |  |  |  |  |  |  |  |  |  |  |

*** ***

Seenotes to consolidated financial statements that are an integral part of theseconsolidated statements.

 

| 3 |
|---|

 
 

 

 

***SOUTHERN  FIRSTBANCSHARES, INC. AND SUBSIDIARYCONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY AND COMPREHENSIVE INCOME FOR THE NINE MONTHS ENDED SEPTEMBER  30, 2008  AND 2007***

*(Dollarsin thousands, except share data)*

* (Unaudited)*

                                                                                                                                                        

** **

** **

** **

** **

** **

** **

** **

** **

** **

**Accumulated**

** **

** **

** **

**Total**

** **

** **

** **

** **

** **

**Nonvested**

** **

**Additional**

** **

**other**

** **

** **

** **

**share-**

** **

**Common  stock**

** **

**restricted**

** **

**paid-in**

** **

**comprehensive**

** **

**Retained**

** **

**holders’**

** **

**Shares**

** **

**Amount**

** **

**stock**

** **

**capital**

** **

**income(loss)**

** **

**Earnings**

** **

**equity**

** **

 

 

 

 

 

 

 

 

 

 

 

 

 

**December 31, 2006**

2,933,868 

 

 $

29 

 

 $

- 

 

 $

30,846 

 

 $

(16)

 

 $

3,724 

 

 $

34,583 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net  income

- 

 

- 

 

- 

 

- 

 

- 

 

2,666 

 

2,666 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income, net of tax -

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized holding loss on 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  securities available for sale

- 

 

- 

 

- 

 

- 

 

(239)

 

- 

 

(239)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income

- 

 

- 

 

- 

 

- 

 

- 

 

- 

 

2,427 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Proceeds from exercise of stock

 

 

 

 

 

 

 

 

 

 

 

 

 

 

options and warrants

10,088 

 

- 

 

- 

 

63 

 

-

 

- 

 

63 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Issuance of restricted stock

2,500 

 

- 

 

(54)

 

54 

 

-

 

- 

 

- 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amortization of deferred 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

compensation on restricted stock

- 

 

- 

 

10 

 

- 

 

-

 

- 

 

10 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Compensation expense related to

 

 

 

 

 

 

 

 

 

 

 

 

 

** **

stock options

- 

 

- 

 

- 

 

9 

 

-

 

- 

 

9 

** **

 

 

 

 

 

 

 

 

 

 

 

 

 

**September 30, 2007**

**2,946,456 **

** **

** $**

**29 **

** **

** $**

**(44)**

** **

** $**

**30,972 **

** **

** $**

**(255)**

** **

** $**

**6,390 **

** **

** $**

**37,092 **

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**December 31, 2007**

2,946,456 

 

 $

29 

 

 $

(41)

 

 $

31,034 

 

 $

96 

 

 $

7,160 

 

 $

38,278 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net  income

- 

 

- 

 

- 

 

- 

 

- 

 

1,482 

 

1,482 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income, net of tax -

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized holding loss on 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  securities available for sale

- 

 

- 

 

- 

 

- 

 

(2,593)
 

- 

 

(2,593)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income (loss)

- 

 

- 

 

- 

 

- 

 

- 

 

- 

 

(1,111)
 

 

 

 

 

 

 

 

 

 

 

 

 

 

Proceeds from exercise of stock

 

 

 

 

 

 

 

 

 

 

 

 

 

 

options and warrants

69,662 

 

1 

 

- 

 

428 

 

- 

 

- 

 

429 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amortization of deferred 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

compensation on restricted stock

- 

 

- 

 

11 

 

- 

 

- 

 

- 

 

11 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Compensation expense related to

 

 

 

 

 

 

 

 

 

 

 

 

 

** **

stock options

- 

 

- 

 

- 

 

42 

 

- 

 

- 

 

42 

** **

 

 

 

 

 

 

 

 

 

 

 

 

 

**September****30, 2008**

**3,016,118**

** **

** $**

**30 **

** **

** $**

**(30)**

** **

** $**

**31,504 **

** **

** $**

**(2,497)**

** **

** $**

**8,642 **

** **

** $**

**37,649 **

 

See  notes to consolidated financial statements that are an integral part of these  consolidated statements.

 

4
 

 

 

 

***SOUTHERNFIRST BANCSHARES, INC. AND SUBSIDIARYCONSOLIDATED STATEMENTS OF CASH FLOWS***

*(Dollarsin thousands)*

 

 

*** ***

 

 

 

** **

 

 

 

*** ***

 

 

**For  the nine months ended**

 

 

** **

 

 

**September  30,**

 

 

** **

 

 

**2008**

** **

**2007**

** **

 

 

 

 

(Unaudited)

**Operating activities**

** **

 

 

 

Net income 

 $

1,482 

 

 $

2,666 

 

Adjustments to reconcile net income to cash

 

 

 

 

 

 

provided by (used for) operating activities:

 

 

 

 

 

Provision for loan losses

1,950 

 

1,290 

 

 

Depreciation and other amortization

389 

 

361 

 

 

Accretion and amortization of securities discounts and premium,  net

111 

 

63 

 

 

Loss on sale of real estate

67 

 

181 

 

 

Gain on sale of property held for sale

- 

 

(319)

 

 

Gain on sale of investment securities

(7)

 

- 

 

 

Other than temporary impairment on investment securities

1,841 

 

- 

 

 

Compensation expense related to stock options

53 

 

18 

 

 

Increase in cash surrender value of bank owned life insurance

(312)

 

(278)

 

 

Decrease in deferred tax asset

17 

 

26 

 

 

Decrease in other assets, net

430 

 

121 

 

 

Increase (decrease) in other liabilities, net

880 

 

(2,141)

 

 

 

 

 

 

 

 

** **

 

 

 

Net cash provided by operating activities

6,901 

         

1,988 

 

 

 

 

 

 

 

 

**Investing activities**

** **

 

 

 

Increase (decrease) in cash realized from:

 

 

 

 

** **

Origination of loans, net

(55,541)

 

(82,306)

 

** **

Purchase of property and equipment 

(4,918)

 

(1,055)

 

 

Purchase of investment securities:

 

 

 

 

 

 

Available for sale

(27,666)

 

(21,083)

 

 

     

Other investments

(909)

 

(2,042)

 

 

Payments and maturity of investment securities:

 

 

 

 

 

 

Available for sale

17,130 

 

5,706 

 

 

 

Held to maturity

1,936 

 

1,816 

 

 

 

Other investments

1,125 

 

810 

 

 

Purchase of bank owned life insurance

(2,500)

 

(390)

 

 

Proceeds from sale of property held for sale

- 

 

2,355 

 

 

Proceeds from sale of real estate acquired in settlement of  loans

47 

 

467 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash used for investing activities

(71,296)

 

(95,722)

 

 

 

 

 

 

 

 

**Financing activities**

** **

 

 

 

Increase (decrease) in cash realized from:

 

 

 

 

 

Increase in deposits, net

65,007 

 

69,560 

** **

 

Increase in short-term borrowings

- 

 

10,000 

** **

 

Proceeds from the exercise of stock options and warrants

429 

 

63 

 

 

Increase in Federal Home Loan Bank advances and related debt

3,180 

 

25,000 

 

** **

 

 

 

 

 

 

 

 

 

 

Net cash provided by financing activities

68,616 

 

104,623 

 

 

 

 

 

 

 

 

 

** **

 

 

Net increase in cash and cash equivalents

4,221 

 

10,889 

 

** **

 

 

 

 

 

 

**Cash and cash equivalents at beginning of  the period**

16,971 

 

16,579 

**Cash and cash equivalents at end of the period**

$

21,192 

 

$

27,468 

 

 

 

 

 

 

 

 

**Supplemental information**

** **

 

 

 

**Cash paid for**

** **

 

 

 

 

Interest 

$

17,366 

 

$

16,307 

 

 

 

 

 

 

 

 

Income taxes 

$

1,317 

  

$

1,252 

 

** **

 

 

**   Schedule of non-cash transactions**

** **

 

 

 

 

Transfer of property and equipment to property held for sale

$

-  

 

$

2,035 

 

 

 

 

 

 

 

 

 

 

Foreclosure of real estate

$

1,907 

 

$

-  

 

 

 

 

 

 

 

Unrealized loss on securities, net of income taxes 

$

(2,593)

 

$

(239)

 

See notes to consolidatedfinancial statements that are an integral part of these consolidatedstatements.

 

5

 

***SOUTHERN FIRSTBANCSHARES, INC.  AND SUBSIDIARYNOTES TO CONSOLIDATED FINANCIAL STATEMENTS***

**Note1 – Nature of Business and Basis of Presentation****Business activity 
 

    ***Southern First Bancshares, Inc.,***(the“Company”) is a South Carolina corporation that owns all of the capital stockof Southern First Bank, N.A. (the “Bank”) and all ofthe stock of Greenville First Statutory Trust I and II (collectively (the“Trusts”)).  On July 2, 2007, the Company and Bank changed their names toSouthern First Bancshares, Inc. and Southern First Bank, N.A., respectively.  TheBank is a national bank organized under the laws of the United States located in Greenville County, South Carolina.  The Bank is primarily engagedin the business of accepting demand deposits and savings deposits insured bythe Federal Deposit Insurance Corporation, and providing commercial, consumerand mortgage loans to the general public.  The Trusts are special purposesubsidiaries organized for the sole purpose of issuing trust preferredsecurities.  

 

**Basisof Presentation**
 
               The accompanying financial statements have been prepared inaccordance with generally accepted accounting principles for interim financialinformation and with the instructions to Form 10-Q.  Accordingly, they do notinclude all the information and footnotes required by accounting principlesgenerally accepted in the United States of America for complete financialstatements.  In the opinion of management, all adjustments (consisting ofnormal recurring accruals) considered necessary for a fair presentation havebeen included.  Operating results for the three-month and nine-month periodsended September 30, 2008 are not necessarily indicative of the results that maybe expected for the year ending December 31, 2008.  For further information,refer to the consolidated financial statements and footnotes thereto includedin the company’s Form 10-K for the year ended December 31, 2007 (Registration Number 000-27719) as filed with the Securities and Exchange Commission.  Theconsolidated financial statements include the accounts of Southern FirstBancshares, Inc., and its wholly owned subsidiary Southern First Bank, N.A.  Inaccordance with Financial Accounting Standards Board (“FASB”) InterpretationNo. 46, the financial statements related to the special purpose subsidiaries,Greenville First Statutory Trust I and Trust II, have not been consolidated.
** **

**Cashand Cash Equivalents**

 

    Forpurposes of the Consolidated Statements of Cash Flows, cash and federal fundssold are included in “cash and cash equivalents.”  These assets havecontractual maturities of less than three months.

 

**Note2 – Other than Temporary Impairment on Investment Securities**

            

    Duringthe three months ended September 30, 2008, we recorded an impairment charge of$1.8 million, pre-tax, on our Federal National Mortgage Association (“FNMA”)preferred stock, which was determined to have suffered an other-than-temporaryimpairment as a result of the Government’s decision on September 7, 2008 toplace the FNMA and Federal Home Loan Mortgage Corporation (“FHLMC”) underconservatorship.

 

    Asa result of the passage of the Emergency Economic Stabilization Act of 2008,the Bank’s ability to utilize the loss on the FNMA preferred stock againstordinary income was considered in determining that the company did not need toestablish a valuation for the the deferred tax asset that was recorded relatedto the $1.8 million impairment charge.

 

**Note3 – Property Held for Sale**

           

    In February 2007, wedecided to actively market the sale of our former main office and corporateheadquarters building.  Accordingly, we reclassified the building from propertyand equipment to property held for sale, in accordance with Statement ofFinancial Accounting Standards (“SFAS”) No. 144 “Accounting for the Impairmentand Disposal of Long-Lived Assets,” and ceased depreciation of the building. In March 2007 we received a sales contract on the building.   Based on thesales contract, adjusted for estimated commissions and other selling costs, werecorded a $375,000 gain in the carrying value of the building at the end ofthe first quarter of 2007.  The $375,000 gain was partially offset by otherunrelated real estate operating expenses of $46,407.  The net gain on realestate operations recorded in the three months ended March 31, 2007 was $328,593.

 

6

  
 

     On April 13, 2007, we completed the sale of the former main office building. Based on the higher carrying value established at March 31, 2007, we incurred aloss of approximately $55,000 on the sale which was recorded in the secondquarter of 2007.    

 

 

**Note4 – Earnings per Share**

 

    The followingschedule reconciles the numerators and denominators of the basic and dilutedearnings per share computations for the three and nine months ended September30, 2008 and 2007.  Dilutive common shares arise from the potentially dilutiveeffect of the company’s stock options and warrants that are outstanding.  Theassumed conversion of stock options and warrants can create a differencebetween basic and dilutive net income per common share.  

 

 

    AtSeptember 30, 2008 and 2007, 59,750 and 13,000 options, respectively, wereanti-dilutive in the calculation of earnings per share as their exercise priceexceeded the fair market value (dollars in thousands, except share data).

 

** **

**Three  months ended September 30,**

** **

**2008**

** **

**2007**

 

 

 

 

 

 

 

Basic  Earnings Per Share

 

 

 

 

 

 

   Average common shares

3,002,205

 

2,946,456

   Net income (loss)

 $

(126)

 

 $

957 

   Earnings (loss) per share

 $

(0.04)

 

 $

0.32 

 

 

 

 

 

 

 

Diluted  Earnings Per Share

 

 

 

   Average common shares

3,002,205

 

2,946,456

   Average dilutive common shares

- 

 

289,503

   Adjusted average common shares

3,002,205

 

3,235,959

   Net income (loss)

 $

(126)

 

 $

957 

   Earnings (loss) per share

 $

(0.04)

 

 $

0.30 

** **

 

** **

**Nine months  ended September 30,**

** **

**2008**

** **

**2007**

 

 

 

 

 

 

 

Basic  Earnings Per Share

 

 

 

 

 

 

   Average common shares

2,984,947

 

2,941,007

   Net income

 $

1,482 

 

 $

2,666 

   Earnings per share

 $

0.50 

 

 $

0.91 

 

 

 

 

 

 

 

Diluted  Earnings Per Share

 

 

 

   Average common shares

2,984,947

 

2,941,007

   Average dilutive common shares

190,327

 

300,430

   Adjusted average common shares

3,175,274

 

3,241,437

   Net income

 $

1,482 

 

 $

2,666 

   Earnings per share

 $

0.47 

 

 $

0.82 

** **

**Note5 – Stock Based Compensation**

 

**         **The company has a stock-based employee compensationplan.  On January 1, 2006, the company adopted the fair value recognitionprovisions of SFAS No. 123(R), “Accounting forStock-Based Compensation,” to account for compensation costs under its stockoption plan.  

 

  In adopting SFAS No. 123(R), the company elected to usethe modified prospective method to account for the transition from theintrinsic value method to the fair value recognition method.  Under themodified prospective method, compensation cost is recognized from the adoptiondate forward for all new stock options granted and for any outstanding unvestedawards as if the fair value method had been applied to those awards as of thedate of grant.             

    

   Thefair value of the option grant is estimated on the date of grant using theBlack-Scholes option-pricing model.  The following assumptions were used forgrants: expected volatility of 10.00% for 2008 and 2007, risk-free interestrate of 4.60% for 2008 and 2007, expected lives of the options 10 years, andthe assumed dividend rate was zero.  

 

7

 
****
 

**Note 6 – Fair Value Measurement**

** **

   Effective January 1, 2008, theCompany adopted SFAS No. 157, “Fair Value Measurements” which provides aframework for measuring and disclosing fair value under generally acceptedaccounting principles. SFAS No. 157 requires disclosures about the fair valueof assets and liabilities recognized in the balance sheet in periods subsequentto initial recognition, whether the measurements are made on a recurring or ona nonrecurring basis. 

 

   SFAS No. 157 defines fair value asthe exchange price that would be received for an asset or paid to transfer aliability (an exit price) in the principal or most advantageous market for theasset or liability in an orderly transaction between market participants on themeasurement date. SFAS No. 157 also establishes a fair value hierarchy whichrequires an entity to maximize the use of observable inputs and minimize theuse of unobservable inputs when measuring fair value. The standard describesthree levels of inputs that may be used to measure fair value:

 

**Level 1**

Quoted prices in active markets foridentical assets or liabilities. Level 1 assets and liabilities include certaindebt and equity securities and derivative contracts that are traded in anactive exchange market. 

