Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

x      ANNUAL REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2010

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

For the Transition Period from                 to                

Commission file number  333-152331

COASTAL CAROLINA BANCSHARES, INC.

(Exact name of registrant as specified in its charter)

2305 Oak Street

Myrtle Beach, South Carolina 29577

(Address of principal executive offices)

(843) 839-2265

(Registrant’s telephone number)

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

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

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

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  x YES  o 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).  o YES  o NO

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

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

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

The estimated aggregate market value of the Common Stock held by non-affiliates (shareholders holding less than 5% of an outstanding class of stock, excluding directors and executive officers) of the Company on June 30, 2010 was $11,968,780. Because there is not an active trading market for the Common Stock, we have used our initial public offering price of $10.00 as an estimate of the market value of a share of our Common Stock for purposes of calculating our public float.

The number of shares outstanding of the registrant’s common stock was 2,191,500 at March 18, 2011.

DOCUMENTS INCORPORATED BY REFERENCE

None.

Table of Contents

COASTAL CAROLINA BANCSHARES, INC.

Table of Contents

2

Table of Contents

PART I

Item 1. Business.

This report on Form 10-K contains “forward-looking statements” relating to, without limitation, future economic performance, plans and objectives of management for future operations, and projections of revenue and other financial items that are based on the beliefs of our management, as well as assumptions made by and information currently available to management. The words “expect,” “estimate,” “anticipate,” and “believe,” as well as similar expressions, are intended to identify forward-looking statements. Our actual results may differ materially from the results discussed in the forward-looking statements, and our operating performance each quarter is subject to various risks and uncertainties that are discussed in detail in our filings with the Securities and Exchange Commission, including, without limitation:

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

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

·                  changes in political conditions or the legislative or regulatory environment;

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

·                  changes occurring in business conditions and inflation;

·                  changes in technology;

·                  the level of allowance for loan loss and the lack of seasoning of our loan portfolio;

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

·                  the rates of loan growth;

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

·                  changes in monetary and tax policies;

·                  loss of consumer confidence and economic disruptions resulting from terrorist activities;

·                  changes in the securities markets; and

·                  other risks and uncertainties detailed from time to time in our filings with the Securities and Exchange Commission.

These risks are exacerbated by the volatility and disruption experienced in national and international financial, capital, and credit markets during the last three years. We are unable to predict what effect these uncertain market conditions will have on our company. There can be no assurance that these unprecedented developments will not materially and adversely affect our business, financial condition and results of operations.

We undertake no obligation to publicly update or otherwise revise any forward-looking statements, whether as a result of new information, future events, or otherwise.

Overview

Coastal Carolina Dream Team, LLC (the LLC) was formed on June 20, 2007, to explore the possibility of establishing a new bank in the Myrtle Beach, South Carolina area. On February 28, 2008, Coastal Carolina Bancshares, Inc. (the Company) was incorporated to act as the holding company for Coastal Carolina National Bank (the Bank), and on April 10, 2008, the LLC merged with, and into the Company (the Merger). As a result of the Merger, all the assets and liabilities of the LLC became assets and liabilities of the Company. Coastal Carolina National Bank is a national banking association organized under the laws of the United States and provides banking services to individual, partnership and corporate borrowers located in Horry County, South Carolina. Since our inception in June 2007 and before our Bank opened for business on June 8, 2009, we engaged in organizational and pre-opening activities necessary to obtain regulatory approvals and to prepare our subsidiary bank to commence business as a financial institution.  The Bank is currently labeled a denovo institution, a term given by the banking regulatory agencies to describe a bank in its first three to five years of operations.  The bank currently operates one branch located in Myrtle Beach.

Business Strategy

Our business strategy is to create a community-oriented financial institution focused on providing personalized service to clients and offering products designed to meet their specific needs. Our target markets include:

·                  Small-to medium-sized commercial, professional and service companies who we believe can be better served by a locally based financial institution providing timely credit decisions along with well-defined business services;

3

Table of Contents

·                  affluent and “emerging affluent” residents who desire a banking relationship tailored to their net worth and service-level expectations;

·                  residential and commercial real estate clients seeking a smaller, more customized service delivery; and

·                  the well-established consumer base in our primary service area.

Our goal is to provide a full range of competitive banking services and to emphasize the effective delivery of those services. We believe we can distinguish ourselves by providing the level of personal service often associated with a community bank, while also offering the requisite technology and skilled advisors to deliver more sophisticated financial products and services than a typical community bank.

Products and Services

The Bank offers a variety of traditional banking services, emphasizing a variety of lending services, including real estate, commercial and equity line and consumer loans to individuals and small- to mid-size businesses that are located or conduct business in our market area. Our deposit products include checking accounts, savings accounts, money market accounts, certificates of deposit, commercial checking accounts and individual retirement accounts, for which rates are reviewed regularly to ensure the Bank remains competitive. We also provide cashier’s checks, debit cards, tax deposits, direct deposit and United States savings bonds. The Bank delivers our services though a variety of methods, including on-line banking, remote deposit capture, banking by mail and drive-thru banking.

Lending Activities

General. The Company emphasizes a range of lending services, including real estate, commercial, consumer loans, and home equity lines of credit.  The bank seeks creditworthy borrowers within a geographic area limited to the Grand Strand, ranging on the south side from Pawleys Island in Georgetown County throughout Horry County including Myrtle Beach and Conway and north to the South Carolina border with North Carolina.  Many of the Bank’s commercial loans are made to small- to medium-sized businesses.

Loan Distribution. The percentage distribution of our loans at December 31, 2010 is as follows:

Our loan distribution will depend on our customers and will likely vary over time.

Allowance for Loan Losses. We maintain an allowance for loan losses, which we establish through a provision for loan losses charged against income. We charge loans against this allowance when we believe the collectibility of the principal is unlikely. The allowance is an estimated amount that we believe will be adequate to absorb losses inherent in the loan portfolio based on evaluations of its collectibility. Over time, we will periodically determine the amount of the allowance based on our consideration of several factors, including:

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

·                  our historical loan loss experience;

·                  evaluation of economic conditions;

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

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

4

Table of Contents

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

Lending Limits.  The Bank’s lending activities are subject to a variety of lending limits imposed by federal law. In general, the Bank will be subject to a legal limit on loans to a single borrower equal to 15% of the Bank’s capital and unimpaired surplus. As of December 31, 2010, our legal lending limit was $2.2 million. Different limits may apply based on the type of loan or the nature of the borrower, including the borrower’s relationship to the Bank. These limits will increase or decrease as the Bank’s capital increases or decreases.  The well-established financial institutions in our primary service area are likely to make proportionately more loans to medium- to large-sized businesses than we can make.

Credit Risk.  The principal credit risk associated with each loan is the creditworthiness of the borrower and any guarantor. Borrower creditworthiness is affected by general economic conditions and the strength of the manufacturing, services and retail market segments. General economic factors affecting a borrower’s ability to repay include interest, inflation, employment rates and the strength of the local and national economy, as well as other factors affecting a borrower’s customers, suppliers and employees. There are no plans to engage in any sub-prime or speculative lending, including plans to originate loans with high loan-to-value ratios.

With respect to real estate loans, additional risks affecting the ability of a borrower to repay a real estate loan include fluctuations in the value of real estate and tenancy rates. In the case of a real estate loan, the borrower may be unable to repay the loan at the end of the loan term and may thus be forced to refinance the loan at a higher interest rate or sell the property, or, in certain cases, the borrower may default. In the case of a real estate construction loan, there is generally no income from the underlying property during the construction period. Each of these factors increases the risk of nonpayment.

Many of our commercial loans are made to small- to medium-sized businesses that may be less able to withstand adverse competitive, economic and financial pressures than large borrowers.  Our commercial borrowers reflect the diversified businesses of our service area, and include commercial, professional and retail service firms involved in the tourist, recreation and retirement industries. The risks associated with our commercial loans depend to a large extent upon various economic factors that affect those industries, including the strength of the economy in our service area and the ability of our commercial borrowers to properly evaluate and respond to a changing marketplace.

Consumer loans generally involve more credit risks than other loans because of the type and nature of the underlying collateral or because of the absence of any collateral. Consumer loan repayments are dependent on the borrower’s continuing financial stability and are likely to be adversely affected by job loss, divorce and illness. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans in the case of default. In most cases, any repossessed collateral will not provide an adequate source of repayment of the outstanding loan balance. Although the underwriting process for consumer loans includes a comparison of the value of the security, if any, to the proposed loan amount, we cannot predict the extent to which the borrower’s ability to pay, and the value of the security, will be affected by prevailing economic and other conditions.

Through the operations of our Bank, we have made contractual commitments to extend credit in the ordinary course of our business activities. These commitments are legally binding agreements to lend money to our customers at predetermined interest rates for a specified period of time, but have not been exercised and may not be immediately obvious when reviewing the financial statements of the Bank. At December 31, 2010, we had issued commitments to extend credit of $4.3 million through various types of lending arrangements. We evaluate each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by us upon extension of credit, is based on our credit evaluation of the borrower. Collateral varies but may include accounts receivable, inventory, property, plant and equipment, and commercial and residential real estate. We manage the credit risk on these commitments by subjecting them to normal underwriting and risk management processes.

Real Estate Loans. These loans generally fall into one of three categories: residential real estate loans, commercial real estate loans and construction and land development loans. These loans include commercial loans where the Bank takes a security interest in real estate out of caution and not as the principal collateral for the loan, but excludes home equity loans, which are classified as consumer loans. We expect to focus our real estate-related activity in three areas: (1) commercial and residential real estate development loans, (2) conforming and non-conforming mortgage loans and (3) owner-occupied commercial real estate loans.

The Bank’s residential real estate loans consist of residential first and second mortgage loans and residential construction loans. We offer fixed and adjustable rates on mortgages. These loans are made consistent with the Bank’s appraisal policy and with the ratio of the loan principal to the value of collateral as established by independent appraisal generally not to exceed 85%. We

5

Table of Contents

expect these loan-to-value ratios will be sufficient to compensate for fluctuations in real estate market value and to minimize losses that could result from a downturn in the residential real estate market such as has occurred recently. Fixed-rate loans may be sold in the secondary market in conjunction with performance management or portfolio management goals. Real estate-related products include:

·                  home mortgage loans (conventional, FHA and non-conforming) 1-4 owner-occupied homes;

·                  acquisition and development loans for residential and multi-family construction loans;

·                  construction and permanent lending for investor-owned property; and

·                  construction and permanent lending for commercial (owner-occupied) property.

The primary risk associated with residential real estate loans is that the residential borrower will be unable to service the debt. If a real estate loan is in default, we also run the risk that the value of a residential real estate loan’s collateral will decrease, and thereby be insufficient to satisfy the loan. To mitigate these risks, we will evaluate each borrower and the value of the property on an individual basis.

