HCSB Financial (HCFB) 10-Q 2012 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, 2012

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

(Issuer’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 preceding12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o

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 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 (do not check if 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 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: 3,738,337 shares of common stock, par value $.01 per share, were issued and outstanding as of May 14, 2012.

HCSB FINANCIAL CORPORATION

Index

	Page No.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets - March 31, 2012 and December 31, 2011	3
Condensed Consolidated Statements of Operations - Three months ended March 31, 2012 and 2011	4
Condensed Consolidated Statements of Comprehensive Income (Loss) — Three months ended March 31, 2012 and 2011	5
Condensed Consolidated Statements of Shareholders’ Equity - Three months ended March 31, 2012 and 2011	6
Condensed Consolidated Statements of Cash Flows - Three months ended March 31, 2012 and 2011	7
Notes to Unaudited Condensed Consolidated Financial Statements	8-40
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	41-57
Item 3. Quantitative and Qualitative Disclosures about Market Risk	57
Item 4. Controls and Procedures	58
PART II. OTHER INFORMATION
Item 1. Legal Proceedings	58
Item 1A. Risk Factors	58
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	58
Item 3. Defaults Upon Senior Securities	58
Item 4. Mine Safety Disclosures	58
Item 5. Other Information	58
Item 6. Exhibits	59

2

HCSB FINANCIAL CORPORATION

Condensed Consolidated Balance Sheets

	March 31,			December 31,
(Dollars in thousands, except shares)	2012			2011
	(Unaudited)			(Audited)
Assets:
Cash and cash equivalents:
Cash and due from banks	$	31,915		$	33,672
Securities available-for-sale	118,037			100,207
Nonmarketable equity securities	3,975			3,975
Total investment securities	122,012			104,182
Loans receivable	350,847			366,995
Less allowance for loan losses	(20,690		)	(21,178		)
Loans, net	330,157			345,817
Premises and equipment, net	22,281			22,514
Accrued interest receivable	2,836			2,776
Cash value of life insurance	10,377			10,285
Other real estate owned	15,998			15,665
Other assets	1,168			787
Total assets	$	536,744		$	535,698
Liabilities and Shareholders’ Equity
Liabilities:
Deposits:
Noninterest-bearing transaction accounts	$	37,459		$	37,029
Interest-bearing transaction accounts	45,737			44,989
Money market savings accounts	123,764			124,987
Other savings accounts	8,207			7,615
Time deposits $100 M and over	145,196			131,561
Other time deposits	129,428			144,672
Total deposits	489,791			490,853
Repurchase Agreements	8,465			7,492
Advances from the Federal Home Loan Bank	22,000			22,000
Subordinated debentures	12,062			12,062
Junior subordinated debentures	6,186			6,186
Accrued interest payable	1,273			1,015
Other liabilities	1,303			1,306
Total liabilities	541,080			540,914
Shareholders’ Equity
Preferred stock, $1,000 par value. Authorized 5,000,000 shares; issued and outstanding 12,895 at March 31, 2012 and December 31, 2011	12,409			12,355
Common stock, $.01 par value; 10,000,000 shares authorized, 3,738,337 shares issued and outstanding at March 31, 2012 and December 31, 2011	37			37
Capital surplus	30,224			30,224
Common stock warrants	1,012			1,012
Accumulated deficit	(46,343		)	(46,033		)
Accumulated other comprehensive loss	(1,675		)	(2,811		)
Total shareholders’ equity	(4,336		)	(5,216		)
Total liabilities and shareholders’ equity	$	536,744		$	535,698

See notes to condensed financial statements.

3

HCSB FINANCIAL CORPORATION

Condensed Consolidated Statements of Operations

(Unaudited)

	Three Months Ended
	March 31,
(Dollars in thousands, except per share amounts)	2012			2011
Interest income:
Loans, including fees	$	4,682		$	5,670
Investment securities:
Taxable	727			1,682
Tax-exempt	103			216
Nonmarketable equity securities	11			8
Other interest income	20			14
Total	5,543			7,590
Interest expense:
Certificates of deposit $100M and over	350			666
Other deposits	710			1,270
Other interest expense	561			1,045
Total	1,621			2,981
Net interest income	3,922			4,609
Provision for loan losses	1,318			8,550
Net interest income (loss) after provision for loan losses	2,604			(3,941		)
Noninterest income:
Service charges on deposit accounts	281			337
Credit life insurance commissions	6			7
Gain on sale of securities available-for-sale	72			1,815
Gain on sale of mortgage loans	50			155
Other fees and commissions	102			93
Brokerage commissions	37			67
Income from cash value of life insurance	115			116
Gain on sale of assets	170			—
Other operating income	38			25
Total	871			2,615
Noninterest expenses:
Salaries and employee benefits	1,660			1,974
Net occupancy expense	308			308
Furniture and equipment expense	301			328
Marketing expense	9			60
Prepayment penalties on FHLB advances	—			1,312
FDIC insurance premiums	391			523
Net cost of operations of other real estate owned	337			1,019
Other operating expenses	725			826
Total	3,731			6,350
Loss before income taxes	(256		)	(7,676		)
Income tax benefit	—			—
Net loss	$	(256	)	$	(7,676	)
Accretion of preferred stock to redemption value	54			50
Preferred dividends accrued	161			161
Net loss available to common shareholders	(471		)	(7,887		)
Basic loss per share	$	(0.13	)	$	(2.10	)
Diluted loss per share	$	(0.13	)	$	(2.10	)

See notes to condensed financial statements.

