HCSB Financial (HCFB) 10-Q 2010 Q1 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

xQUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended March 31, 2010

OR

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

For the Transition Period from             to            

Commission File Number 000-26995

HCSB FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

South Carolina	57-1079444
(State or other jurisdiction of incorporation)	(I.R.S. Employer Identification No.)

5201 Broad Street

Loris, South Carolina 29569

(Address of principal executive
offices, including zip code)

(843) 756-6333

(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 o

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

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

Large accelerated filer o	Accelerated filer o
Non-accelerated o	Smaller reporting company x
(do not check if smaller reporting company)

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

Yes o  No x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:  3,787,170 shares of common stock, $.01 par value, were issued and outstanding as of May 15, 2010.

HCSB FINANCIAL CORPORATION

Index

	Page No.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets - March 31, 2010 and December 31, 2009	3
Condensed Consolidated Statements of Income - Three months ended March 31, 2010 and 2009	4
Condensed Consolidated Statements of Shareholders’ Equity and Comprehensive Income - Three months ended March 31, 2010 and 2009	5
Condensed Consolidated Statements of Cash Flows - Three months ended March 31, 2010 and 2009	6
Notes to Condensed Consolidated Financial Statements	7-16
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	17-27
Item 4. Controls and Procedures	28
PART II. OTHER INFORMATION
Item 1. Legal Proceedings	28
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	28
Item 3. Defaults Upon Senior Securities	28
Item 4. (Removed and Reserved)	28
Item 5. Other Information	28
Item 6. Exhibits	28

2

HCSB FINANCIAL CORPORATION

Condensed Consolidated Balance Sheets

(Dollars in thousands)	March 31,2010			December 31, 2009
	(Unaudited)			(Audited)
Assets:
Cash and cash equivalents:
Cash and due from banks	$	23,624		$	44,902
Federal funds sold	18,148			1,407
Total cash and cash equivalents	41,772			46,309
Securities available-for-sale	185,471			169,463
Nonmarketable equity securities	6,715			6,715
Total investment securities	192,186			176,178
Loans held for sale	9,384			1,669
Loans receivable	483,601			491,652
Less allowance for loan losses	(7,819		)	(7,525		)
Loans, net	475,782			484,127
Premises and equipment, net	23,991			24,152
Accrued interest receivable	4,412			4,120
Cash value of life insurance	9,596			9,492
Other real estate owned	10,126			6,432
Other assets	9,310			7,170
Total assets	776,559			759,649
Liabilities and Shareholders’ Equity
Liabilities:
Deposits:
Noninterest-bearing transaction accounts	35,793			31,661
Interest-bearing transaction accounts	41,089			41,354
Money market savings accounts	173,676			152,553
Other savings accounts	7,213			6,623
Time deposits $100 and over	142,606			130,634
Other time deposits	199,817			215,467
Total deposits	600,194			578,292
Repurchase Agreements	8,545			8,031
Advances from the Federal Home Loan Bank	113,800			118,800
Subordinated debentures	994			—
Junior subordinated debentures	6,186			6,186
Accrued interest payable	1,129			1,444
Other liabilities	1,299			1,824
Total liabilities	732,147			714,577
Shareholders’ Equity
Preferred stock, $1,000 par value. Authorized 5,000,000 shares; issued and outstanding 12,895 and 0 shares at March 31, 2010 and Dec 31, 2009 respectively	12,009			11,962
Common stock, $.01 par value; 10,000,000 shares authorized, 3,787,170 shares issued and outstanding at March 31, 2010 and December 31, 2009	38			38
Capital surplus	30,868			30,856
Common stock warrants	1,012			1,012
Nonvested restricted stock	(645		)	(645		)
Retained earnings	1,058			1,291
Accumulated other comprehensive loss	72			558
Total shareholders’ equity	44,412			45,072
Total liabilities and shareholders’ equity	776,559			759,649

See Notes to Condensed Consolidated Financial Statements.

3

HCSB FINANCIAL CORPORATION

Condensed Consolidated Statements of Income

(Unaudited)

	Three Months Ended March 31,
(Dollars in thousands, except per share amounts)	2010			2009
Interest income:
Loans, including fees	$	6,859		$	6,182
Investment securities:
Taxable	1,517			2,113
Tax-exempt	48			65
Nonmarketable equity securities	7			—
Other interest income	13			8
Total	8,444			8,368
Interest expense:
Certificates of deposit $100M and over	705			771
Other deposits	1,720			2,463
Other interest expense	1,025			892
Total	3,450			4,126
Net interest income	4,994			4,242
Provision for loan losses	1,812			1,523
Net interest income after provision for loan losses	3,182			2,719
Noninterest income:
Service charges on deposit accounts	359			364
Credit life insurance commissions	39			15
Gain / (loss) on securities available-for-sale	79			71
Gain on sale of mortgage loans	247			123
Other fees and commissions	85			76
Brokerage commissions	82			14
Income from cash value of life insurance	124			85
Other operating income	102			35
Total	1,117			783
Noninterest expenses:
Salaries and employee benefits	2,450			2,378
Net occupancy expense	312			290
Furniture and equipment expense	342			309
Marketing expense	83			144
Loss on other than temporary impairment	—			122
FDIC insurance premiums	262			210
Provision for losses on other real estate owned	64			—
Loss on sale of assets	58			48
Other operating expenses	770			679
Total	4,341			4,180
Loss before income taxes	(42		)	(678		)
Income tax provision	(17		)	(239		)
Net loss	$	(25	)	$	(439	)
Accretion of preferred stock to redemption value	47			13
Preferred dividends accrued	77			46
Net loss available to common shareholders	(149		)	(498		)
Basic loss per share	$	(0.04	)	$	(0.13	)
Diluted loss per share	$	(0.04	)	$	(0.13	)

See Notes to Condensed Consolidated Financial Statements.

4

HCSB FINANCIAL CORPORATION

Condensed Consolidated Statement of Shareholders’ Equity and Comprehensive Income

For the Three Months ended March 31, 2010 and 2009

(Unaudited)

(Dollars in thousands except	Common Stock				Common Stock		Preferred Stock			Nonvested Restricted			Capital			Retained Earnings			Accumulated other
share data)	Shares		Amount		Warrants		Shares	Amount		Stock			Surplus			(deficit)			comprehensive			Total
Balance, December 31, 2008	3,788,293		$	38	—		—			(645		)	30,728			3,231			1,098			34,450
Net loss for the period																(439		)				(439		)
Other comprehensive income, net of tax																			931			931
Comprehensive income																						492
Issuance of preferred stock							12,895	11,830														11,830
Issuance of common stock warrants					1,013																	1,013
Accretion of preferred stock to redemption value								13								(13		)				—
Adjustment due to 3% stock dividend	(1,123	)											(19		)	19						—
Stock compensation expense													36									36
Payment of fractional shares																(19		)				(19		)
Balance, March 31, 2009	3,787,170		$	38	$	1,013	12,895	$	11,843	$	(645	)	$	30,745		$	2,779		$	2,029		$	47,802
December 31, 2009	3,787,170		$	38	$	1,012	12,895	$	11,962	$	(645	)	$	30,856		$	1,291		$	558		$	45,072
Net loss for the period																(25		)				(25		)
Other comprehensive income,																			(486		)	(486		)
Comprehensive income																						(511		)
Accretion of preferred stock								47								(47		)				—
Stock compensation expense													12									12
Payment of dividend on preferred stock																(161		)				(161		)
Balance, March 31, 2010	3,787,170		$	38	$	1,012	12,895	$	12,009	$	(645	)	$	30,868		$	1,058		$	72		$	44,412

See Notes to Condensed Consolidated Financial Statements.

