SOUTHCOAST FINANCIAL CORP - FORM 10-Q

Attached files

file	filename
EX-32 - SOUTHCOAST FINANCIAL CORP	sthcst10q1-11ex32.htm
EX-31.2 - SOUTHCOAST FINANCIAL CORP	sthcst10q1-11ex31_2.htm
EX-31.1 - SOUTHCOAST FINANCIAL CORP	sthcst10q1-11ex31_1.htm

U.S. SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

For the Quarterly Period Ended March 31, 2011

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

For the Transition Period from _________to_________

Commission File No.

0-25933

SOUTHCOAST FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

South Carolina		57-1079460
(State or other jurisdiction		(I.R.S. Employer
of incorporation or organization)		Identification No.)

530 Johnnie Dodds Boulevard

Mt. Pleasant, South Carolina 29464

(Address of principal executive offices)

843-884-0504

(Registrant's telephone number, including area code)

________________________________________________

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

YES X] NO [ ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [ ] No [ ] (Not yet applicable to Registrant)

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

Large accelerated filer [ ]		Accelerated filer [ ]
Non-accelerated filer [ ] (Do not check if a smaller reporting company)		Smaller reporting company [ X ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

YES [ ] NO [ X ]

State the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date.

4,800,769 shares of common stock, no par value, as of April 30, 2011

SOUTHCOAST FINANCIAL CORPORATION

INDEX

PART I - FINANCIAL INFORMATION	Page No.

Item 1. Financial Statements (Unaudited)

Condensed Consolidated Balance Sheets – March 31, 2011 and December 31, 2010	2

Condensed Consolidated Statements of Income – Three months ended March 31, 2011 and 2010	3

Condensed Consolidated Statements Changes in Shareholders' Equity and Comprehensive Income (Loss) - Three months ended March 31, 2011 and 2010	4

Condensed Consolidated Statements of Cash Flows - Three months ended March 31, 2011 and 2010	6

Notes to Condensed Consolidated Financial Statements	6-12

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations	13-23

Item 3. Quantitative and Qualitative Disclosures About Market Risk	24

Item 4. Controls and Procedures	24

PART II - OTHER INFORMATION

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	25

Item 6. Exhibits	25

Signatures	25

Exhibit Index	26

SOUTHCOAST FINANCIAL CORPORATION

Condensed Consolidated Balance Sheets

PART I - FINANCIAL INFORMATION

Item 1 - Financial Statements
	March 31,			December 31,
	2011			2010
	(Unaudited)
Assets
Cash and cash equivalents:
Cash and due from banks	$	26,666,714		$	20,061,687
Federal funds sold		2,822,789			-
Total cash and cash equivalents		29,489,503			20,061,687
Investment securities
Available for sale		64,826,117			72,306,006
Federal Home Loan Bank Stock, at cost		4,105,700			4,105,700
Loans held for sale		-			417,000
Loans, net of allowance of $8,813,927 and $9,512,831		322,032,918			326,935,892
Premises and equipment, net		22,205,696			22,447,556
Other real estate owned		9,544,587			8,923,211
Company owned life insurance		11,618,288			11,519,785
Other assets		11,123,943			11,609,432
Total assets	$	474,946,752		$	478,326,269

Liabilities
Deposits
Noninterest-bearing	$	29,037,746		$	28,855,563
Interest-bearing		322,955,722			315,746,759
Total deposits		351,993,468			344,602,322
Securities sold under agreements to repurchase		6,579,661			3,963,399
Federal Home Loan Bank Borrowings		57,000,000			69,000,000
Junior subordinated debentures		10,310,000			10,310,000
Other liabilities		3,082,321			4,672,532
Total liabilities		428,965,450			432,548,253
Shareholders’ Equity
Common stock (no par value; 20,000,000 shares authorized;
4,790,957 shares outstanding at March 31, 2011 and
4,780,822 at December 31, 2010)		54,288,980			54,257,867
Accumulated deficit		(6,619,380	)		(6,039,977	)
Accumulated other comprehensive loss		(1,688,298	)		(2,439,874	)
Total shareholders’ equity		45,981,302			45,778,016
Total liabilities and shareholders’ equity	$	474,946,752		$	478,326,269

See Notes to Condensed Consolidated Financial Statements

SOUTHCOAST FINANCIAL CORPORATION

Condensed Consolidated Statements of Income

(Unaudited)

	For the Three Months Ended
	March 31,
	2011			2010
Interest income
Loans, including fees	$	4,490,880		$	4,774,123
Taxable securities		389,173			608,225
Tax exempt securities		122,853			79,287
Cash and federal funds sold		6,947			13,719
Total interest income		5,009,853			5,475,354
Interest expense
Deposits and borrowings		1,776,687			2,593,452
Net interest income		3,233,166			2,881,902
Provision for loan losses		1,150,000			1,000,000
Net interest income after provision for loan losses		2,083,166			1,881,902
Noninterest income
Service fees on deposit accounts		334,226			258,187
Gain on sale of available for sale securities		21,450			835,412
Company owned life insurance earnings		98,503			106,986
Other-than-temporary impairment on available for sale securities		(175,920	)		-
Other		63,923			56,565
Total noninterest income		342,182			1,257,150
Noninterest expenses
Salaries and employment benefits		1,699,479			1,663,654
Occupancy		291,611			394,996
Furniture and equipment		364,890			372,227
Software		86,907			97,449
Insurance		270,022			196,584
Professional fees		257,637			185,740
Telephone, postage, and supplies		87,171			90,766
Gain on sale of other real estate owned		(2,327	)		(562,300	)
Other real estate owned rental income, impairment provision, and other expenses		119,704			(49,433	)
Other operating expenses		253,451			229,685
Total noninterest expenses		3,428,545			2,619,368
Income (loss) before income taxes		(1,003,197	)		519,684
Income tax expense (benefit)		(423,794	)		156,774
Net income (loss)	$	(579,403	)	$	362,910
Basic net income (loss) per common share	$	(.12	)	$	.08
Diluted net income per common share	$	(.12	)	$	.08
Weighted average shares outstanding
Basic		4,790,957			4,550,015
Diluted		4,790,957			4,550,015

See Notes to Condensed Consolidated Financial Statements

SOUTHCOAST FINANCIAL CORPORATION

Condensed Consolidated Statement of Changes in Shareholders' Equity and Comprehensive Income

For the three months ended March 31, 2011 and 2010

(Unaudited)

	Common Stock				Accumulated			Accumulated other comprehensive income
	Shares		Amount		deficit			(loss)			Total
Balance, December 31, 2009		4,542,023	$	53,583,283	$	(6,108,846	)	$	(2,393,645	)	$	45,080,792

Net income for the period						362,910						362,910

Other comprehensive income
Unrealized holding gains
on securities available for sale
net of taxes of $610,271									1,084,926			1,084,926

Less reclassification adjustment for
gains included in net income, net of
taxes of $300,748									(534,664	)		(534,664	)

Comprehensive income												913,172

Employee stock purchase plan		7,992		27,493		-			. -			27,493

Balance, March 31, 2010		4,550,015	$	53,610,776	$	(5,745,936	)	$	(1,843,383	)	$	46,021,457

Balance, December 31, 2010		4,780,822	$	54,257,867	$	(6,039,977	)	$	(2,439,874	)	$	45,778,016

Net loss for the period						(579,403	)					(579,403	)

Other comprehensive income
Unrealized holding gains on securities available for sale
net of taxes of $430,484									765,304			765,304

Less reclassification adjustment for
gains included in net income, net of
taxes of $7,722									(13,728	)		(13,728	)

Comprehensive income												172,173


Employee stock purchase plan		10,135		31,113		. -			. - .			31,113

Balance, March 31, 2011		4,790,957	$	54,288,980	$	(6,619,380	)	$	(1,688,298	)	$	45,981,302

See Notes to Condensed Consolidated Financial Statements

SOUTHCOAST FINANCIAL CORPORATION

Condensed Consolidated Statements of Cash Flows

(Unaudited)

	For the three months ended
	March 31,
	2011			2010
Operating activities
Net income (loss)	$	(579,403	)	$	362,910
Adjustments to reconcile net income (loss) to net
cash provided by (used for) operating activities
(Increase) decrease in deferred income taxes		(386,417	)		418,933
Provision for loan losses		1,150,000			1,000,000
Depreciation and amortization		252,723			272,172
Discount accretion and premium amortization		113,892			101,067
Gain on sale of securities		(21,450	)		(835,412	)
Other-than-temporary impairment on available for sale securities		175,920			-
Gain on sale of other real estate owned		(2,327	)		(562,300	)
Deferred gain on sale of other real estate owned		(48,237	)		-
Impairment charges on other real estate owned		13,213			-
Originations of loans held for sale		(1,423,575	)		(4,328,878	)
Proceeds from sales of loans held for sale		1,840,575			4,198,957
Increase in value of Company owned life insurance		(98,503	)		(106,986	)
Decrease in other assets		395,568			231,071
Decrease in other liabilities		(1,590,211	)		(2,727,996	)

Net cash used for operating activities		(208,232	)		(1,976,462	)

Investing activities
Purchases of investment securities available-for-sale		-			(55,725,990	)
Sales, calls, and maturities of investment securities available-for-sale		8,439,441			37,543,797
Increase in net proceeds receivable from investment transactions		-			(5,833,657	)
Purchases of premises and equipment		(10,863	)		(802,526	)
Proceeds from sales of other real estate owned		530,535			1,857,887
Proceeds from liquidation of Company owned life insurance		-			8,129,967
Capital expenditures related to other real estate owned		(28,870	)		-
Net decrease in loans		2,667,284			9,327,738

Net cash provided by (used for) investing activities		11,597,527			(5,502,784	)

Financing activities
Decrease in borrowings		(9,383,738	)		(5,202,406	)
Net proceeds from issuances of stock		31,113			27,943
Net increase (decrease) in deposits		7,391,146			(10,383,735	)

Net cash used for financing activities		(1,961,479	)		(15,558,648	)

Increase (decrease) in cash and cash equivalents		9,427,816			(23,037,894	)

Cash and cash equivalents, beginning of period		20,061,687			40,898,730

Cash and cash equivalents, end of period	$	29,489,503		$	17,860,836

Cash paid during the year for:
Income taxes	$	-		$	28,367
Interest	$	1,633,489		$	2,218,333

See Notes to Condensed Consolidated Financial Statements

SOUTHCOAST FINANCIAL CORPORATION

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 1 - Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Regulation S-X of the Securities and Exchange Commission. Accordingly they do not include all information and notes required by generally accepted accounting principles for complete financial statements. However, in the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included.