 

**Level 2**

Observable inputs other than Level 1prices such as quoted prices for similar assets or liabilities; quoted pricesin markets that are not active; or other inputs that are observable or can becorroborated by observable market data for substantially the full term of theassets or liabilities. Level 2 assets and liabilities include fixed incomesecurities and mortgage-backed securities that are held in the Company’savailable-for-sale portfolio, certain derivative contracts and impaired loans.

 

**Level 3**

Unobservable inputs that are supportedby little or no market activity and that are significant to the fair value ofthe assets or liabilities. Level 3 assets and liabilities include financialinstruments whose value is determined using pricing models, discounted cashflow methodologies, or similar techniques, as well as instruments for which thedetermination of fair value requires significant management judgment orestimation.  These methodologies may result in a significant portion of thefair value being derived from unobservable data.  

 

Assets measuredat fair value on a recurring basis as of September 30, 2008 are as follows:

 

 

**Quoted market  price**

** **

**Significant  other**

** **

**Significant**

 

**in active  markets**

** **

**observable  inputs**

** **

**unobservable  inputs**

 

**(Level 1)**

** **

**(Level 2)**

** **

**(Level 3)**

 

**(Dollars in  thousands)**

 

 

 

 

 

 

 

 

 

 

 

 

Investment securities available for  sale 

 $

174 

 

 

 $

63,830 

 

 

 $

4,698 

 

Other investments

 

- 

 

 

 

- 

 

 

 

8,461 

 

 

 

 

 

 

 

    Total

 $

174 

 

 

 $

63,830 

 

 

 $

13,159 

 

 

   The Companyhas no liabilities carried at fair value or measured at fair value on arecurring or nonrecurring basis. 

 

   The Company is predominantly an assetbased lender with real estate serving as collateral on approximately 79% ofloans. Loans which are deemed to be impaired are valued on a nonrecurring basisat the lower of cost or market value of the underlying real estate collateral.Such market values are generally obtained using independent appraisals, whichthe Company considers to be level 2 inputs. The aggregate carrying amount, netof specific reserves, of impaired loans at September 30, 2008 was $3.4 million.

 

   FASB Staff Position No. 157-2 delaysthe implementation of SFAS No. 157 until the first quarter of 2009 with respectto goodwill, other intangible assets, real estate and other assets acquiredthrough foreclosure and other non-financial assets measured at fair value on anonrecurring basis.

 

8

 
 

 

The table belowpresents a reconciliation for the period of January 1, 2008 to September 30,2008, for all Level 3 assets that are measured at fair value on a recurringbasis.

** **

** **

** **

**Investment**

** **

** **

 

** **

**securities**

** **

**Other**

 

** **

**available for sale**

** **

**investments**

 

** **

**(Dollars in thousands)**

 

 

 

 

 

 

 

Beginning balance

 

 $

8,244

 

 $

8,678

Total realized and unrealized gains or losses:

 

 

 

 

   Included in earnings

 

- 

 

- 

   Included in other comprehensive income

 

(2,928)

 

- 

Purchases and sales

 

- 

 

(217)

Principal reductions

 

(618)

 

- 

Transfers in and/or out of Level 3

 

- 

 

- 

 

 

 

 

 

 

Ending Balance

 

 $

4,698 

 

 $

8,461 

 

 

**Item 2.****  Management’s Discussion and Analysisof Financial Condition and Results of Operations**.

 

*Thefollowing discussion reviews our results of operations and assesses ourfinancial condition.  You should read the following discussion and analysis inconjunction with the accompanying consolidated financial statements.  Thecommentary should be read in conjunction with the discussion of forward-lookingstatements, the financial statements and the related notes and the otherstatistical information included in this report.*

**DISCUSSION OF FORWARD-LOOKING STATEMENTS**

                Thisreport contains statements which constitute forward-looking statements withinthe meaning of Section 27A of the Securities Act of 1933 and Section 21E of theSecurities Exchange Act of 1934. These statements are based on many assumptionsand estimates and are not guarantees of future performance.  Our actual resultsmay differ materially from those anticipated in any forward-looking statements,as they will depend on many factors about which we are unsure, including manyfactors which are beyond our control.  The words “may,”  “would,” “could,”“will,” “expect,” “anticipate,” “believe,” “intend,” “plan,” and “estimate,” aswell as similar expressions, are meant to identify such forward-lookingstatements.  Potential risks and uncertainties that could cause our actualresults to differ from those anticipated in any forward-looking statements include,but are not limited to, those described in our Form 10-K for the year endedDecember 31, 2007 under Item 1A- Risk Factors and the following:

 

•        significantincreases in competitive pressure in the banking and financial servicesindustries;

•        changesin the interest rate environment which could reduce anticipated or actualmargins;

•        changesin political conditions or the legislative or regulatory environment; 

•        generaleconomic conditions, either nationally or regionally and especially in ourprimary service area, becoming less favorable than expected resulting in, amongother things, a deterioration in credit quality;

•        changesoccurring in business conditions and inflation;

•        changesin technology;

•        changesin deposit flows,

•        changesin monetary and tax policies;

•        thelevel of allowance for loan loss;

•        therate of delinquencies and amounts of charge-offs; 

•        therates of loan growth and the lack of seasoning of our loan portfolio;

•        adversechanges in asset quality and resulting credit risk-related losses and expenses;

•        lossof consumer confidence and economic disruptions resulting from terroristactivities;

•        changesin the securities markets; and

•        otherrisks and uncertainties detailed from time to time in our filings with theSecurities and Exchange Commission.

 

9

  
 

 

            These risks are exacerbated by the recent developments innational and international financial markets, and we are unable to predict whateffect these uncertain market conditions will have on our company.  During2008, the capital and credit markets have experienced extended volatility anddisruption. In the last 90 days, the volatility and disruption have reachedunprecedented levels.  There can be no assurance that these unprecedentedrecent developments will not materially and adversely affect our business,financial condition and results of operations.

 

            We undertake noobligation to publicly update or otherwise revise any forward-lookingstatements, whether as a result of new information, future events, orotherwise.

 

**Overview**

** **

We were incorporated in March 1999 to organize and serveas the holding company for Greenville First Bank, N.A.  On July 2, 2007, we changed our name to Southern First Bancshares, Inc. and the bank’s name to SouthernFirst Bank, N.A., although we will continue to operate as Greenville First Bankin Greenville County.  Our primary reason for the name change was related to ourexpansion into the Columbia, South Carolina market.  Since we opened our bankin January 2000, we have experienced consistent growth in total assets, loansand deposits which has continued during the first nine months of 2008. 

 

Like most community banks, we derive the majority of our income frominterest received on our loans and investments.  Our primary source of fundsfor making these loans and investments is our deposits, on which we payinterest.  Consequently, one of the key measures of our success is our amountof net interest income, or the difference between the income on ourinterest-earning assets, such as loans and investments, and the expense on ourinterest-bearing liabilities, such as deposits and borrowings.  Another keymeasure is the spread between the yield we earn on these interest-earningassets and the rate we pay on our interest-bearing liabilities, which is calledour net interest spread.  

 

There are risks inherent in all loans, so we maintain an allowance forloan losses to absorb probable losses on existing loans that may becomeuncollectible.  We maintain this allowance by charging a provision for loanlosses against our operating earnings for each period.  We have included adetailed discussion of this process, as well as several tables describing ourallowance for loan losses.

 

In addition to earning interest on our loans and investments, we earnincome through fees and other charges to our customers.  We have also includeda discussion of the various components of this noninterest income, as well asof our noninterest expense.

 

The following discussion and analysis also identifies significant factorsthat have affected our financial position and operating results during theperiods included in the accompanying financial statements.  We encourage you toread this discussion and analysis in conjunction with our financial statementsand the other statistical information included in our filings with theSecurities and Exchange Commission.

 

In response to financial conditionsaffecting the banking system and financial markets and the potential threats tothe solvency of investment banks and other financial institutions, the UnitedStates government has taken unprecedented actions. On October 3, 2008,President Bush signed into law the Emergency Economic Stabilization Act of 2008(the “EESA”).  Pursuant to the EESA, the U.S. Treasury will have the authorityto, among other things, purchase mortgages, mortgage-backed securities, andother financial instruments from financial institutions for the purpose ofstabilizing and providing liquidity to the U.S. financial markets. On October14, 2008, the U.S. Department of Treasury announced the Capital PurchaseProgram under the EESA, pursuant to which the Treasury intends to make seniorpreferred stock investments in participating financial institutions.  We areevaluating whether to participate in the Capital Purchase Program.  Regardlessof our participation, governmental intervention and new regulations under theseprograms could materially and adversely affect our business, financialcondition and results of operations.

 
CriticalAccounting Policies
          We have adopted various accounting policiesthat govern the application of accounting principles generally accepted in the United States and with general practices within the banking industry in the preparation ofour financial statements.  Our significant accounting policies are described inthe footnotes to our audited consolidated financial statements as of December31, 2007, as filed in our annual report on Form 10-K.

 

10

  
 

 

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

 

We believe the allowance for loan lossesis the critical accounting policy that requires the most significant judgmentand estimates used in preparation of our consolidated financial statements. Some of the more critical judgments supporting the amount of our allowance forloan losses include judgments about the credit worthiness of borrowers, theestimated value of the underlying collateral, the assumptions about cash flow,determination of loss factors for estimating credit losses, the impact ofcurrent events, and conditions, and other factors impacting the level ofprobable inherent losses.  Under different conditions, the actual amount ofcredit losses incurred by us may be different from management’s estimatesprovided in our consolidated financial statements.  Refer to the portion ofthis discussion that addresses our allowance for loan losses for a morecomplete discussion of our processes and methodology for determining ourallowance for loan losses.

** **

** **

**Effect of Economic Trends**

** **

             Following an economicdecline and historically low interest rates that ended in the first six monthsof 2004, the Federal Reserve began increasing short-term rates as the economyshowed signs of strengthening.  Between July 2004 and July 2006, the FederalReserve increased rates at 17 of their meetings for a total of 425 basispoints. Between July 2006 and September 18, 2007, the Federal Reserve allowedshort-term rates to remain unchanged.  Beginning in July 2004 and continuinguntil September 18, 2007, our rates on both short-term or variable rateinterest-earning assets and interest-bearing liabilities increased.  The momentumof the 17 rate increases resulted in higher rates on interest-earning assetsand higher interest-bearing liabilities during the first nine months of 2007;subsequently, as fixed rate loans, deposits, and borrowings matured during thisperiod they repriced at higher interest rates.  In lateSeptember 2007, the Federal Reserve reversed their position and lowered theshort-term rates initially by 50 basis points and by an additional 50 basispoints in the fourth quarter of 2007.  The Federal Reserve has continued toaggressively decrease rates by lowering the short-term rate 225 basis points inthe first nine months of 2008 which has caused the rates on our short-term orvariable rate assets and liabilities to decline in 2008.  In addition, theFederal Reserve has decreased rates an additional 100 basis points in October2008.  The following discussion includes our analysis of the effect that weanticipate changes in interest rates will have on our financial condition. However, we can give no assurances as to the future actions of the FederalReserve or to the anticipated results that will actually occur.

** **

** **

**Results of OperationsIncome Statement Review***Summary*

 

*Three monthsended September30, 2008 and 2007*

* *

For the three monthsended September 30, 2008, we incurred a net loss of $126,000 compared to netincome of $957,000 for the three months ended September 30, 2007, a decrease of$1.1million, or 113.3%.  The $1.1 million decrease in net income resultedprimarily from an impairment charge of $1.2 million, net of taxes, related toour FNMA preferred stock, as well as increases of $255,000 in noninterestexpenses and $200,000 in the provision for loan losses, partially offset byincreases of $420,000 in net interest income and $166,000 in noninterest income,excluding the impairment charge.

 

Excluding theimpairment charge, our earnings were $1.1 million for the third quarter 2008, a$115,000, or 12.0% increase from the same period in 2007.  Our efficiency ratioimproved to 57.8% for the three months ended September 30, 2008 from 58.8% forthe same period in 2007.  The lower efficiency ratio is due primarily to ourhaving established a presence in the Columbia market and expansion costsrelated to the Columbia office that are being absorbed as the office increasesloan and deposit production.  Our efficiency ratio is computed by dividingnoninterst expense by the sum of net interest income, excluding the gain onsale and impairment charge on securities and real estate activity, andnoninterest income.

 

11

 
 

 

*                Ninemonths ended September 30, 2008 and 2007*

 

                Our net incomewas $1.5 million and $2.7 million for the nine months ended September 30, 2008and 2007, respectively, a decrease of $1.2 million, or 44.4%.  The decrease innet income resulted primarily from an impairment charge of $1.2 million, net oftaxes, related to our FNMA preferred stock, as well as increases of $1.1million in noninterest expenses and $660,000 in the provision for loan losses, partiallyoffset by increases of $1.7 million in net interest income and $110,000 innoninterest income, excluding the impairment charge.  

 

                Excluding theimpairment charge, our earnings for the nine month period ended September 30,2008 were virtually unchanged from the same period in 2007 at $2.7 million.  Our efficiencyratio improved to 60.8% for the nine months ended September 30, 2008 from 61.3%for the same period in 2007.  The lower efficiency ratio is due primarily toour having established a presence in the Columbia market and expansion costsrelated to the Columbia office that are being absorbed as the office increasesloan and deposit production.  Our efficiency ratio is computed by dividingnoninterest expense by the sum of net interest income, excluding the gain onsale and impairment charge on securities and real estate activity, andnoninterest income.

* *

*Net Interest Income*

 

    Ourlevel of net interest income is determined by the level of earning assets andthe management of our net interest margin.  The continuous growth in our loanportfolio is the primary driver of the increase in net interest income.  Duringthe nine months ended September 30, 2008, our average loan portfolio increased$96.8 million compared to the average for the nine months ended September 30,2007.  The actual growth in the first nine months of 2008 was $52.4 million.  Weanticipate that growth in loans will continue to drive growth in assets and subsequently,growth in net interest income.  However, we expect to incur lower levels ofgrowth during the remainder of 2008.  In an effort to maximize our utilizationof capital, we anticipate managing the level of loan growth to ensure the bankremains well-capitalized.  

 

    Our past decision to grow the loanportfolio created the need for a higher level of capital and the need toincrease deposits and borrowings.  This loan growth strategy also resulted in asignificant portion of our assets being in higher earning loans rather than inlower yielding investments.  At September 30, 2008, net loans represented 79.6%of total assets while investments and federal funds sold represented 14.6% oftotal assets.  However,asdescribedbelow,wehavealsoincreasedourlevelofdepositssignificantly. 

 

    The historically low interest rateenvironment that was experienced between January of 2000 and July of 2004allowed us to obtain short-term borrowings and wholesale certificates ofdeposit at rates that were lower than certificate of deposit rates beingoffered in our local market.  Therefore, we decided not to begin our retaildeposit office expansion program until the beginning of 2005.  This fundingstrategy allowed us to continue to operate in one location until 2005, maintaina smaller staff, and not incur marketing costs to advertise deposit rates,which in turn allowed us to focus on the fast growing loan portfolio. 

 

    We opened two retail deposit offices in2005 and two additional offices in July of 2008.  We also convertedour Columbia loan production office into a full service branch facility duringthe third quarter of 2007.  We now have four retail offices in the Greenvillemarket and two retail offices in the Columbia market.  Our focus for theselocations is to obtain low cost transaction accounts, resulting in an increase inboth the percentage of assets being funded by “in market” retail deposits aswell as  the percentage of low-cost transaction accounts to total deposits. Webelieve that this growth strategy will provide additional clients in our two marketareas and will eventually provide a lower alternative cost of funding.   At September30, 2008, retail deposits represented $285.2 million, or 40.9% of total assets,borrowings represented $175.1 million, or 25.1% of total assets, and wholesaleout-of-market deposits represented $192.6 million, or 27.7% of total assets.

 

    Our net interest income margin for thenine months ended September 30, 2008 exceeded our net interest spread becausewe had more interest-earning assets than interest-bearing liabilities.  Averageinterest-earning assets exceeded average interest-bearing liabilities by $51.2million and $48.7 million for the nine months ended September 30, 2008 and 2007,respectively.