5

HCSB FINANCIAL CORPORATION

Condensed Consolidated Statements of Cash Flows (Unaudited)

	Three Months Ended March 31,
(Dollars in thousands)	2010			2009
Cash flows from operating activities:
Net loss	$	(25	)	$	(439	)
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	286			231
Deferred income tax benefit	(24		)	(54		)
Provision for loan losses	1,812			1,523
Amortization less accretion on investments	225			42
Amortization of deferred loan costs	12			11
Increase in loans held for sale	(7,715		)	(1,323		)
Stock compensation expense	12			36
Net gain on sale of securities available-for-sale	(79		)	(71		)
Loss on sale of other real estate owned	104			49
Loss on other than temporary impairment	—			122
Decrease in interest payable	(315		)	(307		)
Increase in interest receivable	(292		)	(7		)
Increase in other assets	(2,116		)	(2,692		)
Increase in cash value of life insurance	(104		)	(74		)
Decrease in other liabilities	(241		)	(363		)
Net cash provided by operating activities	(8,460		)	(3,316		)
Cash flows from investing activities:
Purchases of securities available-for-sale	(41,195		)	(40,089		)
Maturities of securities available-for-sale	15,790			20,366
Proceeds from sale of other real estate owned	391			1,439
Proceeds from sales of securities available-for-sale	8,481			—
Net increase (decrease) in loans to customers	2,332			(20,468		)
Proceeds for sales of premises and equipment	1			12
Purchase of life insurance contracts	—			(600		)
Purchases of nonmarketable equity securities	—			(497		)
Purchases of premises and equipment	(126		)	(953		)
Net cash used by investing activities	(14,326		)	(40,790		)
Cash flows from financing activities:
Net increase in demand deposits and savings	25,580			15,087
Net increase (decrease) in time deposits	(3,678		)	20,389
Net increase (decrease) in FHLB borrowings	(5,000		)	2,800
Net increase in Preferred stock	—			12,843
Net increase in repurchase agreements	514			4,345
Net decrease in notes payable	—			(4,500		)
Net decrease in fed funds purchased	—			(2,677		)
Dividend paid on preferred stock	(161		)	—
Net increase in subordinated debentures	994			—
Cash paid in lieu of fractional shares	—			(19		)
Net cash provided by financing activities	18,249			48,268
Net increase in cash and cash equivalents	(4,537		)	4,162
Cash and cash equivalents, beginning of period	46,309			10,423
Cash and cash equivalents, end of period	$	41,772		$	14,585
Cash paid during the period for:
Income taxes	$	—		$	—
Interest	$	3,765		$	4,432

See Notes to Condensed Consolidated Financial Statements.

6

HCSB FINANCIAL CORPORATION

Notes to Condensed Consolidated Financial Statements

(Unaudited)

NOTE 1 — BASIS OF PRESENTATION

The accompanying consolidated financial statements have been prepared in accordance with the requirements for interim financial statements and, accordingly, they are condensed and omit disclosures, which would substantially duplicate those contained in the most recent annual report to shareholders.  The financial statements as of March 31, 2010 and for the interim periods ended March 31, 2010 and 2009 are unaudited and, in our opinion, include all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation.  Operating results for the three month period ended March 31, 2010 are not necessarily indicative of the results that may be expected for the year ending December 31, 2010.  The financial information as of December 31, 2009 has been derived from the audited financial statements as of that date.  For further information, refer to the financial statements and the notes included in HCSB Financial Corporation’s 2009 Annual Report on Form 10-K.

On March 6, 2009, as part of the Troubled Asset Relief Program (the “TARP”) Capital Purchase Program (the “CPP”) established by the U.S. Treasury under the Emergency Economic Stabilization Act of 2009 (“EESA”), the Company issued and sold to the U.S. Treasury (i) 12,895 shares of its Fixed Rate Cumulative Perpetual Preferred Stock, Series T, having a liquidation preference of $1,000 per share (the “Series T Preferred Stock”), and (ii) a ten-year warrant to purchase up to 91,714 shares of its common stock at an initial exercise price of $21.09 per share (the “CPP Warrant”), for an aggregate purchase price of $12,895,000 in cash.  Refer to the accompanying Management’s Discussion and Analysis of Financial Condition and results of Operations for additional information.

There was no stock dividend declared in January 2010 because the Company is prohibited from declaring any dividends on its common stock until March 6, 2012 without the U.S. Treasury’s approval unless the 12,985 shares of the Series T Preferred Stock have been repurchased from the U.S. Treasury.  In January 2009, the Board of Directors declared a stock dividend payable on February 20, 2009 to shareholders of record on February 6, 2009.  As a result of the 3% stock dividend, 110,338 shares were issued.  The Company recorded this dividend in shareholders’ equity for the year ended December 31, 2008.  All share and per share amounts have been adjusted to reflect these dividends.

NOTE 2 — RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

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

In January 2010, fair value guidance was amended to require disclosures for significant amounts transferred in and out of Levels 1 and 2 and the reasons for such transfers and to require that gross amounts of purchases, sales, issuances and settlements be provided in the Level 3 reconciliation.  The new disclosures are effective for the Company for the current quarter and have been reflected in the Fair Value footnote.

Guidance related to subsequent events was amended in February 2010 to remove the requirement for an SEC filer to disclose the date through which subsequent events were evaluated.  The amendments were effective upon issuance and had no significant impact on the Company’s financial statements.