Note 2 - Organization

Southcoast Financial Corporation (the “Company”) is a South Carolina corporation organized in 1999 for the purpose of being a holding company for Southcoast Community Bank (the “Bank”). On April 29, 1999, pursuant to a Plan of Exchange approved by the shareholders, all of the outstanding shares of capital stock of the Bank were exchanged for shares of common stock of the Company. The Company presently engages in no business other than that of owning the Bank and another subsidiary, Southcoast Investment Corporation, and has no employees.

Note 3 - Net Income Per Share

The Company calculates earnings per share in accordance with generally accepted accounting principles, which specify the computation, presentation, and disclosure requirements for earnings per share (“EPS”) for entities with publicly held common stock or potential common stock such as options, warrants, convertible securities, or contingent stock agreements if those securities trade in a public market.

They also specify the computation and presentation requirements for both basic EPS and diluted EPS for entities with complex capital structures. Basic EPS is computed by dividing net income or loss by the weighted average common shares outstanding. The computation for diluted EPS is similar to the computation for basic EPS except that the denominator is increased to include the number of additional common shares that would have been outstanding if the dilutive potential common shares had been issued. The dilutive effect of options outstanding is reflected in diluted EPS by application of the treasury stock method. The Company had no dilutive or antidilutive instruments outstanding during the periods ended March 31, 2011 or 2010.

Note 4 – Recently Issued Accounting Standards

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

In July 2010, the FASB issued ASU 2010-20, “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.” ASU 2010-20 requires disclosure of additional information to assist financial statement users in assessing an entity’s credit risk exposures and evaluating the adequacy of the allowance for credit losses. Specifically, ASU 2010-20 requires entities to provide disclosures on a disaggregated basis, consisting of portfolio segment and class of financing receivable. A portfolio segment is defined by ASU 2010-20 as the level at which an entity develops and documents a systematic method for determining its allowance for credit losses. Classes of financing receivables generally are a disaggregation of portfolio segments. ASU 2010-20 amends existing disclosures to require an entity to provide, on a disaggregated basis, (i) a rollforward schedule of the allowance for credit losses from the beginning to the end of the reporting period, with the ending balance further disaggregated on the basis of impairment method, (ii) the recorded investment in financing receivables for each disaggregated ending balance, (iii) the nonaccrual status of financing receivables by class, and (iv) impaired financing receivables by class. Additionally, ASU 2010-20 required additional disclosures, including (i) credit quality indicators of financing receivables by class, (ii) aging of past due financing receivables by class, (iii) nature and extent of troubled debt restructurings (“TDRs”) by class and their effect on the allowance for credit losses, (iv) nature and extent of financing receivables by class modified as TDRs within the previous 12 months that defaulted during the reporting period and their effect on the allowance, and (v) significant purchases and sales of financing receivables during the reporting period disaggregated by portfolio segment. Disclosures pertaining to end of period balances were required for interim and annual reporting periods ending after December 15, 2010 (i.e. beginning December 31, 2010 for calendar year companies). Disclosures pertaining to activity that occurs during the reporting period are required for interim and annual reporting periods beginning on or after December 15, 2010. ASU 2010-20 did not have a material impact on the Company’s financial position, results of operations or liquidity, but did require expansion of its disclosures about credit quality and the allowance for loan and lease losses.

SOUTHCOAST FINANCIAL CORPORATION

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 4 - Recently Issued Accounting Standards- (continued)

In April 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2011-02, “A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring.” The provisions of ASU No. 2011-02 amend and clarify GAAP related to the accounting for debt restructurings. Specifically, ASU No. 2011-02 requires that, when evaluating whether a restructuring constitutes a troubled debt restructuring, a creditor must separately conclude that both (i) the restructuring constitutes a concession and (ii) the debtor is experiencing financial difficulties. In evaluating whether a concession has been granted, a creditor must evaluate whether (i) a debtor has access to funds at a market rate for debt with similar risk characteristics as the restructured debt in order to determine if the restructuring would be considered to be at a below-market rate, indicating that the creditor has granted a concession, (ii) a temporary or permanent increase in the contractual interest rate as a result of a restructuring may be considered a concession because the new contractual interest rate on the restructured debt is still below the market interest rate for new debt with similar risk characteristics, and (iii) a restructuring that results in a delay in payment is either significant and is a concession or is insignificant and is not a concession. In evaluating whether a debtor is experiencing financial difficulties, a creditor may conclude that a debtor is experiencing financial difficulties, even though the debtor is not currently in payment default. A creditor should evaluate whether it is probable that the debtor would be in payment default on any of its debt in the foreseeable future without a modification of the debt. The provisions of ASU No. 2011-02 are effective for the first interim or annual period beginning on or after June 15, 2011 and should be applied retroactively to the beginning of the annual period of adoption assuming the credit was restructured prior to the implementation date. The Company does not believe the new guidance materially differs from its existing methodology for identifying troubled debt restructurings and therefore does not expect the new guidance to have a significant impact on its financial statements.

SOUTHCOAST FINANCIAL CORPORATION

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 5 – Investment Securities

The amortized cost and fair value of investment securities are as follows:

	March 31, 2011
	Amortized		Gross Unrealized				Estimated
	Cost		Gains		Losses		Fair value
Available for sale
Mortgage backed
Government sponsored enterprises	$	49,066,094	$	226,265	$	697,726	$	48,594,633
Other		1,790,580		39,285		-		1,829,865
Municipal securities		12,273,698		210,317		77,290		12,406,725
Other		4,485,665		. -		2,490,771		1,994,894
Total	$	67,616,037	$	475,867	$	3,265,787	$	64,826,117

	December 31, 2010
	Amortized		Gross Unrealized				Estimated
Available for sale	Cost		Gains		Losses		Fair value
Mortgage backed
Government sponsored enterprises	$	57,531,723	$	137,206	$	985,935	$	56,682,994
Other		1,875,479		4,992		-		1,880,471
Municipal securities		12,257,174		90,523		259,908		12,087,789
Other		4,659,464		- .		3,004,712		1,654,752
Total	$	76,323,840	$	232,721	$	4,250,555	$	72,306,006

The following tables show gross unrealized losses and fair value, aggregated by investment category, and length of time that individual securities have been in a continuous unrealized loss position, at March 31, 2011 and December 31, 2010.

Available for Sale

	March 31, 2011
	Less than				Twelve months
	twelve months				or more				Total
			Unrealized				Unrealized				Unrealized
	Fair value		losses		Fair value		losses		Fair value		losses
Mortgage backed	$	32,187,932	$	697,726	$	-	$	-	$	32,187,932	$	697,726
Municipal securities		2,182,201		46,746		471,466		30,544		2,653,667		77,290
Other		-		-		1,034,893		2,490,771		1,034,893		2,490,771
	$	34,370,133	$	744,472	$	1,506,359	$	2,521,315	$	35,876,492	$	3,265,787
Total

	December 31, 2010
	Less than				Twelve months
	twelve months				or more				Total
			Unrealized				Unrealized				Unrealized
	Fair value		losses		Fair value		losses		Fair value		losses
Mortgage backed	$	38,868,650	$	904,061	$	1,056,758	$	81,874	$	39,925,408	$	985,935
Municipal securities		6,782,898		210,605		446,500		49,303		7,229,398		259,908
Other		-		-		694,752		3,004,712		694,752		3,004,712

Total	$	45,651,548	$	1,114,666	$	2,198,010	$	3,135,889	$	47,849,558	$	4,250,555

SOUTHCOAST FINANCIAL CORPORATION

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 5 – Investment Securities – (continued)

Securities classified as available-for-sale are recorded at fair market value. Unrealized losses on securities in a continuous loss position for twelve months or more totaled $2,521,315, or four securities comprising 77% of total unrealized losses, and $3,135,889, or five securities comprising 74% of total unrealized losses, at March 31, 2011 and December 31, 2010, respectively. The Company does not intend to sell these securities and it is more likely than not that the Company will not be required to sell these securities before recovery of their amortized cost.