 

12

  
 

 

In addition to the growth in both assetsand liabilities, and the ratio of interest-earning assets to interest-bearingliabilities, net interest income is also affected by the timing of the repricingof our assets and liabilities and the changes in interest rates earned on ourassets and interest rates paid on our liabilities.  Until September 18, 2007, our yields on interest earning assets and the rates that we paid for ourdeposits and borrowings continued to increase primarily as a result of theactions taken by the Federal Reserve to raise short-term rates prior to July 30, 2006.  Our fixed rate loans were being originated or renewed at higher rates,while the rates on new or maturing interest-bearing liabilities were alsohigher than in the past.  Given the fact that the Federal Reserve increasedshort-term rates by 425 basis points between July 2004 and July 2006 andallowed rates to remain unchanged until September 18, 2007, we believed duringmost of 2006 and the first nine months of 2007 that short-term interest rates wereat or near their peak.  Therefore, we chose to increase the amount of fixedrate loans in our loan portfolio, and we targeted to have a significant portionof our liabilities to reprice within a twelve month period.  On September 18,2007, the Federal Reserve began to decrease short-term rates with an initial 50basis point reduction and continued the decrease with an additional 275 basispoints through the end of 2007 and the first nine months of 2008.  While thebank had more liabilities than assets that repriced down during the nine monthsended September 30, 2008 due to the competition for deposits and the overalllow market rates, we were not able to lower the rates on our liabilities inproportion to the reduction in rates experienced on our assets.  With therecent 100 basis point reduction in short-term rates in October 2008, weanticipate that our net interest margin will decline during the next threemonths as many of our interest-earning assets and interest-bearing liabilitiesreprice to lower rates.  

 

As more fully discussed in the – “MarketRisk” and – “Liquidity and Interest Rate Sensitivity” sections below, atSeptember 30, 2008, approximately 58% of our loans had fixed rates.  For thepast two years, we have placed more emphasis on fixed rate loans; however, wehave recently changed our focus to increasing the amount of variable rate loansin our portfolio.  Our fixed rate loans as a percentage of total loans decreasedfrom 60% at September 30, 2007 to 58% at September 30, 2008.  While increasing ourpercentage of fixed rate loans during the past three years, our focus has beento obtain short-term liabilities to fund our asset growth.  This strategy hasresulted in our ability to move from being asset sensitive to being liabilitysensitive for the next twelve months.  

 

At September 30, 2008, 76.0% of ourinterest-bearing liabilities were either variable rate or had a maturity ofless than one year.   Of the $286.8 million of interest-bearing liabilities setto reprice within three months, 44.3% or $127.1 million are transaction, moneymarket or savings accounts which are already at or near their lowest rates andprovide little opportunity for benefit should market rates continue to declineor stay constant.  However, certificates of deposit that are currently maturingor renewing are repricing at low rates.  We expect to benefit, even if marketrates increase slightly as these deposits reprice.   At September 30, 2008, wehad $148.8 million more liabilities than assets that reprice within the nexttwelve months.  Included in our FHLB advances and related debt, are a number ofborrowings with callable features as of September 30, 2008.  We believe thatthe optionality on many of these borrowings will not be exercised untilinterest rates increase significantly.  In addition, we believe that theinterest rates that we pay on the majority of our interest-bearing transactionaccounts would only be impacted by a portion of any change in market rates. This key assumption is utilized in our overall evaluation of our level ofinterest sensitivity.

 

We have included a number of tables toassist in our description of various measures of our financial performance. For example, the “Average Balances” tables shows the average balance of eachcategory of our assets and liabilities as well as the yield we earned or therate we paid with respect to each category during the three and nine monthperiods ended September 30, 2008 and 2007.  A review of these tables shows thatour loans typically provide higher interest yields than do other types ofinterest-earning assets, which is why we direct a substantial percentage of ourearning assets into our loan portfolio.  Similarly, the “Rate/Volume Analysis”table demonstrates the effect of changing interest rates and changing volume ofassets and liabilities on our financial condition during the periods shown.  Areview of these tables shows that as short-term rates continued to rise, theincrease in net interest income is more effected by the changes in rates thanin prior years.  We also track the sensitivity of our various categories ofassets and liabilities to changes in interest rates, and we have includedtables to illustrate our interest rate sensitivity with respect tointerest-earning accounts and interest-bearing accounts.  Finally, we haveincluded various tables that provide detail about our investment securities,our loans, our deposits, and other borrowings.

 

The following tables set forthinformation related to our average balance sheets, average yields on assets,and average costs of liabilities.  We derived these yields by dividing incomeor expense by the average balance of the corresponding assets or liabilities. We derived average balances from the daily balances throughout the periodsindicated.  During the three and nine month periods ended September 30, 2008 and2007, we had less than $100,000 in interest-bearing deposits in other banks andno securities purchased with agreements to resell.  All investments owned havean original maturity of over one year.  Nonaccrual loans are included in thefollowing tables.  Loan yields have been reduced to reflect the negative impacton our earnings of loans on nonaccrual status.  The net of capitalized loancosts and fees are amortized into interest income on loans.

 

13

 
 

 

 

 

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

 

 

**For the Three  Months Ended September 30,**

 

 

**2008**

 

**2007**

 

 

**Average**

 

**Income/**

 

**Yield/**

 

**Average**

 

**Income/**

 

**Yield/**

 

 

**Balance**

 

**Expense**

 

**Rate(1)**

 

**Balance**

 

**Expense**

 

**Rate(1)**

 

**(Dollars in  thousands)**

Earnings

 

 

 

 

 

 

 

 

 

 

 

 

 

Federal  funds sold

$

11,684 

$

57 

 

1.94%

$

5,876 

$

77 

 

5.20%

 

Investment  securities, taxable

 

90,420 

 

1,246 

 

5.48%

 

76,749 

 

1,072 

 

5.54%

 

Investment  securities, nontaxable (2)

 

3,689 

 

60 

 

6.44%

 

3,629 

 

54 

 

5.90%

 

Loans

 

552,450 

 

8,720 

 

6.28%

 

473,027 

 

9,096 

 

7.63%

 

   Total interest-earning assets

 

658,243 

 

10,083 

 

6.09%

 

559,281 

 

10,299 

 

7.31%

 

Non-interest-earning  assets

 

29,767 

 

 

 

 

 

22,530 

 

 

 

 

 

   Total assets

$

688,010 

 

 

 

 

$

581,811 

 

 

 

 

Interest-bearing  liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

NOW  accounts

$

41,363 

 

99 

 

0.95%

$

34,108 

 

145 

 

1.69%

 

Savings  & money market

 

91,634 

 

398 

 

1.73%

 

89,159 

 

807 

 

3.59%

 

Time  deposits

 

303,476 

 

3,034 

 

3.98%

 

235,017 

 

3,063 

 

5.17%

 

Total  interest-bearing deposits

 

436,473 

 

3,531 

 

3.22%

 

358,284 

 

4,015 

 

4.45%

 

FHLB  advances and related debt

 

159,048 

 

1,502 

 

3.76%

 

134,043 

 

1,555 

 

4.61%

 

Other  borrowings

 

14,068 

 

183 

 

5.18%

 

15,869 

 

287 

 

7.18%

 

Total  interest-bearing liabilities

 

609,589 

 

5,216 

 

3.40%

 

508,196 

 

5,857 

 

4.57%

 

Non-interest-bearing  deposits

 

34,196 

 

 

 

 

 

31,632 

 

 

 

 

 

Non-interest-bearing  liabilities

 

5,172 

 

 

 

 

 

5,436 

 

 

 

 

Shareholders’  equity

 

39,053 

 

 

 

 

 

36,547

 

 

 

 

 

Total  liabilities and shareholders’ equity

$

688,010 

 

 

 

 

$

581,811 

 

 

 

 

Net  interest spread

 

 

 

 

 

2.69%

 

 

 

 

 

2.74%

Net  interest income (tax equivalent) / margin

 

 

$

4,867 

 

2.94%

 

 

$

4,442 

 

3.15%

Less:   tax-equivalent adjustment (2)

 

 

 

24 

 

 

 

 

 

19 

 

 

Net  interest income

 

 

$

4,843 

 

 

 

 

$

4,423 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

     (1) Annualized for the three month period.

     (2) The tax-equivalent adjustment to net interest income adjusts the yield  for assets earning tax-exempt income to a comparable yield on 

a taxable basis.

 

Our net interest spread, on atax-equivalent basis, was 2.69% for the three months ended September 30, 2008 comparedto 2.74% for the three months ended September 30, 2007.  The net interestspread is the difference between the yield we earn on our interest-earningassets and the rate we pay on our interest-bearing liabilities.

 

The 5 basis point reduction in our netinterest spread resulted primarily from the lower spread on the $99.0 milliongrowth in average earning assets in the third quarter of 2008 compared to thesame period in 2007.  Of the $99.0 million in growth, $19.5 million, or 19.7%,occurred in investments and federal funds, while the remaining growth of $79.4million, or 80.3%, occurred in loans.  During the third quarter of 2008, ourinvestments and federal funds yielded a combined weighted rated of 5.12%, whileour loans yielded a weighted rate of 6.28%.  

 

The growth of $99.0 million in earningassets was funded primarily with $68.5 million in certificates of deposit and$23.2 million in borrowings.  For the three months ended September 30, 2008,our certificates of deposit had a weighted rate of 3.98%, while our borrowingshad a weighted rate of 3.88% for a combined weighted rate of 3.94%.

 

14

 
 

 

 

Since we funded 90.4% of the growth inearning assets with higher costing borrowings and certificates of deposit at acombined rate of 3.94% rather than with lower costing transaction accounts at arate of 1.49%, the additional earning assets and liabilities yielded a lowerthan historical net spread of 2.35%, causing the overall net interest spread todecline by 6 basis points.  Offsetting the decrease in net interest spread dueto growth was a 1 basis point increase due to the repricing of short-termliabilities such as one year certificates of deposit which continue to repricedownward to current market rates as they mature.  During 2007 and the firstnine months of 2008, management determined that the bank had capital to supportadditional asset growth.  Consequently, given the flat interest rateenvironment, both earnings and return on equity could be increased withadditional assets and liabilities even if the net interest spreads were at lessthan historical levels. 

 

Our net interest margin is calculated asnet interest income divided by average interest-earning assets.  Our netinterest margin, on a tax-equivalent basis, for the three months ended September30, 2008 was 2.94% compared to 3.15% for the three months ended September 30,2007  During the three months ended September 30, 2008, interest-earning assetsexceeded interest-bearing liabilities by $48.7 million compared to $51.1million for the three month period ended September 30, 2007.  During the third quarterof 2008, interest-earning assets averaged $658.2 million compared to $559.3million in the third quarter of 2007.  

 

Our loan yield decreased 135 basispoints for the three months ended September 30, 2008 compared to the threemonths ended September 30, 2007 as a result of the 325 basis point reduction inshort-term rates in the past twelve months which had an immediate impact on ourvariable rate loans, which represented 42% of our total loans at September 30,2008.  Offsetting the decrease in our loan yield was a 123 basis point decreasein the cost of our interest-bearing deposits for the third quarter of 2008compared to the same period in 2007.  The decrease in the rate on interest-bearingdeposits is due primarily to the 119 basis point decrease on the cost of time depositsas their renewal rates have been lower than their original rates as a result ofthe decreases in market rates over the past twelve months.  In addition, thecost of our transaction, savings and money market accounts has decreased as wehave lowered the rates we offer on these products.  The cost of our savings andmoney market accounts has decreased by 186 basis points from September 30,2007, while the rate on our transaction accounts has decreased 74 basis pointsin the same period.  The 85 basis point decrease in FHLB advances and relateddebt and the 200 basis point decrease in other borrowed funds in the third quarterof 2008 compared to the same period in 2007 resulted primarily from the impactof the 325 basis point decrease in short-term market rates over the past twelvemonths.  As of September 30, 2008, approximately 12% of our FHLB advances hadvariable rates, while all of our other borrowings had variable rates.

 

Net interest income, the largestcomponent of our income, was $4.8 million and $4.4 million for the three monthsended September 30, 2008 and 2007, respectively.  The increase in the thirdquarter of 2008 related primarily to the net effect of higher levels of bothaverage interest-earning assets and interest-bearing liabilities.  Average interest-earningassets were $99.0 million higher during the three months ended September 30,2008 compared to the same period in 2007.  During the same period, averageinterest-bearing liabilities increased $101.4 million.  The higher average balancesresulted in $326,000 of additional net interest income for the three monthsended September 30, 2008, while lower spreads on the average balances reducednet interest income by $40,000. 

 

Interest income for the three monthsended September 30, 2008 was $10.1 million, consisting of $8.7 million onloans, $1.3 million on investments, and $57,000 on federal funds sold.  Interestincome for the three months ended September 30, 2007 was $10.3 million,consisting of $9.1 million on loans, $1.1 million on investments, and $77,000on federal funds sold.  Interest on loans for the three months ended September30, 2008 and 2007 represented 86.7% and 88.5%, respectively, of total interestincome, while income from investments and federal funds sold represented only 13.9%and 11.5%, respectively, of total interest income.  The high percentage ofinterest income from loans relates to our strategy to maintain a significantportion of our assets in higher earning loans compared to lower yieldinginvestments.  Average loans represented 83.9% and 84.6% of averageinterest-earning assets for the three months ended September 30, 2008 and 2007,respectively.  Included in interest income on loans for the three months ended September30, 2008 and 2007 was $148,000 and $179,000, respectively, which related to thenet amortization of loan fees and capitalized loan origination costs.

 

Interest expense for the three monthsended September 30, 2008 was $5.2 million, consisting of $3.5 million relatedto deposits and $1.7 million related to FHLB advances and other borrowings.  Interestexpense for the three months ended September 30, 2007 was $5.9 million,consisting of $4.0 million related to deposits and $1.8 million related to FHLBadvances and other borrowings.  Interest expense on deposits for the threemonths ended September 30, 2008 and 2007 represented 67.7% and 68.5%,respectively, of total interest expense, while interest expense on FHLBadvances and other borrowings represented 32.3% and 31.5%, respectively, oftotal interest expense for the same three month periods.  For the three monthsended September 30, 2008, average interest-bearing deposits increased by $78.2million over the same period in 2007, while FHLB advances increased $25.0million and other borrowings decreased $1.8 million during the three monthsended September 30, 2008 over the same period in 2007.  Both the short-termborrowings from the FHLB advances and the sale of securities under agreementsto repurchase provide us with the opportunity to obtain low cost funding withvarious maturities similar to the maturities on our loans and investments. 

 

15

 
 

 

 

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

 

 

**For the Nine  Months Ended September 30,**

 

 

**2008**

 

**2007**

 

 

**Average**

 

**Income/**

 

**Yield/**

 

**Average**

 

**Income/**

 

**Yield/**

 

 

**Balance**

 

**Expense**

 

**Rate(1)**

 

**Balance**

 

**Expense**

 

**Rate(1)**

 

**(Dollars in  thousands)**

Earnings

 

 

 

 

 

 

 

 

 

 

 

 

 

Federal  funds sold

$

13,805 

$

238 

 

2.30%

$

11,224 

$

441 

 

5.25%

 

Investment  securities, taxable

 

91,935 

 

3,729 

 

5.42%

 

76,395 

 

3,119 

 

5.46%

 

Investment  securities, nontaxable (2)

 

3,746 

 

174 

 

6.21%

 

3,899 

 

161

 

5.53%

 

Loans

 

542,729 

 

26,630 

 

6.55%

 

445,912 

 

25,315 

 

7.59%

 

   Total interest-earning assets

 

652,215 

 

30,771 

 

6.30%

 

537,430 

 

29,036 

 

7.22%

 

Non-interest-earning  assets

 

25,607 

 

 

 

 

 

23,049 

 

 

 

 

 

   Total assets

$

677,822 

 

 

 

 

$

560,479 

 

 

 

 

Interest-bearing  liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

NOW  accounts

$

39,135 

 

318 

 

1.09%

$

34,253 

 

431 

 

1.68%

 

Savings  & money market

 

90,125 

 

1,331 

 

1.97%

 

86,749 

 

2,307 

 

3.56%

 

Time  deposits

 

300,373 

 

9,846 

 

4.38%

 

227,274 

 

8,795 

 

5.17%

 

Total  interest-bearing deposits

 

429,633 

 

11,495 

 

3.57%

 

348,276 

 

11,533 

 

4.43%

 

FHLB  advances and related debt

 

156,590 

 

4,595 

 

3.92%

 

124,914 

 

4,288 

 

4.59%

 

Other  borrowings

 

14,805 

 

600 

 

5.41%

 

15,551 

 

806 

 

6.93%

 

Total  interest-bearing liabilities

 

601,028 

 

16,690

 

3.71%

 

488,741 

 

16,627 

 

4.55%

 

Non-interest-bearing  deposits

 

32,369 

 

 

 

 

 

31,023 

 

 

 

 

 

Non-interest-bearing  liabilities

 

5,077 

 

 

 

 

 

4,721 

 

 

 

 

Shareholders’  equity

 

39,348 

 

 

 

 

 

35,994

 

 

 

 

 

Total  liabilities and shareholders’ equity

$

677,822 

 

 

 

 

$

560,479 

 

 

 

 

Net  interest spread

 

 

 

 

 

2.59%

 

 

 

 

 

2.67%

Net  interest income (tax equivalent) / margin

 

 

$

14,081 

 

2.88%

 

 

$

12,409 

 

3.09%

Less:   tax-equivalent adjustment (2)

 

 

 

66 

 

 

 

 

 

52 

 

 

Net  interest income

 

 

$

14,015 

 

 

 

 

$

12,357 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

     (1) Annualized for the nine month period.