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

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NOTE 3 — EARNINGS PER SHARE

A reconciliation of the numerators and denominators used to calculate basic and diluted earnings per share for the three months ended March 31, 2010 and 2009 is as follows:

	Three Months Ended March 31, 2010
	Income			Average Shares	Per Share
(Dollars in thousands, except share amounts)	(Numerator)			(Denominator)	Amount
Basic loss per share
Income available to common shareholders	$	(149	)	3,787,170	$	(0.04	)
Effect of dilutive securities
Stock options	—			—
Diluted loss per share
Income available to common shareholders plus assumed conversions	$	(149	)	3,787,170	$	(0.04	)

	Three Months Ended March 31, 2009
	Income			Average Shares	Per Share
(Dollars in thousands, except share amounts)	(Numerator)			(Denominator)	Amount
Basic loss per share
Income available to common shareholders	$	(498	)	3,787,806	$	(0.13	)
Effect of dilutive securities
Stock options	—			—
Diluted loss per share
Income available to common shareholders plus assumed conversions	$	(498	)	3,787,806	$	(0.13	)

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NOTE 4 — COMPREHENSIVE INCOME

The following table sets forth the amounts of other comprehensive income (loss) included in equity along with the related tax effect for the three months ended March 31, 2010 and 2009:

	Three Months Ended March 31, 2010
	Pre-tax			(Expense)			Net-of-tax
(Dollars in thousands)	Amount			Benefit			Amount
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during the period	$	(851	)	$	315		$	(536	)
Plus: reclassification adjustment for gains (losses) realized in net income	79			(29		)	50
Net unrealized gains (losses) on securities	(772		)	286			(486		)
Other comprehensive income	$	(772	)	$	286		$	(486	)

	Three Months Ended March 31, 2009
	Pre-tax		(Expense)			Net-of-tax
(Dollars in thousands)	Amount		Benefit			Amount
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during the period	$	1,407	$	(521	)	$	886
Plus: reclassification adjustment for gains (losses) realized in net income	71		(26		)	45
Net unrealized gains (losses) on securities	1,478		(547		)	931
Other comprehensive income	$	1,478	$	(547	)	$	931

Accumulated other comprehensive income (loss) consists solely of the unrealized gain (loss) on securities available-for-sale, net of the deferred tax effects.

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NOTE 5 — FAIR VALUE OF FINANCIAL INSTRUMENTS

The fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  Fair value estimates are made at a specific point in time based on relevant market information and information about the financial instruments.  Because no market value exists for a significant portion of the financial instruments, fair value estimates are based on judgments regarding future expected loss, current economic conditions, risk characteristics of various financial instruments, and other factors.

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

Cash and Due from Banks- The carrying amount is a reasonable estimate of fair value.

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

Time Deposits with Other Banks - Time deposits with other banks have a term less than 90 days and the carrying amount approximates the fair value.

Investment Securities Available-for-Sale- For securities available-for-sale, fair value equals the carrying amount, which is the quoted market price.  If quoted market prices are not available, fair values are based on quoted market prices of comparable securities.

Nonmarketable Equity Securities- The carrying amount is a reasonable estimate of fair value since no ready market exists for these securities.

Loans Held-for-Sale - - Fair values of mortgage loans held for sale are based on commitments on hand from investors or market prices.

Loans Receivable- For certain categories of loans, such as variable rate loans which are repriced frequently and have no significant change in credit risk and credit card receivables, 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 the borrowers with similar credit ratings and for the same remaining maturities.

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

Advances from the Federal Home Loan Bank- For the portion of borrowings immediately callable, fair value is based on the carrying amount.  The fair value of the portion maturing at a later date is estimated using a discounted cash flow calculation that applies the interest rate of the immediately callable portion to the portion maturing at the future date.

Subordinated Debentures — The carrying value of subordinated debentures is a reasonable estimate of fair value since the debentures were issued in the current year.

Junior Subordinated Debentures - The carrying value of junior subordinated debentures is a reasonable estimate of fair value since the debentures were issued at a floating rate.

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

Commitments to Extend Credit and Standby Letters of Credit- The contractual amount is a reasonable estimate of fair value for the instruments because commitments to extend credit and standby letters of credit are issued on a short-term or floating rate basis and include no unusual credit risks.

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

	March 31,
	2010				2009
	Carrying		Estimated		Carrying		Estimated
(Dollars in thousands)	Amount		Fair Value		Amount		Fair Value
Financial Assets:
Cash and due from banks	$	23,624	$	23,624	$	14,585	$	14,585
Federal funds sold	18,148		18,148		—		—
Investment securities available-for-sale	185,471		185,471		188,221		188,221
Nonmarketable equity securities	6,715		6,715		5,636		5,636
Loans and loans held-for-sale	492,985		490,626		449,059		448,357
Accrued interest receivable	4,412		4,412		3,632		3,632
Financial Liabilities:
Demand deposit, interest-bearing transaction, and savings accounts	$	257,771	$	257,771	$	191,269	$	191,269
Certificates of deposit	342,423		343,623		328,958		330,390
Repurchase agreements	8,545		8,545		13,517		13,517
Advances from the Federal Home Loan Bank	113,800		115,796		94,800		96,919
Subordinated debentures	994		994		—		—
Junior subordinated debentures	6,186		6,186		6,186		6,186
Accrued interest payable	1,129		1,129		1,798		1,798

	Notional		Estimated		Notional		Estimated
	Amount		Fair Value		Amount		Fair Value
Off-Balance Sheet Financial Instruments:
Commitments to extend credit	$	52,251	$	N/A	$	59,433	N/A
Standby letters of credit	1,187		N/A		1,562		N/A

Generally accepted accounting principles provide a framework for measuring and disclosing fair value.  They also require disclosures about the fair value of assets and liabilities recognized in the balance sheet in periods subsequent to initial recognition, whether the measurements are made on a recurring basis (for example, available-for-sale investment securities) or on a nonrecurring basis (for example, impaired loans).

Generally accepted accounting principles also define fair value as 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.  They 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.  They describe 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

11

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. This category generally includes certain derivative contracts and impaired loans.

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, 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, and highly-structured or long-term derivative contracts.

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

Investments Securities Available-for-Sale

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

Mortgage Loans Held for Sale

Loans held for sale are carried at the lower of cost or market value.  The fair value of loans held for sale is based on what secondary markets are currently offering for portfolios with similar characteristics.  As such, the Company classifies loans subjected to recurring fair value adjustments as Level 1.

Loans

The Company does not record loans at fair value on a recurring basis.  However, from time to time, a loan is considered impaired and the related impairment is charged against the allowance or a specific allowance is established.  Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired.  Once a loan is identified as individually impaired, management measures impairment in accordance with generally accepted accounting principles.  The fair value of impaired loans is estimated using one of several methods, including collateral net liquidation value, market value of similar debt, enterprise value, and discounted cash flows.  Those impaired loans not requiring a specific allowance represent loans for which the fair value of the expected repayments or collateral meet or exceed the recorded investments in such loans.  At March 31, 2010, substantially all of the total impaired loans were evaluated based on the fair value of the collateral.  In accordance with generally accepted accounting principles, impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy.  When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as nonrecurring Level 2.  When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3.

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Other Real Estate Owned

Other real estate owned (“OREO”) is adjusted to fair value upon transfer of the loans to OREO.  Subsequently, OREO is carried at the lower of carrying value or fair value.  Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral.  When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the foreclosed asset as nonrecurring Level 2.  When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the OREO as nonrecurring Level 3.

