| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **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 March 31, 2009                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| **OR**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| **[  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| **OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| For the Transition Period  from                       to                                                                                                                                                                                                                                                                                                                                                 |
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| Commission file number  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 has submitted electronically and posted	on its corporate Web site, if any, every                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| Interactive Data File required to be submitted and posted	pursuant to Rule 405 of Regulation S-T (232.405 of this chapter)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| during the preceding 12 months (or for such shorter period	that the registrant was required to submit and post such files).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|  Yes [    ]      No [    ]                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| Indicate  by check mark whether the registrant is a large accelerated filer, an accelerated  filer, or a non-accelerated filer.  See                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| definition  of “accelerated filer and large accelerated filer” 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 May 1, 2009.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |

 

 

----

** **

 

**PART I.  CONSOLIDATED FINANCIALINFORMATION**

**            **

**Item 1.  Consolidated Financial Statements**

 

 

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

***CONSOLIDATEDBALANCE SHEETS***

*(inthousands, except share data)*

*** ***

| ** **                     |                                                                                |                                 | ** **                                      | **March 31,**                                                            | ** **    | **December 31,** |
|--------------------------------|-------------------------------------------------------------------------------------|--------------------------------------|-------------------------------------------------|--------------------------------------------------------------------------|---------------|------------------|
| ** **                     |                                                                                |                                 | ** **                                      | **2009**                                                                 | ** **    | **2008**         |
| ** **                     | (Unaudited)                                                                         |                                 | (Audited)                                       |
| **Assets**                     |                                                                                |                                 |                                            |
| ** **                     | Cash and due from banks                                                             |  $                              | 8,867                                      |                                                                     |  $       | 4,360       |
|                           | Federal funds sold                                                                  | 3,668                           |                                            | 8,800                                                               |
|                           | Investment securities available for sale                                            | 75,766                          |                                            | 64,432                                                              |
|                           | Investment securities held to maturity (fair value $11,723 and $12,618)             | 11,484                          |                                            | 12,519                                                              |
|                           | Other investments, at cost                                                          | 9,195                           |                                            | 8,461                                                               |
|                           | Loans, net                                                                          | 558,965                         |                                            | 559,602                                                             |
|                           | Property and equipment, net                                                         | 12,762                          |                                            | 11,701                                                              |
|                           | Accrued interest receivable                                                         | 2,603                           |                                            | 2,900                                                               |
|                           | Other real estate owned                                                             | 3,826                           |                                            | 2,116                                                               |
|                           | Bank owned life insurance                                                           | 13,492                          |                                            | 13,369                                                              |
|                           | Deferred income taxes                                                               | 3,600                           |                                            | 3,864                                                               |
|                           | Other assets                                                                        | 776                             |                                            | 855                                                                 |
|                           |                                                                                |                                 |                                            |                                                                     |          |             |
|                           |                                                                                |   Total assets                  |  $                                         | 705,004                                                             |          |  $          | 692,979  |
|                           |                                                                                |                                 |                                            |                                                                     | ** **    | ** **       |
| **Liabilities**                | ** **                                                                          | ** **                           |                                            |
| ** **                     | Deposits                                                                            |  $                              | 474,797                                    |              |  $       | 469,537     |
|                           | Official checks outstanding                                                         | 853                             |                                            | 1,277                                                               |
|                           | Note Payable                                                                        | 5,000                           |                                            | 15,000                                                              |
|                           | Federal Home Loan Bank advances and related debt                                    | 149,675                         |                                       | 149,675                                                             |
|                           | Junior subordinated debentures                                                      | 13,403                          |                                            | 13,403                                                              |
|                           | Accrued interest payable                                                            | 2,116                           |                                            | 2,247                                                               |
|                           | Accounts payable and accrued expenses                                               | 1,187                           |                                            | 2,054                                                               |
|                           |                                                                                |                                 |                                            |                                                                     |          |             |
|                           |                                                                                |                                 | Total liabilities                               | 647,031                                                             |          | 653,193     |
|                           |                                                                                |                                 |                                            |                                                                     | ** **    | ** **       |
| **Shareholders’  equity** | ** **                                                                          |                                 |                                            |
|                           | Preferred stock, par value $.01 per share, 10,000,000 shares  authorized,           |                                 |                                            |                                                                     |
|                           |                                                                                | 17,299 shares issued and outstanding | 15,814                                     |                                                                     | -        |
|                           | Common stock, par value $.01 per share, 10,000,000 shares  authorized,              |                                 |                                            |                                                                     |
|                           |      3,044,863 shares issued and outstanding  at March 31, 2009 |                                 |                                            |                                                                     |
|                           |      and December 31, 2008, respectively                             | 30                              |                                            | 30                                                                  |
|                           | Nonvested restricted stock                                                          | (24)                                 |                                            | (27)                                                                     |
|                           | Additional paid-in capital                                                          | 33,286                          |                                            | 31,850                                                              |
|                           | Accumulated other comprehensive income (loss)                                       | (674)                                |                                            | (1,079)                                                                  |
|                           | Retained earnings                                                                   | 9,541                           |                                            | 9,012                                                               |
|                           |                                                                                |                                 |                                            |                                                                     |          |             |
|                           |                                                                                |                                 | Total shareholders’ equity                 | 57,973                                                              |          | 39,786      |
|                           |                                                                                |                                 |                                            |                                                                     |          |             |
|                           |                                                                                |                                 | Total liabilities and shareholders’ equity |  $                                                                  | 705,004  |             |  $ | 692,979  |
|                                |                                                                                     |                                      |                                                 |                                                                          |               |                  |  |  |  |  |  |

**                                                                                        **

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

 

----

 

*** SOUTHERNFIRST BANCSHARES, INC. AND SUBSIDIARYCONSOLIDATED STATEMENTS OF INCOME***

*(inthousands, except per share data)*

*** ***

|                                                             |                                                             |        |                               |         | **For  the three months ended** |
|------------------------------------------------------------------|------------------------------------------------------------------|-------------|------------------------------------|--------------|---------------------------------|
| ** **                                                       |                                                             |        |                               |         | **March  31,**                  |
| ** **                                                       |                                                             | ** **  |                               |         | **2009**                        | ** ** | **2008** |
| ** **                                                       |                                                             |        |                               |         | (Unaudited)                     |
| **Interest income**                                              | ** **                                                       |        |                               |
|                                                             | Loans                                                            |  $     | 7,797                         |         |  $                         | 9,009  |
|                                                             | Investment securities                                            | 1,093  |                               | 1,249   |
|                                                             | Federal funds sold                                               | 5      |                               | 84      |
|                                                             |                                                             |        |                               |         |                            |   |   |
|                                                             |         Total interest income | 8,895  |                               | 10,342  |
| **Interest expense**                                             | ** **                                                       |        |                               |
| **  **Deposits                                         | 2,788                                                       |        | 4,097                         |
| **  **Borrowings                                       | 1,646                                                       |        | 1,851                         |
|                                                             |                                                             |        |                               |
| Total interest expense                                           | 4,434                                                       |        | 5,948                         |
|                                                             |                                                             |        |                               |         |                            |   |   |
|    Net interest income                                 | 4,461                                                       |        | 4,394                         |
|    Provision for loan losses                           | 750                                                         |        | 600                           |
|                                                             |                                                             |        |                               |         |                            |   | ** ** |
|    Net interest income after provision for loan losses | 3,711                                                       |        | 3,794                         |
|                                                             | *** ***                                                     |        |                               |         |                            |   |   |
| **Noninterest income**                                           | ** **                                                       |        |                               |
| ** **                                                       | Loan fee income                                                  | 38     |                               | 45      |
|                                                             | Service fees on deposit accounts                                 | 175    |                               | 149     |
|                                                             | Income from bank owned life insurance                            | 123    |                               | 96      |
|                                                             | Real estate owned activity                                       | (7)         |                               | (58)         |
|                                                             | Other income                                                     | 85     |                               | 79      |
|                                                             |                                                             |        |                               |         |                            |   |   |
|                               | Total noninterest income                                         | 414    |                               | 311     |
|                                                             |
| **Noninterest expenses**                                         | ** **                                                       |        |                               |
|                                                             | Compensation and benefits                                        | 1,925  |                               | 1,718   |
|                                                             | Professional fees                                                | 136    |                               | 114     |
|                                                             | Marketing                                                        | 145    |                               | 135     |
|                                                             | Insurance                                                        | 153    |                               | 129     |
|                                                             | Occupancy                                                        | 416    |                               | 348     |
|                                                             | Data processing and related costs                                | 374    |                               | 321     |
|                                                             | Telephone                                                        | 51     |                               | 34      |
|                                                             | Other                                                            | 229    |                               | 187     |
|                                                             |                                                             |        |                               |         |                            |   |   |
|                                                             |                                                             |        | Total noninterest expenses         | 3,429   |                            | 2,986  |
|                                                             |                                                             |        |                               |         |                            |   |   |
|                                                             |                                                             |        | Income before income taxes expense | 696     |                            | 1,119  |
|                                                             |                                                             |        |                               |         |                            |   |   |
| **Income tax expense**                                           | 209                                                         |        | 372                           |
|                                                             | ** **                                                       |        |                               |         |                            |   |   |
| **Net income**                                                   |  $                                                          | 487    |                               |  $      | 747                        |
|                                                             |                                                             |        |                               |         | ** **                      | ** ** | ** ** |
| Preferred stock dividend to be paid                              | 78                                                          |        | **- **                        |
| Dividend accretion                                               | 42                                                          |        | **- **                        |
|                                                             |                                                             |        |                               |         | ** **                      | ** ** | ** ** |
| **Net income available to common shareholders**                  | ** $**                                                      | **367**     | ** **                         | ** $**  | **747 **                   |
|                                                             |                                                             |        |                               |         | ** **                      | ** ** | ** ** |
| **Earnings per common share**                                    | ** **                                                       | ** **  | ** **                         |
| ** **                                                       | Basic                                                            |  $     | .12                           |         |  $                         | .25  |
|                                                             | Diluted                                                          |  $     | .12                           |         |  $                         | .23  |
|                                                             |                                                             |        |                               |         |                            |   |   |
| **Weighted average common shares outstanding**                   | ** **                                                       | ** **  | ** **                         |
|    Basic                                               | 3,044,863                                                   |        | 2,964,951                     |
|    Diluted                                             | 3,053,933                                                   |        | 3,185,827                     |
|                                                                  |                                                                  |             |                                    |              |                                 |  |  |  |  |  |  |

 

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

2

----

 

***SOUTHERN  FIRSTBANCSHARES, INC. AND SUBSIDIARYCONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY AND COMPREHENSIVE INCOME FOR THE THREE MONTHS ENDED MARCH 31, 2009  AND 2008(Unaudited)***

*(in thousands,except share data)*

 

| ** **                         | ** **                           | ** **                | ** **    | ** **   | ** **     | ** **  | ** **       | ** ** | ** **        | ** ** | **Accumulated**  | ** **  | ** **        | ** ** | **Total**   |
|------------------------------------|--------------------------------------|---------------------------|---------------|--------------|----------------|-------------|------------------|------------|-------------------|------------|------------------|-------------|-------------------|------------|-------------|
| ** **                         | ** **                           | ** **                | ** **    | ** **   | ** **     | ** **  | **Nonvested**    | ** ** | **Additional**    | ** ** | **other**        | ** **  | ** **        | ** ** | **share-**  |
| ** **                         | **Common  stock**                    | ** **                | **Preferred** | ** **   | **restricted** | ** **  | **paid-in**      | ** ** | **comprehensive** | ** ** | **Retained**     | ** **  | **holders’** |
| ** **                         | **Shares**                           | ** **                | **Amount**    | ** **   | **stock**      | ** **  | **stock**        | ** ** | **capital**       | ** ** | **income(loss)** | ** **  | **Earnings**      | ** ** | **equity**  |
| ** **                         |                                 |                      |          |         |           |        |             |       |              |       |             |        |              |       |        |
| **December 31, 2007**              | 2,946,456                       |                      |  $       | 29      |           |  $     | -           |       |  $           | (41)       |             |  $     | 31,034       |       |  $     | 96  |   |  $ | 7,160  |   |  $ | 38,278  |
| ** **                         |                                 |                      |          |         |           |        |             |       |              |       |             |        |              |       |        |
| Net income                         | -                               |                      | -        |         | -         |        | -           |       | -            |       | -           |        | 747          |       | 747    |
|                               |                                 |                      |          |         |           |        |             |       |              |       |             |        |              |       |        |
| Comprehensive income, net of tax - |                                 |                      |          |         |           |        |             |       |              |       |             |        |              |       |        |
|                               | Unrealized holding gain on           |                      |          |         |           |        |             |       |              |       |             |        |              |       |        |   |
|                               |   securities available for sale | -                    |          | -       |           | -      |             | -     |              | -     |             | 204    |              | -     |        | 204  |
|                               |                                 |                      |          |         |           |        |             |       |              |       |             |        |              |       |        |
| Comprehensive income               | -                               |                      | -        |         | -         |        | -           |       | -            |       | -           |        | -            |       | 951    |
|                               |                                 |                      |          |         |           |        |             |       |              |       |             |        |              |       |        |
| Proceeds from exercise of stock    |                                 | ** **                | ** **    | ** **   |           |        |             |       |              |       |             |        |              | ** ** |        |
|                               | options and warrants                 | 28,250                    | ** **    | ** **   | ** **     | -      |             | -     |              | 171        |             | -      |              | -     | ** **  | 171  |
|                               |                                 | ** **                | ** **    | ** **   |           |        |             |       |              |       |             |        |              | ** ** |        |
| Amortization of deferred           |                                 | ** **                | ** **    | ** **   |           |        |             |       |              |       |             |        |              | ** ** |        |
|                               | compensation on restricted stock     | -                    | ** **    | **- **  | ** **     | -      |             | 3     |              | -     |             | -      |              | -     | ** **  | 3  |
|                               |                                 | ** **                | ** **    | ** **   | ** **     | ** **  | ** **       | ** ** | ** **        | ** ** | ** **       | ** **  | ** **        | ** ** |        |
| Compensation expense related to    |                                 | ** **                | ** **    | ** **   | ** **     | ** **  | ** **       | ** ** | ** **        | ** ** | ** **       | ** **  | ** **        | ** ** |        |
|                               | stock options, net of tax            | -                    |          | -       |           | -      |             | -     |              | 14         |             | -      |              | -     |        | 14  |
| ** **                         | ** **                           | ** **                | ** **    | ** **   | ** **     | ** **  | ** **       | ** ** | ** **        | ** ** | ** **       | ** **  | ** **        | ** ** | ** **  |
| **March 31, 2008**                 | 2,974,706                       |                      |  $       | 29      |           |  $     | -           |       |  $           | (38)       |             |  $     | 31,219       |       |  $     | 300  |   |  $ | 7,907  |   |  $ | 39,417  |
|                               |                                 |                      |          |         |           |        |             |       |              |       |             |        |              |       |        |
| **December 31, 2008**              | 3,044,863                       |                      |  $       | 30      |           |  $     | -           |       |  $           | (27)       |             |  $     | 31,850       |       |  $     | (1,079) |   |  $ | 9,012  |   |  $ | 39,786  |
|                               |                                 |                      |          |         |           |        |             |       |              |       |             |        |              |       |        |
| Net  income                   | -                               |                      | -        |         | -         |        | -           |       | -            |       | -           |        | 487          |       | 487    |
|                               |                                 |                      |          |         |           |        |             |       |              |       |             |        |              |       |        |
| Comprehensive income, net of tax - |                                 |                      |          |         |           |        |             |       |              |       |             |        |              |       |        |
|                               | Unrealized holding gain on           |                      |          |         |           |        |             |       |              |       |             |        |              |       |        |   |
|                               |   securities available for sale | -                    |          | -       |           | -      |             | -     |              | -     |             | 405    |              | -     |        | 405  |
|                               |                                 |                      |          |         |           |        |             |       |              |       |             |        |              |       |        |
| Comprehensive income               | -                               |                      | -        |         | -         |        | -           |       | -            |       | -           |        | -            |       | 892    |
|                               |                                 |                      |          |         |           |        |             |       |              |       |             |        |              |       |        |
| Preferred stock transactions       |                                 |                      |          |         |           |        |             |       |              |       |             |        |              |       |        |
|                               | Proceeds from issuance of 17,299     |                      |          |         |           |        |             |       |              |       |             |        |              |       |        |   |
|                               |                                 | shares of preferred stock | -        |         | -         |        | 15,856      |       | -            |       | -           |        | -            |       | -      |   | 15,856  |
|                               |                                 |                      |          |         |           |        |             |       |              |       |             |        |              |       |        |
|                               | Proceeds from issuance of            |                      |          |         |           |        |             |       |              |       |             |        |              |       |        |   |
|                               |                                 | common stock warrants     | -        |         | -         |        | -           |       | -            |       | 1,418       |        | -            |       | -      |   | 1,418  |
|                               |                                 |                      |          |         |           |        |             |       |              |       |             |        |              |       |        |
|                               | Dividend accretion                   | -                    |          | -       |           | (42)        |             | -     |              | -     |             | -      |              | 42    |        | -  |
|                               |                                 |                      |          |         |           |        |             |       |              |       |             |        |              |       |        |
| Amortization of deferred           |                                 |                      |          |         |           |        |             |       |              |       |             |        |              |       |        |
|                               | compensation on restricted stock     | -                    |          | -       |           | -      |             | 3     |              | -     |             | -      |              | -     |        | 3  |
|                               |                                 |                      |          |         |           |        |             |       |              |       |             |        |              |       |        |
| Compensation expense related to    |                                 |                      |          |         |           |        |             |       |              |       |             |        |              |       |        |
|                               | stock options                        | -                    |          | -       |           | -      |             | -     |              | 18    |             | -      |              | -     |        | 18  |
| ** **                         |                                 |                      |          |         |           |        |             |       |              |       |             |        |              |       |        |
| **March 31, 2009**                 | **3,044,863 **                  | ** **                | ** $**   | **30 ** | ** **     | ** $** | **15,814 ** | ** ** | ** $**       | **(24)**   | ** **       | ** $** | **33,286 **  | ** ** | ** $** | **(674)** | ** ** | ** $** | **9,541 ** | ** ** | ** $** | **57,973** |
|                                    |                                      |                           |               |              |                |             |                  |            |                   |            |                  |             |                   |            |             |  |  |  |  |  |  |  |  |  |  |  |