     (2) The tax-equivalent adjustment to net interest income adjusts the yield  for assets earning tax-exempt income to a comparable yield on 

a taxable basis.

 

 

Our net interest spread was 2.59% forthe nine months ended September 30, 2008, compared to 2.67% for the nine monthsended September 30, 2007.  The net interest spread is the difference betweenthe yield we earn on our interest-earning assets and the rate we pay on ourinterest-bearing liabilities.  

 

The 8 basis point reduction in our netinterest spread resulted primarily from a lower spread on the $114.8 milliongrowth in average earning assets in the first nine months of 2008 compared tothe same period in 2007.  Of the $114.8 million in growth, $18.0 million, or 15.7%,occurred in investments and federal funds, while the remaining growth of $96.8million, or 84.3%, occurred in loans.  During the first nine months of 2008,our investments and federal funds yielded a combined weighted rated of 5.05%,while our loans yielded a weighted rate of 6.55%.  

 

The growth of $114.8 million in earningassets was funded primarily with $73.1 million in certificates of deposit and$30.9 million in borrowings.  For the nine months ended September 30, 2008, ourcertificates of deposit had a weighted rate of 4.38%, while our borrowings hada weighted rate of 4.05% for a combined weighted rate of 4.26%.

 

16

 
 

 

 

Since we funded 92.6% of the growth inearning assets with higher costing borrowings and certificates of deposit at acombined rate of 4.26% rather than with lower costing transaction accounts at arate of 1.70%, the additional earning assets and liabilities yielded a lowerthan historical net spread of 2.24%, causing the overall net interest spread todecline by 7 basis points.  The remaining 1 basis point reduction in theoverall net interest spread resulted from the immediate impact of loansrepricing in 2008.  During 2007 and the first nine months of 2008, managementdetermined that the bank had capital to support additional asset growth. Consequently, given the flat interest rate environment, both earnings and returnon equity could be increased with additional assets and liabilities even if thenet interest spreads were at less than historical levels. 

 

Our net interestmargin is calculated as net interest income divided by average interest-earningassets.  Our net interest margin, on a tax-equivalent basis, for the ninemonths ended September 30, 2008 was 2.88%, compared to 3.09% for the ninemonths ended September 30, 2007.  During the nine months ended September 30,2008, interest-earning assets averaged $652.2 million, compared to $537.4 millionin the nine months ended September 30, 2007.  Interest earning assets exceededinterest bearing liabilities by $51.2 million and $48.7 million for the ninemonth periods ended September 30, 2008 and 2007, respectively.  

 

Our loan yield decreased 104 basispoints for the nine months ended September 30, 2008, compared to the ninemonths ended September 30, 2007, as a result of the 325 basis point reductionin short-term rates in the past twelve months which had an immediate impact onour variable rate loans, which represented 42% of our total loans at September30, 2008.  Offsetting the decrease in our loan yield was an 86 basis pointdecrease in the cost of our interest-bearing deposits for the first nine monthsof 2008 compared to the same period in 2007.  The decrease in the rate oninterest-bearing deposits is due primarily to the 79 basis point decrease onthe cost of time deposits as their renewal rates have been lower than theiroriginal rates as a result of the decreases in market rates over the past ninemonths.  In addition, the cost of our transaction, savings and money marketaccounts has decreased as we have lowered the rates we offer on theseproducts.  The cost of our savings and money market accounts has decreased by 159basis points from September 30, 2007 while the rate on our transaction accountshas decreased 59 basis points in the same period.  The 67 basis point decreasein FHLB advances and related debt and the 152 basis point decrease in otherborrowed funds in the first nine months of 2008 compared to the same period in2007 resulted primarily from the impact of the 325 basis point decrease inshort-term market rates over the past twelve months.  As of September 30, 2008,approximately 12% of our FHLB advances had variable rates, while all of ourother borrowings had variable rates.

 

Net interest income, the largestcomponent of our income, was $14.0 million and $12.4 million for the ninemonths ended September 30, 2008 and 2007, respectively.  Of the $1.7 millionincrease in net interest income, approximately $2.4 million related to theimpact of higher average earning assets and interest-bearing liabilities in thenine months ended September 30, 2008 compared to the same period in 2007, whilelower spreads on the average balances reduced net interest income by $633,000.

 

Interest income for the nine monthsended September 30, 2008 was $30.7 million, consisting of $26.6 million onloans, $3.8 million on investments, and $238,000 on federal funds sold.  Interestincome for the nine months ended September 30, 2007 was $29.0 million,consisting of $25.3 million on loans, $3.2 million on investments, and $441,000on federal funds sold.  Interest on loans for the nine months ended September30, 2008 and 2007 represented 86.7% and 87.3%, respectively, of total interestincome, while income from investments and federal funds sold represented only 13.3%and 12.7%, respectively, of total interest income.  The high percentage ofinterest income from loans relates to our strategy to maintain a significantportion of our assets in higher earning loans compared to lower yieldinginvestments.  Average loans represented 83.2% and 83.0% of averageinterest-earning assets for the nine months ended September 30, 2008 and 2007,respectively.  Included in interest income on loans for the nine months ended September30, 2008 and 2007, was $583,000 and $525,000, respectively, related to the netamortization of loan fees and capitalized loan origination costs.

 

Interest expense for both nine monthperiods ended September 30, 2008 and 2007 was $16.7 million, consisting of $11.5million related to deposits and $5.2 million and $5.1 million, respectively, relatedto borrowings.  Interest expense on deposits for the nine months ended September30, 2008 and 2007 represented 68.9% and 69.4%, respectively, of total interestexpense, while interest expense on borrowings represented 31.1% and 30.6%,respectively, of total interest expense for the same periods.  During the ninemonths ended September 30, 2008, average interest-bearing deposits increased by$81.4 million, while FHLB and other borrowings increased $30.9 million comparedto the same period in 2007.  During the nine months ended September 30, 2008,we pledged additional collateral to the FHLB, allowing us to increase our FHLBborrowings.  Both the short-term borrowings from the FHLB and the sale ofsecurities under agreements to repurchase provide us with the opportunity toobtain low cost funding with various maturities similar to the maturities onour loans and investments. 

 

17

 
 

*Rate/VolumeAnalysis*

** **

Net interest income can be analyzed interms of the impact of changing interest rates and changing volume.  Thefollowing tables set forth the effect which the varying levels of interest-earningassets and interest-bearing liabilities and the applicable rates have had onchanges in net interest income for the periods presented.

 

 

**Three Months  Ended**

 

**September 30,  2008 vs. 2007**

** **

**September 30,  2007 vs. 2006**

 

**Increase  (Decrease) Due to**

 

**Increase  (Decrease) Due to**

 

**Volume**

** **

**Rate**

 

**Rate/Volume**

 

**Total**

 

**Volume**

** **

**Rate**

 

**Rate/****Volume**

 

**Total**

 

 

 

 

**(Dollars in  thousands)**

**Interest income**

** **

 

 

 

 

 

 

 

 

 

   Loans

$

1,631 

$

(1,719)

$

(289)

$

(377)

$

1,688 

$

114 

$

27 

$

1,829 

   Investment securities

 

185 

 

(8)

 

(1)

 

176 

 

266 

 

69 

 

24 

 

359 

   Federal funds sold

 

77 

 

(49)

 

(48)

 

(20)

 

(21)

 

(2)

 

- 

 

(23)

       Total interest income

 

1,893 

 

(1,776)

 

(338)

 

(221)

 

1,933 

 

181

 

51 

 

2,165 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**Interest  expense**

** **

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

   Deposits

 

1,285 

 

(1,347)

 

(423)

 

(485)

 

350 

 

535 

 

61 

 

946 

   FHLB advances

 

315 

 

(309)

 

(58)

 

(52)

 

460 

 

42 

 

19 

 

521 

   Other borrowings

 

(33)

 

(80)

 

9 

 

(104)

 

(57)

 

10 

 

(2)

 

(49)

       Total interest expense

 

1,567 

 

(1,736)

 

(472)

 

(641)

 

753 

 

587 

 

78 

 

1,418 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**Net  interest income**

**$**

326 

$

(40)

$

134 

$

420 

$

1,180 

$

(406)

$

(27)

$

747 

* *

** **

 

** Nine Months  Ended**

 

**September 30,  2008 vs. 2007**

** **

**September 30,  2007 vs. 2006**

 

**Increase  (Decrease) Due to**

 

**Increase  (Decrease) Due to**

 

**Volume**

** **

**Rate**

 

**Rate/Volume**

 

**Total**

 

**Volume**

** **

**Rate**

 

**Rate/****Volume**

 

**Total**

 

 

 

 

**(Dollars in  thousands)**

**Interest income**

** **

 

 

 

 

 

 

 

 

 

   Loans

$

5,207 

$

(3,198)

$

(694)

$

1,315 

$

4,176 

$

770 

$

159 

$

5,105 

   Investment securities

 

608 

 

1 

 

- 

 

609 

 

1,151 

 

169 

 

105 

 

1,425 

   Federal funds sold

 

102 

 

(248)

 

(57)

 

(203)

 

240 

 

4 

 

5 

 

249 

       Total interest income

 

5,917 

 

(3,445)

 

(751)

 

1,721 

 

5,567 

 

943 

 

269 

 

6,779 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**Interest  expense**

** **

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  Deposits

 

2,466 

 

(2,048)

 

(456)

 

(38)

 

2,324 

 

1,161 

 

351 

 

3,836 

   FHLB advances

 

1,045 

 

(589)

 

(149)

 

307 

 

1,246 

 

203 

 

92 

 

1,541 

   Other borrowings

 

(39)

 

(175)

 

8 

 

(206)

 

(483)

 

152 

 

(61)

 

(392)

       Total interest expense

 

3,472 

 

(2,812)

 

(597)

 

63 

 

3,087 

 

1516 

 

382 

 

4,985 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**Net  interest income**

**$**

2,445 

$

(633)

$

(154)

$

1,658 

$

2,480 

$

(573)

$

(113)

$

1,794 

 

*Provisionfor Loan Losses*             Wehave established an allowance for loan losses through a provision for loanlosses charged as an expense on our statement of income.  We review our loanportfolio periodically to evaluate our outstanding loans and to measure boththe performance of the portfolio and the adequacy of the allowance for loanlosses.  Please see the discussion below under “Balance Sheet Review -Provision and Allowance for Loan Losses” for a description of the factors weconsider in determining the amount of the provision we expense each period tomaintain this allowance.

 

18

 
 

 

*Three and nine monthsended September 30, 2008 and 2007*

 

*F*or the threemonths ended September 30, 2008 and 2007, we incurred a noncash expense relatedto the provision for loan losses of $650,000 and $450,000, respectively,bringing the allowance for loan losses to $6.5 million and $5.4 million,respectively.  The allowance represented 1.16% of gross loans at September 30,2008 and 1.13% of gross loans at September 30, 2007.  During the three monthsended September 30, 2008, we charged-off $621,000 of loans and recorded virtuallyno recoveries on loans previously charged-off.  During the three months ended September30, 2007, we charged off $297,000 of loans and recorded $1,000 of recoveries onloans previously charged-off.  The $621,000 and $296,000 net charge-offs duringthe third quarters of 2008 and 2007, respectively, represented an annualizedrate of 0.45% and 0.25% of the average outstanding loan portfolio for the threemonths ended September 30, 2008 and 2007, respectively. 

 

For the nine monthsended September 30, 2008, we incurred a noncash expense related to theprovision for loan losses of $2.0 million, bringing the allowance for loanlosses to $6.5 million, or 1.16% of gross loans, as of September 30, 2008.  The$2.0 million provision for the nine months ended September 30, 2008 relatedprimarily to the level of charge-offs that occurred during this period.  During the nine month period ended September 30, 2008, we charged-off $1.2million in loans and recorded $10,000 of recoveries on loans previouslycharged-off.  In comparison, for the nine months ended September 30, 2007, weadded $1.3 million to the provision for loan losses, resulting in an allowanceof $5.4 million at September 30, 2007. During the nine months ended September30, 2007, we charged-off $823,000 of loans and recorded $31,000 of recoverieson loans previously charged-off.

 

At September 30,2008, the allowance for loan losses represented 1.9 times the amount ofnon-performing loans.  As a result of this level of coverage on non-performingloans and our internal loan calculation, we determined that the provisions of $650,000and $2.0 million for the three and nine months ended September 30, 2008 wereadequate.

 

*Noninterest Income*

 

*            *The followingtable sets forth information related to our noninterest income. 

 

 

**Three months ended**

** **

**Nine months ended**

 

 

**September 30,**

** **

**September 30,**

 

 

**2008**

** **

**2007**

** **

**2008**

** **

**2007**

** **

** **

**(Dollars in thousands)**

Loan  fee income

$

38 

$

45 

**$**

126 

$

121 

Service  fees on deposit accounts

 

177 

 

111 

** **

468 

 

293 

Income  from bank owned life insurance

 

114 

 

96 

** **

312 

 

278 

Gain on sale of securities

 

7 

 

- 

** **

7 

 

- 

Loss on other than temporary impairment

 

(1,841)

 

- 

** **

(1,841)

 

- 

Real estate owned activity

 

(7)

 

(70)

** **

(58)

 

109 

Other  income

 

85 

 

65 

** **

245 

 

188 

   Total noninterest income (loss)

$

(1,427)

$

247

**$**

(741)

$

989 

** **

*Three months ended September30, 2008 and 2007*

** **

Noninterestincome for the three months ended September 30, 2008 was a loss of $1.4million, a decrease of 677.7% over noninterest income of $247,000 for the same periodof 2007.  The $1.7 million decrease in noninterest income is primarily relatedto a pre-tax impairment charge of $1.8 million on our FNMA preferred stock anda $7,000 decrease in loan fee income.  Partially offsetting these decreaseswere increases of $66,000 in service fees on deposit accounts, $18,000 inincome from bank owned life insurance, a $7,000 gain on sale of securities, $63,000in real estate owned activity and $20,000 in other income.  Excluding theimpairment charge, noninterest income for the third quarter 2008 was $414,000,a $167,000 increase, or 67.6%, compared to the same period in 2007.

 

Loanfee income consists primarily of late charge fees, fees from issuance ofletters of credit, and mortgage origination fees we receive on residentialloans funded and closed by a third party.  Loan fees were $38,000 and $45,000for the three months ended September 30, 2008 and 2007, respectively.  The $7,000decrease for the three months ended September 30, 2008 compared to the sameperiod in 2007 related primarily to a $4,000 decrease in late charge fees, a$2,000 decrease in fees received from the issuance of letters of credit, and a$2,000 decrease in mortgage origination fees.  Late charge fees were $26,000and $30,000 for the third quarter of 2008 and 2007, respectively, while incomerelated to amortization of fees on letters of credit was $11,000 and $13,000for the three months ended September 30, 2008 and 2007, respectively.  Mortgageorigination fees were $0 and $2,000 for the three months ended September 30,2008 and 2007, respectively.