The unrealized loss attributable to other securities relates to market valuations on two individual pooled trust preferred securities. The Company believes, based on industry analyst reports, credit ratings, and third party other-than-temporary loss impairment evaluations, that the deterioration in the value of these securities is attributable to a combination of the lack of liquidity in both of these securities and credit quality concerns for one of the two securities. These securities are considered Level 3 securities in the fair value hierarchy, as they both trade in less than liquid markets. One of the securities with an amortized cost of $1.8 million and fair value of $1.0 million is receiving contractual interest payments, while the other with an amortized cost of $1.7 million and fair value of $15,000 is receiving payment-in-kind interest, which consists of capitalization of interest amounts due on the security. Due to the over-collateralized credit position of the security currently receiving interest payments, no other-than-temporary impairment was recognized on this security.

The Company engaged a firm specializing in security valuations to evaluate the security receiving payment-in-kind interest for other-than- temporary impairment(“OTTI”). This firm uses the OTTI evaluation model to compare the present value of expected cash flows to the previous estimate to measure whether there are any adverse changes in cash flows during the quarter. The OTTI model considers the structure and term of the trust preferred security and the financial condition of the underlying issuers. Specifically, the model details interest rates, principal balances of note classes and issuers, the timing and amount of interest and principal payments of the underlying issuers, and the allocation of the payments to the note classes. The current estimate of expected cash flows is based on the most recent trustee reports and any other relevant market information including announcements of interest payment deferrals or defaults of underlying trust preferred securities. The OTTI evaluation model assumes no recoveries on defaults. The result of the firm’s analysis indicated approximately $176,000 of other-than-temporary impairment on this security during the current period.

The credit quality of the pooled trust preferred securities is directly related to the financial strength and ability to make contractual interest payments of the underlying issuers in these securities, most of which are banks. As such, these securities may show additional other-than-temporary impairment in future periods if the financial condition of the underlying issuers further deteriorates.

The amortized costs and fair values of investment securities available for sale at March 31, 2011 by contractual maturity are shown in the following table. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

	Amortized		Fair
	Cost		Value
Due after five but within ten years	$	2,846,442	$	2,937,836
Due after ten years		13,762,921		11,313,783
Mortgage backed		50,856,674		50,424,498
Equity securities with no maturity		150,000		150,000
Total investment securities available-for-sale	$	67,616,037	$	64,826,117

The proceeds from sales of securities and the associated gains are listed below:

	Period ending March 31,
	2010		2009
Proceeds	$	5,769,799	$	35,542,672
Gross Gains		61,337		835,412
Gross Losses		39,887		-

The tax provision related to the above net realized gains and losses was $7,722 and $300,748 for the periods ended March 31, 2011 and 2010, respectively.

SOUTHCOAST FINANCIAL CORPORATION

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 6 - Loans

The composition of loans by major loan category is presented below:

(Dollars in thousands)	March 31,			December 31,
	2011			2010
Real estate secured loans:
Residential 1-4 Family	$	161,244		$	156,766
Multifamily		5,447			6,657
Commercial		86,550			92,481
Construction and land development		50,986			51,366
Total real estate secured loans		304,227			307,270
Commercial and industrial		23,600			26,242
Consumer		2,468			2,372
Other		552			565
Total gross loans		330,847			336,449
Allowance for loan losses		(8,814	)		(9,513	)
	$	322,033		$	326,936

The Company uses a numerical grading system from 1 to 9 to assess the credit risk inherent in its loan portfolio, with Grade 1 loans having the lowest credit risk and Grade 9 loans having the highest credit risk. The risk percentages assigned to these credit grades are dependent on loan type and are discussed in detail in Management’s Discussion and Analysis. Loans with credit grades from 1 to 5 are considered passing grade, or acceptable, loans. Loans with grades from 6 to 9 are considered to have less than acceptable credit quality. Generally, impaired loans have credit grades of 7 or higher. Following is a listing and brief description of the various risk grades. The grading of individual loans may involve the use of estimates.

Credit Grade	Description
1	Loans secured by cash collateral.
2	Loans secured by readily marketable collateral.
3	Top quality loans with excellent repayment sources and no significant identifiable risk of collection.
4	Acceptable loans with adequate repayment sources and little identifiable risk of collection.
5	Acceptable loans with signs of weakness as to repayment or collateral, but with mitigating factors that minimize the risk of loss.
6	Watch List or Special Mention loans with underwriting tolerances and/or exceptions with no mitigating factors that may, due to economic or other factors, increase the risk of loss.
7	Classified substandard loans inadequately protected by the paying capacity or net worth of the obligor, or of the collateral. Weaknesses jeopardize the liquidation of the debt.
8	Classified doubtful loans in which collection or liquidation in full is highly improbable.
9	Classified loss loans that are uncollectible and of such little value that continuance as an asset is not warranted.

SOUTHCOAST FINANCIAL CORPORATION

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 6 - Loans – (continued)

The following tables provide a summary of our credit risk profile by loan categories as of March 31, 2011 and December 31, 2010.

(Dollars in thousands)

Credit risk Profile by Creditworthiness Category
As of March 31, 2011 and December 31, 2010
		Real Estate Secured
		Residential 1-4 Family				Multi Family				Commercial				Construction and Land Development
		2011		2010		2011		2010		2011		2010		2011		2010
Grade
	1	$	-	$	-	$	-	$	-	$	-	$	-	$	-	$	-
	2		-		-		-		-		-		-		-		-
	3		38,518		33,374		-		-		5,480		5,770		7,172		5,899
	4		65,360		67,724		738		745		26,716		28,268		12,474		13,257
	5		45,563		41,960		3,008		3,030		29,228		38,308		17,689		17,013
	6		2,511		3,585		-		396		10,395		7,857		481		701
	7		7,731		7,978		1,701		1,315		12,852		10,272		11,560		12,674
	8		1,561		2,145		-		1,171		1,879		2,006		1,610		1,822
	9		-		-		-		-		-		-		-		-
Total		$	161,244	$	156,766	$	5,447	$	6,657	$	86,550	$	92,481	$	50,986	$	51,366

		Non-Real Estate Secured
		Commercial				Consumer				Other				Total
			2011		2010		2011		2010		2011		2010		2011		2010
Grade
	1	$	298	$	1,416	$	48	$	52	$	-	$	-	$	346	$	1,468
	2		-		-		-		-		-		-		-		-
	3		1,941		1,959		242		293		202		204		53,555		47,499
	4		4,861		4,865		455		334		290		301		110,894		115,494
	5		11,185		14,964		1,415		1,542		60		60		108,148		116,877
	6		3,292		971		15		23		-		-		16,694		13,533
	7		2,023		2,067		293		128		-		-		36,160		34,434
	8		-		-		-		-		-		-		5,050		7,144
	9		-		-		-		-		-		-		-		-
Total		$	23,600	$	26,242	$	2,468	$	2,372	$	552	$	565	$	330,847	$	336,449

	Residential – Prime				Residential – Subprime (1)				Residential Total
	2011		2010		2011		2010		2011		2010
Grade
Pass	$	145,976	$	139,572	$	3,465	$	3,486	$	149,441	$	143,058
Special Mention		2,511		3,585		-		-		2,511		3,585
Substandard		6,401		6,480		1,330		1,498		7,731		7,978
Doubtful		1,007		1,592		554		553		1,561		2,145
Total	$	155,895	$	151,229	$	5,349	$	5,537	$	161,244	$	156,766

(1) 1-4 Family Residential loans where the borrower has a credit score less than 660 and a debt to income ratio over 50%.

SOUTHCOAST FINANCIAL CORPORATION

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 6 - Loans – (continued)

The following tables provide a summary of past due loans by loan category as of March 31, 2011 and December 31, 2010.

(Dollars in thousands)

Past Due Loans For the Periods Ended March 31, 2011 and December 31, 2010
March 31, 2011	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days		Total Past Due		Current		Total Loans Receivable		Recorded Investment > 90 Days and Accruing
Real Estate Secured
1-4 Family Residential	$	7,414	$	1,273	$	2,605	$	11,292	$	149,952	$	161,244		-
Multi Family Residential		397		-		-		397		5,050		5,447		-
Commercial Real Estate		4,289		178		5,627		10,094		76,456		86,550		-
Construction and Land														-
Development		2,082		5		1,863		3,950		47,036		50,986		-
Non Real Estate Secured														-
Commercial and Industrial		275		393		96		764		22,836		23,600		-
Consumer and Other		61		39		10		110		2,910		3,020		-
Total	$	14,518	$	1,888	$	10,201	$	26,608	$	304,240	$	330,847	$	-

December 31, 2010	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days		Total Past Due		Current		Total Loans Receivable		Recorded Investment > 90 Days and Accruing
Real Estate Secured
1-4 Family Residential	$	4,601	$	1,018	$	3,554	$	9,173	$	147,593	$	156,766	$	44
Multi Family Residential		-		-		1,171		1,171		5,486		6,657		-
Commercial Real Estate		4,815		1,437		4,908		11,160		81,321		92,481		-
Construction and Land														-
Development		202		182		1,899		2,283		49,083		51,366		-
Non Real Estate Secured														-
Commercial and Industrial		612		157		526		1,295		24,947		26,242		-
Consumer and Other		45		40		9		94		2,843		2,937		-
Total	$	10,275	$	2,834	$	12,067	$	25,176	$	311,273	$	336,449	$	44

SOUTHCOAST FINANCIAL CORPORATION

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 6 - Loans – (continued)

The following table provides a summary of nonaccrual loans as of March 31, 2011 and December 31, 2010.