Construction and development loans generally carry a higher degree of risk than long-term financing of existing properties. Repayment usually depends on the ultimate completion of the project within cost estimates and on the sale of the property. Specific risks include cost overruns, construction delays, including those related to weather, mismanaged construction, shortages in labor or materials, inferior or improper construction techniques, economic changes or downturns during construction, a downturn in the real estate market, rising interest rates which may prevent sale of the property and failure to sell completed projects in a timely manner. We attempt to reduce risk by obtaining personal guarantees where possible, and by keeping the loan-to-value ratio of the completed project below specified percentages. We may also reduce risk by selling participations in larger loans to other institutions when possible.

Risks associated with commercial real estate loans include fluctuations in the value of real estate rental rates and other competition in the rental market, employment rates, tenant vacancy rates and the quality of the borrower’s management. Commercial real estate loans are generally riskier than residential real estate loans because commercial properties may be limited to a specific use making it more difficult to sell such properties to recover loan losses.  In addition, the tourist industry is highly competitive and, in our primary service area, subject to weather related risks, including hurricanes.  If a borrower’s business fails, the borrower is likely to be unable to repay its debts. To mitigate these risks, we evaluate each borrower on an individual basis and attempt to determine its business risks and credit profile. We attempt to reduce credit risk in the commercial real estate portfolio by emphasizing loans on owner-occupied office and retail buildings where the loan-to-value ratio is established by independent appraisals. We typically review the personal financial statements of the principal owners and require their personal guarantees. We also attempt to limit our risk by analyzing borrowers’ cash flow and collateral value on an ongoing basis.

Small Business Lending.  Our commercial lending is focused on small- to medium-size businesses located in or serving our service area. We consider “small businesses” to include commercial, professional and retail firms with annual revenues of $50 million or less. Commercial lending includes loans to entrepreneurs, professionals and small- to medium-sized firms. Small business products include:

·                  Working capital loans and lines of credit;

·                  Business term loans to purchase fixtures and equipment or fund site acquisition or business expansion;

·                  Inventory and accounts receivable lending; and

·                  Construction loans for owner-occupied buildings.

Within small business lending, we may from time to time use government enhancements such as the Small Business Administration (“SBA”) programs. These loans will typically be partially guaranteed by the government. As of December 31, 2010, we had not originated any small business loans using government enhancement. Government guarantees of SBA loans will not exceed 80% of the loan value, and will generally be less.

Commercial Loans. Many types of loans are available to business organizations and individuals on a secured and unsecured basis, including commercial, term, working capital, asset based, SBA loans, commercial real estate, lines of credit and mortgages. We intend to focus our commercial lending efforts on companies with revenues of less than $50 million. Construction loans are available for eligible individuals and contractors. The construction lending is short-term, generally with maturities of less than 12 months, and set up on a draw basis.

6

Table of Contents

The primary risk for commercial loans and small business lending is the failure of the business due to economic and financial factors. As a result, the quality of the commercial borrower’s management and its ability both to properly evaluate changes in the supply and demand characteristics affecting its markets for products and services and to effectively respond to such changes are significant factors in a commercial borrower’s creditworthiness and our decision to make a commercial loan.

Consumer Loans.  We offer consumer loans to customers in our primary service area. Consumer lending products include:

·                  home equity loans;

·                  automobile, recreational vehicle and boat loans; and

·                  installment loans (secured and unsecured).

Consumer loans are generally considered to have greater risk than first or second mortgages on real estate because the value of the secured property may depreciate rapidly; they are often dependent on the borrower’s employment status as the sole source of repayment; and some of them are unsecured. To mitigate these risks, we analyze selective underwriting criteria for each prospective borrower, which may include the borrower’s employment history, income history, credit bureau reports and debt-to-income ratios. If the consumer loan is secured by property, such as an automobile loan, we also attempt to offset the risk of rapid depreciation of the collateral with a shorter loan amortization period. Despite these efforts to mitigate our risks, consumer loans have a higher rate of default than real estate loans. For this reason, we also attempt to reduce our loss exposure to these types of loans by limiting their sizes relative to other types of loans.

Deposit Services

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

Deposit Distribution. The percentage distribution of our deposits on December 31, 2010, is as follows:

Our deposit distribution will depend on our customers and will likely vary over time.

Other Banking Services

We offer cashier’s checks, on-line banking, banking by mail, drive-thru banking, direct deposit of payroll and social security checks, United States Savings Bonds, tax deposits, 24-hour telephone banking and remote deposit capture. The Bank is associated with national ATM networks that may be used by the Bank’s customers throughout the country.

Investments

In addition to loans, the Bank makes other investments, subject to the Bank’s policy as set by its Board of Directors. Such investments may include overnight funds, direct obligations of the United States government, obligations guaranteed as to principal and interest by the United States and other Federal agencies, general obligation bonds, revenue bonds, certificates of deposit of financial institutions, mortgage-backed securities (limited to GNMA, FNMA, FHLB and FHLMC issues), municipal securities, bankers’ acceptances and other bank-grade investment securities.  No investment in any of these instruments will exceed any applicable limitations imposed by law or regulation.  The Bank’s asset-liability management committee reviews the investment portfolio on an ongoing basis in order to ensure the investments conform to the Bank’s policy.

Asset and Liability Management

The Bank’s asset/liability management committee oversees the Bank’s assets and liabilities and strives to provide a stable, optimized net interest margin, adequate liquidity and a profitable after-tax return on assets and return on equity. The committee conducts these management functions within the framework of written loan and investment policies the Bank has adopted. The committee attempts to maintain a balanced position between rate-sensitive assets and rate-sensitive liabilities.

7

Table of Contents

Competitive Conditions

The banking business is highly competitive. We compete with other commercial banks, savings banks, credit unions, finance companies and money market mutual funds operating in our primary service area. According to FDIC data as of June 30, 2010, there were 134 banking offices, representing 26 financial institutions operating in our primary service area and holding over $5.4 billion in deposits. Many of these institutions have substantially greater resources and lending limits than we have, and many of these competitors offer services, including extensive and established branch networks and trust services that we either do not provide at this time or will not provide. The Bank’s total deposits ranked 19th among financial institutions in the Myrtle Beach MSA, representing .86% of the total deposits in this market.  Our competitors include large national, super regional and regional banks as well as established community banks.

Employees

As of March 18, 2011, Coastal Carolina Bancshares, Inc., had 24 full-time employees. Management considers our employee relations to be good.

Supervision and Regulation

Banking is a complex, highly regulated industry. Consequently, the growth and earnings performance of the Company and the Bank can be affected not only by management decisions and general and local economic conditions, but also by the statutes administered by, and the regulations and policies of, various governmental regulatory authorities. These authorities include, but are not limited to, the Federal Reserve, the FDIC, the OCC, the Internal Revenue Service and state taxing authorities. The effect of these statutes, regulations and policies and any changes to any of them can be significant and cannot be predicted.

The primary goals of the bank regulatory structure are to maintain a safe and sound banking system and to facilitate the conduct of sound monetary policy. In furtherance of these goals, Congress has created several largely autonomous regulatory agencies and enacted numerous laws that govern banks, bank holding companies and the banking industry. The system of supervision and regulation applicable to the Company and the Bank establishes a comprehensive framework for their respective operations and is intended primarily for the protection of the FDIC’s deposit insurance fund, the Bank’s depositors and the public, rather than the stockholders and creditors. The following is an attempt to summarize some of the relevant laws, rules and regulations governing banks and bank holding companies, but does not purport to be a complete summary of all applicable laws, rules and regulations governing banks and bank holding companies. The descriptions are qualified in their entirety by reference to the specific statutes and regulations discussed.

The Company

General.  We own 100% of the outstanding capital stock of the Bank, and are therefore a bank holding company under the Bank Holding Company Act of 1956, as amended (the Bank Holding Company Act). The Bank Holding Company Act and other federal laws subject bank holding companies to particular restrictions on the types of activities in which they may engage and to a range of supervisory requirements and activities, including regulatory enforcement actions for violations of law and regulations.

The Bank Holding Company Act. Under the Bank Holding Company Act, the Company is subject to periodic examination by the Federal Reserve and is required to file periodic reports of its operations and any additional information that the Federal Reserve may require. Our activities at the bank holding company level are limited to:

·                  banking and managing or controlling banks;

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

·                  engaging in other financial activities that the Federal Reserve determines to be so closely related to banking and managing or controlling banks as to be a proper incident thereto.

Investments, Control and Activities. With certain limited exceptions, the Bank Holding Company Act requires every bank holding company to obtain the prior approval of the Federal Reserve before:

·                  acquiring substantially all the assets of any bank;

·                  acquiring direct or indirect ownership or control of any voting shares of any bank if after the acquisition it would own directly or indirectly or control more than 5% of the voting shares of such bank (unless it already owns or controls the majority of such shares); or

·                  merging or consolidating with another bank holding company.

8

Table of Contents

In addition, and subject to certain exceptions, the Bank Holding Company Act and the Change in Bank Control Act of 1978 (the Change in Bank Control Act), together with regulations thereunder, require written notice to the Federal Reserve prior to any person or company acquiring “control” of a bank holding company. Control is conclusively presumed to exist if an individual or company acquires 25% or more of any class of voting securities of a bank holding company. Control is rebuttably presumed to exist if a person acquires 10% or more, but less than 25%, of any class of voting securities and either the company has registered securities under Section 12 of the Securities Exchange Act of 1934 or no other person owns, controls or holds the power to vote a greater percentage of that class of voting securities immediately after the transaction. At such time, if ever, as we have in excess of 500 shareholders of record and total assets exceeding $10 million, we will be required to register under Section 12 of the Securities Exchange Act of 1934. The regulations provide a procedure for challenge of the rebuttable control presumption.

Under the Bank Holding Company Act, a bank holding company is generally prohibited from engaging in, or acquiring direct or indirect control of more than 5% of the voting shares of any company engaged in, non-banking activities unless the Federal Reserve, by order or regulation, has found those activities to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. Some of the activities that the Federal Reserve has determined by regulation to be proper incidents to the business of a bank holding company include:

·                  making or servicing loans and certain types of leases;

·                  engaging in certain insurance and discount brokerage activities;

·                  performing certain data processing services;

·                  acting in certain circumstances as a fiduciary or investment or financial adviser; and

·                  owning savings associations.

The Federal Reserve imposes certain capital requirements on the Company under the Bank Holding Company Act and the Change in Bank Control Act regulations, including a minimum leverage ratio and a minimum ratio of “qualifying” capital to risk-weighted assets. These requirements are described below under “Capital Regulations.” Subject to its capital requirements and certain other restrictions, the Company will be able to borrow money to make a capital contribution to the Bank, and these loans may be repaid from dividends paid from the Bank to the Company. The Bank’s ability to pay dividends is subject to regulatory restrictions described below under “Dividends.” The Company is also able to raise capital for contribution to the Bank by issuing securities without having to receive regulatory approval, subject to compliance with federal and state securities laws.