 

19

 
 

 

 

Servicefees on deposit accounts consist primarily of service charges on our checking,money market, and savings accounts and the fee income received from clientnon-sufficient funds (“NSF”) transactions.   Deposit fees were $177,000 and $111,000for the three months ended September 30, 2008 and 2007, respectively.  The $66,000increase is primarily related to a $42,000 increase in NSF fees and a $24,000increase in other deposit related fees.  NSF fee income was $122,000 and $80,000for the three months ended September 30, 2008 and 2007, respectively,representing 68.5% of total service fees on deposits in the 2008 periodcompared to 71.5% of total service fees on deposits in the 2007 period. The significant increase in NSF fee income is due primarily toan increased effort to collect rather than waive NSF fees from our clients.  Servicecharges on deposit accounts were $43,000 and $19,000 for the three monthperiods ended September 30, 2008 and 2007, respectively.  The $24,000 increaseis due to the service charges on deposit accounts exceeding the interest earnedcredit on those same accounts as the rate earned on deposit balances hasdecreased with the decrease in short-term market rates.

 

We held $11.7 million of bankowned life insurance at the end of the third quarter of 2008.  Income derivedfrom this life insurance was $114,000 for the three months ended September 30,2008 compared to $96,000 for the three months ended September 30, 2007. 

 

         During the three months endedSeptember 30, 2008, we recorded a $7,000 gain on a Government sponsoredsecurity that was called.  In addition, we recorded an impairment charge of$1.8 million, pre-tax, on our FNMA preferred stock, which was determined tohave suffered an other-than-temporary impairment as a result of the Government’sdecision on September 7, 2008 to place the FNMA underconservatorship. 

 

             Real estate ownedactivity includes income and expenses from property held for sale and otherreal estate we own.  For the three months ended September 30, 2008, we had aloss on real estate owned activity of $7,000, a $63,000 increase from the sameperiod in 2007.  

 

Otherincome consisted primarily of fees received on debit card transactions, sale ofcustomer checks, wire transfers and courier fee income.  Other income was $85,000and $65,000 for the three months ended September 30, 2008 and 2007,respectively.  The $20,000 increase relates primarily to a $13,000 increase indebit card transaction fees.  Debit card transaction fees were $61,000 and $48,000for the three months ended September 30, 2008 and 2007, respectively, andrepresented 71.9% and 73.4% of total other income for the third quarters of 2008and 2007, respectively.  The corresponding transaction costs associated withdebit card transactions are included in noninterest data processing and relatedcosts.  The debit card transaction costs were $25,000 and $20,000 for the threemonths ended September 30, 2008 and 2007, respectively.  The net impact of thefees received and the related cost of the debit card transactions on earningsfor the three months ended September 30, 2008 and 2007 was $36,000 and $28,000,respectively.  

 

*Nine months ended September 30, 2008 and 2007*

 

Noninterestincome in the nine month period ended September 30, 2008 was a loss of $741,000,a decrease of 175.0% over noninterest income of $989,000 in the same period of2007.  The $1.7 million decrease in noninterest income is primarily related toa pre-tax $1.8 million impairment charge on FNMA preferred stock and $167,000in other real estate owned activity.  Partially offsetting these decreases wereincreases of $5,000 in loan fee income, $175,000 in service fees on depositaccounts, $34,000 in income from bank owned life insurance, $7,000 gain on saleof securities, and $57,000 in other income.  Excluding the impairment charge,noninterest income for the nine months ended September 30, 2008 was $1.1million, an $111,000, or 11.2%, increase compared to the same period in 2007.

 

Loan feeincome consists primarily of late charge fees, fees from issuance of letters ofcredit and mortgage origination fees we receive on residential loans funded andclosed by a third party.  Loan fees were $126,000 and $121,000 for the ninemonths ended September 30, 2008 and 2007, respectively.  The $5,000 increasefor the nine months ended September 30, 2008 compared to the same period in 2007related primarily to increases of $2,000 in late charge fees and $13,000 infees received from the issuance of letters of credit, partially offset by adecrease of $11,000 in mortgage origination fees.  Late charge fees were $78,000and $76,000 for the nine months ended September 30, 2008 and 2007, respectively,while income related to amortization of fees on letters of credit was $40,000and $27,000 for the first nine months of 2008 and 2007, respectively.    Mortgageorigination fees were $7,000 and $18,000 for the nine months ended September30, 2008 and 2007, respectively,

 

20

 
 

 

 

Servicefees on deposits were $468,000 and $293,000 for the nine months ended September30, 2008 and 2007, respectively.  While the number of client accounts continuesto grow, the $175,000 increase is primarily related to the amount of NSF feescollected in the first nine months of 2008 compared to the same period in 2007. NSF income increased $116,000 to $319,000 for the nine months ended September30, 2008 from $203,000 for the same period in 2007, representing 68.1% of totalservice fees on deposits in the 2008 period compared to 69.2% of total servicefees on deposits in the 2007 period.  The increase in NSF fee income is dueprimarily to an increased effort to collect rather than waive NSF fees from ourclients.  In addition, service charges on deposit accounts increased $69,000during the nine months ended September 30, 2008 to $127,000 from $58,000 forthe same period in 2007 due to the service charges on deposit accountsexceeding the interest earned credit.  The interest rate earned on depositaccounts has decreased in relation to short-term market rates.  Partiallyoffsetting the increase in NSF fees collected and service charges was an $8,000decrease in overdraft fees which were $13,000 for the nine months endedSeptember 30, 2008 compared to $22,000 for the same period in 2007.  

 

We held$11.7 million of bank owned life insurance at the end of the third quarter of2008.  Income derived from this life insurance was $312,000 for the nine monthsended September 30, 2008 compared to $278,000 in the nine months endedSeptember 30, 2007.  

 

Duringthe three months ended September 30, 2008, we recorded a $7,000 gain on a Governmentsponsored security that was called.  In addition, we recorded an impairmentcharge of $1.8 million, pre-tax, on our FNMA preferred stock, which wasdetermined to have suffered an other-than-temporary impairment as a result ofthe Government’s decision on September 7, 2008 toplace the FNMA under conservatorship. 

 

            Real estate ownedactivity includes income and expenses from property held for sale and otherreal estate we own.  For the nine months ended September 30, 2008, we had aloss on real estate owned activity of $58,000, a $167,000 decrease from thesame period in 2007.  For the nine months ended September 30, 2007, we hadincome from real estate activity of $109,000 which included a pre-tax gain of$319,000 on property held for sale.  In addition, we leased a portion of theproperty held for sale and collected monthly rent of approximately $19,000 inMarch 2007.  We also had income and expenses related to loans that weretransferred into other real estate owned.  Expenses on these properties exceededincome derived from the real estate by $247,000 for the nine months ended September30, 2007.

 

Otherincome consisted primarily of fees received on debit card transactions, sale ofcustomer checks, and wire transfers.  Other income was $245,000 and $188,000for the nine months ended September 30, 2008 and 2007, respectively.  The$57,000 increase relates primarily to a $40,000 increase in debit cardtransaction fees and an $11,000 increase in other fee income.  Debit cardtransaction fees were $170,000 and $130,000 for the nine months ended September30, 2008 and 2007, respectively and represented 69.4% of total other income forthe first nine months of 2008 and 2007.  The corresponding transaction costsassociated with debit card transactions are included in noninterest dataprocessing and related costs.  The debit card transaction costs were $69,000and $55,000 for the nine months ended September 30, 2008 and 2007, respectively. The net impact of the fees received and the related cost of the debit cardtransactions on earnings for the nine months ended September 30, 2008 and 2007was $101,000 and $75,000, respectively.  Other fee income, which includes ACHprocessing fees, was $25,000 and $14,000 for the nine months ended September30, 2008 and 2007, respectively.

 

*Noninterest expenses*

 

*           *Thefollowing table sets forth information related to our noninterest expenses. 

*            *

 

**Three months  ended**

 

**Nine months  ended**

 

 

**September 30,**

 

**September 30,**

 

 

**2008**

** **

**2007**

 

**2008**

** **

**2007**

 

 

**(Dollars in  thousands)**

 

 

 

 

 

 

 

 

 

Compensation and benefits

$

1,625

$

1,547

$

5,149 

$

4,479 

Professional fees

 

127

 

131

 

368 

 

416 

Marketing

 

154

 

139

 

450 

 

387 

Insurance      			

 

141

 

116

 

413 

 

328 

Occupancy

 

437

 

337

 

1,134 

 

1,081 

Data processing and related costs

 

347

 

310

 

1,012 

 

865 

Telephone     			

 

50

 

29

 

126 

 

97 

Other  			

 

159

 

176

 

560 

 

459 

  Total noninterest expenses

$

3,040

$

2,785

$

9,212 

$

8,112 

 

21

 
 

 

*Threemonths ended September30, 2008 and 2007*

 

Weincurred noninterest expenses of $3.0 million for the three months endedSeptember 30, 2008 compared to $2.8 million for the three months endedSeptember 30, 2007.  Average interest-earning assets increased 17.7% duringthis period, while noninterest expenses increased 9.2%.

 

Forthe three months ended September 30, 2008, compensation and benefits,occupancy, and data processing and related costs represented 79.2% of the totalnoninterest expense compared to 78.8% for the same period in 2007.  

 

*Ninemonths ended September 30, 2008 and 2007*

 

Weincurred noninterest expenses of $9.2 million for the nine months endedSeptember 30, 2008 compared to $8.1 million for the nine months ended September30, 2007.  Average interest-earning assets increased 21.4% during this period,while noninterest expenses increased 13.6%.

 

Forthe nine months ended September 30, 2008 and 2007 compensation and benefits,occupancy, and data processing and related costs represented 79.2% of the totalnoninterest expense.  

 

The following table sets forthinformation related to our compensation and benefits.  

 

 

 

**Three months  ended**

 

**Nine months  ended**

 

 

**September 30,**

 

**September 30,**

 

 

**2008**

** **

**2007**

 

**2008**

** **

**2007**

 

 

**(Dollars in  thousands)**

 

 

 

 

 

 

 

 

 

Base compensation

$

1,293 

$

1,055 

$

3,695 

 

3,023 

Incentive compensation

 

73 

 

276 

 

638 

 

759 

  Total compensation

 

1,366 

 

1,331 

 

4,333 

 

3,782 

Benefits         			

 

299 

 

254 

 

940 

 

813 

Capitalized loan origination costs

 

(40)

 

(38)

 

(124)

 

(116)

  Total compensation and benefits

$

1,625 

$

1,547 

$

5,149 

 

4,479 

 

*Threemonths ended September 30, 2008 and 2007*

 

Compensationand benefits expense was $1.6 million and $1.5 million for the three monthsended September 30, 2008 and 2007, respectively.   Compensation and benefitsrepresented 53.5% and 55.5% of our total noninterest expense for the threemonths ended September 30, 2008 and 2007, respectively.  The $78,000 increasein compensation and benefits in the third quarter of 2008 compared to the sameperiod in 2007 resulted from increases of $238,000 in base compensation and $45,000in benefits expense, partially offset by a $203,000 decrease in incentivecompensation and a $2,000 increase in loan origination compensation expense,which is required to be capitalized and amortized over the life of the loan asa reduction of loan interest income.  

 

The $238,000increase in base compensation expense related to the cost of 13 additionalemployees as well as annual salary increases.  Ten of the new employees werehired to staff and support our two additional branch office locations while theremaining three employees were hired to further enhance our credit review,finance and information technology departments.  Incentive compensationrepresented 4.5% and 17.8 % of total compensation and benefits for the threemonths ended September 30, 2008 and 2007, respectively.  The incentivecompensation expense recorded for the third quarters of 2008 and 2007represented an accrual of the estimated incentive compensation earned duringthe third quarter of the respective year.  The incentive compensation accrual wasreduced in the third quarter of 2008 when management determined that certaincorporate objectives affecting incentive compensation would not be achieved.  Benefitsexpense increased $45,000 in the third quarter of 2008 compared to the sameperiod in 2007.  Benefits expense represented 21.9% and 19.1% of the totalcompensation for the three months ended September 30, 2008 and 2007,respectively.

* *

22

 
 

 

*Ninemonths ended September 30, 2008 and 2007*

 

Compensationand benefits expense was $5.1 million and $4.5 million for the nine monthsended September 30, 2008 and 2007, respectively.   Compensation and benefitsrepresented 55.9% and 55.2% of our total noninterest expense for the ninemonths ended September 30, 2008 and 2007, respectively.  The $670,000 increasein compensation and benefits in the first nine months of 2008 compared to thesame period in 2007 resulted from increases of $672,000 in base compensationand $127,000 in benefits expense, partially offset by a $121,000 decrease in incentivecompensation and an $8,000 increase in loan origination compensation expense,which is required to be capitalized and amortized over the life of the loan asa reduction of loan interest income.  

 

The $672,000increase in base compensation expense related to the cost of 13 additionalemployees as well as annual salary increases.  Ten of the new employees werehired to staff and support our two additional branch office locations while theremaining three employees were hired to further enhance our credit review,finance and information technology departments.  Incentive compensationrepresented 12.4% and 16.9 % of total compensation and benefits for the ninemonths ended September 30, 2008 and 2007, respectively.  The incentivecompensation expense recorded for the first nine months of 2008 and 2007represented an accrual of the estimated incentive compensation earned duringthe first nine months of the respective year.  Benefits expense increased $127,000in the first nine months of 2008 compared to the same period in 2007.  Benefitsexpense represented 21.7% and 21.5% of the total compensation for the ninemonths ended September 30, 2008 and 2007, respectively.

 

Thefollowing tables set forth information related to our data processing andrelated costs.  

 

 

**Three months  ended**

 

**Nine months  ended**

 

 

**September 30,**

 

**September 30,**

 

 

**2008**

** **

**2007**

 

**2008**

** **

**2007**

 

 

**(Dollars in  thousands)**

 

 

 

 

 

 

 

 

 

Data processing costs

$

266 

$

227 

$

776 

$

623 

Debit card transaction expense

 

25 

 

20 

 

69 

 

55 

Courier expense

 

26 

 

29 

 

73 

 

83 

Other expenses

 

30 

 

34 

 

94 

 

104 

Total data  processing and related costs 

$

347 

$

310 

$

1,012 

$

865 

 

Dataprocessing and related costs were $347,000 and $310,000, an increase of $37,000,for the three months ended September 30, 2008 and 2007, respectively.   Duringthe first nine months of 2008 and the same period of 2007, our data processingand related costs were $1.0 million and $865,000, respectively, an increase of$147,000.

 

Duringthe three months ended September 30, 2008, our data processing costs for ourcore processing system were $266,000 compared to $227,000 for the three monthsended September 30, 2007.  We have contracted with an outside computer****servicecompany to provide our core data processing services.  Costs for our core dataprocessing services increased $39,000, or 17.2%, from $266,000 to $227,000 forthe three months ended September 30, 2008 compared to the same period in 2007. The increases in costs were caused by a higher number of loan and depositaccounts.  A significant portion of the fee charged by the third partyprocessor is directly related to the number of loan and deposit accounts andthe related number of transactions.  During the nine months ended September 30,2008 and 2007, data processing costs for our core processing system were $776,000and $623,000, respectively, an increase of $153,000, or 24.6%.

 

Wereceive income from debit card transactions performed by our clients.  Since weoutsource this service, we are charged related transaction expenses from ourmerchant service provider.  Debit card transaction expense was $25,000 and $20,000for the three months ended September 30, 2008 and 2007, respectively.  Duringthe first nine months of 2008 and 2007, debit card transaction expense was $69,000and $55,000, respectively.

 

Occupancyexpense represented 14.4% and 12.1% of total noninterest expense for the threemonths ended September 30, 2008 and 2007, respectively.  Occupancy expense forthe three months ended September 30, 2008 and 2007 was $437,000 and $337,000,respectively, an increase of $100,000.  The increase is primarily due to theincreased costs of depreciation and rent expense associated with our two newretail offices which opened in July 2008.  For the nine months ended September30, 2008, occupancy expense increased $53,000 to $1.1 million from the sameperiod ended September 30, 2007.  Occupancy expense represented 12.3% and 13.3%of total noninterest expense for the first nine months of 2008 and 2007,respectively.