(Dollars in thousands)

	March 31,		December 31,
	2011		2010
1-4 Family Residential Prime	$	2,736	$	3,674
1-4 Family Residential Subprime (1)		1,167		1,175
Multi Family Residential		-		1,171
Commercial Real Estate		9,440		8,771
Construction and Land Development		3,665		3,890
Commercial and Industrial		484		923
Consumer and Other		10		9
Total	$	17,502	$	19,613

(1) 1-4 Family Residential loans where the borrower has a credit score less than 660 and a debt to income ratio over 50%.

At March 31, 2011 and December 31, 2010, nonaccrual loans totaled $17.5 million and $19.6 million, respectively. The gross interest income which would have been recorded under the original terms of nonaccrual loans amounted to approximately $868,000 and $793,000 at March 31, 2011and December 31, 2010, respectively. At March 31, 2011 and December 31, 2010, troubled debt restructurings totaled $3.2 million and $3.2 million, respectively. The gross interest income that would have been recognized on troubled debt restructurings according to the original loan terms during the first quarter of 2011 totaled approximately $55,000; actual interest income recognized on these loans according to the restructured terms totaled $38,000. The gross interest income that would have been recognized on troubled debt restructurings according to the original loan terms during 2010 totaled approximately $229,000; actual interest income recognized on these loans according to the restructured terms totaled approximately $190,000. At March 31, 2011 and December 31, 2010, impaired loans (which include non-accrual loans) totaled $20.7 million and $22.8 million, respectively. Impaired loans evaluated individually for impairment totaled $18.3 million and $19.2 million at March 31, 2011 and December 31, 2010, respectively.

SOUTHCOAST FINANCIAL CORPORATION

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 6 - Loans – (continued)

The following tables provide a year to date analysis of activity within the allowance for loan losses.

(Dollars in thousands)	March 31,			March 31
	2011			2010
Balance, beginning of year	$	9,513		$	10,042
Provision for loan losses		1,150			1,000
Net charge offs		(1,849	)		(719	)
Balance, end of quarter	$	8,814		$	10,323

	For the Quarter Ended March 31, 2011
	Beginning Balance		Charge Offs		Recoveries		Provisions			Ending Allowance for Loan Losses
										General Reserves		Specific Reserves		Total
Real Estate Secured
1-4 Family Residential	$	2,532	$	315	$	41	$	412		$	2,007	$	663	$	2,670
Multi Family Residential		358		402		-		185			52		89		141
Commercial Real Estate		1,263		231		-		313			1,126		219		1,345
Construction and Land
Development		2,972		105		8		(840	)		1,436		599		2,035
Non Real Estate Secured
Commercial and Industrial		619		837		-		1,063			845		-		845
Consumer and Other		124		9		1		36			152		-		152
Other
Other General Reserves		1,345		-		-		(16	)		1,329		-		1,329
Unallocated		300		-		-		(3	)		297		-		297
Total	$	9,513	$	1,899	$	50	$	1,150		$	7,244	$	1,570	$	8,814

	For the Year Ended December 31, 2010
	Beginning Balance		Charge Offs		Recoveries		Provisions			Ending Allowance for Loan Losses
										General Reserves		Specific Reserves		Total
Real Estate Secured
1-4 Family Residential	$	2,163	$	1,327	$	22	$	1,674		$	1,723	$	809	$	2,532
Multi Family Residential		64		50		-		344			69		289		358
Commercial Real Estate		2,454		805		256		(642	)		737		526		1,263
Construction and Land
Development		2,413		2,292		33		2,818			2,333		639		2,972
Non Real Estate Secured
Commercial and Industrial		683		63		23		(24	)		619		-		619
Consumer and Other		106		132		5		145			124		-		124
Other
Other General Reserves		1,350		-		-		(5	)		1,345		-		1,345
Unallocated		809		-		-		(509	)		300		-		300
Total	$	10,042	$	4,669	$	339	$	3,801		$	7,250	$	2,263	$	9,513

SOUTHCOAST FINANCIAL CORPORATION

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 6 - Loans – (continued)

Impaired loans with a balance of $250,000 or more are evaluated individually for impairment. All other loans are collectively evaluated for impairment. The following tables provide summaries and totals of loans individually and collectively evaluated for impairment as of March 31, 2011 and December 31, 2010.

(Dollars in thousands)

Loans Receivable:	As of March 31, 2011
	Individually evaluated for impairment		Collectively evaluated for impairment		Total
Real Estate Secured
1-4 Family Residential	$	4,039	$	157,205	$	161,244
Multi Family Residential		817		4,630		5,447
Commercial Real Estate		9,440		77,110		86,550
Construction and Land
Development		4,048		46,938		50,986
Non Real Estate Secured
Commercial and Industrial		-		23,600		23,600
Consumer and Other		-		3,020		3,020
Total:	$	18,344	$	312,503	$	330,847

Loans Receivable:	As of December 31, 2010
	Individually evaluated for impairment		Collectively evaluated for impairment		Total
Real Estate Secured
1-4 Family Residential	$	4,678	$	152,088	$	156,766
Multi Family Residential		1,993		4,664		6,657
Commercial Real Estate		8,262		84,219		92,481
Construction and Land
Development		4,270		47,096		51,366
Non Real Estate Secured
Commercial and Industrial		-		26,242		26,242
Consumer and Other		-		2,937		2,937
Total:	$	19,203	$	317,246	$	336,449

SOUTHCOAST FINANCIAL CORPORATION

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 6 - Loans – (continued)

(Dollars in thousands)

Impaired Loans
For the Quarter Ended March 31, 2011
	Recorded Investment (1)		Impaired Principal Balance		Related Allowance		Life to Date Charge offs		Average Recorded Investment		Interest Income Recognized

With no related allowance recorded:
1-4 Residential Prime	$	1,219	$	1,219	$	-	$	367	$	1,216	$	-
1-4 Residential Subprime (2)		313		313		-		241		313		-
Multi Family Residential		-		-		-		-		-		-
Commercial Real Estate		6,273		6,273		-		1,018		6,399		-
Construction and Land
Development		1,395		1,395		-		1,141		1,406		-
Commercial and Industrial		-		-		-		-		-		-
Consumer and Other		-		-		-		-		-		-

With an allowance recorded:
1-4 Residential Prime	$	1,351	$	1,950	$	599	$	-	$	1,311	$	23
1-4 Residential Subprime (2)		492		556		64		86		492		-
Multi Family Residential		728		817		89		-		677		14
Commercial Real Estate		2,948		3,167		219		-		2,811		-
Construction and Land												14
Development		2,055		2,654		599		195		2,052		-
Commercial and Industrial		-		-		-		-		-		-
Consumer and Other		-		-		-		-		-		-

Total:
1-4 Residential Prime	$	2,570	$	3,170	$	600	$	367	$	2,527	$	23
1-4 Residential Subprime (2)		805		869		64		327		805		-
Multi Family Residential		728		817		89		-		677		14
Commercial Real Estate		9,221		9,440		219		1,018		9,210		-
Construction and Land												14
Development		3,450		4,048		598		1,336		3,458		-
Commercial and Industrial		-		-		-		-		-		-
Consumer and Other		-		-		-		-		-		-
Total:	$	16,774	$	18,344	$	1,570	$	3,048	$	16,677	$	51

(1 Impaired balance and accrued interest less specific reserves, net of deferred fees and costs.

(2) 1-4 Family Residential loans where the borrower has a credit score less than 660 and a debt to income ratio over 50%.

SOUTHCOAST FINANCIAL CORPORATION

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 6 - Loans – (continued)

(Dollars in thousands)

Impaired Loans
For the Year Ended December 31, 2010
	Recorded Investment (1)		Unpaid Principal Balance		Related Allowance		Life to Date Charge offs		Average Recorded Investment		Interest Income Recognized

With no related allowance recorded:
1-4 Residential Prime	$	1,904	$	1,904	$	-	$	832	$	2,184	$	-
1-4 Residential Subprime (2)		240		240		-		86		261		-
Multi Family Residential		410		410		-		-		577		-
Commercial Real Estate		5,412		5,412		-		598		5,490		-
Construction and Land
Development		1,101		1,101		-		576		1,358		-
Commercial and Industrial		-		-		-		-		-		-
Consumer and Other		-		-		-		-		-		-

With an allowance recorded:
1-4 Residential Prime	$	1,181	$	1,851	$	670	$	-	$	1,693	$	8
1-4 Residential Subprime (2)		544		683		139		-		583		-
Multi Family Residential		1,294		1,583		289		13		1,322		4
Commercial Real Estate		2,324		2,850		526		-		2,240		-
Construction and Land												15
Development		2,530		3169		639		655		2,861		-
Commercial and Industrial		-		-		-		-		-		-
Consumer and Other		-		-		-		-		-		-

Total:
1-4 Residential Prime	$	3,085	$	3,755	$	670	$	832	$	3,877	$	8
1-4 Residential Subprime (2)		784		923		139		86		844		-
Multi Family Residential		1,704		1,993		289		13		1,899		4
Commercial Real Estate		7,736		8,262		526		598		7,730		-
Construction and Land												15
Development		3,631		4,270		639		1,231		4,219		-
Commercial and Industrial		-		-		-		-		-		-
Consumer and Other		-		-		-		-		-		-
Total:	$	16,940	$	19,203	$	2,263	$	2,760	$	18,569	$	27

(1) Impaired balance and accrued interest less specific reserves, net of deferred fees and costs.