Source of Strength; Cross-Guarantee. In accordance with Federal Reserve policy, the Company is expected to act as a source of financial strength to the Bank and to commit resources to support the Bank in circumstances in which the Company might not otherwise do so. Under the Bank Holding Company Act, the Federal Reserve may require a bank holding company to terminate any activity or relinquish control of a nonbank subsidiary, other than a nonbank subsidiary of a bank, upon the Federal Reserve’s determination that such activity or control constitutes a serious risk to the financial safety, soundness or stability of any subsidiary depository institution of the bank holding company and is inconsistent with sound banking principles or with the purposes of the Bank Holding Company Act or with the Financial Institutions Supervisory Act of 1966. Further, federal bank regulatory authorities have additional discretion to require a bank holding company to divest itself of any bank or non-bank subsidiary if the agency determines that divestiture may aid the depository institution’s financial condition.

The Gramm-Leach-Bliley Act. The Gramm-Leach-Bliley Act, also known as the Financial Services Modernization Act of 1999, was signed into law on November 12, 1999. Among other things, the act repeals the restrictions on banks affiliating with securities firms contained in sections 20 and 32 of the Glass-Steagall Act. The act also permits bank holding companies that become financial holding companies to engage in a statutorily provided list of financial activities, including insurance and securities underwriting and agency activities, merchant banking and insurance company portfolio investment activities. The act also authorizes activities that are “complementary” to financial activities.

The act is intended, in part, to grant to community banks certain powers as a matter of right that larger institutions have accumulated on an ad hoc basis. Nevertheless, the act may have the result of increasing the amount of competition that we face from larger institutions and other types of companies. In fact, it is not possible to predict the full effect that the act will have on us.

9

Table of Contents

The Bank

The Bank is a national banking association incorporated under the laws of the United States and subject to examination by the OCC. Deposits in the Bank are insured by the FDIC up to a maximum amount, which is currently $250,000 for each general depositor.  See “Deposit Insurance and Assessments” below.

The OCC and the FDIC regulate and monitor virtually all areas of the Bank’s operations, including:

·                  security devices and procedures;

·                  adequacy of capitalization and loss reserves;

·                  loans;

·                  investments;

·                  borrowings;

·                  deposits;

·                  mergers;

·                  issuances of securities;

·                  payment of dividends;

·                  interest rates payable on deposits;

·                  interest rates or fees chargeable on loans;

·                  establishment of branches;

·                  maintenance of books and records; and

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

An example applicable to the Bank because of its lending portfolio is guidance by the federal banking agencies to identify and manage risks associated with concentrations in commercial real estate loans. The guidance states that a growing number of banks have high concentrations of commercial real estate loans on their balance sheets which may make the banks more vulnerable to cyclical downturns in the commercial real estate markets. Banks with high concentrations of commercial real estate loans are subject to greater supervisory scrutiny and will be required to have in place risk-management practices and capital levels that are appropriate in light of the risk associated with these concentrations. The final guidelines relating to concentrations in commercial real estate loans are applicable to the Bank and may adversely affect the Bank’s ability to develop and grow its commercial real estate loan portfolio.

The OCC requires the Bank to maintain specified capital ratios and imposes limitations on the Bank’s aggregate investment in real estate, Bank premises and furniture and fixtures. The OCC also requires the Bank to prepare quarterly reports on the Bank’s financial condition, and the FDIC requires the Bank to conduct an annual audit of its financial affairs in compliance with generally accepted auditing standards and the Federal Deposit Insurance Act (the FDI Act). As a new bank, we are required to notify and obtain from the OCC a written determination of no objection before the Bank engages in any significant deviation or change from its business plan or operations. In addition, during the first three years of the Bank’s operations, the Bank is required to provide the appropriate FDIC regional supervisory office with a copy of any such notice made to the OCC.

Federal Deposit Insurance Corporation Improvement Act of 1991. Under the Federal Deposit Insurance Corporation Improvement Act of 1991 (the FDIC Improvement Act), which amended the FDI Act, all insured institutions must undergo regular on-site examinations by their appropriate banking agency. The cost of examinations of insured depository institutions and any affiliates may be assessed by the appropriate agency against each institution or affiliate to meet the FDIC’s expenses in carrying out such examinations. Insured institutions are required to submit annual reports to the FDIC, their federal banking agency and their state supervisor when applicable. The FDI Act directs the FDIC to develop a method for insured depository institutions to provide disclosure of the assets and liabilities in any balance sheet, financial statement, report of condition or any other report of any insured depository institution required to be filed with a federal banking agency. The FDI Act also requires the federal banking regulatory agencies to prescribe, by regulation or guideline, standards for all insured depository institutions and depository institution holding companies relating to, among other things, the following:

·                  internal controls;

·                  information systems and internal audit systems;

·                  loan documentation;

·                  credit underwriting;

·                  interest rate risk exposure;

·                  asset growth; and

·                  compensation, fees and benefits.

For a period of two years from the date the Bank commenced business, the OCC must review and not object to the hiring of any officer or the appointment or election of any director of the Bank. Further, the Bank must provide written notice to the

10

Table of Contents

OCC at least 90 days before adding or replacing any member of its board of directors, employing any person as a senior executive officer, or changing the responsibilities of any senior executive officer so that the person would assume a different executive officer position if the Bank is not in compliance with minimum capital requirements applicable thereto or is otherwise in troubled condition, or if the OCC determines, in connection with its review of the Bank’s capital restoration plan or otherwise, that such notice is required. The OCC may disapprove such addition or employment within such 90-day period.

In addition, the FDIC requires that an insured depository institution or depository institution holding company notify the appropriate federal banking agency of the proposed addition of any individual to the board of directors or the employment of any individual as a senior executive officer at least 30 days before such addition or employment becomes effective if the institution is not in compliance with the minimum capital requirements applicable to it or is otherwise in troubled condition, or if the agency determines such prior notice is appropriate based on its review of the institution’s capital restoration plan. The agency may disapprove any such addition or appointment within 90 days from the date the agency receives notice of the proposed action. Further, whenever a change in control of an insured depository institution occurs, the institution must report promptly to the appropriate federal banking agency any changes or replacement of its chief executive officer or of any director occurring in the next 12-month period, including in its report a statement of the past and current business and professional affiliations of the new chief executive officer or director.

Deposit Insurance and Assessments.  During the fourth quarter 2008, the amount of FDIC insurance coverage for insured deposits was increased under the Emergency Economic Stabilization Act of 2008 (EESA), generally from $100,000 per depositor to $250,000 per depositor. In July 2010, this increase was made permanent by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”).  In November 2010, the FDIC issued provisions, required by the Dodd-Frank Act, which provide temporary unlimited coverage for non-interest-bearing transaction deposit accounts through December 31, 2012.

Each depository institution is assigned to a risk category based on capital and supervisory measures. A depository institution in the past has been assessed insurance premiums by the FDIC based on its risk category and the amount of deposits held. These amounts have been assessed and due quarterly.  In 2009, the FDIC, as part of its plan to restore the Deposit Insurance Fund, increased deposit insurance assessments by increasing its assessment rates and changing the assessment framework.  A special assessment was assessed in 2009 on each insured depository institution’s assets minus Tier 1 capital as of June 30, 2009, and was collected on September 30, 2009. The Bank’s special assessment was $2,948. In late 2009, the FDIC required insured depository institutions to prepay their quarter risk-based assessments for the fourth quarter of 2009, and for all of 2010, 2011 and 2012, by December 30, 2009, along with each institution’s risk-based assessment for the third quarter of 2009. The Bank’s prepaid assessment was $135,458.  Assumptions for future deposit growth were necessary and the prepaid assessment may differ from the actual assessments in these periods depending on how actual deposit growth compared to the predicted deposit growth on which the prepaid assessment was based.  If the prepaid assessment is depleted, the Bank will return to paying quarter assessments at that time.  In 2010, the FDIC adopted a final rule to change the assessment again, changing the assessment rates and altering the calculation to be based on total assets minus average tangible equity, defined as Tier 1 capital, as opposed to the current deposit based calculation.  The new assessment method will begin with the second quarter financial results in 2011 to be paid in the third quarter.

Transactions with Affiliates and Insiders. The Bank is subject to the provisions of Section 23A of the Federal Reserve Act, which places limits on the amount of loans or extensions of credit to, or investments in, or certain other transactions with, affiliates and on the amount of advances to third parties collateralized by the securities or obligations of affiliates. The aggregate of all covered transactions is limited in amount, as to any one affiliate, to 10% of the Bank’s capital and surplus and, as to all affiliates combined, to 20% of the Bank’s capital and surplus. Furthermore, within the foregoing limitations as to amount, each covered transaction must meet specified collateral requirements. Compliance is also required with certain provisions designed to avoid the taking of low-quality assets.

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

11

Table of Contents

Regulation W. Effective April 1, 2003, the Federal Reserve adopted Regulation W, which implements Sections 23A and 23B of the Federal Reserve Act and provides interpretative guidance with respect to affiliate transactions. Regulation W incorporates the exemption from the affiliate transaction rules but expands the exemption to cover the purchase of any type of loan or extension of credit on a nonrecourse basis from an affiliate under certain conditions. In addition, under Regulation W: a bank and its subsidiaries may not generally purchase a low-quality asset from an affiliate; covered transactions, and other transactions exempt under the applicable regulations, between a bank or its subsidiaries and an affiliate must be on terms and conditions that are consistent with safe and sound banking practices; and with some exceptions, each loan or extension of credit by a bank to an affiliate must be secured by collateral with a market value ranging from 100% to 130% of the amount of the loan or extension of credit depending on the type of collateral,.

Regulation W generally excludes all non-bank and non-savings association subsidiaries of banks from treatment as affiliates, except to the extent that the Federal Reserve decides to treat these subsidiaries as affiliates. Concurrently with the adoption of Regulation W, the Federal Reserve has proposed a regulation which would further limit the amount of loans that could be purchased by a bank from an affiliate to not more than 100% of the Bank’s capital and surplus. That regulation has not yet been adopted.

Dividends. A national bank may not pay dividends from its capital. All dividends must be paid out of undivided profits, subject to other applicable provisions of law. Subject to certain restrictions, the directors of a national bank may declare a dividend of so much of the undivided profits of the Bank as the directors judge to be prudent.  In addition, a national bank may not declare and pay dividends in any year in excess of an amount equal to the sum of the total of the net income of the Bank for that year and the retained net income of the Bank for the preceding two years, minus the sum of any transfers required by the OCC and any transfers required to be made to a fund for the retirement of any preferred stock, unless the OCC approves the declaration and payment of dividends in excess of such amount.  In addition, as a new bank, the Bank will be required to maintain a risk-based total Tier 1 capital ratio equal to at least 8%, which will further limit the Bank’s ability to pay dividends.