 

                                                                                                                             

See notes toconsolidated financial statements that are an integral part of theseconsolidated statements.3

----

 

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

*(inthousands)*

|                                                           |                                           | *** ***                                                         |               |                                                 |                            | ** **                                 |         |
|----------------------------------------------------------------|------------------------------------------------|----------------------------------------------------------------------|--------------------|------------------------------------------------------|---------------------------------|--------------------------------------------|--------------|
|                                                           |                                           | *** ***                                                         |               |                                                 | **For  the three months ended** |
|                                                           |                                           | ** **                                                           |               |                                                 | **March  31,**                  |
|                                                           |                                           | ** **                                                           |               |                                                 | **2009**                        | ** **                                 | **2008**     |
| ** **                                                     |                                           |                                                                 |               |                                                 | (Unaudited)                     |
| **Operating activities**                                       | ** **                                     |                                                                 |               |
|                                                           | Net income                                     |  $                                                              | 487           |                                                 |  $                         | 747                                   |
|                                                           | Adjustments to reconcile net income to cash    |                                                                 |               |                                                 |
|                                                           |                                           | provided by (used for) operating activities:                         |               |                                                 |                            |
|                                                           |                                           | Provision for loan losses                                            | 750           |                                                 | 600                        |
|                                                           |                                           | Depreciation and other amortization                                  | 147           |                                                 | 115                        |
|                                                           |                                           | Accretion and amortization of securities discounts and premium,  net | 79            |                                                 | 31                         |
|                                                           |                                           | Loss on sale of real estate                                          | -             |                                                 | 38                         |
|                                                           |                                           | Compensation expense related to stock options and grants             | 21            |                                                 | 17                         |
|                                                           |                                           | Increase in cash surrender value of bank owned life insurance        | (123)              |                                                 | (96)                            |
|                                                           |                                           | Decrease in deferred tax asset                                       | 52            |                                                 | 462                        |
|                                                           |                                           | Decrease (increase) in other assets, net                             | 376           |                                                 | (62)                            |
|                                                           |                                           | Decrease in other liabilities, net                                   | (1,422)            |                                                 | (772)                           |
|                                                           |                                           |                                                                 |               |                                                 |                            |                                       |         |
| ** **                                                     |                                           |                                                                 |               | Net cash provided by operating activities            | 367                        |         | 1,080   |
|                                                           |                                           |                                                                 |               |                                                 |                            |                                       |         |
| **Investing activities**                                       | ** **                                     |                                                                 |               |
|                                                           | Increase (decrease) in cash realized from:     |                                                                 |               |                                                 |
|                                                           | ** **                                     | Origination of loans, net                                            | (1,823)            |                                                 | (29,992)                        |
|                                                           | ** **                                     | Purchase of property and equipment                                   | (1,208)            |                                                 | (956)                           |
|                                                           |                                           | Purchase of investment securities:                                   |               |                                                 |                            |
|                                                           |                                           |                                                                 | Available for sale | (14,282)                                             |                            | (15,657)                                   |
|                                                           |                                           |                                                  | Other investments  | (680)                                                |                            | (667)                                      |
|                                                           |                                           | Payments and maturity of investment securities:                      |               |                                                 |                            |
|                                                           |                                           |                                                                 | Available for sale | 3,494                                           |                            | 1,932                                 |
|                                                           |                                           |                                                                 | Held to maturity   | 1,027                                           |                            | 491                                   |
|                                                           |                                           |                                                                 | Other investments  | (54)                                                 |                            | 1,125                                 |
|                                                           |                                           | Proceeds from sale of real estate acquired in settlement of  loans   | -             |                                                 | 47                         |
|                                                           |                                           |                                                                 |               |                                                 |                            |                                       |         |
|                                                           |                                           |                                                                 |               | Net cash used for investing activities               | (13,526)                        |                                       | (43,677)     |
|                                                           |                                           |                                                                 |               |                                                 |                            |                                       |         |
| **Financing activities**                                       | ** **                                     |                                                                 |               |
|                                                           | Increase in deposits, net                      | 5,260                                                           |               | 56,240                                          |
| ** **                                                     | Proceeds from the issuance of preferred stock  | 15,856                                                          |               | -                                               |
| ** **                                                     | Proceeds from the issuance of stock warrant    | 1,418                                                           |               | -                                               |
| ** **                                                     | Proceeds from the exercise of stock options    | -                                                               |               | 171                                             |
|                                                           | Decrease  in other borrowings and note payable | (10,000)                                                             |               | (825)                                                |
|                                                           | ** **                                     |                                                                 |               |                                                 |                            |                                       |         |
|                                                           |                                           |                                                                 |               | Net cash provided by financing activities            | 12,534                     |                                       | 55,586  |
|                                                           |                                           |                                                                 |               |                                                 |                            |                                       |         |
|                                                           | ** **                                     |                                                                 |               | Net increase (decrease) in cash and cash equivalents | (625)                      |                                       | 12,989  |
|                                                           | ** **                                     |                                                                 |               |                                                 |                            |                                       |         |
| **Cash and cash equivalents at beginning of  the period** | 13,160                                    |                                                                 | 16,971        |
| ** **                                                     |                                           |                                                                 |               |                                                 |                            |                                       |         |
| **Cash and cash equivalents at end of the period**             |  $                                        | 12,535                                                          |               |  $                                              | 29,960                     |
|                                                           |                                           |                                                                 |               |                                                 |                            |                                       |         |
| **Supplemental information**                                   | ** **                                     |                                                                 |               |
|                                                           | **Cash paid for**                              | ** **                                                           |               |                                                 |
|                                                           |                                           | Interest                                                             |  $            | 4,565                                           |                            |  $                                    | 6,204   |
|                                                           |                                           |                                                                 |               |                                                 |                            |
|                                                           |                                           | Income taxes                                                         |  $            | 127                                             |                            |  $                                    | 1,781   |
|                                                           | ** **                                     |                                                                 |               |
| **   Schedule of non-cash transactions**             | ** **                                     |                                                                 |               |
|                                                           |                                           | Foreclosure of real estate                                           |  $            | 1,710                                           |                            |  $                                    | 1,892   |
|                                                           |                                           |                                                                 |               |                                                 |
|                                                           |                                           | Unrealized gain on securities, net of income taxes                   |  $            | 405                                             |                            |  $                                    | 204     |
|                                                                |                                                |                                                                      |                    |                                                      |                                 |                                            |              |  |  |  |  |  |

 

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

 

4

----

 

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

*(AllDollar Amounts in Thousands, Except Per Share and Where Otherwise Indicated.)*

* *

**NOTE1.  Nature of Business and Basis of Presentation**

** **

*Businessactivity*

** **

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 of the stock of GreenvilleFirst Statutory Trust I and II (collectively (the “Trusts”)).  On July 2, 2007, the Company and Bank changed their names to Southern First Bancshares, Inc.and Southern First Bank, N.A., respectively.  The Bank is a national bankorganized under the laws of the United States located in Greenville County, South Carolina.  The Bank is primarily engaged in the business of accepting demand depositsand savings deposits insured by the Federal Deposit Insurance Corporation (the“FDIC”), and providing commercial, consumer and mortgage loans to the generalpublic.  The Trusts are special purpose subsidiaries organized for the solepurpose of issuing trust preferred securities.  

 

*Basisof Presentation*

** **

The accompanying financial statementshave been prepared in accordance with generally accepted accounting principlesfor interim financial information and with the instructions to Form 10-Q. Accordingly, they do not include all the information and footnotes required byaccounting principles generally accepted in the United States of America forcomplete financial statements.  In the opinion of management, all adjustments(consisting of normal recurring accruals) considered necessary for a fairpresentation have been included.  Operating results for the three-month periodended March 31, 2009 are not necessarily indicative of the results that may beexpected for the year ending December 31, 2009.  For further information, referto the consolidated financial statements and footnotes thereto included in thecompany’s Form 10-K for the year ended December 31, 2008 (Registration Number000-27719) 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*

 

For purposes of the ConsolidatedStatements of Cash Flows, cash and federal funds sold are included in “cash andcash equivalents.”  These assets have contractual maturities of less than threemonths.

** **

**NOTE2 – Note Payable**

** **

The Company had a $15.0 million revolving line ofcredit with Silverton Ban k, N.A. (“Silverton”) for which $5.0 million wasoutstanding at March 31, 2009.  The line of credit matures on December 28, 2012and bears interest at prime less 1.25%, which at March 31, 2009 was 2.00%.  TheCompany has pledged all of the stock of the Bank as collateral for this line ofcredit. The line of credit agreement contains various financial covenantsrelated to net income and asset quality.  As of December 31, 2008 and March31, 2009, the Company was not in compliance with the covenant related to thenonperforming assets ratio.  On April 30, 2009, the Company entered into anAmended and Restated Loan Agreement (the “Amended Loan Agreement”) with Silverton. The total line of credit was reduced to $9.0 million subject to limits based ona borrowing availability calculation.  Had the Amended Loan Agreement been inplace as of March 31, 2009, the maximum allowed to be borrowed would have been$6.7 million.  The amended interest rate is the prime rate plus 0.5% with afloor rate of 4.0%.  The $9.0 million line of credit consists of a $4.0 millionrevolving line of credit with a maturity of April 30, 2011 and a term loan witha maturity of April 30, 2014.  The Amended Loan Agreement contains variousfinancial covenants related to net income and asset quality.  Had the AmendedLoan Agreement been in place at March 31, 2009, the Bank would have been incompliance with all the requirements.  

 

On May 1, 2009, Silverton was closed by the Office of theComptroller of the Currency and the FDIC was named Receiver. The FDIC created abridge bank to take over the operations of Silverton.  The newly created bankis Silverton Bridge Bank, N.A. The creation of the bridge bank allows itsclient banks to transition their correspondent banking needs to other providerswith the least amount of disruptions.  Silverton Bridge Bank, N.A. willcontinue to operate business as usual through July 29, 2009.  As a result ofthis announcement, we may not be able to make additional draws on the revolvingline of credit.

 

5

----

 

**NOTE3 – Preferred Stock Issuance**

 

OnFebruary 27, 2009, as part of the Treasury Department's Capital PurchaseProgram (“CPP”), the Company entered into a Letter Agreement and a Securities PurchaseAgreement (collectively, the “CPP Purchase Agreement”) with the TreasuryDepartment, pursuant to which the Company sold 17,299 shares of its Fixed RateCumulative Perpetual Preferred Stock, Series T (the “Series T Preferred Stock”)and a warrant (the “CPP Warrant”) to purchase 330,554 shares of the Company’scommon stock for an aggregate purchase price of $17.3 million in cash.  The Series T Preferred Stock will qualify as Tier 1 capitaland will be entitled to cumulative dividends at a rate of 5% per annum for thefirst five years, and 9% per annum thereafter.  The Company must consultwith the OCC before it may redeem the Series T Preferred Stock but, contrary tothe original restrictions in the Emergency Economic Stabilization Act of 2008(the "EESA"), will not necessarily be required to raise additionalequity capital in order to redeem this stock.   TheCPP Warrant has a 10-year term and is immediately exercisable upon itsissuance, with an exercise price, subject to anti-dilution adjustments equal to$7.85 per share of the common stock.  The fair value allocation of the$17.3 million between the shares of Series T Preferred Stock and the CPPWarrant resulted in $15.9 million allocated to the shares of Series T PreferredStock and $1.4 million allocated to the CPP Warrant.  

** **

**NOTE4 – Earnings per Common Share**

****             The followingschedule reconciles the numerators and denominators of the basic and dilutedearnings per share computations for the three months ended March 31, 2009 and2008.  Dilutive common shares arise from the potentially dilutive effect of thecompany’s stock options and warrants that are outstanding.  The assumedconversion of stock options and warrants can create a difference between basicand dilutive net income per common share.  

 

             AtMarch 31, 2009 and 2008, 188,113 and 43,250 options, respectively, wereanti-dilutive in the calculation of earnings per share as their exercise priceexceeded the fair market value.