Assets and liabilities measured at fair value on a recurring basis are as follows as of March 31, 2010:

(Dollars in thousands)	Quoted market price in active markets (Level 1)		Significant other oberservable inputs (Level 2)		Significant unobservable inputs (Level 3)
Available-for-sale investment securities			$	185,471	—
Mortgage loans held for sale	$	9,384	$	—	—
Total	$	9,384	$	185,471	—

Assets and liabilities measured at fair value on a recurring basis are as follows as of December 31, 2009:

(Dollars in thousands)	Quoted market price in active markets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable inputs (Level 3)
Available-for-sale investment securities	$	12,192	$	157,271	—
Mortgage loans held for sale	1,669		$	—	—
Total	$	13,861	$	157,271	—

Assets and liabilities recorded at fair value on a non-recurring basis are as follows as of March 31, 2010:

(Dollars in thousands)	Quoted market price in active markets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable inputs (Level 3)
Nonaccrual loans (includes impaired loans)	$	—	$	21,376	—
Other real estate owned	—		$	10,126	—
Total	$	—	$	31,502	—

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Assets and liabilities recorded at fair value on a non-recurring basis are as follows as of December 31, 2009:

(Dollars in thousands)	Quoted market price in active markets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable inputs (Level 3)
Nonaccrual loans (includes impaired loans)	$	—	$	23,138	—
Other real estate owned	—		$	6,432	—
Total	$	—	$	29,570	—

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

NOTE 7 — SUBSEQUENT EVENTS

Subsequent events are events or transactions that occur after the balance sheet date but before financial statements are issued.  Recognized subsequent events are events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements.  Nonrecognized subsequent events are events that provide evidence about conditions that did not exist at the date of the balance sheet but arose after that date.  Management has reviewed events occurring through the date the financial statements were issued and no subsequent events occurred requiring accrual or disclosure.

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CAUTIONARY STATEMENT REGARDING FORWARD LOOKING STATEMENTS

The following is our discussion and analysis of certain significant factors that have affected our financial position and operating results and those of our subsidiary, Horry County State Bank (the “Bank”), during the periods included in the accompanying financial statements.  This commentary should be read in conjunction with the financial statements and the related notes and the other statistical information included in this report.

This report contains statements which constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.  Forward-looking statements relate to the financial condition, results of operations, plans, objectives, future performance, and business of our Company.  Forward-looking statements are based on many assumptions and estimates and are not guarantees of future performance. Our actual results may differ materially from those anticipated in any forward-looking statements, as they will depend on many factors about which we are unsure, including many factors which are beyond our control. The words “may,” “would,” “could,” “should,” “will,” “expect,” “anticipate,” “predict,” “project,” “potential,” “continue,” “assume,” “believe,” “intend,” “plan,” “forecast,” “goal,” and “estimate,” as well as similar expressions, are meant to identify such forward-looking statements.  Potential risks and uncertainties that could cause our actual results to differ materially from those anticipated in our forward-looking statements include, without limitation, those described under the heading “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2009 as filed with the Securities and Exchange Commission (the “SEC”) and the following:

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

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

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

·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;

·the effect of final rules amending Regulation E that prohibit financial institutions from charging consumer fees for paying overdrafts on ATM and one-time debit card transactions, unless the consumer consents or opts-in to the overdraft service for those types of transactions;

·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;

·changes in deposit flows;

·the level of allowance for loan loss;

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

·the rates of loan growth;

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·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 SEC.

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

These risks are exacerbated by the recent developments in national and international financial markets, and we are unable to predict what effect these uncertain market conditions will have on us.  During 2008 and 2009 and continuing through the first quarter of 2010, the capital and credit markets experienced extended volatility and disruption.  There can be no assurance that these unprecedented recent developments will not continue to materially and adversely affect our business, financial condition and results of operations, as well as our ability to raise capital or other funding for liquidity and business purposes.

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

The following discussion describes our results of operations for the quarter ended March 31, 2010 as compared to the quarter ended March 31, 2009 and also analyzes our financial condition as of March 31, 2010 as compared to December 31, 2009.  Like most community banks, we derive most of our income from interest we receive on our loans and investments.  Our primary source of funds for making these loans and investments is our deposits, on which we pay interest.  Consequently, one of the key measures of our success is our amount of net interest income, or the difference between the income on our interest-earning assets, such as loans and investments, and the expense on our interest-bearing liabilities, such as deposits.  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.

Of course, 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.

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

The following discussion and analysis also identifies significant factors that have affected our financial position and operating results during the periods included in the accompanying financial statements.  We encourage you to read this discussion and analysis in conjunction with the financial statements and the related notes and the other statistical information also included in this report.

Real estate markets, especially those along the coast, have weakened and property values have been impacted negatively by the current economic operating environment.  Our primary service area, Horry County, is not immune to these pressures.  If prevailing economic conditions locally and nationally continue to decline, our business may be affected adversely.  A sustained economic downturn would likely contribute to reduced deposits, the deterioration of the quality of the loan portfolio and increased nonperforming loans which could result in a net loss of earnings, an increase in the provision for loan losses and an increase in loan charge offs, all of which could have a material adverse effect on our financial condition and results of operations.

Critical Accounting Policies

We have adopted various accounting policies, which govern the application of accounting principles generally accepted in the United States in the preparation of our financial statements.  Our significant accounting policies are described in the footnotes to the consolidated financial statements at December 31, 2009 as filed on our Annual Report on Form 10-K.  Certain accounting policies involve significant judgments and assumptions by us which have a material impact on the carrying value of certain assets and liabilities.  We consider these accounting policies to be critical accounting policies.  The judgments and assumptions we use are based on historical experience and other factors, which we believe to be reasonable under the circumstances.  Because of the nature of the judgments and assumptions we make, actual results could differ from these judgments and estimates which could have a material impact on our carrying values of assets and liabilities and our results of operations.

We believe the allowance for loan losses is a critical accounting policy that requires the most significant judgments and estimates used in preparation of our consolidated financial statements.  Refer to the portion of this discussion that addresses our allowance for loan losses for a description of our processes and methodology for determining our allowance for loan losses.

General Regulatory Matters

From time to time, various bills are introduced in the United States Congress and various regulations are proposed by appropriate agencies with respect to the regulation of financial institutions.  Certain of these proposals, if adopted, could significantly change the regulation of banks and the financial services industry.  We cannot predict whether any of these proposals will be adopted or, if adopted, how these proposals would affect us.