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

Community Reinvestment Act of 1977. The Community Reinvestment Act of 1977 (the Community Reinvestment Act) requires, in connection with examinations of financial institutions within their respective jurisdictions, the Federal Reserve, the FDIC or the OCC to evaluate the record of each financial institution in meeting the credit needs of its entire community, including low and moderate income neighborhoods. These factors are also considered in evaluating mergers, acquisitions and applications to open a branch or facility. Failure to adequately meet these criteria could impose additional requirements and limitations on the Bank. Under the Gramm-Leach-Bliley Act, banks with aggregate assets of not more than $250 million will be subject to a Community Reinvestment Act examination only once every 60 months if the Bank receives an outstanding rating, once every 48 months if it receives a satisfactory rating, and as needed if the rating is less than satisfactory. Additionally, under the Gramm-Leach-Bliley Act, banks are required to publicly disclose the terms of various Community Reinvestment Act-related agreements.

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

The Gramm-Leach-Bliley Act also contains provisions regarding consumer privacy. These provisions require financial institutions to disclose their policy for collecting and protecting confidential information. Customers generally may prevent financial institutions from sharing personal financial information with nonaffiliated third parties except for third parties that market an institution’s own products and services. Additionally, financial institutions generally may not disclose consumer

12

Table of Contents

account numbers to any nonaffiliated third party for use in telemarketing, direct mail marketing, or other marketing through electronic mail to the consumer.

Other Regulations. Interest and other charges collected or contracted for by the Bank are subject to state usury laws and federal laws concerning interest rates. The Bank’s loan operations are also subject to federal laws, rules and regulations applicable to credit transactions, such as:

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

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

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

·                  the Fair Credit Reporting Act, governing the use and provision of information to credit reporting agencies;

·                  the Fair Debt Collection Practices Act, governing the manner in which consumer debts may be collected by collection agencies; and

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

·                  The deposit operations of the Bank are also subject to:

·                  the Right to Financial Privacy Act of 1978, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records; and

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

Capital Regulations

The federal bank regulatory authorities have adopted risk-based capital guidelines for banks and bank holding companies that are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and bank holding companies and account for off-balance sheet items. The guidelines are minimums, and the federal regulators have noted that banks and bank holding companies contemplating significant expansion programs should not allow expansion to diminish their capital ratios and should maintain ratios in excess of the minimums.

The current guidelines require all bank holding companies and federally-regulated banks to maintain a minimum risk-based total capital ratio equal to at least 8%, of which at least 4% must be Tier 1 capital. Tier 1 capital includes common shareholders’ equity, non-cumulative perpetual preferred stock and related surplus, and minority interests in equity accounts of consolidated subsidiaries, but excludes, among other things, goodwill and most other intangibles and deferred tax assets. Tier 2 capital includes cumulative perpetual preferred stock, long-term preferred stock, convertible preferred stock and any related surplus, under certain conditions, certain mandatory convertible securities, hybrid capital instruments, term subordinated debt and intermediate-term preferred stock, general reserves for loan and lease losses up to 1.25% of risk-weighted assets, and up to 45% of the pretax net unrealized holding gains on available-for-sale equity securities with readily determinable fair values.

Under these guidelines, banks’ and bank holding companies’ assets are given risk-weights of 0%, 20%, 50% or 100%. In addition, certain off-balance sheet items are given credit conversion factors to convert them to asset equivalent amounts to which an appropriate risk-weight applies. These computations result in total risk-weighted assets. Most loans are assigned to the 100% risk category, except for first mortgage loans fully secured by residential property and, under certain circumstances, residential construction loans, both of which carry a 50% rating. Most investment securities are assigned to the 20% category, except for municipal or state revenue bonds, which have a 50% rating, and direct obligations of or obligations guaranteed by the United States Treasury or certain United States Government agencies, which have a 0% rating.

The federal bank regulatory authorities have also implemented a leverage ratio, which is equal to Tier 1 capital as a percentage of average total assets less intangibles, to be used as a supplement to the risk-based guidelines. The principal objective of the leverage ratio is to place a constraint on the maximum degree to which a bank holding company may leverage its equity capital base. The minimum required leverage ratio for the most highly-rated institutions is 3%, but most institutions are required to maintain an additional cushion of at least 100 to 200 basis points.

The FDIC Improvement Act established an additional capital-based regulatory scheme designed to promote early intervention for troubled banks which requires the FDIC to choose the least expensive resolution of bank failures. This capital-based

13

Table of Contents

regulatory framework contains five categories of compliance with regulatory capital requirements, including “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized.” To qualify as a “well capitalized” institution, a bank must have a leverage ratio of 5% or greater, a Tier 1 risk-based capital ratio of 6% or greater, and a total risk-based capital ratio of 10% or greater, and the Bank must not be under any order or directive from the appropriate regulatory agency to meet and maintain a specific capital level.

As a new bank, the OCC has required the Bank maintain a Tier 1 leverage ratio of at least 8%, a Tier 1 risk based capital ratio of 8% or greater, and a total risk-based capital ratio of 12% or greater, in order to be considered “well capitalized”.  Currently, the Bank and the Company continue to be classified as “well capitalized.”

Under the FDIC Improvement Act regulations, the applicable agency can treat an institution as if it were in the next lower category if the agency determines (after notice and an opportunity for hearing) that the institution is in an unsafe or unsound condition or is engaging in an unsafe or unsound practice. The degree of regulatory scrutiny of a financial institution increases, and the permissible activities of the institution decrease, as it moves downward through the capital categories. Institutions that fall into one of the three undercapitalized categories may be required to do some or all of the following:

·                  submit a capital restoration plan;

·                  raise additional capital;

·                  restrict their asset growth, deposit interest rates and other activities;

·                  improve their management;

·                  eliminate management fees; or

·                  divest themselves of all or a part of their operations.

A bank that is not “well capitalized” is also subject to certain limitations relating to so-called “brokered” deposits. Bank holding companies controlling financial institutions can be called upon to boost the institutions’ capital and to partially guarantee the institutions’ performance under their capital restoration plans.

These capital guidelines can affect us in several ways. If the Bank grows at a rapid pace, its capital may be depleted too quickly, and a capital infusion from the Company may be necessary which could impact our ability to pay dividends. Our capital levels will initially be more than adequate; however, rapid growth, poor loan portfolio performance, poor earnings performance or a combination of those factors could change our capital position in a relatively short period of time.

Failure to meet these capital requirements would mean that a bank would be required to develop and file a plan with its primary federal banking regulator describing the means and a schedule for achieving the minimum capital requirements. In addition, such a bank would generally not receive regulatory approval of any application that requires the consideration of capital adequacy, such as a branch or merger application, unless the bank could demonstrate a realistic plan to meet the capital requirement within a reasonable period of time.

Other

Financial Institutions Reform, Recovery and Enforcement Act of 1989. This act expanded and increased the enforcement powers of the regulators in terms of both civil and criminal penalties available for use by the federal regulatory agencies against depository institutions and certain “institution-affiliated parties.” Institution-affiliated parties include management, employees and agents of an insured depository financial institution, as well as independent contractors and consultants such as attorneys and accountants, shareholders and others who participate in the conduct of the financial institution’s affairs. Violations include the failure of an institution to timely file required reports, the filing of false or misleading information or the submission of inaccurate reports. Civil penalties may be as high as $1,000,000 a day for continuing violations. Criminal penalties for some financial institution crimes have been increased to 20 years. In addition, regulators are provided with greater flexibility to commence enforcement actions against institutions and institution-affiliated parties. Possible enforcement actions include the termination of deposit insurance. Furthermore, banking agencies’ power to issue cease-and-desist orders were expanded. Such orders may, among other things, require affirmative action to correct any harm resulting from a violation or practice, including restitution, reimbursement, indemnification or guarantees against loss. A financial institution may also be ordered to restrict its growth, dispose of any loan or assets involved, rescind agreements or contracts, employ qualified officers and employees, or take other actions as determined by the ordering agency to be appropriate.

Privacy and Credit Reporting. Financial institutions are required to disclose their policies for collecting and protecting confidential information. Customers generally may prevent financial institutions from sharing nonpublic personal financial information with nonaffiliated third parties except under narrow circumstances, such as the processing of transactions requested

14

Table of Contents

by the consumer. Additionally, financial institutions generally may not disclose consumer account numbers to any nonaffiliated third party for use in telemarketing, direct mail marketing or other marketing through electronic mail to consumers. It will be the Bank’s policy not to disclose any personal information to nonaffiliated third parties unless required to do so by law.

Like other lending institutions, the Bank will utilize credit bureau data in its underwriting activities. Use of such data is regulated under the Fair Credit Reporting Act on a uniform, nationwide basis, including credit reporting, prescreening, sharing of information between affiliates and the use of credit data.

USA PATRIOT Act of 2001. In October 2001, the USA PATRIOT Act of 2001 was enacted in response to the terrorist attacks in New York, Pennsylvania and Washington D.C. that occurred on September 11, 2001. The PATRIOT Act is intended to strengthen United States law enforcement’s and the intelligence communities’ abilities to work cohesively to combat terrorism on a variety of fronts. The potential impact of the PATRIOT Act on financial institutions is significant and wide ranging. The PATRIOT Act contains sweeping anti-money laundering and financial transparency laws and imposes various regulations, including standards for verifying customer identification at account opening, and rules to promote cooperation among financial institutions, regulators and law enforcement entities in identifying parties who may be involved in terrorism or money laundering.

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

·                  allowing check truncation without making it mandatory;

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

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

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

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

·                  requiring the re-crediting of funds on the next business day after a consumer proves that the financial institution has erred.

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

Recent Regulatory Developments

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

·                  The Emergency Economic Stabilization Act of 2008 (the EESA) was 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 market-to-market accounting, and raised the basic limit of FDIC deposit insurance from $100,000 to $250,000 through December 31, 2013.

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

15

Table of Contents

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

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

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

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

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

·                  A capital assistance program that will invest in mandatory convertible preferred stock of certain qualifying institutions determined on a basis and through a process similar to the Capital Purchase Program;

·                  A consumer and business lending initiative to fund new consumer loans, small business loans and commercial mortgage asset-backed securities issuances;

·                  A new public-private investment fund that will leverage public and private capital with public financing to purchase up to $500 billion to $1 trillion of legacy “toxic assets” from financial institutions; and

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

·                  On February 17, 2009, the American Recovery and Reinvestment Act of 2009, (the ARRA), was signed into law in an effort to, among other things, create jobs and stimulate growth in the United States economy.  The ARRA 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 ARRA also imposes certain limitations on compensation paid by participants in the U.S. Treasury’s Troubled Asset Relief Program (“TARP”).