(2) 1-4 Family Residential loans where the borrower has a credit score less than 660 and a debt to income ratio over 50%.

SOUTHCOAST FINANCIAL CORPORATION

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 7 – Fair Value of Financial Instruments

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Generally accepted accounting principles also establish a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

Level 1 - Quoted prices in active markets for identical assets or liabilities. Level 1 assets and liabilities include debt and equity securities and derivative contracts that are traded in an active exchange market, as well as U.S. Treasuries, and money market funds.

Level 2 - Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 2 assets and liabilities include debt securities with quoted prices that are traded less frequently than exchange-traded instruments, mortgage backed securities, municipal bonds, corporate debt securities, and derivative contracts whose value is determined using a pricing model with inputs that are observable in the market or can be derived principally from or corroborated by observable market data.

Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, real estate appraisals, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation. For example, this category generally includes certain private equity investments, retained residual interests in securitizations, residential mortgage servicing rights, other real estate owned when adjusting for selling costs, and impaired loans.

Assets measured at fair value on a recurring basis are as follows as of March 31, 2011 and December 31, 2010 (amounts in thousands):

	March 31, 2011
	Quoted market price in active markets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable inputs (Level 3)		Total
Available-for-sale investment securities
Mortgage backed
Government sponsored enterprises	$	-	$	48,594	$	-	$	48,594
Other		-		1,830		-		1,830
Municipals		-		12,407		-		12,407
Other		-		460		1,535		1,995
Total assets at fair value	$	-	$	63,291	$	1,535	$	64,826

SOUTHCOAST FINANCIAL CORPORATION

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 7 – Fair Value of Financial Instruments – (continued)

	December 31, 2010
	Quoted market price in active markets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable inputs (Level 3)		Total
Available-for-sale investment securities
Mortgage backed
Government sponsored enterprises	$	-	$	56,683	$	-	$	56,683
Other		-		1,880		-		1,880
Municipals		-		12,088		-		12,088
Other		-		460		1,195		1,655
Total assets at fair value	$	-	$	71,111	$	1,195	$	72,306

The Company has no liabilities carried at fair value or measured at fair value on a recurring basis.

Assets measured at fair value on a nonrecurring basis are as follows as of March 31, 2011 and December 31, 2010 (amounts in thousands):

	March 31, 2011
	Quoted market price in active markets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable inputs (Level 3)		Total

Impaired Loans
1 - 4 Residential Prime	$	-	$	-	$	1,219	$	1,219
1 - 4 Residential Subprime(2)		-		-		313		313
Commercial Real Estate		-		-		6,273		6,273
Construction and Land Development		-		-		1,395		1,395
Other Real Estate Owned
Commercial Office Properties		-		-		1,909		1,909
Commercial Lots		-		-		1,074		1,074
Residential 1 – 4 Family Lots and Homes Under Construction		-		-		4,036		4,036
Residential 1 – 4 Family Homes		-		-		1,537		1,537
Multifamily Properties		-		-		989		989
Total assets at fair value	$	-	$	-	$	18,745	$	18,745

(2) 1 – 4 Family Residential Loans where the borrower has a credit score less than 660 and a debt to income ratio over 50%.

SOUTHCOAST FINANCIAL CORPORATION

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 7 – Fair Value of Financial Instruments – (continued)

	December 31, 2010
	Quoted market price in active markets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable inputs (Level 3)		Total

Impaired Loans
1 - 4 Residential Prime	$	-	$	-	$	1,904	$	1,904
1 - 4 Residential Subprime(2)		-		-		240		240
Multifamily Residential		-		-		410		410
Commercial Real Estate		-		-		5,412		5,412
Construction and Land Development		-		-		1,101		1,101
Other Real Estate Owned
Commercial Office Properties		-		-		1,917		1,917
Commercial Lots		-		-		908		908
Residential 1 – 4 Family Lots and Homes Under Construction		-		-		4,256		4,256
Residential 1 – 4 Family Homes		-		-		1,622		1,622
Multifamily Properties		-		-		220		220
Total assets at fair value	$	-	$	-	$	17,990	$	17,990

(2) 1 – 4 Family Residential Loans where the borrower has a credit score less than 660 and a debt to income ratio over 50%.

The Company has no liabilities carried at fair value or measured at fair value on a nonrecurring basis.

The following table reconciles the changes in recurring Level 3 financial instruments for the three months ended

March 31, 2011 and 2010(amounts in thousands):

	March 31,
	2011			2010
Beginning of Year Balance	$	1,195		$	2,901
Discount Accretion		2			2
Principal Paydowns		-			(7	)
Other-than-temporary impairment on available for sale securities		(176	)		-
Unrealized Gain (Loss)		514			(1,864	)
Ending Balance	$	1,535		$	1,032

Valuation Methodologies – Assets and Liabilities Recorded at Fair Value

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

Available for Sale Investment Securities

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

SOUTHCOAST FINANCIAL CORPORATION

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 7 – Fair Value of Financial Instruments – (continued)

Loans Held for Sale

Mortgage loans held for sale are carried at the lower of cost or market value. The fair value of mortgage loans held for sale is based on what secondary markets are currently offering for portfolios with similar characteristics. As such, the Company categorizes loans subjected to nonrecurring fair value adjustments as Level 2. There were no fair value adjustments to mortgage loans held for sale as of March 31, 2011 and December 31, 2010.

Valuation Methodologies – Assets and Liabilities not recorded at Fair Value

The following is a description of the valuation methodologies used for assets and liabilities that are not recorded at fair value, but whose fair value must be estimated and disclosed:

Loans

For certain categories of loans, such as variable rate loans which reprice frequently and have no significant change in credit risk, fair values are based on the carrying amounts. The fair value of other types of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Impaired loans are carried at the lesser of their principal balance or their fair value. The Company considers problem loans with principal balances of $250,000 or greater individually for impairment. The fair value of loans individually evaluated for impairment is estimated using one of several methods, including the present value of expected cash flows, market price of the loan, if available, or fair value of the underlying collateral less costs to sell. At March 31, 2011, substantially all impaired loans were evaluated based on the fair value of the collateral less costs to sell. Those impaired loans not requiring a specific allowance for loan losses allocation represent loans with fair values exceeding their recorded investments. Impaired loans for which a specific allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of an impaired loan is based on an observable market price the Company records the impaired loan as nonrecurring Level 2. When the fair value of an impaired loan is based on the present value of expected cash flows or the fair value of the underlying collateral the Company records the impaired loan as nonrecurring Level 3.

Other real estate owned

Nonrecurring adjustments to certain commercial and residential real estate properties classified as other real estate owned are measured at fair value, less costs to sell. Fair values are based on recent real estate appraisals. These appraisals may use a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.

Deposits

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

Other borrowings

The carrying amount of variable rate borrowings and securities sold under repurchase agreements approximates fair value. The fair value of fixed rate other borrowings is estimated based on discounted contractual cash flows using the current incremental borrowing rates for similar type borrowing arrangements.

SOUTHCOAST FINANCIAL CORPORATION

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 7 – Fair Value of Financial Instruments – (continued)

The estimated fair values of the Company’s financial instruments are as follows (amounts in thousands):

	March 31,				December 31,
	2011				2010
	Carrying		Fair		Carrying		Fair
	Amount		Value		Amount		Value
Financial assets:
Cash and due from banks	$	26,667	$	26,667	$	20,062	$	20,062
Federal funds sold		2,823		2,823		-		-
Investment securities		64,826		64,826		72,306		72,306
Loans held for sale		-		-		417		417
Loans, net		322,033		320,523		336,449		335,818
Other Real Estate Owned, net		9,545		9,545		8,923		8,923
Financial liabilities:
Deposits		351,993		342,348		344,602		344,602
Short term borrowings		6,580		6,580		3,963		3,963
Advances from Federal Home Loan Bank		57,000		52,336		69,000		63,682
Junior subordinated debentures		10,310		10,310		10,310		10,310

The fair value of both commitments to extend credit, which totaled approximately $18.9 million and $19.4 million at March 31, 2011 and December 31, 2010, respectively, and standby letters of credit, which totaled approximately $601,000 and $615,000 at March 31, 2011 and December 31, 2010, respectively, is not considered material (or is based on the current fees or costs that would be charged to enter into or terminate such arrangements).

SOUTHCOAST FINANCIAL CORPORATION

Item 2. - Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis should be read in conjunction with the financial statements and related notes appearing herein and in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010. Results of operations for the period ending March 31, 2011 are not necessarily indicative of the results to be attained for any other period.