 

| ** **                                 | **Three months  ended March 31,**                          |
|--------------------------------------------|------------------------------------------------------------|
| ** **                                 | **2009**                                                   | ** ** | **2008** |
| Numerator:                                 |                                                       |   |   |
|                                       |  Net  income                                          |  $ | 487  |   |  $ | 747  |
|                             |      Less:                             | Preferred  stock dividends to be paid | 78  |   | -  |
|         | Dividend  accretion                                        | 42  |   | -  |
|                                       | Net  income available to common shareholders               | $ | 367  |   |   | 747  |
|                                       |                                                       |   |   |
| Denominator:                               |                                                       |   |   |
|                                       | Weighted-average  common shares outstanding – basic   | 3,044,863  |   | 2,964,951  |
|                                       | Common  stock equivalents                                  | 9,070  |   | 220,876  |
|                                       | Weighted-average  common shares outstanding – diluted | 3,053,933  |   | 3,185,827  |
|                                       |                                                       |   |   |
| Earnings  per common share:                |                                                       |   |   |
|                                       | Basic                                                      |  $ | 0.12  |   |  $ | 0.25  |
|                                       | Diluted                                                    |  $ | 0.12  |   |  $ | 0.23  |
|                                            |                                                            |  |  |  |  |  |  |  |  |  |  |

** **

** **

**NOTE5 – Stock Based Compensation**

** **
SFAS No. 123(R),

#  

In adopting SFAS No. 123(R), the company elected to use themodified prospective method to account for the transition from the intrinsicvalue method to the fair value recognition method.  Under the modifiedprospective method, compensation cost is recognized from the adoption dateforward 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 26.76% for 2009 and 2008, risk-free interestrate of 3.72% for 2009 and 2008, expected lives of the options 10 years, andthe assumed dividend rate was zero.  

 

6

----

 

**NOTE 6 – Fair Value Measurement**

** **

Effective January 1, 2008, the Companyadopted SFAS No. 157, “Fair Value Measurements,” which provides a framework formeasuring and disclosing fair value under generally accepted accountingprinciples. SFAS No. 157 requires disclosures about the fair value of assetsand liabilities recognized in the balance sheet in periods subsequent toinitial recognition, whether the measurements are made on a recurring or on anonrecurring basis. 

 

SFAS No. 157 defines fair value as theexchange price that would be received for an asset or paid to transfer aliability (an exit price) in the principal or most advantageous market for theasset or liability in an orderly transaction between market participants on themeasurement date. 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 measured at fairvalue on a recurring basis as of March 31, 2009 are as follows:

 

|                                | **Quoted market  price** | ** ** | **Significant  other** | ** ** | **Significant**          |
|-------------------------------------|--------------------------|------------|------------------------|------------|--------------------------|
|                                | **in active  markets**   | ** ** | **observable  inputs** | ** ** | **unobservable  inputs** |
|                                | **(Level 1)**            | ** ** | **(Level 2)**          | ** ** | **(Level 3)**            |
|                                | ** **               |
|                                |                     |       |                   |       |                     |   |   |   |   |   |   |
| Collateralized Mortgage Obligations |  $                  | -     |                   |       |  $                  | -  |   |   |  $ | 5,098  |   |
| Other securities available for sale |                     | 58    |                   |       |                     | 70,610  |   |   |   | -  |   |
| Other investments                   |                     | -     |                   |       |                     | -  |   |   |   | 9,195  |   |
|                                |                     |       |                   |       |                     |
|     Total            |  $                  | 58    |                   |       |  $                  | 70,610  |   |   |  $ | 14,293  |   |
|                                     |                          |            |                        |            |                          |  |  |  |  |  |  |  |  |  |

 

The Company hasno liabilities carried at fair value or measured at fair value on a recurringor nonrecurring basis. 

 

The Company is predominantly an assetbased lender with real estate serving as collateral on approximately 79.1% ofloans. Loans which are deemed to be impaired and real estate acquired insettlement of loans are valued on a nonrecurring basis at the lower of cost or marketvalue of the underlying real estate collateral. Such market values are generallyobtained using independent appraisals, which the Company considers to be level2 inputs. The aggregate carrying amount, net of specific reserves, of impairedloans at March 31, 2009 was $9.8 million.  In addition, real estate acquired insettlement of loans is valued at $3.8 million at March 31, 2009.

 

FASB Staff Position No. FAS 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.

 

7

----

 

The table below presents areconciliation for the period of January 1, 2009 to March 31, 2009, for allLevel 3 assets that are measured at fair value on a recurring basis.

** **

| ** **                                          | ** ** | **Investment**         | ** **  | ** **      |
|-----------------------------------------------------|------------|------------------------|-------------|-----------------|
|                                                | ** ** | **securities**         | ** **  | **Other**       |
|                                                | ** ** | **available for sale** | ** **  | **investments** |
|                                                | ** ** | ** **             |
|                                                |       |                   |        |            |   |   |
| Beginning balance                                   |       |  $                | 5,213  |            |  $ | 8,461  |
| Total realized and unrealized gains or losses:      |       |                   |        |            |
|    Included in earnings                   |       | -                 |        | -          |
|    Included in other comprehensive income |       | 155               |        | -          |
| Purchases, sales and principal reductions           |       | (270)                  |        | 734        |
| Transfers in and/or out of Level 3                  |       | -                 |        | -          |
|                                                |       |                   |        |            |   |
| Ending Balance                                      |       |  $                | 5,098  |            |  $ | 9,195  |

** **

** **

**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-looking statements. Potential risks and uncertainties that could cause our actual results to differfrom those anticipated in any forward-looking statements include, but are notlimited to, those described in our Form 10-K for the year ended December 31,2008 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.

 

These risks are exacerbated by therecent developments in national and international financial markets, and we areunable to predict what effect these uncertain market conditions will have onour Company.  During 2008, the capital and credit markets experienced extendedvolatility and disruption. In the last 180 days, the volatility and disruptionhave reached unprecedented levels.  There can be no assurance that theseunprecedented recent developments will not materially and adversely affect ourbusiness, financial condition and results of operations.

 

8

----

               

                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 toorganize and serve as the holding company for Greenville First Bank, N.A.  On July 2, 2007, we changed the name of our company and bank to Southern First Bancshares,Inc. and Southern First Bank, N.A., respectively.  Since we opened our bank inJanuary 2000, we have experienced consistent growth in total assets, loans,deposits, and shareholders’ equity.  

 

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 key measureis the spread between the yield we earn on these interest-earning assets andthe rate we pay on our interest-bearing liabilities, which is called our netinterest 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.

 

#### Critical Accounting Policies

 

 

                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, assumptions about cash flow,determination of loss factors for estimating credit losses, and the impact ofcurrent events, conditions, and other factors impacting the level of probableinherent losses.  Under different conditions, the actual amount of creditlosses incurred by us may be different from management’s estimates provided inour consolidated financial statements.  Refer to the portion of this discussionthat addresses our allowance for loan losses for a more complete discussion ofour processes and methodology for determining our allowance for loan losses.

** **

9

----

 

**Effect of Economic Trends**

 

**           ** Following an economic decline andhistorically low interest rates that ended in the first six months of 2004, theFederal Reserve began increasing short-term rates as the economy showed signsof strengthening.  Between July 2004 and July 2006, the Federal Reserveincreased rates at 17 of their meetings for a total of 425 basis points. BetweenJuly 2006 and September 18, 2007, the Federal Reserve allowed short-term ratesto remain unchanged.  Beginning in July 2004 and continuing until September 18, 2007, our rates on both short-term or variable rate interest-earning assetsand interest-bearing liabilities increased.  The momentum of the 17 rateincreases resulted in higher rates on interest-earning assets and higherinterest-bearing liabilities during the first nine months of 2007;subsequently, as fixed rate loans, deposits, and borrowings have matured theyhave repriced at higher interest rates.  In lateSeptember 2007, the Federal Reserve reversed their position and has since loweredthe short-term rates by 500 basis points through December 2008, causing therates on our short-term or variable rate assets and liabilities to decline.  Themajority of economic analysts predict little to no change in short-term ratesthroughout the remainder of 2009.  The following discussion includes ouranalysis of the effect that we anticipate changes in interest rates will haveon our financial condition.  However, we can give no assurances as to the futureactions of the Federal Reserve or to the anticipated results that will actuallyoccur.

** **

**RecentLegislative and Regulatory Initiatives to Address Financial and Economic Crises**

** **

Markets in the United States and elsewhere have experienced extreme volatility and disruption for morethan 12 months.  These circumstances have exerted significant downward pressureon prices of equity securities and virtually all other asset classes, and haveresulted in substantially increased market volatility, severely constrainedcredit and capital markets, particularly for financial institutions, and anoverall loss of investor confidence.  Loan portfolio performances havedeteriorated at many institutions resulting from, among other factors, a weakeconomy and a decline in the value of the collateral supporting their loans.  Dramaticslowdowns in the housing industry, due in part to falling home prices andincreasing foreclosures and unemployment, have created strains on financialinstitutions.  Many borrowers are now unable to repay their loans, and thecollateral securing these loans has, in some cases, declined below the loanbalance.   In response to the challenges facing the financial services sector, several regulatory and governmental actions have recently beenannounced including:

 
    -  The     EESA, approved by Congress and signed by President Bush on October 3,     2008, which, among other provisions, allowed the Treasury Department to     purchase troubled assets from banks, authorized the Securities and     Exchange Commission to suspend the application of marked-to-market     accounting, and temporarily raised the basic limit of FDIC deposit     insurance from $100,000 to $250,000; the legislation contemplated a return     to the $100,000 limit on December 31, 2009;

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

 
    -  On     October 14, 2008, the U.S. Treasury announced the creation of the CPP     which encourages and allows financial institutions to build capital     through the sale of senior preferred shares to the Treasury Department on     terms that are non-negotiable;  

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

 

§TheTransaction Account Guarantee Program (“TAGP”), which provides unlimiteddeposit insurance coverage through December 31, 2009 for noninterest-bearingtransaction accounts (typically business checking accounts) and certain fundsswept into noninterest-bearing savings accounts.  Institutions participating inthe TLGP pay a 10 basis points fee (annualized) on the balance of each coveredaccount in excess of $250,000, while the extra deposit insurance is in place;

 

§ TheDebt Guarantee Program (“DGP”), under which the FDIC guarantees certain seniorunsecured debt of FDIC-insured institutions and their holding companies.  Theunsecured debt must be issued on or after October 14, 2008 and not later thanJune 30, 2009, and the guarantee is effective through the earlier of thematurity date or June 30, 2012.  The DGP coverage limit is generally 125% ofthe eligible entity’s eligible debt outstanding on September 30, 2008 andscheduled to mature on or before June 30, 2009 or, for certain insuredinstitutions, 2% of their liabilities as of September 30, 2008.  Depending onthe term of the debt maturity, the nonrefundable DGP fee ranges from 50 to 100basis points (annualized) for covered debt outstanding until the earlier ofmaturity or June 30, 2012.  The TAGP and DGP are in effect for all eligibleentities, unless the entity opted out on or before December 5, 2008.

  

10

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

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

 

§ TheLegacy Loan Program, which the primary purpose will be to facilitate the saleof troubled mortgage loans by eligible institutions, which include FDIC-insuredfederal or state banks and savings associations. Eligible assets may not bestrictly limited to loans; however, what constitutes an eligible asset will bedetermined by participating banks, their primary regulators, the FDIC and the U.S.Treasury. Additionally, the Loan Program’s requirements and structure will besubject to notice and comment rulemaking, which may take some time to complete.

 

§ TheSecurities Program, which will be administered by the U.S. Treasury, involvesthe creation of public-private investment funds to target investments ineligible residential mortgage-backed securities and commercial mortgage-backedsecurities issued before 2009 that originally were rated AAA or the equivalentby two or more nationally recognized statistical rating organizations, withoutregard to rating enhancements (collectively, “Legacy Securities”). LegacySecurities must be directly secured by actual mortgage loans, leases or otherassets, and may be purchased only from financial institutions that meet TARPeligibility requirements.

 

On February27, 2009, as part of the CPP, we entered into the CPP Purchase Agreement withthe Treasury Department under the CPP pursuant to which we sold 17,299 sharesof our Series T Preferred Stock and the CPP Warrant to purchase 330,554 sharesof our common stock for an aggregate purchase price of $17.3 million in cash.  The Series T Preferred Stock will qualify as Tier 1 capitaland will be entitled to cumulative dividends at a rate of 5% per annum for thefirst five years, and 9% per annum thereafter.  We must consult with theOCC before we may redeem the Series T Preferred Stock but, contrary to theoriginal restrictions in the EESA, will not necessarily be required to raiseadditional equity capital in order to redeem this stock.   The CPP Warrant has a 10-year term and is immediatelyexercisable upon its issuance, with an exercise price, subject to anti-dilutionadjustments equal to $7.85 per share of the common stock.  The fairvalue allocation of the $17.3 million between the shares of Series T PreferredStock and the CPP Warrant resulted in $15.9 million allocated to the shares ofSeries T Preferred Stock and $1.4 million allocated to the CPP Warrant. 

 

Wewill participate in the TAGP and have opted out of the DGP. 

** **

11

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

* *

                Our net incomewas $487,000 and $747,000 for the three months ended March 31, 2009 and 2008,respectively, a decrease of $260,000, or 34.7%.  The $260,000 decrease in netincome resulted primarily from increased noninterest expenses of $443,000 and a$150,000 increase in provision for loan losses, partially offset by anadditional $67,000 in net interest income, $103,000 in noninterest income and a$163,000 decrease in income tax expense.  Our efficiency ratio, excluding realestate owned activity, was 70.23% for the three months ended March 31, 2009compared to 62.7% for the same period in 2008.  The higher efficiency ratiorelates primarily to the additional administrative costs associated with ourtwo new retail offices.  

* *

*Net Interest Income*

* *

                Ourlevel of net interest income is determined by the level of earning assets andthe management of our net interest margin.  During the three months ended March31, 2009 our average earning assets increased $38.8 million compared to theaverage for the three months ended March 31, 2008, primarily due to a $41.2million increase in average loans, partially offset by a $2.4 million decreasein average investments and federal funds sold.  

 

                Our decision to grow the loan portfolio during thefirst six months of 2008 created the need for a higher level of capital and theneed to increase deposits and borrowings.  During the second half of 2008, inresponse to the deteriorating economic conditions, and the limited amount ofcapital available to the financial industry, we decided to manage and limit thelevel of future loan growth to ensure the Bank remains well-capitalized.  As aresult, during the first quarter of 2009, net loans declined $637,000.  Our loangrowth strategy also resulted in a significant portion of our assets in thefirst quarter of 2009 being in higher earning loans rather than in loweryielding investments.  At March 31, 2009, net loans represented 79.3% of totalassets, while investments and federal funds sold represented 14.2% of totalassets.  In addition, asdescribedbelow,wehavealsoincreasedourlevelofdepositssignificantly. 

 

                DuringJuly 2008 we opened two additional retail deposit offices.  We now have fourretail offices in the Greenville market and two retail offices in the Columbiamarket.  Our focus for these locations is to obtain low cost transactionaccounts, resulting in an increase in both the percentage of assets beingfunded by “in market” retail deposits and to increase the percentage oflow-cost transaction accounts to total deposits.  We believe that this growthstrategy will provide additional clients in our two market areas and willeventually provide a lower alternative cost of funding.   At March 31, 2009,retail deposits represented $261.7 million, or 37.1% of total assets,borrowings represented $168.1 million, or 23.8% of total assets, and wholesaleout-of-market deposits represented $213.1 million, or 30.2% of total assets.

 

We have included a number of tables toassist in our description of various measures of our financial performance. For example, the “Average Balances, Income and Expenses, Yields and Rates”table shows the average balance of each category of our assets and liabilitiesas well as the yield we earned or the rate we paid with respect to eachcategory during the three months ended March 31, 2009 and 2008.  A review of thistable shows that our loans typically provide higher interest yields than doother types of interest-earning assets, which is why we direct a substantialpercentage of our earning assets into our loan portfolio.  Similarly, the“Rate/Volume Analysis” table demonstrates the effect of changing interest ratesand changing volume of assets and liabilities on our financial condition duringthe periods shown.  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.