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

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

·                  The second plan is the Securities Program, which is administered by the Treasury and involves the creation of public-private investment funds (“PPIFs”) to target investments in eligible residential mortgage-backed securities and commercial mortgage-backed securities issued before 2009 that originally were rated AAA or the equivalent by two or more nationally recognized statistical rating organizations, without regard to rating enhancements (collectively, “Legacy Securities”). Legacy Securities must be directly secured by actual

16

Table of Contents

mortgage loans, leases or other assets, and may be purchased only from financial institutions that meet TARP eligibility requirements. The U.S. Treasury received over 100 unique applications to participate in the Legacy Securities PPIP and in July 2009 selected nine PPIF managers. As of September 20, 2010, the PPIFs had completed their fundraising and have closed approximately $7.4 billion of private sector equity capital, which was matched 100% by the Treasury, representing $12.4 billion of total equity capital. The U.S. Treasury has also provided $249.4 billion of debt capital, representing $24.8 billion of total purchasing power. As of September 30, 2010, the PPIFs have drawn-down approximately $18.6 billion of total capital which has been invested in eligible assets and cash equivalents pending investment.

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

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

·                  In June 2010, the Federal Reserve, the FDIC and the OCC issued a comprehensive final guidance on incentive compensation policies intended to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of such organizations by encouraging excessive risk-taking. The guidance, which covers all employees that have the ability to materially affect the risk profile of an organization, either individually or as part of a group, is based upon the key principles that a banking organization’s incentive compensation arrangements should (i) provide incentives that do not encourage risk-taking beyond the organization’s ability to effectively identify and manage risks, (ii) be compatible with effective internal controls and risk management, and (iii) be supported by strong corporate governance, including active and effective oversight by the organization’s board of directors. The Federal Reserve will review, as part of the regular, risk-focused examination process, the incentive compensation arrangements of banking organizations, such as the Company, that are not “large, complex banking organizations.” These reviews will be tailored to each organization based on the scope and complexity of the organization’s activities and the prevalence of incentive compensation arrangements. The findings of the supervisory initiatives will be included in reports of examination. Deficiencies will be incorporated into the organization’s supervisory ratings, which can affect the organization’s ability to make acquisitions and take other actions. Enforcement actions may be taken against a banking organization if its incentive compensation arrangements, or related risk-management control or governance processes, pose a risk to the organization’s safety and soundness and the organization is not taking prompt and effective measures to correct the deficiencies.

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

17

Table of Contents

·                  On September 27, 2010, the U.S. President signed into law the Small Business Jobs Act of 2010 (the “Act”).  The Small Business Lending Fund (the “SBLF”), which was enacted as part of the Act, is a $30 billion fund that encourages lending to small businesses by providing Tier 1 capital to qualified community banks with assets of less than $10 billion. On December 21, 2010, the U.S. Treasury published the application form, term sheet and other guidance for participation in the SBLF.  Under the terms of the SBLF, the Treasury will purchase shares of senior preferred stock from banks, bank holding companies, and other financial institutions that will qualify as Tier 1 capital for regulatory purposes and rank senior to a participating institution’s common stock. The application deadline for participating in the SBLF is March 31, 2011.

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

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

·                  In November 2010, the FDIC approved two proposals that amend the deposit insurance assessment regulations. The first proposal implements a provision in the Dodd-Frank Act that changes the assessment base from one based on

18

Table of Contents

domestic deposits (as it has been since 1935) to one based on assets. The assessment base changes from adjusted domestic deposits to average consolidated total assets minus average tangible equity.  The second proposal changes the deposit insurance assessment system for large institutions in conjunction with the guidance given in the Dodd-Frank Act.  Since the new base would be much larger than the current base, the FDIC will lower assessment rates, which achieves the FDIC’s goal of not significantly altering the total amount of revenue collected from the industry. Risk categories and debt ratings will be eliminated from the assessment calculation for large banks which will instead use scorecards. The scorecards will include financial measures that are predictive of long-term performance. A large financial institution will continue to be defined as an insured depository institution with at least $10 billion in assets.  Both changes in the assessment system will be effective as of April 1, 2011 and will be payable at the end of September.  In December 2010, the FDIC voted to increase the required amount of reserves for the designated reserve ratio (“DRR”) to 2.0%. The ratio is higher than the 1.35% set by the Dodd-Frank Act in July 2010 and is an integral part of the FDIC’s comprehensive, long-range management plan for the DIF.  On December 16, 2010, the Federal Reserve issued a proposal to implement a provision in the Dodd-Frank Act that requires the Federal Reserve to set debit card interchange fees. The proposed rule, if implemented in its current form, would result in a significant reduction in debit-card interchange revenue. Though the rule technically does not apply to institutions with less than $10 billion in assets, there is concern that the price controls may harm community banks, which could be pressured by the marketplace to lower their own interchange rates. In February 2011, the FDIC approved the final rules that, as noted above, change the assessment base from domestic deposits to average assets minus average tangible equity, adopt a new scorecard-based assessment system for financial institutions with more than $10 billion in assets, and finalize the DRR target size at 2.0% of insured deposits.

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

We did not participate in the unlimited deposit insurance component of the TLGP.  Although the TLGP expired on December 31, 2010, a provision of the Dodd-Frank Act requires the FDIC to provide unlimited deposit insurance for all deposits in non-interest bearing transaction accounts.  This deposit insurance mandate created by the Dodd-Frank Act took effect on December 31, 2010, and will continue through December 31, 2012.  The deposit insurance mandate created by the Dodd-Frank Act is not an extension of the TAGP.  Although the TAGP and the Dodd-Frank Act establish unlimited deposit insurance for certain types of non-interest bearing deposit accounts, unlike the TAGP, the coverage provided by the Dodd-Frank Act does not apply to NOW accounts and will be funded through general FDIC assessments, not special assessments.  With respect to any other potential future government assistance programs, we will evaluate the merits of the programs, including the terms of the financing, our capital position, the cost to the Company of alternative capital, and our strategy for the use of additional capital, to determine whether it is prudent to participate.  Specifically, we will evaluate participating in the fund pursuant to the Small Business Jobs and Credit Act.  Regardless of our lack of participation, governmental intervention and new regulations under these programs could materially and adversely affect our business, financial condition and results of operations.

Proposed Legislation and Regulatory Action. New regulations and statutes are regularly proposed that contain wide-ranging proposals for altering the structures, regulations and competitive relationships of the nation’s financial institutions. The United States Treasury Department recently has recommended a major restructuring of the financial institution regulatory framework in this country. We cannot predict whether or in what form any proposed regulation or statute will be adopted or the extent to which our business may be affected by any new regulation or statute.

Item 1A. Risk Factors.

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

Negative developments beginning in the latter half of 2007 in the global credit and securitization markets have resulted in uncertainty in the financial markets. As a result of this “credit crunch,” commercial as well as consumer loan portfolio performances have deteriorated at many institutions and the competition for deposits and quality loans has increased significantly.  In addition, the values of real estate collateral supporting many commercial loans and home mortgages have declined and may continue to decline.  Global securities markets, and bank holding company stock prices in particular, have been negatively affected, as has the ability of banks and bank holding companies to raise capital or borrow in the debt markets.  As a result, significant new federal laws and regulations relating to financial institutions have been adopted.  Furthermore, the potential exists for additional federal or state laws and regulations regarding, among other matters, lending and funding practices and liquidity standards, and bank regulatory agencies are expected to be active in responding to concerns and trends

19

Table of Contents

identified in examinations, including the continued issuance of formal enforcement orders.  Negative developments in the financial industry and the domestic and international credit markets, and the impact of new legislation in response to those developments, may negatively impact our operations by restricting our business operations, including our ability to originate or sell loans, and adversely impact our financial performance.  We can provide no assurance regarding the manner in which any new laws and regulations will affect us.

There can be no assurance that recently enacted legislation will help stabilize the U.S. financial system.

As described above under Supervision and Regulation, in response to the challenges facing the financial services sector, a number of regulatory and governmental actions have been enacted or announced.  There can be no assurance that these government actions will achieve their purpose.  The failure of the financial markets to stabilize, or a continuation or worsening of the current financial market conditions, could have a material adverse effect on our business, our financial condition, the financial condition of our customers, our common stock trading price, as well as our ability to access credit.  It could also result in declines in our investment portfolio, which could be “other-than-temporary impairments.”

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

Our success significantly depends upon the growth in population, income levels, deposits, and housing starts in our markets.  The current economic downturn has negatively affected the markets in which we operate and, in turn, the quality of our loan portfolio.  If the communities in which we operate do not grow or if prevailing economic conditions locally or nationally remain unfavorable, our business may not succeed.  A continuation of the economic downturn or prolonged recession would likely result in the deterioration of the quality of our loan portfolio and reduce our level of deposits, which in turn would hurt our business.  Interest received on loans represented approximately 30% of our interest income for the year ended December 31, 2010.  If the economic downturn continues or a prolonged economic recession occurs in the economy as a whole, borrowers will be less likely to repay their loans as scheduled.  Moreover, in many cases the value of real estate or other collateral that secures our loans has been adversely affected by the economic conditions and could continue to be negatively affected.  Unlike many larger institutions, we are not able to spread the risks of unfavorable local economic conditions across a large number of diversified economies.  A continued economic downturn could, therefore, result in losses that materially and adversely affect our business.

We may not be able to maintain and manage our growth, which may adversely affect our results of operations and financial condition.

We may not be able to maintain and manage our growth and may not even be able to grow our business at all.  Various factors, such as economic conditions, regulatory and legislative considerations, and competition, may impede our ability to expand our market presence.  If we experience a decrease in our historical rate of growth or do not grow at all, our results of operations and financial condition may be adversely affected because a high percentage of our operating costs are fixed expenses.

Changes in interest rates affect our interest margins, which can adversely affect our profitability.

We may not be able to effectively manage changes in interest rates that affect what we charge as interest on our earning assets and the expense we must pay on interest-bearing liabilities, which may significantly reduce our earnings. Since rates charged on our loans often tend to react to market conditions faster than do rates paid on our deposit accounts, rate cuts may have a negative impact on our earnings until we could make appropriate adjustments in our deposit rates. Fluctuations in interest rates are not predictable or controllable and, therefore, there can be no assurances of our ability to produce a consistent positive spread between the interest earned on our earning assets and the interest paid on our interest-bearing liabilities.

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

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

·              the duration of the credit;

·              credit risks of a particular customer;

·              changes in economic and industry conditions; and

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

20

Table of Contents

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

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

·              our historical loan loss experience;

·              evaluation of economic conditions;

·              regular reviews of loan delinquencies; and

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

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

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

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

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

A significant portion of our loan portfolio is secured by real estate.  As of December 31, 2010, 93.9% of our loans had real estate as a primary or secondary component of collateral.  The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended.  A weakening of the real estate market in our primary market area could result in an increase in the number of borrowers who default on their loans and a reduction in the value of the collateral securing their loans, which in turn could have an adverse effect on our profitability and asset quality.  If we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, our earnings and capital could be adversely affected.  Acts of nature, including hurricanes, tornados, earthquakes, fires and floods, which may cause uninsured damage and other loss of value to real estate that secures these loans, may also negatively impact our financial condition.