This Report on Form 10-Q may contain forward-looking statements relating to such matters as anticipated financial performance, business prospects, technological developments, new products and similar matters. All statements that are not historical facts are "forward-looking statements." The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements. In order to comply with terms of the safe harbor, the Company notes that a variety of factors could cause the Company's actual results and experience to differ materially from the anticipated results or other expectations expressed in the Company's forward-looking statements. Forward-looking statements include statements with respect to management's beliefs, plans, objectives, goals, expectations, anticipations, assumptions, estimates, intentions, and future performance, and involve known and unknown risks, uncertainties and other factors, which may be

beyond the Company's control, and which may cause actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. All statements other than statements of historical fact are statements that could be forward-looking statements. These forward-looking statements can be identified through use of words such as "may," "will," "anticipate," "assume," "should," "indicate," "would," "believe," "contemplate," "expect," "seek," "estimate," "continue," "plan," "point to," "project," "predict," "could," "intend," "target," "potential," and other similar words and expressions of the future. These forward-looking statements may not be realized due to a variety of factors, including, without limitation:

o future economic and business conditions;

o lack of sustained growth and disruptions in the economy of the Greater Charleston area;

o government monetary and fiscal policies;

o the effects of changes in interest rates on the levels, composition and costs of deposits, loan demand, and the values

of loan collateral, securities, and interest sensitive assets and liabilities;

o the effects of competition from a wide variety of local, regional, national and other providers of financial,

investment, and insurance services;

o credit risks;

o higher than anticipated levels of defaults on loans;

o perceptions by depositors about the safety of their deposits;

o the failure of assumptions underlying the establishment of the allowance for loan losses and other estimates, including

the value of collateral securing loans;

o the risks of opening new offices, including, without limitation, the related costs and time of building customer

relationships and integrating operations as part of these endeavors and the failure to achieve expected gains,

revenue growth and/or expense savings from such endeavors;

o changes in laws and regulations, including tax, banking and securities laws and regulations and deposit

insurance assessments;

o the effect of agreements with regulatory authorities, which restrict various activities and impose additional

administrative requirements without commensurate benefits;

o changes in the requirements of regulatory agencies;

o changes in accounting policies, rules and practices;

o changes in technology or products may be more difficult or costly, or less effective than anticipated;

o the effects of war or other conflicts, acts of terrorism or other catastrophic events that may affect general

economic conditions and economic confidence;

o ability to continue to weather the current economic downturn;

o loss of consumer or investor confidence; and

o other factors and information described in any of the reports that we file with the Securities and Exchange

Commission under the Securities Exchange Act of 1934.

All forward-looking statements are expressly qualified in their entirety by this cautionary notice. The Company has no obligation, and does not undertake, to update, revise or correct any of the forward-looking statements after the date of this report. The Company has expressed its expectations, beliefs, and projections in good faith and believes they have a reasonable basis. However, there is no assurance that these expectations, beliefs or projections will result or be achieved or accomplished.

SOUTHCOAST FINANCIAL CORPORATION

Item 2. - Management’s Discussion and Analysis of Financial Condition and Results of Operations - continued

Results of Operations

The Company’s net loss for the three months ended March 31, 2011 was approximately $579,000, or $.12 per basic share, compared to net income of approximately $363,000, or $.08 per basic share, for the three months ended March 31, 2010. The average number of basic shares outstanding for the three months ended March 31, 2011 was 4,790,957 compared to 4,550,015 for the three months ended March 31, 2010.

Net Interest Income

Net interest income is the difference between the interest earned on interest earning assets and the interest paid for funds acquired to support those assets, and is the principal source of the Company’s earnings. Net interest income was approximately $3.2 million for the three months ended March 31, 2011, compared to approximately $2.9 million for the three months ended March 31, 2010.

Changes that affect net interest income include changes in the average rate earned on interest earning assets, changes in the average rate paid on interest bearing liabilities, and changes in the volumes of interest earning assets and interest bearing liabilities.

Average earning assets for the three months ended March 31, 2011 decreased 6.6 percent to $398.8 million from the $426.9 million reported for the three months ended March 31, 2010. The decrease was attributable to decreases of $14.6 million in average loans and $13.5 million in average total investments, cash, and federal funds sold. The decrease in average loans between the two periods was primarily due to loan chargeoffs and foreclosures during 2010, which totaled $4.3 million and $9.0 million, respectively. Additionally, the slow lending environment resulting from the continued sluggish economy has caused the volume of new loans to lag behind loan paydowns.

Average interest bearing liabilities for the three months ended March 31, 2011 decreased 9.1 percent to $392.2 million from the $431.5 million reported for the three months ended March 31, 2010. The decrease was attributable to decreases of $40.4 million and $17.8 million in average time deposits and average other borrowings, respectively. These decreases were partially offset by an increase of $18.9 million in average savings and transaction accounts. The decrease in average time deposits was attributable to decreases of $28.9 million and $11.5 million in average brokered and wholesale time deposits and average retail time deposits, respectively. The decrease in average other borrowings was primarily attributable to decreases of $12.6 million and $5.0 million in average Federal Home Loan Bank Borrowings and average brokered repurchase agreements, respectively. These changes in the funding mix are consistent with the Company’s efforts to build its core deposits while reducing its reliance on wholesale funding sources and retail time deposits.

The following table compares the average balances, yields and rates for the interest sensitive segments of the Company’s balance sheets for the three months ended March 31, 2011 and 2010.

SOUTHCOAST FINANCIAL CORPORATION

Item 2. - Management’s Discussion and Analysis of Financial Condition and Results of Operations - continued

Net Interest Income – (continued)

	For the three months ended							For the three months ended
	March 31, 2011							March 31, 2010
	Average		Income/		Yield/			Average		Income/		Yield/
	Balance		Expense		Rate(1)			Balance		Expense		Rate(1)
Assets
Cash and Federal funds sold	$	13,669,552	$	6,947		0.21	%	$	15,824,444	$	13,719		0.35	%
Investments – taxable		58,414,755		389,173		2.70			74,601,709		608,225		3.31
Investments - nontaxable (2)		12,262,647		191,958		6.35			7,402,557		123,886		6.79
Total investments and
federal funds sold		84,346,954		588,078		2.83			97,828,710		745,830		3.09
Loans (3) (4)		314,475,859		4,490,880		5.76			329,117,297		4,774,123		5.86
Total earning assets/ interest income		398,822,813		5,078,958		5.14	%		426,946,007		5,519,953		5.22	%
Other assets		71,348,975							83,180,296
Total assets	$	470,171,788						$	510,126,303
Liabilities
Savings and
transaction accounts	$	95,383,599		304,687		1.30	%	$	76,533,228		309,019		1.64	%
Time deposits		220,032,181		848,331		1.56			260,396,950		1,337,654		2.08
Other borrowings		66,448,858		578,596		3.53			84,252,222		788,270		3.79
Subordinated debt		10,310,000		45,073		1.77			10,310,000		158,509		6.24
Total interest bearing
liabilities/interest expense		392,174,638		1,776,687		1.84			431,492,400		2,593,452		2.44
Non-interest bearing
liabilities		32,117,491							33,082,779
Total liabilities		424,292,129		1,776,687		1.70			464,575,179		2,593,452		2.26
Equity		45,879,659							45,551,124
Total liabilities
and equity	$	470,171,788						$	510,126,303
Net interest
income/margin (5)			$	3,302,271		3.27	%			$	2,926,501		2.72	%
Net interest spread (6)						3.30	%						2.78	%

(1)	Annualized

(2)	Tax equivalent yields for nontaxable investments assuming a 36% tax rate.

(3)	Does not include nonaccruing loans.

(4)	Income includes loan fees of $193,335 in 2011 and $128,291 in 2010.

(5)	Net interest income divided by total earning assets.

(6)	Total interest earning assets yield less interest bearing liabilities rate.

As shown above, for the three months ended March 31, 2011 the average yield on earning assets was 5.14 percent, while the average cost of interest bearing liabilities was 1.84 percent. For the three months ended March 31, 2010 the average yield on earning assets was 5.22 percent and the average cost of interest-bearing liabilities was 2.44 percent. The decrease in the asset yields and average rates paid is due to market rate decreases over the last year. The net interest margin is computed by annualizing year to date interest income and expense, taking the difference, and dividing the resulting figure by average interest earning assets. The net interest margin was 3.27 percent and 2.72 percent for the three months ended March 31, 2011 and 2010, respectively. The increase in the net interest margin is primarily attributable to a $376,000 increase in net interest income along with a $28.1 million decrease in average interest earning assets between the two periods. The increase in net interest income was the result of an $817,000 decrease in interest expense, partially offset by a $441,000 decrease in interest income. The decrease in interest expense was driven by maturities of higher cost time deposits and other borrowings and the partial replacement of these time deposits and other borrowings with core deposits consisting of lower cost savings and transaction accounts.

SOUTHCOAST FINANCIAL CORPORATION

Item 2. - Management’s Discussion and Analysis of Financial Condition and Results of Operations - continued

Net Interest Income – continued

The following tables present changes in the Company’s net interest income which are primarily a result of changes in the volume and rates of its interest-earning assets and interest-bearing liabilities.