 

12

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The following table sets 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 month periods ended March 31, 2009 and 2008, wehad no interest-bearing deposits in other banks or any securities purchasedwith agreements to resell.  All investments were owned at an original maturityof over one year.  Nonaccrual loans are included in the following tables.  Loanyields have been reduced to reflect the negative impact on our earnings ofloans on nonaccrual status.  The net of capitalized loan costs and fees areamortized into interest income on loans.

 

|                                                                                                                                                          |                                             | **Average  Balances, Income and Expenses, Yields and Rates** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------|--------------------------------------------------|--------------------------------------------------------------|
|                                                                                                                                                          |                                             | **For the Three  Months Ended March 31,**                    |
|                                                                                                                                                          |                                             | **2009**                                                     |   | **2008** |
|                                                                                                                                                          |                                             | **Average**                                                  |   | **Income/** |   | **Yield/** |   | **Average** |   | **Income/** |   | **Yield/** |
|                                                                                                                                                          |                                             | **Balance**                                                  |   | **Expense** |   | **Rate(1)** |   | **Balance** |   | **Expense** |   | **Rate(1)** |
|                                                                                                                                                          | ** **                                       |
| Earnings                                                                                                                                                      |                                             |                                                         |   |   |   |   |   |   |   |   |   |   |
|                                                                                                                                                          | Federal  funds sold                              | $                                                            | 8,482  | $ | 5  |   | 0.24% | $ | 10,322  | $ | 84  |   | 3.27% |
|                                                                                                                                                          | Investment  securities, taxable                  |                                                         | 89,460  |   | 1,057  |   | 4.79% |   | 89,980  |   | 1,213  |   | 5.42% |
|                                                                                                                                                          | Investment  securities, nontaxable (2)           |                                                         | 3,793  |   | 58  |   | 6.21% |   | 3,792  |   | 58  |   | 6.16% |
|                                                                                                                                                          | Loans                                            |                                                         | 566,456  |   | 7,797  |   | 5.58% |   | 525,266  |   | 9,009  |   | 6.90% |
|                                                                                                                                                          |    Total earning-assets                     |                                                         | 668,191  |   | 8,917  |   | 5.41% |   | 629,360  |   | 10,364  |   | 6.62% |
|                                                                                                                                                          | Non-earning  assets                              |                                                         | 37,507  |   |   |   |   |   | 22,545  |   |   |   |   |
|                                                                                                                                                          |    Total assets                             | $                                                            | 705,698  |   |   |   |   | $ | 651,905  |   |   |   |   |
| Interest-bearing  liabilities                                                                                                                                 |                                             |                                                         |   |   |   |   |   |   |   |   |   |   |
|                                                                                                                                                          | NOW  accounts                                    | $                                                            | 41,975  |   | 71  |   | 0.69% | $ | 35,960  |   | 121  |   | 1.35% |
|                                                                                                                                                          | Savings  & money market                      |                                                         | 88,597  |   | 257  |   | 1.18% |   | 90,380  |   | 563  |   | 2.51% |
|                                                                                                                                                          | Time  deposits                                   |                                                         | 312,265  |   | 2,460  |   | 3.19% |   | 281,143  |   | 3,413  |   | 4.88% |
|                                                                                                                                                          | Total  interest-bearing deposits                 |                                                         | 442,837  |   | 2,788  |   | 2.55% |   | 407,483  |   | 4,097  |   | 4.04% |
|                                                                                                                                                          | Notes  payable and other borrowings              |                                                         | 164,839  |   | 1,522  |   | 3.74% |   | 156,457  |   | 1,618  |   | 4.16% |
|                                                                                                                                                          | Junior  subordinated debentures                  |                                                         | 13,403  |   | 124  |   | 3.75% |   | 13,403  |   | 233  |   | 6.99% |
|                                                                                                                                                          | Total  interest-bearing liabilities              |                                                         | 621,079  |   | 4,434  |   | 2.90% |   | 577,343  |   | 5,948  |   | 4.20% |
|                                                                                                                                                          | Non-interest  bearing liabilities                |                                                         | 38,554  |   |   |   |   |   | 35,344  |   |   |   |   |
| Shareholders’  equity                                                                                                                                    |                                             | 46,065                                                  |   |   |   |   |   | 39,218  |   |   |   |   |
|                                                                                                                                                          | Total  liabilities and shareholders’ equity | $                                                            | 705,698  |   |   |   |   | $ | 651,905  |   |   |   |   |
| Net  interest spread                                                                                                                                          |                                             |                                                         |   |   |   | 2.51% |   |   |   |   |   | 2.42% |
| Net  interest income (tax equivalent) / margin                                                                                                                |                                             |                                                         | $ | 4,483  |   | 2.72% |   |   | $ | 4,416  |   | 2.82% |
| Less:   tax-equivalent adjustment (2)                                                                                                                    |                                             |                                                         |   | 22  |   |   |   |   |   | 22  |   |   |
| Net  interest income                                                                                                                                          |                                             |                                                         | $ | 4,461  |   |   |   |   | $ | 4,394  |   |   |
|                                                                                                                                                          |                                             |                                                         |   |   |   |   |   |   |   |   |   |   |   |
|      (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 income margin for thethree months ended March 31, 2009 exceeded our net interest spread because wehad more interest-earning assets than interest-bearing liabilities.  Averageinterest-earning assets exceeded average interest-bearing liabilities by $47.1million, and $52.0 million for the three months ended March 31, 2009 and 2008,respectively.

 

Our net interest spread, was 2.51% forthe three months ended March 31, 2009, compared to 2.42% for the three monthsended March 31, 2008.  The net interest spread is the difference between theyield we earn on our interest-earning assets and the rate we pay on ourinterest-bearing liabilities.

 

                The9 basis point increase in the net interest spread is primarily due to the factthat more of our rate-sensitive liabilities repriced downward than ourrate-sensitive assets during the twelve months ended March 31, 2009.  Given the500 basis point decrease in short-term rates over the past 18 months, the rateson our new and maturing loans and deposits are much lower than they were in thepast.  However, in response to the significant decrease in rates, we have beguninstituting interest rate floors on our new and maturing loans.  This actionhas resulted in only a 132 basis point decrease in our weighted average rate onloans compared to a 149 basis point decrease in the average weighted rate ondeposits, the two largest components of net interest income.

 

13

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Our net interest margin is calculated asnet interest income, on an annualized basis, divided by averageinterest-earning assets.  Our net interest margin, on a tax-equivalent basis,for the three months ended March 31, 2009 was 2.72% compared to 2.82% for thethree months ended March 31, 2008.  During the first quarter of 2009,interest-earning assets averaged $668.2 million compared to $629.4 million inthe first quarter of 2008.  

 

Our loan yield decreased 132 basispoints for the three months ended March 31, 2009 compared to the three monthsended March 31, 2008 as a result of the 500 basis point reduction in short-termrates in the past 18 months.  The short-term rate reduction had an immediateimpact on our variable rate loans which represent 46.5% of our total loans atMarch 31, 2009.  Offsetting the decrease in our loan yield was a 149 basispoint decrease in the cost of our interest-bearing deposits for the firstquarter of 2009 compared to the same period in 2008.  The decrease in the rateon interest-bearing deposits is due primarily to the 169 basis point decreaseon the 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 year.  Inaddition, the cost of our transaction, savings and money market accounts hasdecreased as we have lowered the rates we offer on these products.  The cost ofour savings and money market accounts has decreased by 133 basis points fromMarch 31, 2008, while the rate on our transaction accounts has decreased 66basis points in the same period.  

 

In addition, the 42 basis point decreasein notes payable and other borrowings and the 324 basis point decrease in juniorsubordinated debt in the first quarter of 2009 compared to the same period in2008 resulted primarily from the impact of the 500 basis point decrease inshort-term market rates over the past 18 months.  As of March 31, 2009,approximately 12% of our FHLB advances had variable rates, while all of ourother borrowings, including notes payable and junior subordinated debt, hadvariable rates.

 

As more fully discussed in the – “MarketRisk” and – “Liquidity and Interest Rate Sensitivity” sections below, at March31, 2009, 46% of our loans had variable rates.  During the past two years wehave placed a greater emphasis on fixed rate loans; however, we recentlychanged our focus to increase the amount of variable rate loans in ourportfolio.  Our variable rate loans as a percentage of total loans increasedfrom 38% at March 31, 2008 to 46% at March 31, 2009.  We believe that interestrates are at or near their lowest levels and that this change in focus willposition us to benefit from future increases in the short-term rates. 

 

At March 31, 2009, 80.4% of our interest-bearingliabilities were either variable rate or had a maturity of less than oneyear.   Of the $312.9 million of interest-bearing liabilities set to repricewithin three months, 40.8% are transaction, money market or savings accountswhich are already at or near their lowest rates and provide little opportunityfor benefit should market rates continue to decline or stay constant.  However,certificates of deposit that are currently maturing or renewing are repricingat lower rates.  We expect to benefit as these deposits reprice, even if marketrates increase slightly.  At March 31, 2009, we had $135.8 million moreliabilities than assets that reprice within the next twelve months.  Includedin our other borrowings are a number of FHLB advances and structured repurchaseagreements with callable features as of March 31, 2009.  We believe that theoptionality on many of these borrowings will not be exercised until interestrates increase significantly.  In addition, we believe that the interest ratesthat we pay on the majority of our interest-bearing transaction accounts, wouldonly be impacted by a portion of any change in market rates.  This keyassumption is utilized in our overall evaluation of our level of interestsensitivity.

 

14

 

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*Rate/VolumeAnalysis*

*** ***

Net interest income can be analyzed interms of the impact of changing interest rates and changing volume.  Thefollowing table sets forth the effect which the varying levels ofinterest-earning assets and interest-bearing liabilities and the applicable rateshave had on changes in net interest income for the periods presented.

 

|                                                   | **Three Months  Ended**         |
|--------------------------------------------------------|---------------------------------|
|                                                   | **March 31, 2009  vs. 2008**    | ** ** | **March 31, 2008 vs.  2007** |
|                                                   | **Increase  (Decrease) Due to** |   | **Increase  (Decrease) Due to** |
|                                                   | **Volume**                      | ** ** | **Rate** |   | **Rate/  Volume** |   | **Total** |   | **Volume** | ** ** | **Rate** |   | **Rate/****Volume** |   | **Total** |
|                                                   |                            |
|                                                   |                            | ** ** |
| **Interest income**                                    | ** **                      |   |   |   |   |   |   |   |   |   |
|    Loans                                          | $                               | 761  | $ | (1,829) | $ | (144) | $ | (1,212) | $ | 2,171  | $ | (737) | $ | (190) | $ | 1,244  |
|    Investment securities                          |                            | (8) |   | (149) |   | 1  |   | (156) |   | 215  |   | -  |   | -  |   | 215  |
|    Federal funds sold                             |                            | (15) |   | (78) |   | 14  |   | (79) |   | (33) |   | (57) |   | 12  |   | (78) |
|        Total interest income  |                            | 738  |   | (2,056) |   | (129) |   | (1,447) |   | 2,353  |   | (794) |   | (178) |   | 1,381  |
|                                                   |                            |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Interest  expense**                                  | ** **                      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|    Deposits                                       |                            | 372  |   | (1,544) |   | (137) |   | (1,309) |   | 805  |   | (290) |   | (58) |   | 457  |
|    Other borrowings                               |                            | 100  |   | (186) |   | (10) |   | (96) |   | 491  |   | (130) |   | (47) |   | 314  |
|    Junior subordinated debt                       |                            | -  |   | (109) |   | -  |   | (109) |   | -  |   | -  |   | -  |   | -  |
|        Total interest expense |                            | 472  |   | (1,839) |   | (147) |   | (1,514) |   | 1,296  |   | (420) |   | (105) |   | 771  |
|                                                   |                            |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Net  interest income**                               | **$**                           | 266  | $ | (217) | $ | 18   | $ | 67  | $ | 1,057  | $ | (374) | $ | (73) | $ | 610  |
|                                                        |                                 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

* *

Net interest income, the largestcomponent of our income, was $4.5 million and $4.4 million for the three monthsended March 31, 2009 and 2008, respectively.  The slight increase in the firstquarter of 2009 related primarily to the net effect of higher levels of bothaverage interest-earning assets and interest-bearing liabilities.  Average interest-earningassets were $38.8 million higher during the three months ended March 31, 2009compared to the same period in 2008.  During the same period, averageinterest-bearing liabilities increased $43.7 million.  The higher averagebalances resulted in $266,000 of additional net interest income for the threemonths ended March 31, 2009, while lower rates on the average balances reducednet interest income by $217,000. 

 

Interest income for the three monthsended March 31, 2009 was $8.9 million, consisting of $7.8 million on loans, $1.1million on investments, and $5,000 on federal funds sold.  Interest income forthe three months ended March 31, 2008 was $10.3 million, consisting of $9.0million on loans, $1.3 million on investments, and $84,000 on federal fundssold.  Interest on loans for the three months ended March 31, 2009 and 2008represented 87.7% and 87.1%, respectively, of total interest income, whileincome from investments and federal funds sold represented only 12.3% and 12.9%,respectively, of total interest income.  The high percentage of interest incomefrom loans relates to our strategy to maintain a significant portion of ourassets in higher earning loans compared to lower yielding investments.  Averageloans represented 84.8% and 83.5% of average interest-earning assets for thethree months ended March 31, 2009 and 2008, respectively.  Included in interestincome on loans for the three months ended March 31, 2009 and 2008 was $168,000and $196,000, respectively, related to the net amortization of loan fees andcapitalized loan origination costs.

 

Interest expense for the three monthsended March 31, 2009 was $4.4 million, consisting of $2.8 million related todeposits and $1.6 million related to other borrowings.  Interest expense forthe three months ended March 31, 2008 was $6.0 million, consisting of $4.1million related to deposits and $1.9 million related to other borrowings. Interest expense on deposits for the three months ended March 31, 2009 and 2008represented 62.9% and 68.9%, respectively, of total interest expense, whileinterest expense on other borrowings represented 37.1% and 31.1%, respectively,of total interest expense for the same three month periods.  During the threemonths ended March 31, 2009, average interest-bearing deposits increased by $35.4million over the same period in 2008, while our notes payable and otherborrowings increased $8.4 million during the three months ended March 31, 2009over the same period in 2008.  The note payable and other borrowings provide uswith the opportunity to obtain low cost funding with various maturities similarto the maturities on our loans and investments.  

* *

15

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*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 we considerin determining the amount of the provision we expense each period to maintainthis allowance.

* *

For the threemonths ended March 31, 2009 and 2008, we incurred a noncash expense related tothe provision for loan losses of $750,000 and $600,000, respectively, bringingthe allowance for loan losses to $7.4 million and $6.2 million, respectively,or 1.31% and 1.16% of gross loans for the respective periods.  During the threemonths ended March 31, 2009 and 2008, we reported net charge-offs of $326,000and $127,000, respectively, which represented an annualized 0.23% and 0.10% ofthe average outstanding loan portfolio for the respective periods.