 

23

 
 

 

Theremaining $40,000 increase in noninterest expense for the three month periodended September 30, 2008 compared to the same period in 2007 resulted primarilyfrom increases of $15,000 in marketing expenses, $25,000 in insurance, and $21,000in telephone expenses, partially offset by decreases of $4,000 in professionalfees and $17,000 in other noninterest expenses.  The increase in marketingexpenses relates primarily to our new Greenville and Columbia offices, as wellas expanding our market awareness in those areas while the $25,000 increase ininsurance costs is related to the growth in deposits and the FDIC depositinsurance assessment based on our deposit balances.  In addition, telephoneexpenses have increased with the addition of our two new offices and theadditional number of employees.  The decrease in professional fees is dueprimarily to the additional costs incurred during 2007 related to the namechange of our company while the decrease in other noninterest expenses relatesprimarily to a reduction in collection expenses compared to the same period in2007.

 

Forthe nine month period ended September 30, 2008, remaining noninterest expensesincreased $230,000 from the same period in 2007.  Of this amount, marketingexpenses represented $63,000 of the increase, $85,000 was related to insurance,$29,000 related to telephone expenses and other expenses represented $101,000of the increase.  Partially offsetting these increases was a $48,000 decreasein professional fees due to the additional costs incurred during 2007 relatedto the name change of our company.  The increase in marketing expenses relates primarilyto our new Greenville and Columbia offices, as well as expanding our marketawareness in those areas while the $85,000 increase in insurance costs isrelated to the growth in deposits and the FDIC deposit insurance assessment basedon our deposit balances.  In addition, telephone expenses have increased withthe addition of our two new offices and the additional number of employees.  Asignificant portion of the increase in other expenses is due to increased costsof postage and office supplies, business meals, education expenses and depositaccount losses. 

 

Werecorded an income tax benefit of $148,000 for the three months ended September30, 2008 compared to an expense of $478,000 during the same period in 2007.   Forthe nine months ended September 30, 2008, income tax expense was $630,000compared to $1.3 million for the same period in 2007.  Our effective tax ratewas (54.0)% and 33.3%, respectively, for the three month periods ended September30, 2008 and 2007, respectively, and 29.8% and 32.4% for the nine month periodsended September 30, 2008and 2007, respectively.  

 

Theimpact of the loss on the other than temporary impairment and income fromtax-exempt municipal securities and bank owned life insurance resulted in thenegative tax rate for the three months ended September 30, 2008.  Below is atable reflecting the actual income tax expense (benefit) compared to the income(loss) before taxes and the proforma income, excluding the impairment charge,for the three and nine month periods ended September 30, 2008.  The decrease inthe effective tax rate, based on operating earnings, for the 2008 periodscompared to 2007 results primarily from the tax exempt income on additionalbank owned life insurance which we purchased in the third quarter of 2008.

 

 

**Three Months  Ended**

** **

**Nine Months  Ended**

 

**September 30,  2008**

** **

**September 30,  2008**

 

**Actual**

** **

**Proforma**

** **

**Actual**

** **

**Proforma**

 

**(Dollars  in thousands)**

 

 

 

 

 

 

 

 

Income (loss) before  taxes

 $

(274)

 

 

1,566 

 

 $

2,112 

 

 

3,952 

Income tax expense  (benefit)

 $

(148)

 

 

417 

 

 $

630 

 

 

1,195 

 

 

 

 

 

 

 

 

Effective tax rate

(54.0) %

 

26.6 %

 

29.8 %

 

30.2 %

 

                As aresult of the passage of the EESA, the bank’s ability to utilize the loss onthe FNMA preferred stock against ordinary income was considered in determiningthat the company did not need to establish a valuation allowance for thedeferred tax asset that was recorded in relation to the $1.8 million impairmentcharge.

** **

** **

**BalanceSheet Review**

 

*General*

 

*           *At September 30, 2008, we hadtotal assets of $696.6 million, consisting principally of $554.8 million inloans, $90.0 million in investments, $12.0 million in federal funds sold, and$9.2 million in cash and due from banks, and $11.7 in bank owned life insurance. Our liabilities at September 30, 2008 totaled $658.9 million, which consistedprincipally of $477.8 million in deposits, $161.7 million in FHLB advances andrelated debt, and $13.4 million in junior subordinated debentures.  AtSeptember 30, 2008, our shareholders’ equity was $37.7 million.

 

24

  
 

 

 

At December 31, 2007, we hadtotal assets of $628.1 million, consisting principally of $503.1 million inloans, $87.5 million in investments, $9.3 million in federal funds sold, $7.7million in cash and due from banks and $8.9 million in bank owned lifeinsurance.  Our liabilities at December 31, 2007 totaled $589.9 million,consisting principally of $412.8 million in deposits, $158.5 million in FHLBadvances, and $13.4 million of junior subordinated debentures.  At December 31, 2007, our shareholders’ equity was $38.3 million.

 

*FederalFunds Sold*

 

At September 30, 2008, our federal fundssold were $12.0 million, or 1.7% of total assets.  At December 31, 2007, our $9.3 million in federal funds sold on an overnight basis comprised 1.5% oftotal assets.  

* *

*Investments*

Contractual maturities and yields on ourinvestments that are available for sale and are held to maturity at September30, 2008 are shown in the following table.  Expected maturities may differ fromcontractual maturities because issuers may have the right to call or prepayobligations with or without call or prepayment penalties.  We had no securitieswith maturities less than one year at September 30, 2008.

 

** **

** **

**One to Five Years**

** **

**Five to Ten Years**

** **

**Over Ten Years**

** **

**Total**

** **

** **

**Amount**

**Yield**

** **

**Amount**

**Yield**

** **

**Amount**

**Yield**

** **

**Amount**

**Yield**

** **

** **

**(Dollars in thousands)**

** **

** **

** **

** **

** **

** **

** **

** **

** **

** **

** **

** **

** **

**Available  for Sale**

 

** **

** **

** **

** **

** **

** **

** **

** **

** **

** **

** **

Government  sponsored enterprises

$

- 

- 

$

11,989 

5.05 %

$

6,844 

5.06 %

$

18,832 

5.06 %

State and  political subdivisions

 

-

-

 

628

3.81 %

 

3,021 

3.79 %

 

3,649 

3.80 %

Mortgage-backed  securities

 

460

4.69 %

 

7,369 

4.87 %

 

38,219 

5.77 %			

 

46,048 

5.61 %

Preferred  stock

 

-

-

 

- 

- 

 

174 

8.44 %

 

174 

8.44 %

Total

$

460

4.69 %

$

19,986 

4.95 %

$

48,258 

5.55 %

$

68,703 

5.45 %

** **

** **

 

 

 

 

 

 

 

 

 

 

 

**Held to  Maturity**

** **

 

 

 

 

 

 

 

 

 

 

 

Mortgage-backed  securities

$

259

3.98 %

 

- 

- 

$

12,595 

4.64 %

$

12,854 

4.63%

 

 

            AtSeptember 30, 2008, our investments included securities issued by the FederalHome Loan Mortgage Corporation and Federal National Mortgage Association withcarrying values of $16.3 million, and $37.8 million, respectively.

 

The amortized costs and the fair value ofour investments at September 30, 2008 and December 31, 2007 are shown in thefollowing table.

 

* *

 

**September 30,  2008**

 

**December 31, 2007**

 

** **

**Amortized**

** **

**Fair**

** **

**Amortized**

** **

**Fair**

 

** **

**Cost**

** **

**Value**

** **

**Cost**

** **

**Value**

 

** **

**(Dollars in  thousands)**

**Available  for Sale**

** **

** **

Government sponsored enterprises

$

19,485 

$

18,832 

$

10,992 

$

11,078 

State and political subdivisions

 

3,791 

 

3,649 

 

3,793 

 

3,736 

Mortgage-backed  securities

 

49,037 

 

46,047 

 

47,061 

 

47,172 

Preferred stock

 

174 

 

174 

 

2,019 

 

2,024 

 Total

$

72,487 

$

68,703 

$

63,865 

$

64,010 

** **

 

 

 

 

 

 

 

 

**Held  to Maturity**

 

 

 

 

 

 

 

 

Mortgage-backed  securities

$

13,235 

$

12,994 

$

14,819 

$

14,573 

 

              Otherinvestments totaled $8.5 million at September 30, 2008 and consisted primarily ofFederal Home Loan Bank stock with a cost of $6.7 million, Federal Reserve Bankstock with a cost of $1.3 million, and investments in Greenville FirstStatutory Trust I and Trust II of $186,000 and $217,000, respectively.

 

25

 
 

At September 30,2008, we had $90.0 million in our investment securities portfolio whichrepresented approximately 12.9% of our total assets.  We held U.S. Governmentsponsored enterprise securities, municipal securities, and mortgage-backedsecurities with a fair value of $81.2 million and an amortized cost of $85.2 millionfor an unrealized loss of $4.0 million.  We believe, based on industry analystreports and credit ratings that the deterioration in value of these securities,except for our FNMA preferred stock for which we recorded an impairment chargeof $1.8 million in the third quarter 2008, is attributed to changes in marketinterest rates and not in the credit quality of the issuer and therefore, theselosses are not considered other-than-temporary.  We have the ability andintent to hold these securities until such time as the value recovers or thesecurities mature.

 

AtDecember 31, 2007, the $87.5 million in our investment securities portfoliorepresented approximately 13.9% of our total assets.  We held governmentsponsored enterprise securities, municipal securities, and mortgage-backedsecurities with a fair value of $78.6 million and an amortized cost of $78.7million for an unrealized loss of $101,000.  

 

Contractual maturities and yields on ouravailable for sale and held to maturity investments at December 31, 2007 areshown in the following table.  Expected maturities may differ from contractualmaturities because issuers may have the right to call or prepay obligationswith or without call or prepayment penalties.  At December 31, 2007, we had nosecurities with a maturity of less than one year.

 

** **

** **

**One to Five Years**

** **

**Five to Ten Years**

** **

**Over Ten Years**

** **

**Total**

** **

** **

**Amount**

** **

**Yield**

** **

**Amount**

** **

**Yield**

** **

**Amount**

** **

**Yield**

** **

**Amount**

** **

**Yield**

** **

** **

 

** **

** **

** **

** **

** **

** **

** **

** **

** **

** **

** **

** **

** **

** **

** **

** **

 

** **

** **

** **

**(Dollars in thousands)**

** **

** **

** **

** **

**Available  for Sale**

 

 

** **

** **

** **

** **

** **

** **

** **

** **

** **

** **

** **

** **

** **

** **

Government  sponsored enterprises

$

- 

 

- 

$

11,078 

 

5.71% 

$

- 

 

- 

$

11,078 

 

5.71 %

State and  political subdivisions

 

-

 

-

 

-

 

-

 

3,736 

 

3.79 %

 

3,736 

 

3.79 %

Mortgage-backed  securities

 

531 

 

4.56 %

 

8,739 

 

4.78 %

 

37,902 

 

5.87 %

 

47,172 

 

5.66 %

Preferred  stock

 

- 

 

- 

 

- 

 

- 

 

2,024 

 

7.88 %

 

2,024 

 

7.88 %

Total

$

531 

 

4.56 %

$

19,817 

 

5.30 %

$

43,662 

 

5.79 %

$

64,010 

 

5.63 %

** **

** **

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**Held to  Maturity**

** **

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Mortgage-backed  securities

$

- 

 

- 

$

333 

 

3.93 %

$

14,486 

 

4.66 %

$

14,819 

 

4.64 %

 

At December 31, 2007, our investmentsincluded securities issued by the Federal National Mortgage Association andFederal Home Loan Mortgage Corporation with carrying values of $37.6 millionand $16.2 million, respectively.

 

Other investments totaled $8.7 millionat December 31, 2007 and consistedof Federal Reserve Bank stock with a cost of $1.0 million, investments inGreenville First Statutory Trust I and II of $186,000 and $217,000,respectively, and Federal Home Loan Bank stock with a cost of $7.2 million.

 

*Loans*

 

*           *Since loans typically provide higherinterest yields than other types of interest earning assets, a substantialpercentage of our earning assets are invested in our loan portfolio.  For thenine months ended September 30, 2008 and 2007, average loans were $542.7million and $445.9 million, respectively.  Before the allowance for loanlosses, total loans outstanding at September 30, 2008 were $561.3 million. Average loans for the year ended December 31, 2007 were $459.2 million.  Before the allowance for loan losses, total loans outstanding at December 31, 2007were $508.9 million.

 

The principal component of our loanportfolio is loans secured by real estate mortgages.    Most of our real estateloans are secured by residential or commercial property.  We do not generallyoriginate traditional long term residential mortgages, but we do issuetraditional second mortgage residential real estate loans and home equity linesof credit.  We obtain a security interest in real estate whenever possible, inaddition to any other available collateral.  This collateral is taken toincrease the likelihood of the ultimate repayment of the loan.  Generally, welimit the loan-to-value ratio on loans we make to 80%.  Due to the short timeour portfolio has existed, the current mix may not be indicative of the ongoingportfolio mix.  We attempt to maintain a relatively diversified real estate loanportfolio to help reduce the risk inherent in concentration in certain types ofcollateral.

 

26

 
 

 

The following table summarizes thecomposition of our loan portfolio at September 30, 2008 and December 31, 2007.

** **

 

** **

**September 30,  2008**

** **

**December 31,  2007**

 

** **

**Amount**

** **

**% of Total**

** **

**Amount**

** **

**% of Total**

 

 

**(Dollars in  thousands)**

Real  estate:

 

** **

 Commercial:

 

 

 

 

 

 

 

 

Owner occupied

$

111,947 

 

20.0 %

$

114,168 

 

22.4 %

Non-owner occupied

 

150,338 

 

26.8 %

 

147,478 

 

29.0 %

Construction

 

54,210 

 

9.6 %

 

38,464 

 

7.6 %

Total commercial real estate

 

316,495 

 

56.4 %

 

300,110 

 

59.0 %

Consumer:

 

 

 

 

 

 

 

 

Residential

 

59,823 

 

10.7 %

 

59,815 

 

11.7 %

Home equity

 

58,700 

 

10.4 %

 

46,806 

 

9.2 %

Construction

 

8,658 

 

1.5 %

 

7,154 

 

1.4 %

Total consumer real estate

 

127,181 

** **

22.6 %

 

113,775 

 

22.3 %

 

 

 

** **

 

 

 

 

 

Total real estate

 

443,676 

** **

79.0 %

 

413,885 

 

81.3 %

 

 

 

 

 

 

 

 

 

Commercial  business

 

106,929 

 

19.1 %

 

86,863 

 

17.1 %

Consumer-other

 

11,648 

 

2.1 %

 

9,051 

 

1.8 %

Deferred  origination fees, net

 

(979)

 

(0.2)%

 

(949)

 

(0.2)%

       Total gross loans, net of

 

 

 

 

 

 

 

           deferred fees

 

561,274 

 

100.0 %

 

508,850 

 

100.0 %

Less—allowance  for loan losses

 

(6,492)

 

 

 

(5,751)

 

 

   Total loans, net

$

554,782 

 

 

$

503,099 

 

 

 

*Maturities and Sensitivity ofLoans to Changes in Interest Rates*

The information in the following tablesis based on the contractual maturities of individual loans, including loanswhich may be subject to renewal at their contractual maturity.  Renewal of suchloans is subject to review and credit approval, as well as modification ofterms upon maturity.  Actual repayments of loans may differ from the maturitiesreflected below because borrowers have the right to prepay obligations with orwithout prepayment penalties.

 

The followingtable summarizes the loan maturity distribution by type and related interestrate characteristics at September 30, 2008.

 

 

 

 

 

** **

** **

**After one but  within five years**

** **

** **

** **

** **

 
* *

 

**One year or less**

** **

**After five years**

** **

** **

 
 

 

 

** **

**Total**

 
 

 

 

 

**(Dollars in thousands)**

** **

 

 
 

 

 

 

 

 

 

 

 

 
Real  estate – mortgage

$

66,510 

$

247,822 

$

66,476 

$

380,808 

 
Real  estate – construction

 

32,704 

 

14,211 

 

15,953 

 

62,868 

 
   Total real estate

 

99,214 

 

262,033 

 

82,429 

 

443,676 

 
 

 

 

 

 

 

 

 

 

 
Commercial  business

 

55,756 

 

46,957 

 

4,216 

 

106,929 

 
Consumer-other

 

4,775 

 

6,208 

 

665 

 

11,648 

 
Deferred  origination fees, net

 

(316)

 

(483)

 

(180)

 

(979)

  Total gross  loans, net of   deferred fees 

$

159,429 

$

314,715 

$

87,130 

$

561,274 

 
 

 

 

 

 

 

 

 
Loans maturing after one year with:

 

 

 

 

 

 

 
Fixed interest rates

 

 

 

 

$

234,195 

 
Floating interest rates

 

 

 

 

$

167,650 

 
 

27

 
 

 

 

The following table summarizes the loanmaturity distribution by type and related interest rate characteristics at December 31, 2007.