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

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

We depend on the accuracy and completeness of information about customers and counterparties and our financial condition could be adversely affected if we have been provided misleading information.

In deciding whether to extend credit or to enter into other transactions with customers and counterparties, we may rely on information furnished to us by or on behalf of customers and counterparties, including financial statements and other financial information, which we do not independently verify.  We also may rely on representations of customers and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors.  For example, in deciding whether to extend credit to customers, we may assume that a customer’s audited financial statements conform with GAAP and present fairly, in all material respects, the financial condition, results of operations and cash flows of the customer.  Our financial condition and results of operations could be negatively impacted to the extent we rely on financial statements that do not comply with GAAP or are materially misleading.

21

Table of Contents

We are dependent on key individuals and the loss of one or more of these key individuals could curtail our growth and adversely affect our prospects.  Our success also depends, in part, on our continued ability to attract and retain experienced loan originators, as well as other management personnel.  Competition for personnel can be intense, and we may not be successful in attracting or retaining qualified personnel.  Our failure to compete for these personnel, or the loss of the services of several of such key personnel, could adversely affect our growth strategy and seriously harm our business, results of operations, and financial condition.

We are subject to extensive regulation that could limit or restrict our activities.

We operate in a highly regulated industry and are subject to examination, supervision, and comprehensive regulation by various regulatory agencies.  Our compliance with these regulations is costly and restricts certain of our activities, including payment of dividends, mergers and acquisitions, investments, loans and interest rates charged, interest rates paid on deposits, and locations of offices.  We are also subject to capitalization guidelines established by our regulators, which require us to maintain adequate capital to support our growth.

The laws and regulations applicable to the banking industry could change at any time, and we cannot predict the effects of these changes on our business and profitability.  Because government regulation greatly affects the business and financial results of all commercial banks and bank holding companies, our cost of compliance could adversely affect our ability to operate profitably.

Proposals for further regulation of the financial services industry are continually being introduced in the Congress of the United States of America and the General Assembly of the State of South Carolina.  The agencies regulating the financial services industry also periodically adopt changes to their regulations. See the “Supervision and Regulation” section of this Form 10-K for a summary description of proposed regulations and legislative action that has been introduced and/or adopted over the last two years. It is possible that additional legislative proposals may be adopted or regulatory changes may be made that would have an adverse effect on our business.

The FDIC Deposit Insurance assessments that we are required to pay may materially increase in the future, which would have an adverse effect on our earnings and our ability to pay our liabilities as they come due.

As a member institution of the FDIC, we are required to pay deposit insurance premium assessments to the FDIC.  We are generally unable to control the amount of premiums that are required to be paid for FDIC insurance.  If there are additional bank or financial institution failures, we may be required to pay even higher FDIC premiums than recently increased levels.  Any future increases may materially and adversely affect our results of operations.  Additionally, the Dodd-Frank Act changed the assessment base for federal deposit insurance from the amount of insured deposits to consolidated assets less tangible capital.  It is too early to predict how new regulations in this area may affect our results of operations.

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

We are required by regulatory authorities to maintain adequate levels of capital to support our operations.  To support our continued growth, we may need to raise additional capital.  Our ability to raise additional capital, if needed, will depend in part on conditions in the capital markets at that time, which are outside our control.  Accordingly, we cannot assure you of our ability to raise additional capital, if needed, on terms acceptable to us.  If we cannot raise additional capital when needed, our ability to further expand our operations through internal growth and acquisitions could be materially impaired.  In addition, if we decide to raise additional equity capital, your interest could be diluted.

We may be adversely affected by the soundness of other financial institutions.

Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships.  We have exposure to many different industries and counterparties, and routinely execute transactions with counterparties in the financial services industry, including commercial banks, brokers and dealers, investment banks, and other institutional clients. Many of these transactions expose us to credit risk in the event of a default by a counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by the Bank cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the credit or derivative exposure due to the Bank. Any such losses could have a material adverse effect on our financial condition and results of operations.

22

Table of Contents

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

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

Given the geographic concentration of our operations, we could be significantly affected by any hurricane that affects coastal South Carolina.

Our operations are concentrated in and our loan portfolio consists almost entirely of loans to persons and businesses located in coastal South Carolina. The collateral for many of our loans consists of real and personal property located in this area, which is susceptible to hurricanes that can cause extensive damage to the general region. Disaster conditions resulting from any hurricane that hits in this area would adversely affect the local economies and real estate markets, which could negatively impact our business. Adverse economic conditions resulting from such a disaster could also negatively affect the ability of our customers to repay their loans and could reduce the value of the collateral securing these loans. Furthermore, damage resulting from any hurricane could also result in continued economic uncertainty that could negatively impact businesses in those areas. Consequently, our ability to continue to originate loans may be impaired by adverse changes in local and regional economic conditions in this area following any hurricane.

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

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

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

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

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

·                  the risk of loss of key employees and customers.

There is no public market for our shares, and we do not believe that we have enough shareholders or outstanding shares to support an active trading market, even if we are eventually listed on a recognized trading exchange.

There is currently no established market for our common stock, and we have no current plans to list our stock on NASDAQ, or any other exchange.  For these reasons, we do not expect a liquid market for our common stock to develop for several years, if at all.

23

Table of Contents

We are exposed to the possibility of technology failure.

We rely on our computer systems and the technology of outside service providers. Our daily operations depend on the operational effectiveness of their technology. We rely on our systems to accurately track and record our assets and liabilities. If our computer systems or outside technology sources become unreliable, fail, or experience a breach of security, our ability to maintain accurate financial records may be impaired, which could materially affect our business operations and financial condition.

Item 1B. Unresolved Staff Comments.

Not applicable.

Item 2. Properties.

We are located at 2305 Oak Street, Myrtle Beach, South Carolina 29577. This location, which serves as our executive headquarters, is also the Bank’s main office. The property is subject to a lease, which began on November 1, 2007, with a three-year term which may be extended at our option for up to four additional one-year terms.  The first lease extension was exercised in November 2010 and expires in October 2011.  Rent for the current term is $13,789 a month.  Total aggregate rent for the current term is $165,468.  Future minimum lease payments under this term are $137,891 in 2011. Monthly rent will increase during each remaining extension term as follows: 2nd extension term—$14,203; 3rd extension term—$14,629; and 4th extension term—$15,068. We are also required to pay all utilities and property taxes levied on the site and to keep the building insured. The building has two levels with a total of approximately 8,887 square feet and is set on approximately 1.29 acres of land. The building has two drive-thru teller lanes. The property is owned by Myrtle Beach Farms Company, Inc., a subsidiary of Burroughs & Chapin Company, Inc.  J. Egerton Burroughs, who is an organizer and director of the Company as well as a director of the Bank, is the Chairman of the Board of Burroughs & Chapin Company, Inc.

Item 3. Legal Proceedings.

In the ordinary course of operations, we may be a party to various legal proceedings from time to time. We do not believe that there is any pending or threatened proceeding against us, which, if determined adversely, would have a material effect on our business, results of operations, or financial condition.

Item 4. Removed and Reserved.

PART II

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

As of March 18, 2011, there were 2,191,500 shares of common stock outstanding held by approximately 272 shareholders of record. All of our currently issued and outstanding common stock, with the exception of 5,000 shares subsequently issued to certain employees as restricted stock grants described below, was issued on June 8, 2009, in connection with the closing of our initial public offering of common stock. The price per share in our initial public offering was $10.

The current total of issued restricted stock is 5,000 shares. In June 2009, we issued to certain employees of the Bank an aggregate of 5,000 shares of restricted common stock. In November 2009, we issued to an employee of the Bank 1,000 shares of restricted common stock.  With both issuances, the restricted stock contained a vesting period of the third anniversary of the date of the grant. We did not receive any cash proceeds from the issuance of such shares of restricted common stock. All of such shares were issued in reliance upon the exemption from registration provided by Section 4(2) of the Securities Act, as the shares were issued in transactions not involving any public offering or distribution. During 2010, one employee voluntarily terminated his employment and forfeited 1,000 shares of unvested restricted stock.

There is currently no established public trading market in our common stock, and we are not aware of any trading or quotations of our common stock. Because there has not been an established market for our common stock, we may not be aware of all prices at which our common stock has been traded. Based on information available to us from a limited number of sellers and purchasers of common stock who have engaged in privately negotiated transactions of which we are aware, stock trades in 2010 occurred at $10 per share.

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

24

Table of Contents

Typically, as a national bank, Coastal Carolina National Bank may only pay dividends out of its net profits, after deducting expenses, including losses and bad debts. Currently, the Bank is prohibited by its regulators, the OCC, from declaring a dividend on its shares of common stock until its surplus equals its stated capital, unless there has been transferred to surplus no less than one-tenth of the Bank’s net profits of the preceding two consecutive half-year periods (in the case of an annual dividend). The approval of the Office of the Comptroller of the Currency will be required if the total of all dividends declared in any calendar year by the bank exceeds the Bank’s net profits to date for that year combined with its retained net profits for the preceding two years less any required transfers to surplus. The Office of the Comptroller of the Currency also has the authority under federal law to enjoin a national bank from engaging in what in its opinion constitutes an unsafe or unsound practice in conducting its business, including the payment of a dividend under certain circumstances.

Item 6.  Selected Financial Data.

Not applicable because the Company is a smaller reporting company.

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

Introduction

The following is management’s discussion of our results of operations for 2010 and 2009 and includes an analysis of our financial condition as of December 31, 2010 and 2009.  Because the Bank opened in June 2009, comparisons to 2009 are not necessarily meaningful in all contexts because 2009 was only a partial year operation.

Throughout this Item, the terms “we”, “us, and “our” refer to the Company and the Bank on a consolidated basis.

Like most community bank holding companies, we derive most of our income from the earnings of the Bank.

A significant portion of our income is received from interest earned on our loans and investments. Our primary source of funds for making these loans and investments is our deposits.  A significant amount of our deposits result in interest expenses.  Consequently, one of the key measures of our success is our amount of net interest income, or the difference between the income on our interest-earning assets, such as loans and investments, and the expense on our interest-bearing liabilities, such as deposits.  Another key measure is the spread between the yield we earn on these interest-earning assets and the rate we pay on our interest-bearing liabilities.