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Recent Legislative and Regulatory Initiatives to Address Financial and Economic Crises

Markets in the United States and elsewhere have experienced extreme volatility and disruption for more than 18 months.  These circumstances have exerted significant downward pressure on prices of equity securities and virtually all other asset classes, and have resulted in substantially increased market volatility, severely constrained credit and capital markets, particularly for financial institutions, and an overall loss of investor confidence.  Loan portfolio performances have deteriorated at many institutions resulting from, among other factors, a weak economy and a decline in the value of the collateral supporting their loans.  Dramatic slowdowns in the housing industry, due in part to falling home prices and increasing foreclosures and unemployment, have created strains on financial institutions.  Many borrowers are now unable to repay their loans, and the collateral securing these loans has, in some cases, declined below the loan balance.  In response to the challenges facing the financial services sector, several regulatory and governmental actions have recently been announced including:

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

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

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

·The Transaction Account Guarantee Program (“TAGP”), which provides unlimited deposit insurance coverage through December 30, 2010 for noninterest-bearing transaction accounts (typically business checking accounts) and certain funds swept into noninterest-bearing savings accounts.  Institutions participating in the TLGP pay a 15 to 25 basis points fee (annualized) on the balance of each covered account in excess of $250,000, while the extra deposit insurance is in place;

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

·On February 17, 2009 President Obama signed into law The American Recovery and Reinvestment Act of 2009 (“ARRA”), more commonly known as the economic stimulus or economic recovery package. ARRA includes a wide variety of programs intended to stimulate the economy and provide for extensive infrastructure, energy, health, and education needs.  In addition, ARRA imposes certain new executive compensation and corporate expenditure limits on all current and future TARP recipients, including our Company, that are in addition to those previously announced by the U.S. Treasury. These new limits are in place until the institution has repaid the U.S. Treasury, which is now permitted under ARRA without penalty and without the need to raise new capital, subject to the U.S. Treasury’s consultation with the recipient institution’s appropriate regulatory agency.

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·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 Legacy Loan Program, in which the primary purpose will be to facilitate the sale of troubled mortgage loans by eligible institutions, which include FDIC-insured federal or state banks and savings associations. Eligible assets may not be strictly limited to loans; however, what constitutes an eligible asset will be determined by participating banks, their primary regulators, the FDIC and the U.S. Treasury. Additionally, the Loan Program’s requirements and structure will be subject to notice and comment rulemaking, which may take some time to complete.

·The Securities Program, which will be administered by the U.S. Treasury, involves the creation of public-private investment funds to target investments in eligible residential mortgage-backed securities and commercial mortgage-backed securities issued before 2009 that originally were rated AAA or the equivalent by two or more nationally recognized statistical rating organizations, without regard to rating enhancements (collectively, “Legacy Securities”). Legacy Securities must be directly secured by actual mortgage loans, leases or other assets, and may be purchased only from financial institutions that meet TARP eligibility requirements.

·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.

The Bank is participating in the TAGP but will not participate in the DGP.

On March 6, 2009, the Company issued and sold to the U.S. Treasury (i) 12,895 shares of its Series T Preferred Stock and (ii) the CPP Warrant to purchase up to 91,714 shares of its common stock at an initial exercise price of $21.09 per share, for an aggregate purchase price of $12,895,000 in cash.

It is likely that further regulatory actions may arise as the Federal government continues to attempt to address the economic situation.  Governmental intervention and new regulations under these programs could materially and adversely affect our business, financial condition and results of operations.  The following discussion and analysis describes our performance in this challenging economic environment.  We encourage you to read this discussion and analysis in conjunction with our financial statements and the other statistical information included in this report.

CHANGES IN FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Net Interest Income

For the quarter ended March 31, 2010, net interest income was $4,994,000, an increase of $752,000, or 17.73%, over the same period in 2009.  Interest income from loans, including fees, was $6,859,000 for the three months ended March 31, 2010, an increase of $677,000, or 10.95%, over the three months ended March 31, 2009.  This increase was attributable to the increase in the average volume of our loan portfolio for the three months ended March 31, 2009 of $440,254,000 to $495,723,000 for the three months ended March 31, 2010, with only a slight decrease in the yield.  Interest income on taxable securities totaled $1,517,000 for the three months ended March 31, 2010, a decrease of $596,000 over the same period in 2009.  Our interest income on taxable securities decreased due to management’s decision to realize gains throughout 2009 and in turn, reinvesting this cash flow into our securities portfolio at lower yields.  Interest expense for the three months ended March 31, 2010 was $3,450,000, compared to $4,126,000 for the same period in 2009, a decrease of $676,000, or 16.38%.  This decrease is attributable to our decrease in the cost of funding from 2.76% as of March 31, 2009 to 2.02% as of March 31, 2010, particularly in the cost of our certificate of deposits (CDs).  The net interest margin realized on earning assets was 2.81% for the three months ended March 31, 2010, as compared to 2.71% for the three months ended March 31, 2009.  The interest rate spread increased from 2.58% at March 31, 2009 to 2.72% at March 31, 2010.

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Provision and Allowance for Loan Losses

The allowance is subject to examination and adequacy testing by regulatory agencies.  In addition, such regulatory agencies could require allowance adjustments based on information available to them at the time of their examination.

The allowance for loan losses was $7,819,000 and $5,496,000, or 1.62% and 1.23% of total loans, as of March 31, 2010 and 2009, respectively.  For the three months ended March 31, 2010 and 2009, the provision was $1,812,000 and $1,523,000, respectively.  Nonperforming loans at March 31, 2010 totaled $21,376,000 compared to $23,138,000 at December 31, 2009.  At March 31, 2010, loans totaling $45,029,000 were considered classified loans and loan totaling $62,861,000 were criticized.  We monitor and evaluate the adequacy of the allowance and loss exposure in the loan portfolio by considering the borrowers’ financial conditions and other factors in the unallocated component of the allowance.  Accordingly, we believe the allowance is adequate, based on our assessment of probable losses, and available facts and circumstances then prevailing.

The provision for loan losses is the charge to operating earnings that we believe is necessary to maintain the allowance for loan losses at an adequate level.  There are risks inherent in making all loans, including risks with respect to the period of time over which loans may be repaid, risks resulting from changes in economic and industry conditions, risks inherent in dealing with individual borrowers, and, in the case of a collateralized loan, risks resulting from uncertainties about the future value of the collateral.

We maintain an allowance for loan losses with the intention of estimating the probable losses in the loan portfolio. The provision for loan losses is based on management’s periodic evaluation of the composition of the loan portfolio, review of all past due and nonperforming loans, review of historical loan charge-offs and recoveries, evaluation of prevailing economic conditions, and other relevant factors.  In evaluating the loan portfolio, management identifies loans believed to be impaired.  Impaired loans are those not likely to be repaid as to principal and interest in accordance with the terms of the loan agreement.  Impaired loans are reviewed individually by management and the net present value of the collateral is estimated.  Reserves are maintained for each loan in which the principal balance of the loan exceeds the net present value of the collateral.  In addition to the specific allowance for individually reviewed loans, a general allowance for potential loan losses is established based on management’s review of pools of loans with similar risk characteristics by application of a historical loss factor for each loan pool.  The final component of the allowance for loan losses incorporates management’s evaluation of current economic conditions and other risk factors which may impact the inherent losses in the loan portfolio.  These evaluations are highly subjective and require that a great degree of judgmental assumptions be made by management.  This component of the allowance for loan losses includes additional estimated reserves for trends in loan delinquencies, impaired loans, charge-offs and recoveries, and economic trends and conditions.