	Analysis of Changes in Net Interest Income
	For the three months ended March 31, 2011
	Versus three months ended March 31, 2010 (1)
	Volume			Rate			Net Change
Interest income:

Cash and Federal funds sold	$	(1,868	)	$	(4,904	)	$	(6,772	)
Investments - taxable		(131,972	)		(87,080	)		(219,052	)
Investments - non taxable (2)		81,336			(13,264	)		68,072
Total investments and federal funds sold		(52,504	)		(105,248	)		(157,752	)
Net loans (3)		(211,381	)		(71,862	)		(283,243	)
Total interest income		(263,885	)		(177,110	)		(440,995	)
Interest expense:
Savings and transaction accounts		76,112			(80,444	)		(4,332	)
Time deposits		(207,353	)		(281,970	)		(489,323	)
Other borrowings		(166,570	)		(43,104	)		(209,674	)
Subordinated debt		-			(113,436	)		(113,436	)
Total interest expense		(297,811	)		(518,954	)		(816,765	)
Net interest income	$	33,926		$	341,844		$	375,770

(1)	Changes in rate/volume have been allocated on a consistent basis to rate.

(2)	Tax equivalent yields for nontaxable investments assuming a 36% tax rate.

(3)	Income includes loan fees of $193,335 in 2011 and $128,291 in 2010.

Noninterest Income and Expenses

Noninterest income for the three months ended March 31, 2011 was approximately $342,000, compared to approximately $1,257,000 for the three months ended March 31, 2010, a decrease of approximately $915,000. This decrease was primarily due to a decrease of approximately $814,000 in gains on sales of available for sale securities, which totaled approximately $21,000 and $835,000 for the three months ended March 31, 2011 and 2010, respectively. The Company’s noninterest income also decreased between the two periods due to the recognition of approximately $176,000 of other-than-temporary impairment on available for sale securities during the three months ended March 31, 2011, compared to no other-than-temporary impairment for the three months ended March 31, 2010. This impairment charge is discussed in more detail in Note 5 to the financial statements. Partially offsetting these decreases in noninterest income was an approximate $76,000 increase in service fees on deposit accounts, which totaled approximately $334,000 and $258,000 for the three months ended March 31, 2011 and 2010, respectively. This increase in service fees was attributable to an $18.9 million increase in average savings and interest bearing transaction accounts between the two periods. Growth in these types of core deposit accounts commonly generates additional deposit fee income.

Item 2. - Management’s Discussion and Analysis of Financial Condition and Results of Operations - continued

SOUTHCOAST FINANCIAL CORPORATION

Noninterest Income and Expenses – continued

Noninterest expenses for the three months ended March 31, 2011 were approximately $3,428,000, compared to approximately $2,619,000 for the three months ended March 31, 2010, an increase of approximately $809,000. This increase was primarily due to an approximate $560,000 decrease in gains on sales of other real estate owned, which totaled approximately $2,000 and $562,000 for the three months ended March 31, 2011 and 2010, respectively. Gains or losses on the sales of other real estate owned may vary greatly between periods and are highly dependent on the types of property being sold and the presence of willing cash or creditworthy buyers in the market. Noninterest expenses for impairment provisions and other expenses related to other real estate owned offset by rental income from other real estate owned increased approximately $169,000. These expenses totaled approximately $120,000 for the three months ended March 31, 2011, compared to a net positive result of approximately $49,000 for the three months ended March 31, 2010. The majority of this difference was due to rental income on other real estate owned, which totaled approximately $17,000 and $112,000 for the three months ended March 31, 2011and 2010, respectively, a difference of approximately $95,000 between the two periods. This difference was primarily due to the second quarter 2010 sale of a $3.7 million commercial property which generated the majority of the Company’s rental income from other real estate owned during the three months ended March 31, 2010. Also contributing to the increase in noninterest expenses between the periods was insurance expense, which increased by approximately $73,000, totaling approximately $270,000 and $197,000 for the three months ended March 31, 2011 and 2010, respectively. This was primarily attributable to an increase of approximately $57,000 in FDIC insurance premiums between the two periods. Professional fees also increased by approximately $72,000 between the two periods, totaling approximately $258,000 and $186,000 for the three months ended March 31, 2011 and 2010, respectively. This increase was primarily attributable to increases in legal, audit, and shareholder and registration expenses, which increased approximately $23,000, $28,000, and $22,000, respectively. Legal expenses increased primarily due to additional expenses incurred for assistance with regulatory matters, and audit and shareholder and registration expense increases were primarily due to timing differences in the services performed between the two periods.

Liquidity

Liquidity is the ability to meet current and future obligations through liquidation or maturity of existing assets or the acquisition of additional liabilities. Adequate liquidity is necessary to meet the requirements of customers for loans and deposit withdrawals in the most timely and economical manner. Some liquidity is ensured by maintaining assets which may be immediately converted into cash at minimal cost (amounts due from banks and federal funds sold). However, the most manageable sources of liquidity are composed of liabilities, with the primary focus of liquidity management being on the ability to obtain deposits within the Bank’s service area. Core deposits (total deposits less certificates of deposit $100,000 or more, wholesale and brokered deposits) provide a relatively stable funding base, and were equal to 69.9% of total deposits as of March 31, 2011. Asset liquidity is provided from several sources, including amounts due from banks and federal funds sold and funds from maturing loans. The Bank is a member of the Federal Home Loan Bank of Atlanta (”FHLBA”) and, as such has the ability to borrow against pledges of its 1-4 family residential mortgage loans and its commercial real estate loans. Available borrowings under this line totaled $25.9 million at March 31, 2011. The Company also has federal funds accommodations of $5 million with Alostar Bank of Commerce, $5 million with South Carolina Bank and Trust, and $5 million with Center State Bank. Additionally, the Company has a borrowing line with the Federal Reserve Bank of Richmond’s discount window. The Company has pledged its portfolios of construction and land development loans and commercial and industrial loans against this borrowing line. Total available borrowings under this line were $32.0 million at March 31, 2011.

Loans

At March 31, 2011, the Company had no loans 90 days delinquent and still accruing interest and $17.5 million of nonaccrual loans. Of these, $17.0 million are secured by real estate. The primary risk of loss on these loans is a potential deterioration of real estate collateral values. The Company also had $9.5 million of other real estate owned at March 31, 2011. At December 31, 2010, the Company had $44,000 of loans 90 days past due and still accruing interest, $8.9 million in other real estate owned, and $19.6 million of nonaccrual loans. At March 31, 2010, the Company had no loans 90 days past due and still accruing interest, $9.5 million in other real estate owned, and $25.9 million of nonaccrual loans. The allowance for loan losses was 2.66 percent of loans as of March 31, 2011, compared to 2.83 percent as of December 31, 2010 and 2.98 percent as of March 31, 2010. For the three months ended March 31, 2011 the Company recorded a loan loss provision of $1,150,000 compared to a loan loss provision of $1,000,000 during the first three months of 2010. The current year’s loan loss provision is the result of loan chargeoffs and continued elevated levels of nonperforming loans. Due to the current depressed state of the economy and declining real estate values in the Company’s market area, management expects nonperforming assets to remain at elevated levels for the foreseeable future. In management’s opinion, the allowance for loan losses is adequate to absorb estimated losses inherent in our Company’s loan portfolio. In reviewing the adequacy of the allowance for loan losses at each quarter end, management takes into consideration the historical loan losses we experienced, current levels of past due loans by loan type, the historical severity of loan losses by loan type, loan to value exceptions present in our loan portfolio, and collateral values of impaired loans deemed to be collateral dependent. In 2011, management adjusted the length of the historical loss period used from four years to one year in order to better reflect recent loss trends. After charging off all known losses, management considers the allowance for loan losses adequate to cover its estimate of inherent losses in the loan portfolio as of March 31, 2011.

SOUTHCOAST FINANCIAL CORPORATION

Item 2. - Management’s Discussion and Analysis of Financial Condition and Results of Operations - continued

Loans – (continued)

For the three months ended March 31, 2011, net chargeoffs to average loans outstanding totaled 2.21% on an annualized basis while the allowance for loan losses to gross loans totaled 2.66% at March 31, 2011.

Management identifies and maintains a list of potential problem loans. These are loans that are internally risk graded substandard or below but which are not included in nonaccrual status and are not past due 90 days or more. A loan is added to the potential problem list when management becomes aware of information about possible credit problems of the borrower which raises serious doubts as to the ability of such borrower to comply with the current loan repayment terms. At March 31, 2011 potential problem loans totaled $23.7 million. The Company’s potential problem loans are comprised of $9.5 million of construction and land development real estate loans, $5.3 million of nonfarm, nonresidential real estate loans, $5.6 million of 1-4 family mortgage loans, $1.7 million of multifamily real estate loans, and $1.6 million of various loan types not secured by real estate, primarily commercial and industrial loans. As the majority of potential problem loans are real estate secured, management closely tracks the current values of real estate collateral when assessing the collectibility of these loans.

Deposits

Deposits increased $7.4 million during the first three months of 2011 to $342.9 million at March 31, 2011. The increase was primarily attributable to interest bearing deposits, which increased $7.2 million. Included in this amount were increases of $2.3 million in interest bearing transaction accounts, $3.8 million in savings and money market accounts, and $1.1 million in time deposit accounts. The increases in interest bearing transaction accounts and savings and money market accounts were primarily attributable to continued growth in the Company’s Rewards Checking and Savings products, which are high interest rate checking and savings accounts offered to retail customers designed to increase the Company’s market share in transaction and savings accounts and increase its core deposits. Brokered and wholesale time deposits totaled $71.7 million and $61.7 million at December 31, 2010, and March 31, 2011, respectively, a decrease of $10.0 million, as the Company continued efforts to decrease its reliance on wholesale funding. Offsetting this decrease in brokered and wholesale deposits was an $11.1 million increase in retail time deposits, which totaled $160.5 million and 149.4 million at March 31, 2011 and December 31, 2010, respectively.