We have included a number of tables to assist in our description of these measures.  For example, the “Average Balances” table shows the average balance in 2009 of each category of our assets and liabilities, as well as the yield we earned or the rate we paid with respect to each category.  A review of this table shows that our loans typically provide higher interest yields than do other types of interest earning assets, which is why we intend to channel a substantial percentage of our earning assets into our loan portfolio.  We also track the sensitivity of our various categories of assets and liabilities to changes in interest rates, and we have included an “Interest Sensitivity Analysis Table” to help explain this.  Finally, we have included a number of tables that provide detail about our investment securities, our loans, and our deposits.

We earn additional income through fees and other expenses we charge to our customers for services we provide. We incur additional expenses for necessary overhead and from the daily operations of the bank.  We describe the various components of this noninterest income, as well as our noninterest expense, in the “Noninterest Income” and “Noninterest Expense” sections.

Also affecting our net income are provisions made to the allowance for loan losses.  There are risks inherent in all loans, so we maintain an allowance for loan losses to absorb probable losses on existing loans that may become uncollectible. We establish and maintain this allowance by charging a provision for loan losses against our operating earnings. In the following section, we have included a detailed discussion of this process.

The following discussion and analysis identifies significant factors that have affected our financial position and operating results during the periods included in the accompanying consolidated financial statements.   Reference should be made to those statements and the financial data presented throughout this report for an understanding of the following discussion and analysis.

General

The Company is a corporation organized under the laws of the state of South Carolina to be a holding company for the Bank.  The Company’s inception was February 28, 2008.  The Company conducted an initial stock offering and raised $21.8 million

25

Table of Contents

selling 2,180,000 shares of its common stock at $10 per share.  Upon receipt of all final regulatory approvals, the Company capitalized the Bank through the purchase of 1,994,000 shares at $10 per share, or $19.94 million, on June 5, 2009, and Coastal Carolina National Bank, the holding company subsidiary, opened for business on June 8, 2009.

Critical Accounting Policies

We have adopted various accounting policies, which govern the application of accounting principles generally accepted in the United States of America in the preparation of our financial statements. Our significant accounting policies are described in the notes to our audited financial statements included in this report. Additionally, recent accounting pronouncements that may or may not materially affect our accounting, reporting, and disclosure of financial information in the future are also described in the notes to our audited financial statements.

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

Allowance for Loan Losses. We believe that the determination of the allowance for loan losses is the critical accounting policy that requires the most significant judgments and estimates used in preparation of our financial statements. Refer to Note 1 in the Notes to the Consolidated Financial Statements, under the section “Allowance For Loan Losses”, for a more detailed description of the methodology related to the allowance for loan losses.

Estimates of Fair Value.  The estimate of fair value is significant to a number of the Company’s assets, including, but not limited to, investment securities and impaired loans.  Investment securities are recorded in the financial statements at fair value while impaired loans are recorded at either cost or fair value, whichever is lower.

Fair values for investment securities are based on quoted market prices, and if not available, quoted prices on similar instruments.  The fair values of impaired loans are often determined based on the value of the collateral.  Third-party appraisals of the property and alternative data, such as market listing prices, may be used.  The estimation of fair value and subsequent changes of fair value can have a significant impact on the value of the Company, as well as have an impact on the recorded values and subsequently reported net income.  Refer to Note 17, Fair Value, in the Notes to the Consolidated Financial Statements, for more information regarding fair values.

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

Results of Operations

General

We incurred a net loss of $2 million for the year ended December 31, 2010, compared to $2.6 million for the year ended December 31, 2009.  The bank opened in June 2009 and, therefore, did not experience a full year of operating expenses.  Of the $2.6 million loss in 2009, $770,450 in expenses were incurred prior to opening the Bank and the remaining $1.8 million of net losses were incurred after the opening of the Bank.  Basic loss per share in 2010 was $.92, compared to basic loss per share of $2.11 for the year ended December 31, 2009.

26

Table of Contents

Net Interest Income

Net interest income before the provision for loan losses in 2010 was $1,276,055, an increase of $1,079,912 when compared to net interest income before the provision for loan losses of $196,143 in 2009.  The increase is attributed to growth in the loan portfolio with yields higher than the cost of the deposits, which also increased.  Additionally, the bank was only open for 7 months in 2009 compared to a full 12 months in 2010.  Total interest income for the year 2010 was $2,159,316 compared to $612,934 in 2009, and was offset by total interest expense of $883,261 in 2010 and $416,791 in 2009. The components of interest income in 2010 were $971,602 from loans, $812,475 from investment securities, and $375,239 from federal funds sold and other interest-bearing bank deposits, compared to $171,862, $150,285, and $212,541, respectively, in 2009.  During 2010, interest expense was composed almost entirely of interest expense on deposits totaling $883,173, with a small amount of $88 related to interest expense on borrowings.  Comparatively, during 2009, interest expense totaled $416,791 of which $374,449 was related to deposits and $42,342 was related to borrowings.

The net interest spread is the difference between the yield we earn on our interest-earning assets and the rate we pay on our interest-bearing liabilities. The net interest margin is calculated as net interest income divided by average earning assets. Our net interest spread and net interest margin in 2010 were 1.61% and 2.04%, respectively, compared to (0.43%) and 0.66%, respectively, in 2009.  Improvements in both ratios were the result of increased growth in the loan portfolio earning higher rates than the cost of the deposits, which also grew in 2010.  Additionally, in 2009 higher rates were paid initially upon the Bank’s opening to attract deposits and new customers. Also impacting the net interest spread and net interest margin is the challenging economic environment that has made it difficult to find lending relationships that meet our credit standards. As a result, we have an unusually large proportion of our earning assets invested in lower yielding assets.  Additionally, as a result of the challenging economic environment, both loan rates and deposit rates have declined significantly in 2010.  The Bank’s loan yields decreased 17 basis points in 2010.  However, the impact of decreased rates has been more significant in the deposit portfolio.  The cost of funding, including deposits, decreased 64 basis points in 2010, and overall the Bank’s performance in net interest spread and net interest margin has improved.

Average Balances, Income and Expenses, and Rates. The following table sets forth, for 2010 and 2009, certain information related to our average balance sheet and our average yields on earning assets and average costs of interest-bearing liabilities. Such yields are derived by dividing income or expense by the average balance of the corresponding assets or liabilities. In 2009, the average balances were derived from the daily balances from June 8, 2009 to December 31, 2009, and month end

27

Table of Contents

balances prior to such date.

Nonaccrual loans and the interest income which was recorded on these loans, if any, are included in the yield calculation for loans in 2010.  There were no loans in nonaccrual status in 2009 and two loans in nonaccrual status totaling $137,277 as of December 31, 2010.  Loan and late fees totaled $19,948 and $3,861 for the years ended December 31, 2010 and 2009, respectively, and are included with interest income on loans.

Rate/Volume Analysis

Net interest income can be analyzed in terms of the impact of changing interest rates and changing volume. The following table shows the relative impact on net interest income of changes in the average outstanding balances (volume) of earning assets and interest bearing liabilities and the rates earned and paid by us on such assets and liabilities for the year ended December 31, 2010.  Due to 2009 being the first year of banking operations, all interest and expense is attributed to the volume of interest earning assets during 2009.

28

Table of Contents

Interest Sensitivity. We monitor and manage the pricing and maturity of our assets and liabilities in order to diminish the potential adverse impact that changes in interest rates could have on our net interest income. One of the monitoring techniques employed by us is the measurement of our interest sensitivity “gap”, which is the positive or negative dollar difference between assets and liabilities that are subject to interest rate repricing within a given period of time. A company is considered “asset sensitive” when a larger amount of its earning assets will reprice than its interest-bearing liabilities.  A company is considered “liability sensitive” when a larger amount of its interest bearing liabilities will reprice than its earning assets.  We generally would benefit from increasing market rates of interest when we are in an asset-sensitive gap position and generally would benefit from decreasing market rates of interest when we are liability-sensitive.

Interest rate sensitivity can be managed by repricing assets or liabilities, replacing an asset or liability at maturity, adjusting the interest rate during the life of an asset or liability, or changing the mix of the assets and liabilities on the balance sheet. Managing the amount of assets and liabilities repricing in the same time interval is performed in order to hedge the risk and minimize the impact on net interest income of rising or falling interest rates.

29

Table of Contents

The following table sets forth our interest-rate sensitivity at December 31, 2010.

(1)          Securities are reported at their amortized cost.

The above table reflects the balances of interest-earning assets and interest-bearing liabilities at the earlier of their repricing or maturity dates. Overnight federal funds are reflected at the earliest pricing interval due to the immediately available nature of the instruments. Debt securities are reflected at each instrument’s ultimate maturity date. Scheduled payment amounts of fixed rate amortizing loans are reflected at each scheduled payment date.

Scheduled payment amounts of variable rate amortizing loans are reflected at each scheduled payment date until the loan may be repriced contractually; the unamortized balance is reflected at that point. Interest-bearing liabilities with no contractual maturity, such as savings deposits and interest-bearing transaction accounts, are reflected in the earliest repricing period due to contractual arrangements which give us the opportunity to vary the rates paid on those deposits within a thirty-day or shorter period. Fixed rate certificates of deposit are reflected at their contractual maturity date.

We are cumulatively asset sensitive, although we are temporarily liability sensitive in periods less than 12 months.

However, our gap analysis is not a precise indicator of its interest sensitivity position. The analysis presents only a static view of the timing of maturities and repricing opportunities, without taking into consideration future changes in the volume and mix of earning assets and interest-bearing liabilities.  Additionally, the model does not reflect that changes in interest rates do not affect all assets and liabilities equally.

Provision for Loan Losses

We have established an allowance for loan losses through a provision for loan losses charged as a non-cash expense to our consolidated statement of operations. We review our loan portfolio periodically to evaluate our outstanding loans and to measure both the performance of the portfolio and the adequacy of the allowance for loan losses.

Our provision for loan losses was $485,702 in 2010 and $144,845 for 2009.  The increased expense is directly related to the increase growth in the loan portfolio in 2010.  Management continues to review and evaluate the adequacy of the reserve for possible loan losses given the size, mix, and quality of the current loan portfolio. Please see the discussion below under “Provision and Allowance for Loan Losses” for a description of the factors we consider in determining the amount of the provision we expense each period to maintain this allowance.

30

Table of Contents

Noninterest Income

Noninterest income totaled $416,026 in 2010 compared to $28,685 in 2009.  The most significant component of noninterest income in 2010 and the primary reason for the increase compared to 2009 was the recognition of $364,278 in net gains on the sale of investment securities.  In 2009, the net gains on sale of securities was $11,058. Additionally in 2010, we recognized gains on the sale of mortgage loans in the secondary market of $27,525, compared to $1,256 in 2009.  Noninterest income also includes service charge and fee income for services offered by the bank.  In 2010, all other non-interest income, including service charges, totaled $24,223, compared to $16,371 in 2009.  Non-interest income in 2009 included $12,500 recognized in connection with the receipt of a leasehold improvements allowance.