 

At March 31, 2009,the allowance for loan losses represented less than one time the amount ofnon-performing loans, compared to 2.1 times at March 31, 2008.  The coveragelevel of the allowance at March 31, 2009 decreased from the coverage level atMarch 31, 2008 due to an increase in non-performing loans.  A significantportion, or 82.9%, of nonperforming loans at March 31, 2009 are secured by realestate.  We have evaluated the underlying collateral on these loans and believethat the collateral on these loans is sufficient to minimize future losses.  Asa result of this level of coverage on non-performing loans, we believe that theprovision of $750,000 for the three months ended March 31, 2009 to be adequate.

 

*Noninterest Income*

 

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

 

|                                  | ** ** | **Three months  ended** |
|---------------------------------------|------------|-------------------------|
|                                  | ** ** | **March 31,**           |
|                                  | ** ** | **2009**                | ** ** | **2008** |
| ** **                            | ** ** |                    |   |   |
| Loan fee income                       | $          | 38            | $ | 45  |
| Service fees on deposit accounts      | ** ** | 175                |   | 149  |
| Income from bank owned life insurance | ** ** | 123                |   | 96  |
| Real estate owned activity            | ** ** | (7)                     |   | (58) |
| Other income                          | ** ** | 85                 |   | 79  |
|   Total noninterest income       | $          | 414                | $ | 311  |

** **

Noninterestincome for the three month period ended March 31, 2009 was $414,000, anincrease of 33.1% over noninterest income of $311,000 for the same period of2008.  The $103,000 increase in 2009 was primarily related to a $26,000 increasein service fees on deposit accounts, $27,000 in income from bank owned lifeinsurance and a $51,000 decrease in the loss on real estate owned.  

 

Loanfee income was $38,000 and $45,000 for the three months ended March 31, 2009and 2008, respectively, consisting primarily of late charge fees, fees fromissuance of lines and letters of credit, and mortgage origination fees wereceive on residential loans funded and closed by a third party.  The $7,000 decreasefor the three months ended March 31, 2009 compared to the same period in 2008related primarily to a $5,000 decrease in late charge fees and a $3,000 decreasein mortgage origination fees, partially offset by a $1,000 increase in feesrelated to lines and letters of credit.  Late charge fees were $24,000 and $29,000for the three months ended March 31, 2009 and 2008, respectively, while mortgageorigination fees were $3,000 and $6,000 for the first quarter of 2009 and 2008,respectively.  Income related to lines and letters of credit was $11,000 and $10,000for the three months ended March 31, 2009 and 2008, respectively.  

 

Servicefees on deposit accounts consist primarily of service charges on our checking,money market, and savings accounts and the fee income received from client non-sufficientfunds (“NSF”) transactions.   Deposit fees were $175,000 and $149,000 for thethree months ended March 31, 2009, and 2008, respectively.  The $26,000increase is primarily related to a $21,000 increase in deposit related feessuch as service charges and a $14,000 increase in overdraft and stop paymentfees, partially offset by a $9,000 decrease in NSF fees.  Service charge feeswere $57,000 and $36,000 for the periods ended March 31, 2009 and 2008,respectively, and other fees such as overdraft and returned item fees were$15,000 and $1,000 for the same periods in 2009 and 2008, respectively.  NSFincome was $103,000 and $112,000 for the three months ended March 31, 2009 and2008, respectively, representing 59.0% of total service fees on deposits in the2009 period compared to 75.4% of total service fees on deposits in the 2008period.   

 

We purchased an additional $4.0million of bank owned life insurance during the second half of 2008.  Incomederived from life insurance was $123,000 and $96,000 for the three months endedMarch 31, 2009 and 2008.  

 

16

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           Real estateowned activity includes income and expenses from property held for sale andother real estate we own, including real estate acquired in settlement of loans. For the three months ended March 31, 2009 and 2008, our expenses related toowning the real estate exceeded income received on the properties by $7,000 and$58,000, respectively.  

 

Otherincome consisted primarily of fees received on debit card transactions, sale ofcustomer checks, and wire transfers.  Other income was $85,000 and $79,000 forthe three months ended March 31, 2009 and 2008, respectively.  The $6,000 increaserelates primarily to a $9,000 increase in debit card transaction fees,partially offset by a $3,000 decrease in other client service related fees.  Debitcard transaction fees were $59,000 and $50,000 for the three months ended March31, 2009 and 2008, respectively and represented 68.9% and 63.4% of total otherincome for the first quarters of 2009 and 2008, respectively.  Thecorresponding transaction costs associated with debit card transactions are includedin noninterest data processing and related costs.  The debit card transactioncosts were $23,000 and $20,000 for the three months ended March 31, 2009 and2008, respectively.  The net impact of the fees received and the related costof the debit card transactions on earnings for the three months ended March 31,2009 and 2008 was $36,000 and $30,000, respectively. 

 

*Noninterest expenses*

 

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

| *            * |   | **Three months  ended** |
|----------------------------------------------------------------------------|--------|-------------------------|
|                                                                       |   | **March 31,**           |
|                                                                       |   | **2009**                | ** ** | **2008** |
|                                                                       |   |                    |   |   |
| Compensation and benefits                                                  | $      | 1,925              | $ | 1,718  |
| Professional fees                                                          |   | 136                |   | 114  |
| Marketing                                                                  |   | 145                |   | 135  |
| Insurance                                    |   | 153                |   | 129  |
| Occupancy                                                                  |   | 416                |   | 348  |
| Data processing and related costs                                          |   | 374                |   | 321  |
| Telephone                                         |   | 51                 |   | 34  |
| Other                                                            |   | 229                |   | 187  |
|   Total noninterest expenses                                          | $      | 3,429              | $ | 2,986  |

 

Weincurred noninterest expenses of $3.4 million for the three months ended March31, 2009 compared to $3.0 million for the three months ended March 31, 2008, anincrease of $443,000 or 14.9%.

 

Noninterestexpense as a percentage of noninterest income and net interest income, or theefficiency ratio, was 70.2% for the three months ended March 31, 2009 comparedto 62.7% for the same period in 2008, excluding real estate owned activity.  Managementbelieves that the appropriate measure of the effectiveness of noninterestexpenses in comparison to the overall operations of the company excludes anynon-recurring items, such as the income or loss from real estate owned activity.The primary reason for the higher efficiency ratio in the 2009 period is due tothe additional retail offices and their related expenses.  The initialoperating costs for these two locations in their first year of operationsexceed the benefits from obtaining additional low cost deposits.  As thesebranch offices increase their retail deposits, we anticipate that ourefficiency ratio will begin to improve; however, no assurance can be given thatthe levels of deposits will cover the additional expenses or that other costswill not increase.  

 

Forthe three months ended March 31, 2009, compensation and benefits, occupancy,and data processing and related costs represented 79.2% of the totalnoninterest expense compared to 79.9% for the same period in 2008.  

 

17

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

 

|                                                           |   | **Three months  ended** |
|----------------------------------------------------------------|--------|-------------------------|
|                                                           |   | **March 31,**           |
|                                                           |   | **2009**                | ** ** | **2008** |
|                                                           |   |                    |   |   |
| Base compensation                                              | $      | 1,336              | $ | 1,159  |
| Incentive compensation                                         |   | 209                |   | 247  |
|   Total compensation                                      |   | 1,545              |   | 1,406  |
| Benefits          |   | 415                |   | 348  |
| Capitalized loan origination costs                             |   | (35)                    |   | (36) |
|   Total compensation and benefits                         | $      | 1,925              | $ | 1,718  |

 

Compensationand benefits expense was $1.9 million and $1.7 million for the three monthsended March 31, 2009 and 2008, respectively.   Compensation and benefitsrepresented 56.1% and 57.5% of our total noninterest expense for the threemonths March 31, 2009 and 2008, respectively.  The $207,000 increase incompensation and benefits in the first quarter of 2009 compared to the sameperiod in 2008 resulted from increases of $177,000 in base compensation and $67,000in benefits expense, partially offset by a reduction of $38,000 in incentivecompensation.  In addition, loan origination compensation expense, which isrequired to be capitalized and amortized over the life of the loan as areduction of loan interest income, decreased by $1,000.  

 

The $177,000increase in base compensation expense related to the cost of 12 additional employeesas well as annual salary increases.  Ten of the new employees were hired to staffour two new retail office locations, one employee was hired as a mortgage loanoriginator and another to support the accounting and human resource functions. Incentive compensation represented 10.9% and 14.4% of total compensation andbenefits for the three months ended March 31, 2009 and 2008, respectively.  Theincentive compensation expense recorded for the first quarter of 2009 and 2008represented an accrual of the estimated incentive compensation earned duringthe first quarter of the respective year.  Benefits expense increased $67,000in the first quarter of 2009 compared to the same period in 2008.  Benefitsexpense represented 26.9% and 24.8% of the total compensation for the threemonths ended March 31, 2009 and 2008, respectively.

 

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

|                                     |   | **Three months  ended** |
|------------------------------------------|--------|-------------------------|
|                                     |   | **March 31,**           |
|                                     |   | **2009**                | ** ** | **2008** |
|                                     |   |                    |   |   |
| Data processing costs                    | $      | 294                | $ | 249  |
| Debit card transaction expense           |   | 23                 |   | 20  |
| Courier expense                          |   | 27                 |   | 24  |
| Other expenses                           |   | 30                 |   | 28  |
| Total data  processing and related costs | $      | 374                | $ | 321  |

* *

Dataprocessing and related costs were $374,000 and $321,000 for the three monthsended March 31, 2009 and 2008, respectively.   During the three months ended March31, 2009, our data processing costs for our core processing system were $294,000compared to $249,000 for the three months ended March 31, 2008.   We havecontracted with an outside computer****service company to provide our coredata processing services.  

 

Dataprocessing costs increased $45,000, or 18.3%, for the three months ended March31, 2009 compared to the same period in 2008.  The increases in costs areprimarily related to a higher number of loan and deposit accounts.  A significantportion of the fee charged by the third party processor is directly related tothe number of loan and deposit accounts and the related number oftransactions.  We receive income from debit card transactions performed by ourclients.  Since we outsource this service, we are charged related transactionexpenses from our merchant service provider.  Debit card transaction expensewas $23,000 and $20,000 for the three months ended March 31, 2009 and 2008,respectively.    

 

18

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Occupancyexpense represented 12.1% and 11.6% of total noninterest expense for the threemonths ended March 31, 2009 and 2008, respectively.  Occupancy expense for thethree months ended March 31, 2009 and 2008 was $416,000 and $348,000,respectively, an increase of $68,000.  The increase is primarily due to theincreased costs of depreciation and maintenance associated with the two retailoffices opened in July 2008.  

 

Theremaining $115,000 increase in noninterest expense for the three month periodended March 31, 2009 compared to the same period in 2008 resulted primarilyfrom increases of $22,000 in professional fees, $10,000 in marketing expenses, $24,000in insurance, $17,000 in telephone expenses, and $42,000 in other expenses.   Theincrease in professional fees relates primarily to increased legal andaccounting fees, while the increase in insurance costs is related to the growthin deposits and the FDIC deposit insurance expense which is based on ourdeposit balances. The increases in marketing and telephone expenses are largelydue to the two new retail offices added in July 2008.  In addition, the $42,000increase in other expenses is primarily due to an additional $79,000 incollection expenses and $12,000 in office supplies during the first quarter of2009, partially offset by a $21,000 decrease in travel and business mealsexpenses and a $28,000 decrease in deposit account losses

 

Incometax expense was $209,000 for the three monthsended March 31, 2009 compared to $372,000 during the same period in 2008.   Oureffective tax rate was 29.9% and 33.3%, respectively, for the first quarters of2009 and 2008, respectively.  The lower net income during the first quarter of2009 increased the impact that our tax-exempt income had in lowering oureffective tax rate from the same period in the prior year.

 

 

**BalanceSheet Review**

*General*

 

*               *At March 31, 2009, we had totalassets of $705.0 million, consisting principally of $566.4 million in loans, $96.5million in investments, $3.7 million in federal funds sold, $8.9 million incash and due from banks and $13.5 million in bank owned life insurance.  Ourliabilities at March 31, 2009 totaled $647.0 million, which consistedprincipally of $474.8 million in deposits, $154.7 million in notes payable andother borrowings, and $13.4 million in junior subordinated debentures.  At March31, 2009, our shareholders’ equity was $58.0 million.

 

At December 31, 2008, we hadtotal assets of $693.0 million, consisting principally of $566.6 million inloans, $85.4 million in investments, $8.8 million in federal funds sold, $4.4million in cash and due from banks and $13.4 million in bank owned lifeinsurance.  Our liabilities at December 31, 2008 totaled $653.2 million,consisting principally of $469.5 million in deposits, $164.7 million in notespayable and other borrowings, and $13.4 million of junior subordinateddebentures.  At December 31, 2008, our shareholders’ equity was $39.8 million.

 

*FederalFunds Sold*

 

*               *At March 31, 2009, our federal fundssold were $3.7 million, or 0.5% of total assets.  At December 31, 2008, our $8.8million in short-term investments in federal funds sold on an overnight basiscomprised 1.3% of total assets.  As short-term market rates have decreased inthe past 18 months, we have lowered the balances in our overnight federal fundssold accounts. 

* *

*Investments*

At March 31, 2009, the $96.5 million in our investment securitiesportfolio represented approximately 13.7% of our total assets.  We heldGovernment sponsored enterprise securities, municipalsecurities, and mortgage-backed securities with a fair value of $87.5 millionand an amortized cost of $88.3 million for an unrealized loss of $769,000.  

 

19

----

 

Contractual maturities and yields on ourinvestments that are available for sale and are held to maturity at March 31,2009 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 March 31, 2009.

 

| ** **                       | ** ** | **One  to Five Years** | ** **  | **Five  to Ten Years** | ** **   | **Over  Ten Years** | ** ** | **Total**         |
|----------------------------------|------------|------------------------|-------------|------------------------|--------------|---------------------|------------|-------------------|
| ** **                       | ** ** | **Amount**             | **Yield**   | ** **             | **Amount**   | **Yield**           | ** ** | **Amount**        | **Yield** | ** ** | **Amount** | **Yield** |
| ** **                       | ** ** | ** **             |
| ** **                       | ** ** | ** **             | ** **  | ** **             | ** **   | ** **          | ** ** | ** **        | ** ** | ** ** | ** ** | ** ** |
| **Available for Sale**           |       | ** **             | ** **  | ** **             | ** **   | ** **          | ** ** | ** **        | ** ** | ** ** | ** ** | ** ** |
| Government sponsored enterprises | $          | -                      | - %    | $                      | 11,164  | 5.20 %         | $          | 7,604   | 5.06 % | $ | 18,768  | 5.14 % |
| State and political subdivisions |       | -                      | - %    |                   | 2,941        | 3.79 %         |       |  829    | 3.82 % |   | 3,770  | 3.80 % |
| Mortgage-backed securities       |       | 375                    | 4.74 % |                   | 4,614   | 4.50 %         |       | 48,181       | 5.21 % |   | 53,170  | 5.15 % |
| Preferred stock                  |       | -                      | - %    |                   | -       | - %            |       | 58           | - % |   | 58  | - % |
| Total                            | $          | 375                    | 4.74 % | $                      | 18,719  | 4.80 %         | $          | 56,672       | 5.17 % | $ | 75,766  | 5.23 % |
| ** **                       | ** ** |                   |        |                   |         |                |       |              |   |   |   |   |
| **Held to Maturity**             | ** ** |                   |        |                   |         |                |       |              |   |   |   |   |
| Mortgage-backed securities       | $          | 217                    | 3.94 % |                   | 2,217   | 4.39 %         | $          | 9,050        | 4.52 % | $ | 11,484  | 4.49 % |

 

             Otherinvestments at March 31, 2009, consisted of Federal Reserve Bank stock with acost of $1.3 million, investment in Greenville First Statutory Trust I and IIof $186,000 and $217,000, respectively, and Federal Home Loan Bank stock with acost of $7.4 million.  At March 31, 2009, our investments included securitiesissued by Federal Home Loan Mortgage Corporation and Federal National MortgageAssociation with carrying values of $23.2 million, and $31.9 million,respectively.