The downturn in the real estate market has resulted in an increase in loan delinquencies, defaults and foreclosures, and we believe these conditions will continue.  In some cases, this downturn has resulted in a significant impairment to the value of our collateral and our ability to sell the collateral upon foreclosure, and there is a risk that this trend will continue.  The real estate collateral in each case provides alternate sources of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended.  If real estate values continue to decline, it is also more likely that we would be required to increase our allowance for loan losses.

Thus, there is a risk that charge-offs in future periods could exceed the allowance for loan losses or that substantial additional increases in the allowance for loan losses could be required.  Additions to the allowance for loan losses would result in a decrease in our net income and, possibly, our capital.

Noninterest Income

Noninterest income during the three months ended March 31, 2010 was $1,117,000, an increase of $334,000, or 42.66%, over the same period in 2009.  The increase of $334,000 is largely a result of gains on sale of residential loans sold in the secondary market, which increased $124,000, or 100.81%, from $123,000 for the three months ended March 31, 2009 to $247,000 for the three months ended March 31, 2010.  This increase is a result of an increase of personnel in this area, which helped contribute to an increase in originations of mortgage loans held for sale from $7,240,000 for the first quarter of 2009 to $15,374,000 for the comparable period in 2010.  Brokerage commissions increased $68,000, or 485.71%, from $14,000 for the quarter ended March 31, 2009 to $82,000 for the quarter ended March 31, 2010.  This increase is due to an increase in personnel in this area.  In addition, income

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from cash value of life insurance increased $39,000, or 45.88%, to $124,000 for the quarter ended March 31, 2010 due to an increase in our investment in bank-owned life insurance of $600,000.  Also other income increased $67,000, or 191.43%, from $35,000 for the three months ended March 31, 2009 to $102,000 for the comparable period in 2010.  The increase in other income was the result of the sale of the guaranteed portion of SBA loans in the secondary market.

Noninterest Expense

Total noninterest expense for the three months ended March 31, 2010 was $4,341,000, an increase of $161,000, or 3.85%, over the three months ended March 31, 2009.  The primary basis for this rise was the increase in other operating expenses, which increased $91,000, or 13.40%, from $679,000 for the three months ended March 31, 2009 to $770,000 for the three months ended March 31, 2010.  This increase is attributable to an increase in our professional fees from $154,000 for the quarter ended March 31, 2009 to $213,000 for the comparable period in 2010 due to the increase in legal fees attributable to our foreclosure activity.  Salaries and employee benefits increased $72,000, or 3.03%, from $2,378,000 for the three months ended March 31, 2009 to $2,450,000 for the three months ended March 31, 2010.  Personnel expenses should not continue to increase during 2010 as management has taken action to cut expenses in this area.  In addition, the construction of the new operations center and a permanent location at Ocean Drive led to an increase in net occupancy expense of $22,000, or 7.59%, from $290,000 for the three months ended March 31, 2009 to $312,000 for the three months ended March 31, 2010, and also, an increase in furniture and equipment expense of $33,000, or 10.68%.  FDIC insurance premiums also increased $52,000, or 24.76%, from $210,000 for the three months ended March 31, 2009 to $262,000 for the three months ended March 31, 2010 due to an increase in deposits during 2009. There was also a $64,000 increase in our provision for losses on our other real estate owned due to decreases in the valuation of some of our foreclosed properties.  There were decreases in noninterest expenses as well.  Marketing expenses decreased $61,000 from $144,000 for the three months ended March 31, 2009 to $83,000 for the three months ended March 31, 2010.

Income Taxes

The income tax provision for the three months ended March 31, 2010 was $(17,000), as compared to $(239,000) for the same period in 2009.  The effective tax rates were 40.48% and 35.25% at March 31, 2010 and 2009, respectively.

Earnings Performance

During the first quarter of 2010, the bank continued to experience improvements in net interest income of $752,000, or 17.73%, over the comparable period in 2009.  The improvement in net interest income was a result of managing our interest rate spread by maintaining our yield on our earning assets while decreasing the bank’s cost of funds.  The bank’s cost of funding decreased 74 basis points from 2.76% for the quarter ended March 31, 2009 to 2.02% for the quarter ended March 31, 2010.  The bank also experienced an increase in noninterest income of $334,000, or 42.66%, due to employing additional personnel in our mortgage lending and brokerage services areas.  Management is also taking steps to better manage its noninterest expenses by reducing expenses, primarily in our marketing and salaries and employee benefits areas.  Although noninterest expenses went up marginally during the first quarter, we expect those expenses to decrease in 2010.  Non-performing assets, however, continue to be a problem for our bank due to poor economic conditions and the combination of our borrowers’ inability to repay and an increase in our loan portfolio required us to increase in our loan loss provision $289,000, or 18.98%.  As a result of the factors noted above, we experienced a net loss for the quarter of $25,000, which is an improvement of $222,000, or 92.89%, from the first quarter of 2009.  The above also resulted in a loss per share of $0.04 for the quarter ended March 31, 2010 compared to a loss per share of $0.13 for the quarter ended March 31, 2009.  We believe this should improve as economic conditions strengthen and interest rates begin to increase.

BALANCE SHEET REVIEW

Assets and Liabilities

During the quarter ended March 31, 2010, total assets increased $16,910,000, or 2.23%, when compared to December 31, 2009.  The primary reason for the increase in assets was due to an increase in securities available-for-sale of $16,008,000 during the quarter ended March 31, 2010.  Total deposits increased $21,902,000, or 3.79%, from the December 31, 2009 balance of $578,292,000.  Within the deposit area, interest-bearing deposits increased

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$17,770,000, or 3.25%, and noninterest-bearing deposits increased $4,132,000, or 13.05%, during the quarter ended March 31, 2010.

Investment Securities

Investment securities available-for-sale increased from $169,463,000 at December 31, 2009 to $185,471,000 at March 31, 2010.  This represents an increase of $16,008,000, or 9.45%.

Securities available-for-sale consisted of the following:

	Amortized		Gross Unrealized				Estimated
(Dollars in thousands)	Cost		Gains		Losses		Fair Value
March 31, 2010
Government-sponsored enterprises	$	33,838	$	231	$	37	$	34,032
Mortgage-backed securities	146,358		2,080		2,384		146,054
Obligations of state and local governments	5,160		245		20		5,385
Total	$	185,356	$	2,556	$	2,441	$	185,471
March 31, 2009
Government-sponsored enterprises	$	13,797	$	598	$	—	$	14,395
Mortgage-backed securities	164,739		3,582		1,080		167,241
Obligations of state and local governments	6,465		131		11		6,585
Total	$	185,001	$	4,311	$	1,091	$	188,221

The following is a summary of maturities of securities available-for-sale as of March 31, 2010.  The amortized cost and estimated fair values are based on the contractual maturity dates.  Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalty.