 

 

 

 

 

** **

** **

**After one**

** **

** **

** **

** **

* *

 

**One year**

** **

**but within**

**After five**

** **

** **

 

 

**or less**

 

**five years**

**years**

** **

**Total**

 

**(Dollars in  thousands)**

 
 

 

 

 

 

 

 

 

 

 
Real  estate – mortgage

$

70,081 

$

251,978 

$

46,208 

$

368,267 

 
Real  estate – construction

 

17,418 

 

21,256 

 

6,944 

 

45,618 

 
   Total real estate

 

87,499 

 

273,234 

 

53,152 

 

413,885 

 
 

 

 

 

 

 

 

 

 

 
Commercial  business

 

48,659 

 

37,477 

 

727 

 

86,863 

 
Consumer  – other

 

4,568 

 

3,973 

 

510 

 

9,051 

 
Deferred  origination fees, net

 

(258)

 

(577)

 

(114)

 

(949)

 
  Total gross  loans, net of   deferred fees

$

140,468 

$

314,107 

$

54,275 

$

508,850 

 
Loans maturing  after one year with:

 

 

 

 

 

 

 
Fixed interest rates

 

 

 

 

$

229,060 

 
Floating interest rates

 

 

 

 

$

139,322 

 
 

*Provision and Allowance for LoanLosses*

** **

We have established an allowance forloan losses through a provision for loan losses charged to expense on ourstatement of income.  The allowance for loan losses represents an amount whichwe believe will be adequate to absorb probable losses on existing loans thatmay become uncollectible.  Our judgment as to the adequacy of the allowance forloan losses is based on a number of assumptions about future events, which webelieve to be reasonable, but which may or may not prove to be accurate.  Ourdetermination of the allowance for loan losses is based on evaluations of the collectabilityof loans, including consideration of factors such as the balance of impairedloans, the quality, mix, and size ofour overall loan portfolio, economic conditions that may affect the borrower’sability to repay the loan, the amount and quality of collateral securing theloans, our historical loan loss experience, and a review of specific problemloans.  We also consider subjective issues such as changes in the lendingpolicies and procedures, changes in the local/national economy, changes involume or type of credits, changes in volume/severity of problem loans, qualityof loan review and board of director oversight, concentrations of credit, andpeer group comparisons.  Due to our limited operating history, the provisionfor loan losses has been made primarily as a result of our assessment ofgeneral loan loss risk compared to banks of similar size and maturity.  Due tothe rapid growth of our bank over the past several years and our shortoperating history, a large portion of the loans in our loan portfolio and ofour lending relationships are of relatively recent origin.  In general, loansdo not begin to show signs of credit deterioration or default until they havebeen outstanding for some period of time, a process known as seasoning.  As aresult, a portfolio of older loans will usually behave more predictably than anewer portfolio.  Because our loan portfolio is relatively new, the currentlevel of delinquencies and defaults may not be representative of the level thatwill prevail when the portfolio becomes more seasoned, which may be higher thancurrent levels.  If delinquencies and defaults increase, we may be required toincrease our provision for loan losses, which would adversely affect ourresults of operations and financial condition.  Periodically, we adjust theamount of the allowance based on changing circumstances.  We charge recognizedlosses to the allowance and add subsequent recoveries back to the allowance forloan losses.  There can be no assurance that charge-offs of loans in futureperiods will not exceed the allowance for loan losses as estimated at any pointin time or that provisions for loan losses will not be significant to aparticular accounting period.  

 

28

 
 

 

 

The following table summarizes theactivity related to our allowance for loan losses for the nine months ended September30, 2008 and 2007:

 

 

 

**September 30,**

 

 

**2008**

** **

**2007**

 

 

**(Dollars in  thousands)**

 

 

 

 

Balance,  beginning of period

$

5,751 

$

4,949 

 

 

 

 

 

Loans  charged-off

 

(1,219)

 

(823)

 

 

 

 

 

Recoveries  of loans previously charged-off

 

10 

 

31 

 

 

 

 

 

Net  loans (charged-off) recovery

$

(1,209)

$

(792)

 

 

 

 

 

Provision  for loan losses

 

1,950 

 

1,290 

 

 

 

 

 

Balance,  end of period

$

6,492 

$

5,447 

** **

 

 

 

 

Allowance  for loan losses to gross loans

 

1.16%     			

 

1.13%     			

 

 

 

 

 

Net  charge-offs to average loans

 

0.30%

 

0.24%

 

We do not allocate the allowance forloan losses to specific categories of loans.  Instead, we evaluate the adequacyof the allowance for loan losses on an overall portfolio basis utilizing ourcredit grading system which we apply to each loan.  We have retained anindependent consultant to review the loan files on a test basis to confirm ourinternal grading of our loans.

*NonperformingAssets*

*           *The followingtable shows the nonperforming assets, percentages of total assets, and therelated percentage of allowance for loan losses for the nine months ended September30, 2008 and the year ended December 31, 2007.  

 

 

 

**September 30,**

** **

**December  31,**

 

 

**2008**

** **

**2007**

 

 

**(Dollars  in thousands)**

 

 

 

 

 

Loans  over 90 days past due (1)

$

2,654 

$

4,382 

 

 

 

 

 

Loans  on nonaccrual:

 

 

 

 

Mortgage

 

2,754 

 

4,316 

Commercial

 

658 

 

75 

Consumer

 

31 

 

45 

Total nonaccrual loans

 

3,443 

 

4,436 

 

 

 

 

 

Troubled  debt restructuring

 

- 

 

- 

** **

 

 

 

 

Total of nonperforming loans

 

3,443 

 

4,436 

 

 

 

 

 

Other  nonperforming assets

 

2,061 

 

268 

 

 

 

 

 

Total nonperforming assets

$

5,504 

$

4,704 

 

 

 

 

 

 Percentage  of total assets

 

0.79  %

 

0.75 %

 

 

 

 

 

 Percentage  of nonperforming loans 

 

 

 

 

     and  assets to gross loans

 

0.98  %

 

0.92 %

** **

 

 

 

 

(1)     All loans over90 days past due are on and included in loans on nonaccrual.

 

29

 
****
 

 

 

                Theallowance for loan losses was $6.5 million and $5.8 million at September 30,2008 and December 31, 2007, respectively or 1.16% and 1.13% of outstandingloans, respectively.  During the year ended December 31, 2007, we had netcharged-off loans of $1.3 million.  During the nine months ended September 30,2008 and 2007 we had net charge-offs of $1.2 million and $792,000, respectively. 

 

At September30, 2008 and December 31, 2007, nonaccrual loans represented 0.61% and 0.87% oftotal loans, respectively.  At September 30, 2008 and December 31, 2007, we had$3.4 million and $4.4 million of loans, respectively, on nonaccrual status.  Generally, a loan is placed on nonaccrual status when it becomes 90 days pastdue as to principal or interest, or when we believe, after considering economicand business conditions and collection efforts, that the borrower’s financialcondition is such that collection of the loan is doubtful.  A payment ofinterest on a loan that is classified as nonaccrual is recognized as incomewhen received**.**

 

Other nonperforming assets, whichincludes real estate acquired through foreclosure, was $2.1 million and$268,000 at September 30, 2008 and December 31, 2007, respectively.  AtSeptember 30, 2008, other nonperforming assets consisted of three properties,two of which are residential properties valued at $158,000 and $11,000,respectively.  The third property is commercial real estate valued at $1.9million.  We believe that these properties are appropriately valued at thelower of cost or market as of September 30, 2008.  

 

The amount of foregone interest incomeon the nonaccrual loans in the first nine months of 2008 was approximately $226,000.  The amount of interest income recorded in the first nine months of 2008 for loansthat were on nonaccrual at September 30, 2008 was approximately $57,000.

 

At September 30, 2008, impaired loansamounted to approximately $13,000 for which a $13,000 reserve was allocated inthe allowance.

 

*Depositsand Other Interest-Bearing Liabilities*

 

*           *Our primary source of funds for loansand investments is our deposits, advances from the FHLB, and short-termrepurchase agreements.  National and local market trends over the past severalyears suggest that consumers have moved an increasing percentage ofdiscretionary savings funds into investments such as annuities, stocks, andfixed income mutual funds.  Accordingly, it has become more difficult to attractdeposits.  We have chosen to obtain a portion of our certificates of depositsfrom areas outside of our market.  The deposits obtained outside of our marketarea generally have comparable rates compared to rates being offered forcertificates of deposits in our local market.  We also utilize out-of-marketdeposits in certain instances to obtain longer-term deposits than are readilyavailable in our local market.  The amount of out-of-market deposits was $155.3million at December 31, 2007 and $192.6 million at September 30, 2008. 

 

Core deposits, which excludeout-of-market deposits and time deposits of $100,000 or more, provide arelatively stable funding source for our loan portfolio and other earningassets.  Our core deposits were $214.8 million and $196.0 million at September30, 2008 and December 31, 2007, respectively.  Although core deposits do notinclude deposits obtained out-of-market, we believe the $192.6 million ofout-of-market funds to be a stable source of funding.  Except for the event ofdeath, these deposits do not have the ability to prepay.

 

We anticipate being able to either renewor replace these out-of-market deposits when they mature, although we may notbe able to replace them with deposits with the same terms or rates.  Ourloan-to-deposit ratio was 117% and 123% at September 30, 2008 and December 31,2007, respectively.  

 

30

 
 

The following table shows the averagebalance amounts and the average rates paid on deposits held by us for the nine monthsended September 30, 2008 and 2007.  

** **

* *

** **

** **

**2008**

** **

**2007**

* *

** **

** **

**Amount**

** **

**Rate**

** **

**Amount**

** **

**Rate**

 

 

**(Dollars in  thousands)**

 
 

 

 

 

 

 

 

 

 

 
Noninterest  bearing demand deposits

$

32,369 

 

- %

$

31,023 

 

- %

 
Interest  bearing demand deposits

 

39,135 

 

1.08 %

 

34,327 

 

1.68 %

 
Money  market accounts

 

   88,284 

 

2.01 %

 

84,014 

 

3.59 %

 
Savings  accounts

 

1,841 

 

0.35 %

 

1,509 

 

0.68 %

 
Time  deposits less than $100,000

 

47,770 

 

4.05 %

 

44,526 

 

5.03 %

 
Time  deposits $100,000 or greater

 

252,603 

 

4.44 %

 

178,958 

 

5.21 %

 
    Total deposits

$

462,002 

 

3.32 %

$

379,299 

 

4.05 %

 
 

The increase in time deposits of$100,000 or more for the nine months ended September 30, 2008 compared to the2007 period resulted primarily from a $47.2 million increase in wholesaledeposits.  

 

All of our time deposits arecertificates of deposits.  The maturity distribution of our time deposits of$100,000 or more at September 30, 2008 was as follows: 

 

 

** **

**September 30, 2008**

 

 

**(Dollars in  thousands)**

Three months or less

$

58,650 

Over three through six months

 

69,484 

Over six  through twelve months

 

48,902 

Over twelve months

 

84,158 

   Total

$

261,194 

 

Another aspect of the EESA (in addition to the CapitalPurchase Plan described above) which became effective on October 3, 2008 is atemporary increase of the basic limit on federal deposit insurance coveragefrom $100,000 to $250,000 per depositor.  The basic deposit insurance limitwill return to $100,000 after December 31, 2009.  At September 30, 2008 the bankhad time deposits of $100,000 or more of $261.2 million.  Approximately $213.4 millionor 81.7% of these deposits would be covered under the new FDIC insurance coverage. An additional $900,000 or 0.34% of these deposits, are to local public entitiesthat are required to have securities as collateral.  

 

                In addition, our bank anticipates participatingin the FDIC's Temporary Liquidity Guarantee Program which was announced October14, 2008 as part of EESA.  This guarantee applies to the following:

 

             •           Funds in non-interest-bearingtransaction deposit accounts (up to $500 billion) held byFDIC-insured banks until December 31, 2009.

 

                All FDIC institutions are covered untilDecember 5, 2008 at no cost.  After this initial period expires, theinstitution must opt out if it no longer wishes to participate in the program;otherwise, it will be assessed for future participation. There will be a75-basis point fee to protect new debt issues and an additional 10-basis pointfee to fully cover non-interest bearing deposit transaction accounts.

** **

31

 
 

 

 

**CapitalResources**

 

**           **Totalshareholders’ equity at September 30, 2008 was $37.7 million.  At December 31, 2007, total shareholders’ equity was $38.3 million.  The decrease during thefirst nine months of 2008 resulted primarily from the $2.6 million netunrealized holding loss on securities, partially offset by the $1.5 million ofnet income earned, which includes the $1.2 million impairment charge on ourFNMA preferred stock, and $429,000 of exercised stock options and warrants.

 

Thefollowing table shows the return on average assets (net income divided byaverage total assets), return on average equity (annualized net income dividedby average equity), and equity to assets ratio (average equity divided byaverage total assets) for the nine months ended September 30, 2008 and the yearended December 31, 2007.  Since our inception, we have not paid any cashdividends.

 

 

**September 30,  2008**

**December 31,  2007**

Return  on average assets

0.29 %

0.60 %

Return  on average equity

5.02 %

9.40 %

Average  equity to average assets ratio

5.81 %

6.35 %

 

Our return onaverage assets was 0.29% for the nine months ended September 30, 2008, adecrease from 0.60% for the year ended December 31, 2007.  In addition, ourreturn on average equity decreased to 5.02% from 9.40% for the nine monthsended September 30, 2008 and the year ended December 31, 2007, respectively. The decrease in the equity to assets ratio is a function of the $83.5 millionincrease in average assets compared to the $3.1 million increase in averageequity.

 

Under the capital adequacyguidelines, regulatory capital is classified into two tiers.  These guidelinesrequire an institution to maintain a certain level of Tier 1 and Tier 2 capitalto risk-weighted assets.  Tier 1 capital consists of common shareholders’equity, and a limited amount of qualifying preferred stock, reduced by theunrealized gain or loss on securities available for sale and certain intangibleassets.  In determining the amount of risk-weighted assets, all assets,including certain off-balance sheet assets, are multiplied by a risk-weightfactor of 0% to 100% based on the risks believed to be inherent in the type ofasset.  Tier 2 capital consists of Tier 1 capital plus the general reserve forloan losses, subject to certain limitations, and preferred stock that did notqualify as Tier 1 capital.  We are also required to maintain capital at aminimum level based on total average assets, which is known as the Tier 1leverage ratio.

 

             At both theholding company and bank level, we are subject to various regulatory capitalrequirements administered by the federal banking agencies.  To be considered“adequately capitalized” under these capital guidelines, we must maintain aminimum total risk-based capital of 8%, with at least 4% being Tier 1 capital. In addition, we must maintain a minimum Tier 1 leverage ratio of at least 4%. To be considered “well-capitalized,” we must maintain total risk-based capitalof at least 10%, Tier 1 capital of at least 6%, and a leverage ratio of atleast 5%.  

 

             Thefollowing table sets forth the holding company’s and the bank’s various capitalratios at September 30, 2008 and at December 31, 2007.  For all periods, thebank was considered “well capitalized” and the holding company met or exceededits applicable regulatory capital requirements.

 

 

**September  30, 2008**

** **

**December  31, 2007**

 

**Holding**

** **

** **

** **

**Holding**

** **

** **

 

**Company**

** **

**Bank**

** **

**Company**

** **

**Bank**

 

 

 

 

 

 

 

 

Total risk-based capital

10.3 %

 

12.3 %

 

11.1 %

 

12.4 %

Tier 1 risk-based capital

9.2 %

 

11.2  %

 

10.0  %

 

11.3 %

Leverage  capital

7.7 %

 

9.4 %

 

8.3 %

 

9.5 %

** **

** **

32

 
 

**Effect ofInflation and Changing Prices**

 

             The effect ofrelative purchasing power over time due to inflation has not been taken intoaccount in our consolidated financial statements.  Rather, our financialstatements have been prepared on an historical cost basis in accordance withgenerally accepted accounting principles.