 

The amortized costs and the fair valueof our investments at March 31, 2009 and December 31, 2008 are shown in thefollowing table.

 

| * *                         | ** ** | **March 31, 2009** | ** ** | **December 31,  2008** |
|----------------------------------|------------|--------------------|------------|------------------------|
|                             | ** ** | **Amortized**      | ** ** | **Fair**               | ** ** | **Amortized** | ** ** | **Fair** |
|                             | ** ** | **Cost**           | ** ** | **Value**              | ** ** | **Cost** | ** ** | **Value** |
|                             | ** ** | ** **         |
| **Available  for Sale**          | ** ** | ** **         |
| Government sponsored enterprises | $          | 18,483        | $          | 18,768            | $ | 18,482  | $ | 18,708  |
| State and political subdivisions |       | 3,790         |       | 3,770             |   | 3,790  |   | 3,772  |
| Mortgage-backed  securities      |       | 54,418        |       | 53,170            |   | 43,700  |   | 41,886  |
| Preferred stock                  |       | 84            |       | 58                |   | 84  |   | 66  |
|  Total                      | $          | 76,775        | $          | 75,766            | $ | 66,056  | $ | 64,432  |
| ** **                       |       |               |       |                   |   |   |   |   |
| **Held  to Maturity**            |       |               |       |                   |   |   |   |   |
| Mortgage-backed  securities      | $          | 11,484        | $          | 11,723            | $ | 12,519  | $ | 12,618  |
|                                  |            |                    |            |                        |  |  |  |  |  |

 

At March31, 2009, the Company had unrealized losses on 4 of its individual investmentsin government sponsored enterprises, state and political subdivisions, and FNMApreferred stock.  The Company believes, based on industry analyst reports andcredit ratings that the deterioration in the value of these investments isattributed to market turmoil and liquidity and not the credit quality of theissuer.  The Company has the ability and intent to hold these securities untilsuch time as the value recovers or the securities mature.  In addition, theCompany held 2 collateralized mortgage obligations (“CMOs”) that were in anunrealized loss position at March 31, 2009.  The Company utilized the guidanceprovided by the FASB staff position number FAS 157-3, in determining that theseCMOs had not incurred a market value loss that was other than temporary.  Thepurpose of FAS 157-3 is to “Determine the Fair Value of a Financial Asset Whenthe Market for That Asset Is Not Active.”  FAS 157-3 allows us to use our ownassumptions about the expected future cash flows to apply a risk-adjusteddiscount rate to the cash flows.  Our assumptions as to the expected cash flowswere based on the historical cash flows experience for each security, and thenmodified for the impact of the change in current market rates. 

 

At December 31, 2008, the $85.4 million in our investmentsecurities portfolio represented approximately 12.3% of our total assets.  Weheld Government sponsored enterprisesecurities, municipal securities, and mortgage-backed securities with a fairvalue of $77.1 million and an amortized cost of $78.6 million for an unrealizedloss of $1.5 million.  

 

20

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Contractual maturities and yields on our investments at December31, 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.  At December 31,2008, we had no securities 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** |
| ** **                       | ** ** |                  | ** ** | ** **            | ** ** | ** **         | ** ** | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                       |       | ** **            |
| **Available for Sale**           |       |                  | ** ** | ** **            | ** ** | ** **         | ** ** | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Government sponsored enterprises | $          | -                |       | - %              | $          | 11,238        |       | 5.19 %      | $ | 7,470  |   | 5.06%  | $ | 18,708  |   | 5.14 % |
| State and political subdivisions |       | -                |       | - %              |       | 645           |       | 3.81%  |   | 3,127  |   | 3.79 % |   | 3,772  |   | 3.80 % |
| Mortgage-backed securities       |       | 414                   |       | 4.69 %                |       | 4,838         |       | 4.51 %      |   | 36,634  |   | 5.74 % |   | 41,886  |   | 5.59 % |
| Preferred Stock                  |       | -                |       | - %              |       | -             |       | - %         |   | 66  |   | - % |   | 66  |   | - % |
| Total                            | $          | 414                   |       | 4.69 %                | $          | 16,721        |       | 4.94 %      | $ | 47,297  |   | 5.48 % | $ | 64,432  |   | 5.50 % |
| ** **                       | ** ** |                  |       |                  |       |               |       |        |   |   |   |   |   |   |   |   |
| **Held to Maturity**             |       |                  |       |                  |       |               |       |        |   |   |   |   |   |   |   |   |
| Mortgage-backed securities       | $          | 238              |       | 3.95%            | $          | 2,333         |       | 4.45 %      | $ | 9,948  |   | 4.70 % | $ | 12,519  |   | 4.64 % |

            

Other investments at December 31, 2008 consisted of FederalReserve Bank stock with a cost of $1.3 million, investments in Greenville FirstStatutory Trust I and II of $186,000 and $217,000, respectively, and FederalHome Loan Bank stock with a cost of $6.7 million.  At December 31, 2007, weowned Federal Reserve Bank stock with a cost of $1.0 million, Federal Home LoanBank stock with a cost of $7.2 million, and investments in Greenville FirstStatutory Trust I and II of $186,000 and $217,000, respectively. 

* *

*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 the threemonths ended March 31, 2009 and 2008, average loans were $566.5 million and $525.3million, respectively.  Before the allowance for loan losses, total loansoutstanding at March 31, 2009 were $566.4 million.  Average loans for the yearended December 31, 2008 were $547.7 million.  Before the allowance for loanlosses, total loans outstanding at December 31, 2008 were $566.6 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%.  We attempt to maintaina relatively diversified loan portfolio to help reduce the risk inherent inconcentration in certain types of collateral.

 

21

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The following table summarizes thecomposition of our loan portfolio at March 31, 2009 and December 31, 2008.

** **

|                                                                  | ** ** | **March 31, 2009** | ** ** | **December 31,  2008** |
|-----------------------------------------------------------------------|------------|--------------------|------------|------------------------|
|                                                                  | ** ** | **Amount**         | ** ** | **%  of Total**   | ** ** | **Amount** | ** ** | **%  of Total** |
|                                                                  |       | ** **         |
| Real  estate:                                                         |       | ** **         |
|  Commercial:                                                     |       |               |       |                   |   |   |   |   |
| Owner occupied                                                        | $          | 124,756       |       | 22.0 %            | $ | 113,370  |   | 20.0 % |
| Non-owner occupied                                                    |       | 156,613       |       | 27.7 %            |   | 151,274  |   | 26.7 % |
| Construction                                                          |       | 32,942        |       | 5.8 %                  |   | 52,981  |   | 9.4 % |
| Total commercial real estate                                          |       | 314,311       |       | 55.5 %            |   | 317,625  |   | 56.1 % |
| Consumer:                                                             |       |               |       |                   |   |   |   |   |
| Residential                                                           |       | 60,293        |       | 10.7 %            |   | 60,336  |   | 10.7 % |
| Home equity                                                           |       | 67,035        |       | 11.8 %            |   | 62,987  |   | 11.1 % |
| Construction                                                          |       | 6,335         |       | 1.1 %             |   | 8,905  |   | 1.5 % |
| Total consumer real estate                                            |       | 133,663       | ** ** | 23.6 %            |   | 132,228  |   | 23.3 % |
|                                                                  |       |               | ** ** |                   |   |   |   |   |
| Total real estate                                                     |       | 447,974       | ** ** | 79.1 %            |   | 449,853  |   | 79.4 % |
|                                                                  |       |               |       |                   |   |   |   |   |
| Commercial  business                                                  |       | 109,619       |       | 19.4 %                 |   | 106,479  |   | 18.8 % |
| Consumer-other                                                        |       | 9,660         |       | 1.7 %                  |   | 11,194  |   | 2.0 % |
| Deferred  origination fees, net                                       |       | (859)              |       | (0.2)%                 |   | (919) |   | (0.2)% |
|        Total gross loans, net of             |       |               |       |                   |   |   |   |
|            deferred fees |       | 566,394       |       | 100.0 %           |   | 566,607  |   | 100.0 % |
| Less—allowance  for loan losses                                  |       | (7,429)            |       |                   |   | (7,005) |   |   |
|    Total loans, net                                         | $          | 558,965       |       |                   | $ | 559,602  |   |   |
|                                                                       |            |                    |            |                        |  |  |  |  |  |

 

* *

*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 March 31, 2009.

 

|                                                            |   |          |       | ** **     | ** **     | **After one** | ** ** | ** **    | ** ** | ** ** |
|-----------------------------------------------------------------|--------|---------------|------------|----------------|----------------|---------------|------------|---------------|------------|------------|
| * *                                                        |   | **One year**  | ** ** | **but within** | **After five** | ** **    | ** ** |
|                                                            |   | **or less**   |       | **five years** | **years**      | ** **    | **Total**  |
|                                                            |   |          |       |           |           |          |       |          |
| Real  estate – mortgage                                    | $      | 73,179   | $          | 260,813   | $              | 74,705   | $          | 408,697  |
| Real  estate – construction                                |   | 21,056   |       | 12,920    |           | 5,301    |       | 39,277   |
|    Total real estate                                       |   | 94,235   |       | 273,733   |           | 80,006   |       | 447,974  |
|                                                            |   |          |       |           |           |          |       |          |
| Commercial  business                                            |   | 56,949   |       | 47,683    |           | 4,987    |       | 109,619  |
| Consumer-other                                                  |   | 4,498    |       | 4,593     |           | 569      |       | 9,660    |
| Deferred  origination fees, net                                 |   | (253)         |       | (473)          |           | (133)         |       | (859)         |
|   Total gross  loans, net of                     |   |          |       |           |           |          |       |          |
|          deferred  fees | $      | 155,429  | $          | 325,536   | $              | 85,429   | $          | 566,394  |
|                                                            |   |          |       |           |           |          |
| Loans maturing after one year with:                             |   |          |       |           |           |          |
| Fixed interest rates                                            |   |          |       |           | $              | 219,866  |
| Floating interest rates                                         |   |          |       |           | $              | 191,099  |

 

22

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The following table summarizes the loanmaturity distribution by type and related interest rate characteristics atDecember 31, 2008. 

 

|                                                                                                                                  |   |          |       | **After one**  | ** ** |           |       |          |
|---------------------------------------------------------------------------------------------------------------------------------------|--------|---------------|------------|----------------|------------|----------------|------------|---------------|
|                                                                                                                                  |   | **One year**  | ** ** | **but within** | ** ** | **After five** | ** ** | ** **    |
| ** **                                                                                                                            |   | **or less**   | ** ** | **five years** | ** ** | **years**      | ** ** | **Total**     |
|                                                                                                                                  |   |          |       |           |       |           |       |          |
| Real  estate- mortgage                                                                                                                | $      | 68,356   |       | 253,325   |       | 66,286    |       | 387,967  |
| Real  estate- construction                                                                                                            |   | 30,555   |       | 13,390    |       | 17,941    |       | 61,886   |
|       Total real estate                                                                                           |   | 98,911   |       | 266,715   |       | 84,227    |       | 449,853  |
|                                                                                                                                  |   |          |       |           |       |           |       |          |
| Commercial  business                                                                                                                  |   | 56,291   |       | 46,275    |       | 3,913     |       | 106,479  |
| Consumer-  other                                                                                                                      |   | 4,260    |       | 6,318     |       | 616       |       | 11,194   |
| Deferred  origination fees, net                                                                                                       |   | (290)         |       | (455)          |       | (174)          |       | (919)         |
|       Total gross loan, net of                                                                                    |   |          |       |           |       |           |       |          |
|             deferred fees                                                           | $      | 159,172  |       | 318,853   |       | 88,582    |       | 566,607  |
|                                                                                                                                  |   |          |       |           |       |           |       |          |
| Loans  maturing – after one year with                                                                                            |   |          |       |           |       |           |       |          |
|       Fixed interest rates                                                                                        |   |          |       |           |       |           | $          | 232,645  |
|       Floating interest rates               |   |          |       |           |       |           | $          | 174,790  |

* *

* *

*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 thecollectibility of loans, including consideration of factors such as the balanceof impaired loans, the quality, mix, and size of our overall loan portfolio,economic conditions that may affect the borrower’s ability to repay, the amountand quality of collateral securing the loans, our historical loan lossexperience, and a review of specific problem loans.  We also considersubjective issues such as changes in the lending policies and procedures,changes in the local/national economy, changes in volume or type of credits,changes in volume/severity of problem loans, quality of loan review and boardof director oversight, concentrations of credit, and peer group comparisons. Due to our limited operating history, the provision for loan losses has beenmade primarily as a result of our assessment of general loan loss risk comparedto banks of similar size and maturity.  Due to the rapid growth of our Bankover the past several years and our short operating history, a large portion ofthe loans in our loan portfolio and of our lending relationships are ofrelatively recent origin.  In general, loans do not begin to show signs ofcredit deterioration or default until they have been outstanding for someperiod of time, a process known as seasoning.  As a result, a portfolio ofolder loans will usually behave more predictably than a newer portfolio. Because our loan portfolio is relatively new, the current level ofdelinquencies and defaults may not be representative of the level that willprevail 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.  

 

23

----

 

The following table summarizes theactivity related to our allowance for loan losses for the three months ended March31, 2009 and 2008:

 

|                                           |   | **March 31,**             |
|------------------------------------------------|--------|---------------------------|
|                                           |   | **2009**                  | ** ** | **2008** |
|                                           |   |                      |   |
| Balance,  beginning of period                  | $      | 7,005                | $ | 5,751  |
|                                           |   |                      |   |   |
| Loans  charged-off                             |   | (327)                     |   | (127) |
|                                           |   |                      |   |   |
| Recoveries  of loans previously charged-off    |   | 1                    |   | -  |
|                                           |   |                      |   |   |
| Net  loans (charged-off) recovery              | $      | (326)                     | $ | (127) |
|                                           |   |                      |   |   |
| Provision  for loan losses                     |   | 750                  |   | 600  |
|                                           |   |                      |   |   |
| Balance,  end of period                        | $      | 7,429                | $ | 6,224  |
| ** **                                     |   |                      |   |   |
| Allowance  for loan losses to gross loans      |   | 1.31  %    |   | 1.16  %    |
|                                           |   |                      |   |   |
| Net  charge-offs to average loans (annualized) |   | 0.23 %               |   | 0.10 % |

 

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 assess thegrading of our loans.

* *

Theallowance for loan losses was $7.4 million and $7.0 million at March 31, 2009and December 31, 2008, respectively or 1.31% and 1.24% of outstanding loans,respectively.  During the year ended December 31, 2008, we had net charged-offloans of $1.9 million.  During the three months ended March 31, 2009 and 2008we had net charge-offs of $326,000 and $127,000, respectively.  