	Estimated
(Dollars in thousands)	Fair Value
Due in less than one year	$	419
Due after one year but within five years	6,413
Due after five years but within ten years	27,959
Due after ten years	150,680
Total	$	185,471

The following table shows gross unrealized losses and fair value, aggregated by investment category, and length of time that individual securities have been in a continuous unrealized loss position, at:

Securities Available for Sale

					March 31, 2010
	Less than				Twelve months
	twelve months				or more				Total
			Unrealized				Unrealized				Unrealized
(Dollars in thousands)	Fair value		losses		Fair value		losses		Fair value		losses
Government-sponsored enterprises	$	12,963	$	37	$	—	$	—	$	12,963	$	37
Mortgage-backed securities	46,652		2,275		1,165		109		47,817		2,384
Obligations of state and local governments	255		20		—		—		255		20
Total	$	59,870	$	2,332	$	1,165	$	109	$	61,035	$	2,441

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					March 31, 2009
	Less than				Twelve months
	twelve months				or more				Total
			Unrealized				Unrealized				Unrealized
(Dollars in thousands)	Fair value		losses		Fair value		losses		Fair value		losses
Government-sponsored enterprises	$	—	$	—	$	—	$	—	$	—	$	—
Mortgage-backed securities	35,477		730		1,735		350		37,212		1,080
Obligations of state and local governments	1,594		11		—		—		1,594		11
Total	$	37,071	$	741	$	1,735	$	350	$	38,806	$	1,091

At March 31, 2010, the Bank had two individual securities, or 0.63% of the security portfolio, that have been in an unrealized loss position for more than twelve months.  The Bank does not intend to sell these securities and it is more likely than not that the Bank will not be required to sell these securities before recovery of their amortized cost.  The Bank believes, based on industry analyst reports and credit ratings, that the deterioration in value is attributable to changes in market interest rates and is not in the credit quality of the issuer and therefore, these losses are not considered other-than-temporary.

At March 31, 2010 and 2009, investment securities with a book value of $137,547,000 and $138,501,000, respectively, and a market value of $139,004,000 and $141,715,000, respectively, were pledged to secure deposits.

Gross realized gains on sales of available-for-sale securities as of March 31, 2010 were $137,000 and gross realized losses were $58,000.

Loans

Net loans decreased $8,345,000, or 1.72%, from December 31, 2009 to March 31, 2010.  Balances within the major loans receivable categories as of March 31, 2010 and December 31, 2009, are as follows:

(Dollars in thousands)	March 31, 2010		December 31, 2009
Real estate – construction and land development	$	85,550	$	95,788
Real estate – other	306,698		305,561
Agricultural	12,474		10,338
Commercial and industrial	62,169		60,914
Consumer	15,522		15,871
Other, net	1,188		3,180
	$	483,601	$	491,652

Risk Elements in the Loan Portfolio

The following is a summary of risk elements in the loan portfolio:

	March 31,		December 31,
(Dollars in thousands)	2010		2009
Loans:     Nonaccrual loans	$	21,376	$	23,138
Loans over 90 days past due and still accruing interest	—		—
Other real estate owned	$	10,126	$	6,432
Loans identified by the internal review mechanism:
Criticized	$	45,029	$	35,521
Classified	$	62,861	$	49,631
Impaired loans	$	35,876	$	37,275

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The increases in our criticized and classified loans are due to weaknesses in the marketplace, particularly in the real estate sector.  The areas that have been impacted the most are our land development and loans secured by one-to-four family residential properties.  For further discussion on the increases in our criticized and classified loans, refer to management’s discussion on the methodology regarding the calculation of the Provision for Loan Losses under Item 2.

Activity in the Allowance for Loan Losses is as follows:

	Three months ended March 31,
(Dollars in thousands)	2010			2009
Balance, January 1	$	7,525		$	4,416
Provision for loan losses for the period	1,813			1,523
Less: Charge-offs	(1,665		)	(2,616		)
Plus: Recoveries	146			2,173
Balance, end of period	$	7,819		5,496
Gross loans outstanding, end of period	$	483,601		$	447,666
Allowance for Loan Losses to loans outstanding	1.62		%	1.23		%
Ratio of net charge-offs to average loans	0.31		%	0.10		%

Deposits

As of March 31, 2010, total deposits increased by $21,902,000, or 3.79%, from December 31, 2009.  The largest increase was in money market savings accounts, which increased $21,123,000 to $173,676,000 at March 31, 2010.  Expressed in percentages, noninterest-bearing deposits increased 13.05% and interest-bearing deposits increased 3.25%.

Balances within the major deposit categories as of March 31, 2010 and December 31, 2009 were as follows:

(Dollars in thousands)	March 31, 2010		December 31, 2009
Noninterest-bearing demand deposits	$	35,793	$	31,661
Interest-bearing demand deposits	41,089		41,354
Savings and money market deposits	180,889		159,176
Certificates of deposit	342,423		346,101
	$	600,194	$	578,292

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Advances from the Federal Home Loan Bank

Advances from the Federal Home Loan Bank consisted of the following at March 31, 2010:

(Dollars in thousands)

Date of Advance	Rate		Quarterly Payment		Maturity Date	Balance
May 18, 2000	6.49	%	$	76	May 24, 2010	$	4,600
March 19, 2001	0.27	%	3		March 22, 2011	5,000
January 17, 2002	0.25	%	4		January 17, 2012	5,000
July 23, 2002	3.81	%	50		July 23,2012	5,000
December 8, 2004	3.24	%	41		December 8, 2014	5,000
September 4, 2007	4.42	%	55		September 4, 2012	5,000
September 7, 2007	4.05	%	10		September 7, 2012	1,000
October 15, 2007	4.59	%	59		October 15, 2010	5,000
January 25, 2008	2.73	%	14		January 26, 2015	2,000
March 19, 2008	2.66	%	26		March 19, 2015	4,000
August 20, 2008	3.44	%	45		August 20, 2018	5,000
September 4, 2008	3.60	%	18		September 4,2018	2,000
September 4,2008	3.32	%	41		September 4,2018	5,000
September 8, 2008	3.25	%	41		September 10, 2018	5,000
September 8, 2008	3.45	%	43		September 10, 2018	5,000
September 18, 2008	2.95	%	37		September 18, 2018	5,000
October 10, 2008	2.63	%	33		October 10, 2018	5,000
December 18, 2008	2.63	%	32		October 18, 2013	5,000
January 22,2009	2.95	%	1		January 22, 2014	200
January 29, 2009	2.87	%	14		January 29, 2013	2,000
February 17,2009	1.94	%	2		March 16, 2011	500
February 20, 2009	2.93	%	14		February 20, 2013	2,000
March 2, 2009	2.90	%	21		March 4, 2013	3,000
March 5, 2009	2.56	%	6		April 13, 2012	1,000
March 17, 2009	2.56	%	3		March 19, 2012	500
March 20, 2009	3.05	%	15		March 20, 2014	2,000
April 8, 2009	2.86	%	14		April 8, 2013	2,000
April 14, 2009	2.65	%	13		April 15, 2013	2,000
April 20, 2009	2.95	%	22		April 21, 2014	3,000
April 21, 2009	2.55	%	13		April 22, 2013	2,000
April 27, 2009	2.95	%	15		April 28, 2014	2,000
May 1, 2009	2.60	%	13		May 1, 2013	2,000
May 8, 2009	3.00	%	22		May 8, 2014	3,000
August 20, 2009	3.86	%	50		August 20, 2019	5,000
October 1, 2009	2.89	%	21		October 1, 2014	3,000
			$	887		$	113,800