 

 Unlike most industrial companies, ourassets and liabilities are primarily monetary in nature.  Therefore, the effectof changes in interest rates will have a more significant impact on ourperformance than will the effect of changing prices and inflation in general. In addition, interest rates may generally increase as the rate of inflationincreases, although not necessarily in the same magnitude.  As discussedpreviously, we seek to manage the relationships between interest sensitiveassets and liabilities in order to protect against wide rate fluctuations,including those resulting from inflation.

 

**Off-BalanceSheet Risk**

 

             Commitments to extendcredit are agreements to lend money to a client as long as the client has notviolated any material condition established in the contract.  Commitmentsgenerally have fixed expiration dates or other termination clauses and mayrequire the payment of a fee.  At September 30, 2008, unfunded commitments toextend credit were $96.1 million, of which $17.7 million was at fixed rates and$78.4 million was at variable rates.  At December 31, 2007, unfundedcommitments to extend credit were $104.5 million, of which approximately $65.0million was at fixed rates and $39.5 million was at variable rates.  Asignificant portion of the unfunded commitments related to consumer equitylines of credit.  Based on historical experience, we anticipate that asignificant portion of these lines of credit will not be funded.  We evaluateeach client’s credit worthiness on a case-by-case basis.  The amount of collateralobtained, if deemed necessary by us upon extension of credit, is based on ourcredit evaluation of the borrower.  The type of collateral varies but mayinclude accounts receivable, inventory, property, plant and equipment, andcommercial and residential real estate.

 

At September 30, 2008 and December 31,2007, there was a $4.0 million and $2.8 million commitment under letters ofcredit, respectively.  The credit risk and collateral involved in issuingletters of credit is essentially the same as that involved in extending loanfacilities to customers.  Since most of the letters of credit are expected toexpire without being drawn upon, they do not necessarily represent future cashrequirements.

 

Except as disclosed in this document, weare not involved in off-balance sheet contractual relationships, unconsolidatedrelated entities that have off-balance sheet arrangements or transactions thatcould result in liquidity needs or other commitments that significantly impactearnings.

** **

**Market Risk**

 

**           **Market risk isthe risk of loss from adverse changes in market prices and rates, whichprincipally arises from interest rate risk inherent in our lending, investing,deposit gathering, and borrowing activities.  Other types of market risks, suchas foreign currency exchange rate risk and commodity price risk, do notgenerally arise in the normal course of our business.  Our asset/liabilitymanagement committee (“ALCO”) monitors and considers methods of managingexposure to interest rate risk.  We have both an internal ALCO consisting of executive management that meets at various times during each month and a board ALCO that meets monthly.  The ALCOs are responsible for maintaining the levelof interest rate sensitivity of our interest sensitive assets and liabilitieswithin board-approved limits.

 

We actively monitor and manage ourinterest rate risk exposure principally by measuring our interest sensitivity“gap,” which is the positive or negative dollar difference between assets andliabilities that are subject to interest rate repricing within a given periodof time.  Interest rate sensitivity can be managed by repricing assets orliabilities, selling securities available for sale, replacing an asset orliability at maturity, or adjusting the interest rate during the life of anasset or liability.  Managing the amount of assets and liabilities repricing inthis same time interval helps to hedge the risk and minimize the impact on netinterest income of rising or falling interest rates.  We generally would benefitfrom increasing market rates of interest when we have an asset-sensitive gapposition and generally would benefit from decreasing market rates of interestwhen we are liability-sensitive.

 

33

 
 

 

 

We were liability sensitive during theyear ended December 31, 2007 and through the nine months ended September  30,2008.  Our variable rate loans and a majority of our deposits reprice overa 12-month period.  Approximately 40% and 39% of our loans were variable rateloans at September 30, 2008 and December 31, 2007, respectively.  The ratio ofcumulative gap to total earning assets after 12 months is (24.5%) because$161.0 million more liabilities will reprice in a 12 month period than assets. However, our gap analysis is not a precise indicator of our interest sensitivityposition.  The analysis presentsonly a static view of the timing of maturities and repricing opportunities,without taking into consideration that changes in interest rates do not affectall assets and liabilities equally.  For example, rates paid on a substantialportion of core deposits may change contractually within a relatively shorttime frame, but those rates are viewed by us as significantly lessinterest-sensitive than market-based rates such as those paid on noncoredeposits.  Net interest income may be affected by other significant factors ina given interest rate environment, including changes in the volume and mix ofinterest-earning assets and interest-bearing liabilities.

 

**Liquidity andInterest Rate Sensitivity**

 

             Liquidityrepresents the ability of a company to convert assets into cash or cashequivalents without significant loss, and the ability to raise additional fundsby increasing liabilities.  Liquidity management involves monitoring oursources and uses of funds in order to meet our day-to-day cash flowrequirements while maximizing profits.  Liquidity management is made morecomplicated because different balance sheet components are subject to varyingdegrees of management control.  For example, the timing of maturities of our investmentportfolio is fairly predictable and subject to a high degree of control at thetime investment decisions are made.  However, net deposit inflows and outflowsare far less predictable and are not subject to the same degree of control.

 

             AtSeptember 30, 2008, our liquid assets, consisting of cash and due from banksand federal funds sold, amounted to $21.2 million, or 3.0%, of total assets.  Ourinvestment securities at September 30, 2008 amounted to $90.0 million, or 12.9%of total assets.  Investment securities traditionally provide a secondarysource of liquidity since they can be converted into cash in a timely manner. However, $68.0 million of these securities are pledged against outstandingdebt.  Therefore, the related debt would need to be repaid prior to thesecurities being sold in order for these securities to be converted to cash. At December 31, 2007, our liquid assets amounted to $17.0 million, or 2.7% oftotal assets.  Our investment securities at December 31, 2007 amounted to $87.5million, or 13.9% of total assets.  However, substantially all of thesesecurities were pledged against outstanding debt.  

 

Our ability to maintain and expand ourdeposit base and borrowing capabilities serves as our primary source ofliquidity.  We plan to meet our future cash needs through the liquidation oftemporary investments, the generation of deposits, and from additionalborrowings.  In addition, we will receive cash upon the maturity and sale ofloans and the maturity of investment securities.  We maintain four federalfunds purchased lines of credit with correspondent banks totaling $43.8 millionfor which there were no borrowings against the lines at September 30, 2008.  Weare also a member of the Federal Home Loan Bank of Atlanta (FHLB), from whichapplications for borrowings can be made for leverage purposes.  The FHLBrequires that securities, qualifying mortgage loans, and stock of the FHLBowned by the bank be pledged to secure any advances from the FHLB.  The unusedborrowing capacity currently available from the FHLB at September 30, 2008 was$10.6 million, based on the bank’s $6.7 million investment in FHLB stock, aswell as qualifying mortgages available to secure any future borrowings.  Thecompany also has a $15.0 million revolving line of credit with another bank forwhich $3.0 million was unused at September 30, 2008.

 

            On September 20, 2005, we signed aten-year, five-month lease on our new headquarters and main office.  The leaseprovides for annual lease rate escalations based on cost of livingadjustments.  

 

We believe that our existing stable baseof core deposits, borrowings from the FHLB, and short-term repurchaseagreements will enable us to successfully meet our long-term liquidity needs.

** **

Asset/liability management is theprocess by which we monitor and control the mix and maturities of our assetsand liabilities. The essential purposes of asset/liability management are toensure adequate liquidity and to maintain an appropriate balance betweeninterest sensitive assets and liabilities in order to minimize potentiallyadverse impacts on earnings from changes in market interest rates.  We haveboth an internal ALCO consisting of executive management that meets at varioustimes during each month and a board ALCO that meets monthly.  The ALCOs areresponsible for maintaining the level of interest rate sensitivity of ourinterest sensitive assets and liabilities within board-approved limits.

 

The following table sets forthinformation regarding our rate sensitivity as of September 30, 2008 for each ofthe time intervals indicated. The information in the table may not beindicative of our rate sensitivity position at other points in time.  Inaddition, the maturity distribution indicated in the table may differ from thecontractual maturities of the earning assets and interest-bearing liabilitiespresented due to consideration of prepayment speeds under various interest ratechange scenarios in the application of the interest rate sensitivity methodsdescribed above. 

 

34

 
 

** **

 

 

 

 

**Within**

** **

**After  three but**

** **

**After  one but**

** **

**After**

** **

** **

 

 

 

 

**three**

** **

**within  twelve**

** **

**within  five**

** **

**five**

** **

** **

 

 

 

 

**months**

** **

**months**

** **

**years**

** **

**years**

** **

**Total**

** **

 

**(Dollars  in thousands**)

Interest-earning assets:

 

 

 

 

 

 

 

 

 

 

Federal funds sold

$

12,003 

$

- 

$

- 

$

- 

$

12,003 

Investment securities

 

2,635 

 

7,250 

 

26,214 

 

45,458 

 

81,557 

Loans

 

249,874 

 

48,994 

 

189,501 

 

67,974 

 

556,343 

 

 

 

 

 

 

 

 

 

 

 

Total interest-earning assets

$

264,512 

$

56,244 

$

215,715 

$

113,432 

$

649,903 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing liabilities:

 

 

 

 

 

 

 

 

 

 

Money market and NOW

$

125,274 

$

- 

$

- 

$

- 

$

125,274 

Regular savings

 

1,873 

 

- 

 

- 

 

- 

 

1,873 

Time deposits

 

75,203 

 

147,667 

 

92,470 

 

- 

 

315,340 

FHLB advances and related  debt

 

71,025 

 

35,075 

 

45,600 

 

10,000 

 

161,700 

Junior  subordinated debentures

 

13,403 

 

- 

 

- 

 

- 

 

13,403 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total interest-bearing  liabilities

$

286,778 

$

182,742 

$

138,070 

$

10,000 

$

617,590 

 

 

 

 

 

 

 

 

 

 

 

Period gap

$

(22,266)

$

(126,498)

$

77,645 

$

103,432 

 

 

Cumulative gap

 

(22,266)

 

(148,764)

 

(71,119)

 

32,313 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ratio  of cumulative gap to total earning assets

 

(3.4%)

 

(22.9%)

 

(10.9%)

 

5.0 %

 

 

** **

The followingtable sets forth information regarding our rate sensitivity, as of December 31,2007, at each of the time intervals. 

** **

 

 

 

 

**Within**

** **

**After  three but**

** **

**After  one but**

** **

**After**

** **

** **

 

 

 

 

**three**

** **

**within  twelve**

** **

**within  five**

** **

**five**

** **

** **

 

 

 

 

**months**

** **

**months**

** **

**years**

** **

**years**

** **

**Total**

** **

 

**(Dollars  in thousands)**

 Interest-earning assets:

 

 

 

 

 

 

 

 

 

 

Federal funds sold

$

9,257 

$

- 

$

- 

$

- 

$

9,257 

Investment securities

 

2,875 

 

19,042 

 

27,984 

 

28,928 

 

78,829 

Loans

 

204,533 

 

49,411 

 

202,907 

 

47,351 

 

504,202 

 

 

 

 

 

 

 

 

 

 

 

Total earning assets

$

216,665 

$

68,453 

$

230,891 

$

76,279 

$

592,288 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing liabilities:

 

 

 

 

 

 

 

 

 

 

Money market and NOW

$

118,273 

$

- 

$

- 

$

- 

$

118,273 

Regular savings

 

1,692 

 

- 

 

- 

 

- 

 

1,692 

Time deposits

 

82,554 

 

160,578 

 

18,126 

 

- 

 

261,258 

FHLB advances and related  debt

 

95,520 

 

14,000 

 

39,000 

 

10,000 

 

158,520 

Junior  subordinated debentures

 

13,403 

 

- 

 

- 

 

- 

 

13,403 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total interest-bearing  liabilities

$

311,442 

$

174,578 

$

57,126 

$

10,000 

$

553,146 

 

 

 

 

 

 

 

 

 

 

 

Period gap

$

(94,777)

$

(106,125)

$

173,765 

$

66,279 

 

 

Cumulative gap

 

(94,777)

 

(200,902)

 

(27,137)

 

39,142 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ratio  of cumulative gap total assets   total earning assets

 

(16.0 %)

 

(33.9 %)

 

(4.6 %)

 

6.6 %

 

 

** **

** **

35

 
 

**Accounting,Reporting, and Regulatory Matters**

*RecentlyIssued Accounting Standards*

Thefollowing is a summary of recent authoritative pronouncements that affectaccounting, reporting, and disclosure of financial information by us:

 

 In May, 2008, the FASB issued StatementSFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles,”(“SFAS No. 162”).  SFAS No. 162 identifies the sources of accounting principlesand the framework for selecting the principles used in the preparation offinancial statements of nongovernmental entities that are presented inconformity with generally accepted accounting principles (GAAP) in the UnitedStates (the GAAP hierarchy).  SFAS No. 162 will be effective 60 days followingthe SEC’s approval of the Public Company Accounting Oversight Board’samendments to AU Section 411, “*The Meaning of Present Fairly inConformity With Generally Accepted Accounting Principles*”.  The applicationof the Statement will have no effect on the Company’s financial position,results of operations or cash flows.

 

June, 2008, the FASB issued FASB Staff Position No. EITF 03-6-1, “DeterminingWhether Instruments Granted in Share-Based Payment Transactions areParticipating Securities,” (“FSP EITF 03-6-1”).  The Staff Position providesthat unvested share-based payment awards that contain nonforfeitable rights todividends or dividend equivalents are participating securities and must beincluded in the earnings per share computation.  FSP EITF 03-6-1 is effectivefor financial statements issued for fiscal years beginning after December 15,2008, and interim periods within those years. All prior-period earnings pershare data presented must be adjusted retrospectively. Early application is notpermitted.  The adoption of the Staff Position will have no material effect onthe Company’s financial position, results of operations or cash flows.

 

            Other accounting standards that have been issuedor proposed by the FASB or other standards-setting bodies that do not requireadoption until a future date are not expected to have a material impact on theconsolidated financial statements upon adoption.

 

               

**Item3. Quantitative and Qualitative Disclosures about Market Risk.**

 

There have been no material changes inour quantitative and qualitative disclosures about market risk as of September30, 2008 from that presented in our annual report on Form 10-K for the yearended December 31, 2007.  See “Market Risk” and “Liquidity and Interest RateSensitivity” in Item 2, Management Discussion and Analysis of FinancialCondition and Results of Operations for quantitative and qualitativedisclosures about market risk, which information is incorporated herein byreference.

 

 

**Item4.  Controls and Procedures.**

 

As of the end of the period covered bythis report, we carried out an evaluation, under the supervision and with theparticipation of our management, including our Chief Executive Officer andChief Financial Officer, of the effectiveness of our disclosure controls andprocedures as defined in Exchange Act Rule 13a-15(e).  Based upon thatevaluation, our Chief Executive Officer and Chief Financial Officer have concludedthat our current disclosure controls and procedures are effective as of September30, 2008.  Therehave been no significant changes in our internal controls over financialreporting during the fiscal quarter ended September 30, 2008 that have materiallyaffected, or are reasonably likely to materially affect, our internal controlsover financial reporting.

 

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

 

** **

36

  
** **

 

** **

**PARTII.  OTHER INFORMATION**

** **

**Item 6.            Exhibits.**

 

10.1                 Amendment No. 1Southern First Bancshares, Inc. 2000 Stock Incentive Plan adopted October 21,2008.

 

31.1                  Rule 13a-14(a)Certification of the Principal Executive Officer.

 

31.2                 Rule 13a-14(a) Certification ofthe Principal Financial Officer.  

 

32                    Section1350 Certifications.  

 

37

 
 

 

 

 

**SIGNATURES**

 

             Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 

 

 

 

SOUTHERN  FIRST BANCSHARES, INC.

 

 

Registrant

 

 

 

 

 

 

Date: November 14, 2008

 

/s/R.  Arthur Seaver, Jr.          

 

 

R. Arthur Seaver, Jr.

 

 

Chief Executive Officer

 

 

 

 

 

 

Date: November 14, 2008

 

/s/James M. Austin,  III                      

 

 

James M. Austin, III

 

 

Chief Financial Officer

 

 

38

 
 

 

 

 

**INDEXTO EXHIBITS**

ExhibitNumber                       Description

10.1        Amendment No. 1 SouthernFirst Bancshares, Inc. 2000 Stock Incentive Plan adopted October 21, 2008.

 

31.1        Rule13a-14(a) Certification of the Principal Executive Officer.

 

31.2        Rule 13a-14(a) Certification of the PrincipalFinancial Officer.  

 

32           Section1350 Certifications. 

 

 

39**