 

*Nonperforming Assets*

 

The following table shows the nonperforming assets, percentages ofnet charge-offs, and the related percentage of allowance for loan losses forthe three months ended March 31, 2009 and the year ended December 31, 2008.  Generally,a loan is placed on nonaccrual status when it becomes 90 days past due as toprincipal or interest, or when we believe, after considering economic andbusiness 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 areduction in principal when received.

 

24

----

 
|                                      |   | **March 31,** | ** ** | **December 31,** |
|-------------------------------------------|--------|---------------|------------|------------------|
|                                      |   | **2009**      | ** ** | **2008**         |
|                                      |   |          |
| Loans on  nonaccrual:                     |   |          |       |             |
| Mortgage                                  | $      | 8,103    |       | 6,818       |
| Commercial                                |   | 1,660    |       | 868         |
| Consumer                                  |   | 10       |       | 13          |
| Total nonaccrual loans                    |   | 9,773    |       | 7,699       |
|                                      |   |          |       |             |
| Total of nonperforming loans              |   | 9,773    |       | 7,699       |
|                                      |   |          |       |             |
| Other  nonperforming assets               |   | 3,826    |       | 2,116       |
|                                      |   |          |       |             |
| Total nonperforming assets                | $      | 13,599   |       | 9,815       |
|                                      |   |          |       |             |
| Loans  over 90 days past due (1)          | $      | 6,560    |       | 7,008       |
|                                      |   |          |       |             |
| Nonperforming  assets as a percentage of: |   |          |       |             |
|     Total  assets          |   | 1.93 %   |       | 1.42 %      |
|   Gross loans                        |   | 2.40 %   |       |             |

                                                                   

 (1)Loans over 90 days areincluded in nonaccrual loans

 

 AtMarch 31, 2009 nonperforming assets were $13.6 million, or 1.93% of totalassets and 2.40% of gross loans.  Comparatively, nonperforming assets were $9.8million, or 1.42% of total assets and 1.73% of gross loans at December 31,2008.  Nonaccrual loans increased $2.1 million to $9.8 million at March 31,2009 from $7.7 million at December 31, 2008.  This increase is primarilyrelated to commercial real estate and business loans.  The amount offoregone interest income on the nonaccrual loans in the first three months of2009 was approximately $67,000.   The amount of interest income recorded in thefirst three months of 2009 for loans that were on nonaccrual at March 31, 2009was approximately $21,000.

 

Other nonperforming assets include realestate acquired in settlement of loans.  These assets increased $1.7 million to$3.8 million at March 31, 2009 from $2.1 million at December 31, 2008.  Thebalance at March 31, 2009 includes 6 commercial properties totaling $3.7million and 2 pieces of residential real estate for $151,000.  We believe thatthese properties are appropriately valued at the lower of cost or market as ofMarch 31, 2009.

 

At March 31, 2009, impaired loansamounted to approximately $9.8 million for which a $1.1 million reserve wasallocated in the 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 toattract deposits.  We have chosen to obtain a portion of our certificates ofdeposits from areas outside of our market.  The deposits obtained outside ofour market area generally have comparable rates compared to rates being offeredfor certificates of deposits in our local market.  We also utilizeout-of-market deposits in certain instances to obtain longer-term deposits thanare readily available in our local market.  The amount of out-of-marketdeposits was $213.1 million at March 31, 2009 and $200.9 million at December31, 2008.  

 

We generally obtain out-of-market timedeposits of $100,000 or more through brokers with whom we maintain ongoingrelationships.  We have adopted guidelines regarding our use of brokered CDsthat limit our brokered CDs to 50% of total deposits and dictate that ourcurrent interest rate risk profile determines the terms.  In addition, we donot obtain time deposits of $100,000 or more through the Internet.  Theseguidelines allow us to take advantage of the attractive terms that wholesalefunding can offer while mitigating the inherent related risk.

 

25

----

 

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 119% and 121% at March 31, 2009 and December 31, 2008,respectively.  

 

The following table shows the averagebalance amounts and the average rates paid on deposits held by us for the threemonths ended March 31, 2009 and 2008.  

** **

| * * | ** ** | ** ** | **2009**   | ** ** | **2008** |
|----------|------------|------------|------------|------------|----------|
| * * | ** ** | ** ** | **Amount** | ** ** | **Rate** | ** ** | **Amount** | ** ** | **Rate** |
|     |       |       |       |       |     |   |   |   |  
Noninterest  bearing demand deposits

$

33,403 

 

- %

$

29,958 

 

- %

 
Interest  bearing demand deposits

 

41,975 

 

0.69 %

 

35,960 

 

1.35 %

 
Money  market accounts

 

86,606 

 

1.20 %

 

88,609 

 

2.55 %

 
Saving  accounts

 

1,991 

 

0.18 %

 

1,771 

 

0.48 %

 
Time  deposits less than $100,000

 

45,396 

 

3.33 %

 

42,579 

 

4.80 %

 
Time  deposits greater than $100,000

 

266,869 

 

3.00 %

 

238,564 

 

4.90 %

 
    Total deposits

$

476,240 

 

2.28 %

$

437,441 

 

3.77 %

 
 

The increase in time deposits of $100,000or more for the three months ended March 31, 2009 compared to the 2008 periodresulted from a $29.0 million increase in wholesale deposits.  

 

Core deposits, which exclude out-of-marketdeposits and time deposits of $100,000 or more, provide a relatively stablefunding source for our loan portfolio and other earning assets.  Our coredeposits were $201.5 million and $205.9 million at March 31, 2009 and December31, 2008, respectively.  

 

All of our time deposits arecertificates of deposits.  The maturity distribution of our time deposits of$100,000 or more at March 31, 2009 was as follows: 

 

 

** **

**March 31,**

 

** **

**2009**

 

 

** **

Three months or less

$

67,755 

Over three through six months

 

97,869 

Over six  through twelve months

 

43,415 

Over twelve months

 

62,368 

   Total

$

271,407 

** **

 

**CapitalResources**

 

**               **Totalshareholders’ equity at March 31, 2009 was $58.0 million.  At December 31, 2008,total shareholders’ equity was $39.8 million.  The $18.2 million increaseduring the first three months of 2009 resulted primarily from the $17.3 millionissuance of preferred stock as well as $487,000 from net income earned and$405,000 from an unrealized gain on securities available for sale.

 

OnFebruary 27, 2009, as part of the CPP, the Company entered into the CPP PurchaseAgreement with the Treasury Department, pursuant to which we sold 17,299 sharesof our Series T Preferred Stock and the CPP Warrant to purchase 330,554 sharesof our common stock for an aggregate purchase price of $17.3 million in cash.  The Series T Preferred Stock will be entitled to cumulativedividends at a rate of 5% per annum for the first five years, and 9% per annumthereafter.  The CPP Warrant has a 10-year term and is immediately exercisableupon its issuance, with an exercise price, subject to anti-dilution adjustmentsequal to $7.85 per share of the common stock.

 

26
****
 

Thefollowing table shows the return on average assets (net income divided byaverage total assets), return on average equity (net income divided by averageequity), and equity to assets ratio (average equity divided by average totalassets) annualized for the three months ended March 31, 2009 and the year endedDecember 31, 2008.  Since our inception, we have not paid cash dividends.

                                      

 

**March 31, 2009**

** **

**December 31,  2008**

Return  on average assets

0.46 %

 

0.27 %

 

 

 

 

Return  on average equity

4.29 %

 

4.70 %

Return  on average common equity

4.13 %

 

4.70 %

 

 

 

 

Equity  to total assets ratio

6.02 %

 

5.73 %

Common  equity to total assets ratio

5.70 %

 

5.73 %

             

Our return onaverage assets was 0.46% for the three months ended March 31, 2009, an increasefrom 0.27% for the year ended December 31, 2008.  In addition, our return onaverage equity decreased to 4.29% from 4.70% for the first quarter ended March31, 2009 and the year ended December 31, 2008, respectively.  The increase inthe equity to total assets ratio from December 31, 2008 is primarily related tothe $17.3 million received in conjunction with the issuance of preferredstock.  In addition, our return on average common equity was 4.13% and ourcommon equity to total assets ratio was 5.70% for the three months ended March31, 2009. 

 

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, excluding the unrealized gain or loss on securities available for sale,minus certain intangible assets.  In determining the amount of risk-weightedassets, all assets, including certain off-balance sheet assets, are multipliedby a risk-weight factor of 0% to 100% based on the risks believed to beinherent in the type of asset.  Tier 2 capital consists of Tier 1 capital plusthe general reserve for loan losses, subject to certain limitations.  We arealso required to maintain capital at a minimum level based on total averageassets, which is known as the Tier 1 leverage ratio.

 

Atboth the holding company and bank level, we are subject to various regulatorycapital requirements administered by the federal banking agencies.  To beconsidered “adequately capitalized” under these capital guidelines, we mustmaintain a minimum total risk-based capital of 8%, with at least 4% being Tier1 capital.  In addition, we must maintain a minimum Tier 1 leverage ratio of atleast 4%.  To be considered “well-capitalized,” we must maintain totalrisk-based capital of at least 10%, Tier 1 capital of at least 6%, and aleverage ratio of at least 5%.  

 

In October, 2008, President Bush signedin law the EESA in response to the financial crises affecting the bankingsystem.  The Treasury Department and banking regulators are implementing anumber of programs under this legislation to address capital and liquidityissues in the banking system.  Under the Treasury Department’s CPP, we received$17.3 million through issuance of Series T Preferred Stock and the CPP Warrantfor common stock to the Treasury Department.  The Series T Preferred Stockissuance and the related CPP Warrant both qualify for Tier 1 capital and addedapproximately 300 basis points to that measure.  The fair value allocation ofthe $17.3 million between the shares of Series T Preferred Stock and the CPPWarrant resulted in $15.9 million allocated to the shares of Series T PreferredStock and $1.4 million allocated to the CPP Warrant.  See discussion ofshareholders’ equity above for additional details.

 

The following table sets forth the Company’sand the Bank’s various capital ratios at March 31, 2009 and at December 31, 2008. For all periods, the Bank was considered “well capitalized” and the Company metor exceeded its applicable regulatory capital requirements.

 

 

**March  31, 2009**

 

**December  31, 2008**

 

**Holding**

** **

** **

** **

**Holding**

** **

** **

 

**Company**

** **

**Bank**

** **

**Company**

** **

**Bank**

 

 

 

 

 

 

 

 

Total risk-based capital

13.4 %

 

12.9 %

 

10.4 %

 

12.8 %

Tier 1 risk-based capital

12.2 %

 

11.7  %

 

9.2  %

 

11.6 %

Leverage  capital

10.1 %

 

9.7 %

 

7.7 %

 

9.8 %

** **

27
****
 

**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 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 March 31, 2009, unfunded commitments toextend credit were $84.4 million, of which $11.0 million was at fixed rates and$73.4 million was at variable rates.  At December 31, 2008, unfundedcommitments to extend credit were $89.0 million, of which approximately $13.8million was at fixed rates and $75.1 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 ofcollateral obtained, if deemed necessary by us upon extension of credit, isbased on our credit evaluation of the borrower.  The type of collateral variesbut may include accounts receivable, inventory, property, plant and equipment,and commercial and residential real estate.

 

At March 31, 2009, there was a $5.4million commitment under letters of credit.  The credit risk and collateralinvolved in issuing letters of credit is essentially the same as that involvedin extending loan facilities to customers.  Since most of the letters of creditare expected to expire without being drawn upon, they do not necessarilyrepresent future cash requirements.

 

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.

 

**MarketRisk and Interest Rate Sensitivity**

 

**                **Market risk is the risk of loss fromadverse changes in market prices and rates, which principally arises frominterest rate risk inherent in our lending, investing, deposit gathering, andborrowing activities.  Other types of market risks, such as foreign currencyexchange rate risk and commodity price risk, do not generally arise in thenormal course of our business.  

 

We actively monitor and manage ourinterest rate risk exposure in order to control the mix and and maturities ofour assets and liabilities utilizing a process we call asset/liabilitymanagement.  The essential purposes of asset/liability management are to ensureadequate liquidity and to maintain an appropriate balance between interestsensitive assets and liabilities in order to minimize potentially adverse impactson earnings from changes in market interest rates.  Our asset/liabilitymanagement committee (“ALCO”) monitors and considers methods of managingexposure to interest rate risk.  We have both an internal ALCO consisting ofsenior management that meets at various times during each month and a boardALCO that meets monthly.  The ALCOs are responsible for maintaining the levelof interest rate sensitivity of our interest sensitive assets and liabilitieswithin board-approved limits.

 

28
****
 

Our interest rate risk exposure is managed principally bymeasuring our interest sensitivity “gap,” which is the positive or negativedollar difference between assets and liabilities that are subject to interestrate repricing within a given period of time.  Interest rate sensitivity can bemanaged by repricing assets or liabilities, selling securities available forsale, replacing an asset or liability at maturity, or adjusting the interestrate during the life of an asset or liability.  Managing the amount of assetsand liabilities repricing in this same time interval helps to hedge the riskand minimize the impact on net interest income of rising or falling interestrates.  We generally would benefit from increasing market rates of interestwhen we have an asset-sensitive gap position and generally would benefit fromdecreasing market rates of interest when we are liability-sensitive.

 

The followingtable sets forth information regarding our rate sensitivity as of March 31, 2009for each of the time intervals indicated. 

** **

 

 

 

 

**Within**

** **

**After three but**

** **

**After one but**

** **

**After**

** **

** **

 

 

 

 

**three**

** **

**within twelve**

** **

**within five**

** **

**five**

** **

** **

 

 

 

 

**months**

** **

**months**

** **

**years**

** **

**years**

** **

**Total**

** **

 

 

Interest-earning  assets:

 

 

 

 

 

 

 

 

 

 

Federal funds sold

$

3,668 

$

- 

$

- 

$

- 

$

3,668 

Investment securities

 

5,104 

 

31,036 

 

33,531 

 

17,579 

 

87,250 

Loans

 

276,667 

 

38,479 

 

184,205 

 

55,828 

 

555,178 

 

 

 

 

 

 

 

 

 

 

 

Total  earning assets

$

285,439 

$

69,515 

$

217,736 

$

73,406 

$

646,096 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing  liabilities:

 

 

 

 

 

 

 

 

 

 

Money market and NOW

$

125,738 

$

- 

$

- 

$

- 

$

125,738 

Regular savings

 

2,045 

 

- 

 

- 

 

- 

 

2,045 

Time deposits

 

79,660 

 

170,834 

 

64,150 

 

- 

 

314,644 

Note payable and other borrowings

 

92,100 

 

6,975 

 

45,600 

 

10,000 

 

154,675 

Junior  subordinated debentures

 

13,403 

 

- 

 

- 

 

- 

 

13,403 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total interest-bearing liabilities

$

312,946 

$

177,809 

$

109,750 

$

10,000 

$

610,505 

 

 

 

 

 

 

 

 

 

 

 

Period  gap

$

(27,507)

$

(108,294)

$

107,986 

$

63,406 

 

 

Cumulative  gap

 

(27,507)

 

(135,801)

 

(27,815)

 

35,591 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ratio of  cumulative gap to total earning assets

 

(4.3%)

 

(21.0%)

 

(4.3 %)

 

5.5 %

 

 

** **

 

The following table sets forth information regarding our ratesensitivity, as of December 31, 2008, at each of the time intervals. 