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Interest is payable quarterly except for the advances that are fixed rate credits in the amount of $44,800,000, on which interest is payable monthly.  Initially all advances bear interest at a fixed rate; however at a certain date for each of the advances, the Federal Home Loan Bank has the option to convert the rates to floating except for those advances that are fixed rate credits in the amount of $44,800,000.  Also on these dates, the Federal Home Loan Bank has the option to call the advances.  All advances are subject to early termination with two days notice.  As of March 31, 2010, $44,800,000 were fixed rate credits; $59,000,000 were convertible advances; and $10,000,000 were adjustable rate credits.

As collateral for the advances, we have pledged our portfolio of first mortgage loans on one-to-four family residential properties aggregating approximately $18,291,000 at March 31, 2010, as well as our commercial nonindustrial loans totaling approximately $4,010,000 at March 31, 2010.  We have also pledged our portfolio of home equity lines of credit aggregating approximately $6,099,000, our investment in Federal Home Loan Bank stock of $6,505,000, which is included in nonmarketable equity securities, and $88,002,000 of our securities portfolio.

Liquidity

We meet liquidity needs through scheduled maturities of loans and investments on the asset side and through pricing policies on the liability side for interest-bearing deposit accounts and borrowings from the Federal Home Loan Bank.  The level of liquidity is measured by the loans-to-total borrowed funds ratio, which was 66.27% at March 31, 2010 and 69.12% at December 31, 2009.

Unpledged securities available-for-sale, which totaled $46,468,000 at March 31, 2010, serve as a ready source of liquidity.  We also have lines of credit available with correspondent banks to purchase federal funds for periods from one to seven days.  At March 31, 2010, unused lines of credit totaled $21,000,000.  In addition, we have the ability to borrow additional funds from the Federal Home Loan Bank.  As of March 31, 2010, our unused line of credit with Federal Home Loan Bank was $10,462,000.

Capital Resources

Total shareholders’ equity decreased from $45,072,000 at December 31, 2009 to $44,412,000 at March 31, 2010. The decrease of $660,000 is primarily attributable to the change in fair market value on securities available-for-sale, which decreased $486,000, or 87.10%.  Shareholders’ equity was also negatively impacted by the quarterly payment of our dividends on our Series T Preferred Stock to the U.S. Treasury of $161,000.

Bank holding companies, such as us, and their banking subsidiaries are required by banking regulators to meet certain minimum levels of capital adequacy, which are expressed in the form of certain ratios.  Capital is separated into Tier 1 capital (essentially common shareholders’ equity less intangible assets) and Tier 2 capital (essentially the allowance for loan losses limited to 1.25% of risk-weighted assets).  The first two ratios, which are based on the degree of credit risk in a company’s assets, provide the weighting of assets based on assigned risk factors and include off-balance sheet items such as loan commitments and stand-by letters of credit.  The ratio of Tier 1 capital to risk-weighted assets must be at least 4.0% and the ratio of total capital (Tier 1 capital plus Tier 2 capital) to risk-weighted assets must be at least 8.0%.  The capital leverage ratio supplements the risk-based capital guidelines.  Banks and bank holding companies are required to maintain a minimum ratio of Tier 1 capital to adjusted quarterly average total assets of 3.0%.  At March 31, 2010, the bank was considered “well capitalized” and the holding company met or exceeded its applicable regulatory capital requirements.

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The following table summarizes our risk-based capital at March 31, 2010 for the Company and the Bank:

(Dollars in thousands)	Company			Bank
Shareholders’ equity	$	44,412		$	51,043
Less: unrealized gains on securities available-for-sale	72			72
Plus: qualifying trust preferred securities	6,000			—
Tier 1 capital	50,340			50,971
Plus: allowance for loan losses (1)	6,676			6,685
Plus: subordinated debentures	994			—
Total capital	58,010			57,656
Net risk-weighted assets	$	532,900		$	533,704
Risk-based capital ratios
Tier 1 capital (to risk-weighted assets)	9.45		%	9.55		%
Total capital (to risk-weighted assets)	10.89		%	10.80		%
Tier 1 capital (to total average assets)	6.50		%	6.59		%

(1) Limited to 1.25% of risk-weighted assets

Off-Balance Sheet Risk

Through our operations, 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.  At March 31, 2010, we had issued commitments to extend credit of $52,251,000 and standby letters of credit of $1,187,000 through various types of commercial lending arrangements.  At December 31, 2009, we had issued commitments to extend credit of $53,840,000 and standby letters of credit $1,137,000 through various types of commercial lending arrangements.

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, 2010:

			After One		After Three
			Through		Through				Greater
	Within One		Three		Twelve		Within One		Than
(Dollars in thousands)	Month		Months		Months		Year		One Year		Total
Unused commitments to extend credit	$	2,230	$	4,061	$	23,898	$	30,189	$	22,062	$	52,251
Standby letters of credit	301		120		442		863		324		1,187
Totals	$	2,531	$	4,181	$	24,340	$	31,052	$	22,386	$	53,438

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 the credit evaluation of the borrower.  Collateral varies but may include accounts receivable, inventory, property, plant and equipment, commercial and residential real estate.

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Item 4.  Controls and Procedures.

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

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

PART II - OTHER INFORMATION

Item 1. Legal Proceedings.

There are no material legal proceedings to which the Company or any of its subsidiaries is a party or of which any of their property is the subject.

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

None.

Item 3. Defaults Upon Senior Securities.

None.

Item 4. [Removed and Reserved].

Item 5. Other Information

None.

Item 6. Exhibits

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

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

32            Section 1350 Certifications.

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SIGNATURE

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 14, 2010	By:	/s/ JAMES R. CLARKSON
		James R. Clarkson
		President and Chief Executive Officer
Date: May 14, 2010	By:	/s/ EDWARD L. LOEHR, JR.
		Edward L. Loehr, Jr.
		Chief Financial Officer

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EXHIBIT INDEX

Exhibit Number	Description
31.1	Rule 13a-14(a) Certification of Principal Executive Officer.
31.2	Rule 13a-14(a) Certification of the Principal Financial Officer.
32	Section 1350 Certifications.

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