Federal Home Loan Bank Borrowings

Other borrowings are primarily comprised of FHLBA advances. FHLBA advances are collateralized by pledged FHLBA stock and certain residential mortgage and commercial real estate loans. FHLBA advances are summarized as follows:

Maturity	Rate			Balance
November 2011		0.36	%	$	5,000,000
September 2013		4.75	%		10,000,000
June 2014		3.92	%		2,000,000
October 2016		4.25	%		5,000,000
November 2016		4.08	%		5,000,000
January 2017		4.35	%		5,000,000
January 2017		4.40	%		5,000,000
January 2017		4.46	%		5,000,000
January 2017		4.60	%		5,000,000
March 2018		2.33	%		5,000,000
April 2018		3.03	%		5,000,000

Balance				$	57,000,000

SOUTHCOAST FINANCIAL CORPORATION

Item 2. - Management’s Discussion and Analysis of Financial Condition and Results of Operations - continued

Junior Subordinated Debentures

On August 5, 2005 Southcoast Capital Trust III (the "Capital Trust"), a non-consolidated subsidiary of the Company, issued and sold a total of 10,310 floating rate securities, with a $1,000 liquidation amount per security (the "Capital Securities"). Institutional buyers bought 10,000 of the Capital Securities denominated as preferred securities and the Company bought the other 310 Capital Securities which are denominated as common securities. The proceeds of those sales, $10.3 million, were used by the Capital Trust to buy $10.3 million of junior subordinated debentures from the Company which are reported on its consolidated balance sheets. The Capital Securities mature or are mandatorily redeemable upon maturity on September 30, 2035, or upon earlier optional redemption as provided in the indenture. The Company had the right to redeem the Capital Securities in whole or in part, on or after September 30, 2010. See Note 12 to the consolidated financial statements for the year ended December 31, 2010, and the information set forth in Exhibit 13 under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations- Junior Subordinated Debentures” filed with our Form 10-K for the year ended December 31, 2010, for more information about the terms of the junior subordinated debentures. During the first nine months of 2010 the securities issued by Southcoast Capital Trust III were effectively converted from a floating rate to a fixed rate through the use of an interest rate swap agreement. The agreement, which expired September 30, 2010, provided for the Company to make payments at a fixed rate of 6.32% in exchange for receiving payments at a variable rate (three month LIBOR plus 150 basis points). See Note 13 to the consolidated financial statements filed with our Form 10-K for the year ended December 31, 2010, for more information about the terms of the interest rate swap agreement. Since September 30, 2010 the Company has paid the variable rate of three month LIBOR plus 150 basis points (1.77 percent per annum for the first quarter of 2011).

Capital Resources

The Company’s total shareholders’ equity increased by approximately $203,000 during the first three months of 2011, due to other comprehensive income of approximately $751,000 and proceeds from stock issuances of approximately $31,000 pursuant to our Employee Stock Purchase Plan, partially offset by a net loss of approximately $579,000. The Company’s Tier 1 capital to average assets ratio was 11.39 percent as of March 31, 2011 compared to 11.70 percent as of December 31, 2010.

The Federal Reserve Board and other bank regulatory agencies require bank holding companies and financial institutions to maintain capital at adequate levels based on a percentage of assets and off-balance sheet exposures, adjusted for risk weights ranging from 0% to 100%. Under the risk-based standard, capital is classified into two tiers. The Company’s and the Bank’s Tier 1 capital consists of common shareholders’ equity minus a portion of deferred tax assets plus, in the case of the Company, junior subordinated debt subject to certain limitations. The Company’s and the Bank’s Tier 2 capital consists of the allowance for loan losses subject to certain limitations and, in the case of the Company, its junior subordinated debt in excess of 25% of its Tier 1 capital. A bank holding company’s qualifying capital base for purposes of its risk-based capital ratio consists of the sum of its Tier 1 and Tier 2 capital. The regulatory minimum requirements are 4% for Tier 1 and 8% for

total risk-based capital. The Company and the Bank are also required to maintain capital at a minimum level based on quarterly average assets, which is known as the leverage ratio. These requirements are set by regulation and are shown in the table below which is applicable to all but the most highly-rated institutions that are not anticipating or experiencing significant growth and have well-diversified risk, including no undue interest rate risk exposure, excellent asset quality, high liquidity and good earnings. The regulators may require individual bank holding companies and banks to maintain higher levels of capital depending on the regulators’ assessment of the risks faced by the bank holding company or the bank. As of March 31, 2011, the Company and the Bank exceeded each of the capital requirements shown in the following table.

Capital Ratios

Well Capitalized

Adequately Capitalized

Actual

Requirement

(Dollars in thousands)

Amount

Ratio

Amount

Ratio

Amount

Ratio

The Bank

Total capital (to risk-weighted assets)	50,839	14.85	%	34,230	10.00	%	27,384	8.00	%
Tier 1 capital (to risk-weighted assets)	46,436	13.57	%	20,538	6.00	%	13,692	4.00	%
Tier 1 capital (to average assets)	46,436	10.09	%	23,189	5.00	%	18,551	4.00	%
The Company
Total capital (to risk-weighted assets)	57,449	16.55	%	N/A	N/A		27,777	8.00	%
Tier 1 capital (to risk-weighted assets)	52,986	15.26	%	N/A	N/A		13,889	4.00	%
Tier 1 capital (to average assets)	52,986	11.39	%	N/A	N/A		18,607	4.00	%

SOUTHCOAST FINANCIAL CORPORATION

Item 2. - Management’s Discussion and Analysis of Financial Condition and Results of Operations - continued

Off Balance Sheet Risk

The Company makes contractual commitments to extend credit and issues standby letters of credit in the ordinary course of its business activities. These commitments are legally binding agreements to lend money to customers at predetermined interest rates for a specified period of time. In addition to commitments to extend credit, the Company also issues standby letters of credit which are assurances to a third party that it will not suffer a loss if the customer fails to meet a contractual obligation to the third party. At March 31, 2011, the Company had issued commitments to extend credit of approximately $18.9 million and standby letters of credit of approximately $601,000 through various types of commercial lending arrangements. Approximately $15.9 million of these commitments to extend credit had variable rates.

The following table sets forth the length of time until maturity for unused commitments to extend credit and standby letters of credit at March 31, 2011.

	Within One Month		After One Through Three Months		After Three Through Twelve Months		Within One Year		Greater Than One Year		Total
Unused commitments to extend credit	$	1,242,604	$	1,443,484	$	7,092,334	$	9,778,422	$	9,158,476	$	18,936,898
Standby letters of credit		114,829		-		486,260		601,089		-		601,089
Totals	$	1,357,433	$	1,443,484	$	7,578,594	$	10,379,511	$	9,158,476	$	19,537,987

Based on historical experience, many of the commitments and letters of credit will expire unfunded. Accordingly, the amounts shown in the table above do not necessarily reflect the Company’s need for funds in the periods shown. Further, through its various sources of liquidity, the Company believes it will be able to fund these obligations as they arise. The Company evaluates each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary upon extension of credit, is based on the Company’s credit evaluation of the borrower. Collateral varies but may include accounts receivable, inventory, property, plant and equipment, commercial and residential real estate.

Item 3. - Quantitative and Qualitative Disclosures About Market Risk.

Information about the Company’s exposure to market risk was disclosed in its Annual Report on Form 10-K for the year ended December 31, 2010, which was filed with the Securities and Exchange Commission on March 10, 2011. There have been no material quantitative or qualitative changes in market risk exposure since the date of that filing.

Item 4. - Controls and Procedures.

Based on the evaluation required by 17 C.F.R. Sections 240.13a-15(b) or 240.15d-15(b) of the Company’s disclosure controls and procedures (as defined in 17 C.F.R. Section 240.13a-15(e) and 240.15d-15(e), the Company's chief executive officer and chief financial officer concluded that such controls and procedures, as of the end of the period covered by this quarterly report, were effective.

There has been no change in the Company’s internal control over financial reporting during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

SOUTHCOAST FINANCIAL CORPORATION

PART II - OTHER INFORMATION

Item 6. Exhibits

31-1 Rule 13a-14(a) Certifications of CEO

31-2 Rule 13a-14(a) Certifications of CFO

32 Section 1350 Certification

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934 the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Date: May 12, 2011	By:	s/L. Wayne Pearson
		L. Wayne Pearson
		Chief Executive Officer

Date: May 12, 2011	By:	s/William C. Heslop
		William C. Heslop
		Chief Financial Officer

SOUTHCOAST FINANCIAL CORPORATION

Exhibit Index

31.1	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. This exhibit is not “filed” for purposes of Section 18 of the Securities Exchange Act of 1934 but is instead furnished as provided by applicable rules of the Securities and Exchange Commission.

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SOUTHCOAST FINANCIAL CORP Reports