Noninterest Expense

Noninterest expense totaled $3,217,168 in 2010, compared to $2,678,988 in 2009. Included in noninterest expense in 2009 was $818,833 related to pre-opening and organizational costs incurred prior to the Bank’s opening on June 8, 2009.  Salaries and employee benefits comprise the largest component of noninterest expense which totaled $1.9 million in 2010 and $1.6 million in 2009.  Included in salaries and employee benefits expense was $16,488 related to the 2009 issuance of warrants to organizers and directors of the company, and $72,797 related to the 2009 issuance of stock options and restricted stock to employees. In 2009, these expenses were $157,432 and $71,130 respectively.  The following additional noninterest expense components were the next most significant expenses experienced in 2010:  occupancy and equipment expenses were $399,294, data processing/IT/telecommunication related expenses were $310,936, and professional services expenses, including auditors and legal counsel, were $232,885.  These same expenses in 2009 were $394,311 for occupancy and equipment expense, $172,133 for data processing/IT/telecommunications expense, and $216,905 for professional services.  FDIC and regulatory expense assessments increased from $39,203 in 2009 to $118,631 in 2010.  FDIC and regulatory assessments have been based on deposit size and this expense is expected to increase as the Company grows.

Income Taxes

Due to our history of net losses, the bank has not recognized any tax expenses.  Additionally, until we become profitable, we will not recognize any tax income.  For further discussion regarding our tax position, please refer to Note 1 to the Consolidated Financial Statements.

Balance Sheet Review

General

As of December 31, 2010, we had total assets of $71.9 million compared to $61.2 million as of December 31, 2009.  The major asset categories were $18.6 million in cash and bank deposits, $28.7 million in available-for-sale securities, and $22.8 million in net loans.  Compared to 2009, we have significantly reduced our cash and deposit position and reinvested our dollars into higher yielding loans and available for sale securities.  Total liabilities as of December 31, 2010 were $57.1 million and were comprised primarily by retail customer deposits totaling $56.7 million.  As of December 31, 2009 total liabilities were $44.2 million, with total deposits of $44 million. Shareholders’ equity was $14.8 million, or 20.6 % of assets, as of December 31, 2010, compared to $16.9 million, or 27.6% of assets, as of December 31, 2009. Book value per share was $6.76 at December 31, 2010, compared to $7.75 at December 31, 2009.

Cash and Due From Other Banks

Generally the Bank maintains only enough cash and deposits necessary to meet the needs of our day to day operations.  Any excess funds are invested in higher yielding investment securities and loans.  Occasionally, excess funds may be deposited in interest bearing bank deposits.  As of December 31, 2010, the Company had $4.3 million in cash and deposits for operational needs, including $1.6 million in overnight funds sold and $2.2 million at the Federal Reserve.  Additionally, the Company had $14.3 million in other interest-bearing bank deposits, including $9.1 million in time deposits.

During 2010, we invested our excess cash and funds into investments and loans, effectively decreasing our cash and due from other banks total from $32.3 million as of December 31, 2009 to $18.6 million as of December 31, 2010.

31

Table of Contents

Loans

Since loans typically provide higher interest yields than other types of interest-earning assets, a substantial percentage of our earning assets are invested in our loan portfolio. Total net loans at December 31, 2010 were $22.8 million, compared to $10.4 million as of December 31, 2009.  Net loans outstanding were 31.71% of our total assets as of December 31, 2010, compared to 17.07% as of December 31, 2009.  Growth levels experienced in the first three years of a bank organization are high and our growth in the loan portfolio is consistent with our status as a new bank.

The principal component of our loan portfolio is loans secured by real estate. Most of our real estate loans are secured by residential or commercial property.  Additionally, construction loans, commercial and industrial loans, and consumer loans round out the rest of the portfolio.  Generally, fixed-rate mortgages are sold to investors with no servicing responsibilities retained and therefore are not reflected in the loan portfolio balances, whereas the Bank generally retains the adjustable-rate loans in its portfolio. We obtain a security interest in real estate whenever possible, in addition to any other available collateral. This collateral is taken to increase the likelihood of the ultimate repayment of the loan.

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

The largest component of our loan portfolio at December 31, 2010 was loans that had real estate as a primary or secondary component of collateral, which represented 93.9% of the gross loan portfolio before the allowance for loan losses.  Within this category, 1-4 family residential mortgages represent 24.17% of the gross loan portfolio, while commercial and other real estate loans represent 46.01% of the gross loan portfolio.  Also of significance are the Construction and Land Development loans, which represent 23.72% of the gross loan portfolio as of December 31, 2010.

Additionally, the Bank has made contractual commitments to extend credit in the future.  These commitments are not reflective in the financial statements until they are disbursed.  At December 31, 2010, the Bank had unfunded commitments of $4.3 million, compared to $660,743 at December 31, 2009.

Maturities and Sensitivity of Loans to Changes in Interest Rates

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

32

Table of Contents

The following table summarizes the loan maturity distribution by type and related interest rate characteristics at December 31, 2010.

Provision and Allowance for Loan Losses

We have established an allowance for loan losses through a provision for loan losses charged to expense on our consolidated statement of operations. The allowance for loan losses was $432,750 as of December 31, 2010 or 1.86% of gross loans outstanding, compared to $144,845 as of December 31, 2009 or 1.36% of gross loans outstanding. Total provision expense for the year ended December 31, 2010 was $485,702, compared to $144,845 for the year ended December 31, 2009.  The increase in provision during 2010 was primarily due to growth in the loan portfolio.

The allowance for loan losses represents an amount which we believe will be adequate to absorb probable losses on existing loans that may become uncollectible. Additions to the allowance are often the result of growth in the loan portfolio.  Additionally, our judgment as to the adequacy of the allowance for loan losses is based on an ongoing review of the quality, mix, and size of our overall loan portfolio.  We make a number of assumptions regarding current portfolio and economic conditions.  We consider our historical loan loss experience, the loan loss experience of our peers, and any specific problem loans and commitments that may affect the borrower’s ability to pay.   We believe the assumptions we have made to be reasonable, but which may or may not prove to be accurate.

Periodically, we will adjust the amount of the allowance based on changing circumstances. We will charge recognized losses to the allowance and add subsequent recoveries back to the allowance for loan losses. There can be no assurance that charge-offs of loans in future periods will not exceed the allowance for loan losses as estimated at any point in time or that provisions for loan losses will not be significant to a particular accounting period.

Management considers the allowance for loan losses as of December 31, 2010 to be adequate and sufficient.

Credit Quality and Non-Performing Assets

One of the adverse indicators used in monitoring the credit quality of a loan is the past due status of the loan payments.  As of December 31, 2010, we had loans past due totaling $253,714.

Generally, a loan will be placed on nonaccrual status when it becomes 90 days past due as to principal or interest, or when management believes, after considering economic and business conditions and collection efforts, that the borrower’s financial condition is such that collection of the loan is doubtful. When a loan is placed on non-accrual, all previously accrued interest that has not been received is reversed against current income.  The recognition of interest on a non-accrual loan is placed on a cash basis and can be recognized when and if a payment is received.  Generally, payments received on non-accrual loans are applied directly to principal.  At December 31, 2010, we had two real estate loans totaling $137,277 in non-accrual status.  At December 31, 2009, we did not have any loans in non-accrual status.

33

Table of Contents

Loans are assigned a credit quality “grade” upon their origination.  The credit quality grade is determined by the Chief Credit Officer during his review of the loan, prior to its approval.  Loans are monitored for non-performance and may be downgraded to reflect adverse conditions that might affect collectability.  Heightened risk characteristics include a history of poor payment performance, poor financial performance, as well as the potential for adverse earnings impact from deteriorating collateral values.  The individual loan officers are responsible for assessing the risk of each loan in their respective portfolios.  In addition, our Chief Credit Officer coordinates the periodic assessment of credits.  Generally, any loans classified as Substandard, Doubtful, and Loss represent our non-performing loans and include loans past due and loans on nonaccrual.  We had $651,956 in loans classified as Substandard or worse as of December 31, 2010.

Generally, non-performing loans are reviewed for their collectability.  If it is determined that any part of the principal of the loan may not be collectible through payments from the customer or liquidation of the loan collateral, the loan is considered impaired and the bank will charge off the uncollectible amount.  In 2010, we recognized one partial charge off, totaling $197,797.  This amount represents 1.23% of average loans outstanding in 2010.  Impaired loans and non-performing loans can require higher loan loss reserves.

As of December 31, 2010, we had individually evaluated eight loans for impairment totaling $2,534,734.  Reserves for these eight loans totaled $171,300, or 6.76% of their outstanding balances.

If a loan is modified as a result of a customer’s inability to meet the original terms, and if the modification gives the customer more favorable terms that would not otherwise be granted, the loan is considered to be a troubled debt restructuring.  As of December 31, 2010, we had one loan restructured totaling $37,277.

As of December 31, 2010, management was not aware of any additional loans with possible credit problems of borrowers that would cause management to have serious doubts as to the ability of such borrowers to comply with the present loan repayment terms, and which may result in disclosure of such loans as nonaccrual, past due, or impaired in future periods.

Investments

At December 31, 2010, the fair value of our investment portfolio totaled $28.7 million and represented 39.93% of our total assets. Our investments are diversified among government agency backed mortgage-backed securities, GNMA collateralized mortgage obligations (CMOs), and a limited number of municipal bonds.  The agencies backing the mortgage backed securities include the Government National Mortgage Association (GNMA), the Federal National Mortgage Association (FNMA), the Federal Home Loan Mortgage Company (FHLMC), and the Federal Home Loan Bank (FHLB).

The amortized cost and fair value of our securities as of December 31, 2010 and 2009 are detailed in the following table.

All of our investment securities are classified as “available-for-sale”. Our investment portfolio is managed with consideration given to multiple factors, including, but not limited to, diversification, yield, duration, prepayment risk, and interest rate risk.  Contractual maturities and yields on our investment securities available for sale at December 31, 2010 are shown in the following table. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.  In 2010, consistent with the bank’s growth, the size of the investment portfolio was increased.  The investment portfolio is used to maximize the earnings potential of our cash.

34

Table of Contents

At December 31, 2010 and 2009, the Bank also had restricted equity securities that consisted of stock in the Federal Reserve Bank of Richmond totaling $456,300 and $525,250, respectively.  This stock is required as part of our membership with the Federal Reserve and is not classified as available for sale.  The amount of the stock ownership required is based on the Bank’s equity position and is subject to change quarterly upon notification by the Federal Reserve.  In 2010, this stock paid a quarterly dividend equal to 6%.

Deposits and Other Interest-Bearing Liabilities

Our primary source of funds for loans and investments is our deposits. Our total deposits as of December 31, 2010 were $56.7 million, compared to $44 million at December 31, 2009.  The following table shows the average balance outstanding for each deposit type and the average rates paid on deposits held by us during the years ended December 31, 2010 and 2009.