 

 

 

**Within  three  months**

** **

**After three but**

**within twelve**

**months**

** **

**After one but**

**within five**

**years**

** **

**After**

**five**

**years**

** **

**Total**

** **

 

** **

Interest-earning assets:

 

 

 

 

 

 

 

 

 

 

Federal funds sold                          	

$

8,800 

$

- 

$

- 

$

- 

$

8,800 

Investment securities                  	

 

4,673 

 

22,187 

 

26,209 

 

23,882 

 

76,951 

Loans                                         	

 

262,203 

 

41,558 

 

191,387 

 

64,269 

 

559,417 

 

 

 

 

 

 

 

 

 

 

 

Total earning assets                        	

$

275,676 

$

63,745 

$

217,596 

$

88,151 

$

645,168 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing liabilities:

 

 

 

 

 

 

 

 

 

 

Money market and NOW        	

$

122,608 

$

- 

$

- 

$

- 

$

122,608 

Regular savings                          	

 

1,918 

 

- 

 

- 

 

- 

 

1,918 

Time deposits                             	

 

101,083 

 

135,611 

 

73,549 

 

- 

 

310,243 

FHLB advances and related debt            	

 

94,575 

 

14,500 

 

45,600 

 

10,000 

 

164,675 

Junior subordinated debentures           	

 

13,403 

 

- 

 

- 

 

- 

 

13,403 

 

 

 

 

 

 

 

 

 

 

 

Total interest-bearing liabilities             	

$

333,587 

$

150,111 

$

119,149 

$

10,000 

$

612,847 

 

 

 

 

 

 

 

 

 

 

 

Period gap                                               	

$

(57,911) 

$

(86,366)

$

98,447 

$

78,151 

 

 

Cumulative Gap                                    	

 

(57,911) 

 

(144,277)

 

(45,830)

 

32,321 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ratio of cumulative gap to total earning assets

 

(9.0%)

 

(22.4%)

 

(7.1%)

 

5.0%

 

 

** **

29
****
 

We were liability sensitive during theyear ended December 31, 2008 and through the three months ended March 31, 2009. Our variable rate loans and a majority of our deposits reprice over a 12-monthperiod.  Approximately 46% and 43% of our loans were variable rate loans atMarch 31, 2009 and December 31, 2008, respectively.  The ratio of cumulativegap to total earning assets after 12 months is (21.0%) because $135.8 millionmore liabilities will reprice in a 12 month period than assets.  However, ourgap analysis is not a precise indicator of our interest sensitivity position. 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 Risk**

 

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

 

At March 31, 2009, our liquid assets,consisting of cash and due from banks and federal funds sold, amounted to $12.5million and $13.2 million, or 1.8% and 1.9% of total assets, respectively.  Ourinvestment securities at March 31, 2009 and December 31, 2008 amounted to $96.4million and $85.4 million, or 13.7% and 12.3% of total assets, respectively. Investment securities traditionally provide a secondary source of liquiditysince they can be converted into cash in a timely manner.  However, asubstantive portion of these securities are pledged against outstanding debt. Therefore, the related debt would need to be repaid prior to the securitiesbeing sold in order for these securities to be converted to cash.  Therefore,the related debt would need to be repaid prior to the securities being sold inorder for these securities to be converted to cash.

 

Ourability to maintain and expand our deposit base and borrowing capabilities servesas our primary source of liquidity.  We plan to meet our future cash needsthrough the liquidation of temporary investments, the generation of deposits,and from additional borrowings.  In addition, we will receive cash upon thematurity and sale of loans and the maturity of investment securities.  Wemaintain four federal funds purchased lines of credit with correspondent bankstotaling $43.8 million for which there were no borrowings against the lines atMarch 31, 2009.  However, we anticipate that one of these lines of credittotaling $15.0 million may not be available after July 29, 2009.  Accordingly,we are presently pursuing increasing our existing lines of credit as well asobtaining new federal funds purchased lines with other correspondent banks.

 

Weare also a member of the Federal Home Loan Bank of Atlanta (FHLB), from whichapplications for borrowings can be made.  The FHLB requires that securities,qualifying mortgage loans, and stock of the FHLB owned by the bank be pledgedto secure any advances from the FHLB.  The unused borrowing capacity currentlyavailable from the FHLB at March 31, 2009 was $4.1 million, based on the bank’s$7.4 million investment in FHLB stock, as well as qualifying mortgagesavailable to secure any future borrowings.Effective April 30, 2009, the Company has a $9.0 million line of credit with Silvertonof which $5.0 million was outstanding at March 31, 2009.  See Note 2 to ourConsolidated Financial Statements for a more detailed description of the termsof this line of credit and the consequences of the OCC closure of Silverton onthis line of credit.

 

                We signed a ten-year, five-month lease onour new headquarters and main office.  The lease provides for annual lease rateescalations based on cost of living adjustments.  

 

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.

** **

As a result of the Treasury’s Capital Purchase Program, wereceived $17.3 million of capital on February 27, 2009 in exchange for 17,299shares of preferred stock.  This additional capital will allow us to remainwell-capitalized and provide additional liquidity on our balance sheet.

 

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**Accounting,Reporting, and Regulatory Matters**

*RecentlyIssued Accounting Standards*

 

*               *The following is a summaryof recent authoritative pronouncements that affect accounting, reporting, anddisclosure of financial information by us:

 

FSP EITF 99-20-1, “Amendments to theImpairment Guidance of EITF Issue No. 99-20,” (“FSP EITF 99-20-1”) was issuedin January 2009.  Prior to the FSP, other-than-temporary impairment wasdetermined by using either Emerging Issues Task Force (“EITF”) Issue No. 99-20,“Recognition of Interest Income and Impairment on Purchased BeneficialInterests and Beneficial Interests that Continue to be Held by a Transferor inSecuritized Financial Assets,” (“EITF 99-20”) or SFAS No. 115, “Accounting forCertain Investments in Debt and Equity Securities,” (“SFAS 115”) depending onthe type of security.  EITF 99-20 required the use of market participantassumptions regarding future cash flows regarding the probability of collectingall cash flows previously projected.  SFAS 115 determined impairment to beother than temporary if it was probable that the holder would be unable tocollect all amounts due according to the contractual terms. To achieve a moreconsistent determination of other-than-temporary impairment, the FSP amends EITF 99-20 to determine any other-than-temporary impairment based on theguidance in SFAS 115, allowing management to use more judgment in determiningany other-than-temporary impairment.  The FSP was effective for reportingperiods ending after December 15, 2008.  Management has reviewed the Company’ssecurity portfolio and evaluated the portfolio for any other-than-temporaryimpairments. 

 

OnApril 9, 2009, the FASB issued three staff positions related to fair valuewhich are discussed below.  

 

FSP SFAS 115-2 and SFAS 124-2,“Recognition and Presentation of Other-Than-Temporary Impairments,” (“FSP SFAS115-2 and SFAS 124-2") categorizes losses on debt securities available-for-saleor held-to-maturity determined by management to be other-than-temporarilyimpaired into losses due to credit issues and losses related to all otherfactors.  Other-than-temporary impairment (OTTI) exists when it is more likelythan not that the security will mature or be sold before its amortized costbasis can be recovered. An OTTI related to credit losses should be recognizedthrough earnings.  An OTTI related to other factors should be recognized inother comprehensive income.  The FSP does not amend existing recognition andmeasurement guidance related to other-than-temporary impairments of equitysecurities. Annual disclosures required in SFAS 115 and FSP SFAS 115-1 and SFAS124-1 are also required for interim periods (including the aging of securitieswith unrealized losses). 

 

FSPSFAS 157-4, “Determining Fair Value When the Volume and Level of Activity forthe Asset or Liability Have Significantly Decreased and IdentifyingTransactions That are Not Orderly” recognizes that quoted prices may not bedeterminative of fair value when the volume and level of trading activity hassignificantly decreased.  The evaluation of certain factors may necessitatethat fair value be determined using a different valuation technique.  Fairvalue should be the price that would be received to sell an asset or paid totransfer a liability in an orderly transaction, not a forced liquidation ordistressed sale. If a transaction is considered to not be orderly, little, ifany, weight should be placed on the transaction price. If there is notsufficient information to conclude as to whether or not the transaction isorderly, the transaction price should be considered when estimating fairvalue.  An entity’s intention to hold an asset or liability is not relevant indetermining fair value.  Quoted prices provided by pricing services may stillbe used when estimating fair value in accordance with SFAS 157; however, theentity should evaluate whether the quoted prices are based on currentinformation and orderly transactions. Inputs and valuation techniques arerequired to be disclosed in addition to any changes in valuation techniques.

 

FSPSFAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of FinancialInstruments” requires disclosures about the fair value of financial instrumentsfor interim reporting periods of publicly traded companies as well as in annualfinancial statements and also requires those disclosures in summarizedfinancial information at interim reporting periods  A publicly traded companyincludes any company whose securities trade in a public market on either astock exchange or in the over-the-counter market, or any company that is aconduit bond obligor.  Additionally, when a company makes a filing with aregulatory agency in preparation for sale of its securities in a public marketit is considered a publicly traded company for this purpose. 

 

The threestaff positions are effective for periods ending after June 15, 2009, withearly adoption permitted for periods ending after March 15, 2009, in which caseall three must be adopted.  The Company will adopt the staff positions for its secondquarter 10-Q but does not expect the staff positions to have a material impacton the consolidated financial statements. 

 

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TheSecurities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin(“SAB”) No. 111 on April 9, 2009 to amend Topic 5.M., “Other Than TemporaryImpairment of Certain Investments in Debt and Equity Securities” and tosupplement FSP SFAS 115-2 and SFAS 124-2.  SAB 111 maintains the staff’sprevious views related to equity securities; however debt securities areexcluded from its scope. The SAB provides that “other-than-temporary”impairment is not necessarily the same as “permanent” impairment and unlessevidence exists to support a value equal to or greater than the carrying valueof the equity security investment, a write-down to fair value should berecorded and accounted for as a realizedloss. The SAB was effective upon issuance and had no impact on the Company’sfinancial position. 

 

                 Otheraccounting standards that have been issued or proposed by the FASB or otherstandards-setting bodies that do not require adoption until a future date arenot expected to have a material impact on the consolidated financial statementsupon 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 March 31,2009 from that presented in our annual report on Form 10-K for the year endedDecember 31, 2008.  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 haveconcluded that our current disclosure controls and procedures are effective asof March 31, 2009.  There have been no significant changes in our internalcontrols over financial reporting during the fiscal quarter ended March 31, 2009that have materially affected, or are reasonably likely to materially affect,our internal controls over 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.

 

 

**Item5.  Other Information**

             OnApril 30, 2009, the Company entered into an Amended and Restated Loan Agreement(the “Amended Loan Agreement”) with Silverton Bank, N.A.  For a more detaileddescription of the Amended Loan Agreement, see Note 2 to our ConsolidatedFinancial Statements.  A copy of the Amended Loan Agreement is attached to thisQuarterly Report on Form 10-Q as Exhibit 10.1.

 

** **

**PARTII.  OTHER INFORMATION**

** **

**Item 1.            Legal Proceedings.**

There are no material pending legal proceedings towhich the company is a party or of which any of its property is the subject.

 

**Item 2.            Unregistered Sales of Equity Securities and Use ofProceeds.**

Not applicable

 

**Item 3.            Defaults Upon Senior Securities.**

                         Notapplicable

 

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

                          Notapplicable

 

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**Item 5.            Other Information.**

                         Notapplicable

 

**Item 6.            Exhibits.**

3.1                   Articles of Amendment to the Articles of Incorporation establishing the terms ofthe Series A Preferred Stock (incorporated by reference to Exhibit 3.1 of theCompany's Current Report on Form 8-K filed on March 3, 2009).

4.1                    Formof Series T Preferred Stock Certificate (incorporated by reference to Exhibit4.2 of the Company's Form 8-K filed March 3, 2009).

 

10.1                 Amended andRestated Loan Agreement.

 

10.2                  Warrantwith The United States Department of Treasury to Purchase up to 330,554 sharesof Common Stock (incorporated by reference to Exhibit 4.1 of the Company's Form8-K filed March 3, 2009).

 

10.3                  LetterAgreement, dated February 27, 2009, including Securities Purchase Agreement -Standard Terms incorporated by reference therein, between the Company and theUnited States Department of the Treasury (incorporated by reference to Exhibit10.1 of the Company's Form 8-K filed March 3, 2009).

 

10.4                  ARRASide Letter Agreement, dated February 27, 2009, between the Company and theUnited States Department of the Treasury (incorporated by reference to Exhibit10.2 of the Company's Form 8-K filed March 3, 2009).

 

10.5                  Formof Waiver, executed by each of Messrs. James M. Austin, III, Fred Gilmer, III,R. Arthur Seaver, Jr., F. Justin Strickland, and J. Edward Terrell(incorporated by reference to Exhibit 10.3 of the Company's Form 8-K filedMarch 3, 2009).

 

10.6                  Formof Letter Amendment, executed by each of Messrs. James M. Austin, III, FredGilmer, III, R. Arthur Seaver, Jr., F. Justin Strickland, and J. Edward Terrellwith the Company (incorporated by reference to Exhibit 10.4 of the Company'sForm 8-K filed March 3, 2009).

 

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

 

31.2                 Rule13a-14(a) Certification of the Principal Financial Officer.  

 

32                     Section1350 Certifications.  

 

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**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: May	7, 2009

 

/s/R.  Arthur Seaver, Jr.          

 

 

R. Arthur Seaver, Jr.

 

 

Chief Executive Officer

 

 

 

 

 

 

Date: May	7, 2009

 

/s/James M. Austin,  III                      

 

 

James M. Austin, III

 

 

Chief Financial Officer

 

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**INDEXTO EXHIBITS**

ExhibitNumber                       Description

3.1                                Articlesof Amendment to the Articles of Incorporation establishing the terms of theSeries A Preferred Stock (incorporated by reference to Exhibit 3.1 of theCompany's Current Report on Form 8-K filed on March 3, 2009).  

 

4.1                                Formof Series T Preferred Stock Certificate (incorporated by reference to Exhibit4.2 of the Company's Form 8-K filed March 3, 2009).

 

10.1                              Amendedand Restated Loan Agreement.

 

10.2                              Warrantwith The United States Department of Treasury to Purchase up to 330,554 sharesof Common Stock (incorporated by reference to Exhibit 4.1 of the Company's Form8-K filed March 3, 2009).

 

10.3                               LetterAgreement, dated February 27, 2009, including Securities Purchase Agreement -Standard Terms incorporated by reference therein, between the Company and theUnited States Department of the Treasury (incorporated by reference to Exhibit10.1 of the Company's Form 8-K filed March 3, 2009).

 

10.4                               ARRASide Letter Agreement, dated February 27, 2009, between the Company and theUnited States Department of the Treasury (incorporated by reference to Exhibit10.2 of the Company's Form 8-K filed March 3, 2009).

 

10.5                              Formof Waiver, executed by each of Messrs. James M. Austin, III, Fred Gilmer, III,R. Arthur Seaver, Jr., F. Justin Strickland, and J. Edward Terrell(incorporated by reference to Exhibit 10.3 of the Company's Form 8-K filedMarch 3, 2009).

 

10.6                               Formof Letter Amendment, executed by each of Messrs. James M. Austin, III, FredGilmer, III, R. Arthur Seaver, Jr., F. Justin Strickland, and J. Edward Terrellwith the Company (incorporated by reference to Exhibit 10.4 of the Company's Form8-K filed March 3, 2009).

 

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

            

31.2                              Rule13a-14(a) Certification of the Principal Financial Officer.  

 

32                                  Section1350 Certifications.  

 

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