4

HCSB FINANCIAL CORPORATION

Condensed Consolidated Statements of Comprehensive Income (Loss)

(Unaudited)

	Three Months Ended
	March 31,
(Dollars in thousands)	2012			2011
Net loss	$	(256	)	$	(7,676	)
Other comprehensive income (loss):
Unrealized gains on securities available for sale:
Unrealized holding gains arising during the period, pretax	788			(335		)
Tax expense	—			124
Reclassification to realized gains	(72		)	(1,815		)
Tax expense	—			672
Write-down of deferred tax asset on AFS securities	420			—
Other comprehensive income	1,136			(1,354		)
Comprehensive income (loss)	$	880		$	(9,030	)

See notes to condensed financial statements.

5

HCSB FINANCIAL CORPORATION

Condensed Consolidated Statements of Shareholders’ Equity

For the Three Months ended March 31, 2012 and 2011

(Unaudited)

																				Accumulated
						Common					Nonvested						Retained			other
(Dollars in thousands except	Common Stock					Stock		Preferred Stock			Restricted			Capital			Earnings			comprehensive
share data)	Shares		Amount			Warrants		Shares	Amount		Stock			Surplus			(deficit)			income			Total
Balance, December 31, 2010	3,780,845		$	38		$	1,012	12,895	$	12,152	$	(564	)	$	30,787		$	(16,813	)	$	(113	)	$	26,499
Net loss for the period																	(7,676		)				(7,676		)
Other comprehensive income, net of tax																				(1,354		)	(1,354		)
Accretion of preferred stock to redemption value									50								(50		)				—
Termination of employee stock option plans	(42,508	)	(1		)						564			(563		)							—
Balance, March 31, 2011	3,738,337		$	37		$	1,012	12,895	$	12,202	$	—		$	30,224		$	(24,539	)	$	(1,467	)	$	17,469
Balance, December 31, 2011	3,738,337		$	37		$	1,012	12,895	$	12,355	$	—		$	30,224		$	(46,033	)	$	(2,811	)	$	(5,216	)
Net loss for the period																	(256		)				(256		)
Other comprehensive income, net of tax																				716			716
Valuation allowance on deferred tax asset on AFS securities																				420			420
Accretion of preferred stock to redemption value									54								(54		)				—
Balance, March 31, 2012	3,738,337		$	37		$	1,012	12,895	$	12,409	$	—		$	30,224		$	(46,343	)	$	(1,675	)	$	(4,336	)

See notes to condensed financial statements.

6

HCSB FINANCIAL CORPORATION

Condensed Consolidated Statements of Cash Flows

(Unaudited)

	Three Months Ended
(Dollars in thousands)	March 31, 2012			March 31, 2011
Cash flows from operating activities:
Net loss	$	(256	)	$	(7,676	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization	239			259
Provision for loan losses	1,318			8,550
Amortization less accretion on investments	(138		)	195
Amortization of deferred loan costs	22			6
Net gain on sale of securities available-for-sale	(72		)	(1,815		)
(Gain) loss on sale of other real estate owned	63			(33		)
Gain on sale of other assets	(170		)	—
Writedowns of other real estate owned	—			789
Increase (decrease) in interest payable	258			69
(Increase) decrease in interest receivable	(60		)	704
(Increase) decrease in other assets	(431		)	1,072
Income (net of mortality cost) on cash value of life insurance	(92		)	(96		)
Decrease in other liabilities	(3		)	(260		)
Net cash provided by operating activities	678			1,764
Cash flows from investing activities:
Decrease in loans to customers	12,583			10,060
Purchases of securities available-for-sale	(27,812		)	(514		)
Maturities and calls of securities available-for-sale	9,039			11,663
Proceeds from sale of other real estate owned	1,341			4,228
Proceeds from sales of securities available-for-sale	2,289			94,232
Proceeds from sale of other assets	220			—
Repurchases of nonmarketable equity securities	—			(910		)
Purchases of premises and equipment	(6		)	(118		)
Net cash provided (used) by investing activiities	(2,346		)	118,641
Cash flows from financing activities:
Net increase (decrease) in demand deposits and savings	547			(19,314		)
Net decrease in time deposits	(1,609		)	(49,190		)
Net decrease in FHLB borrowings	—			(56,000		)
Net increase in repurchase agreements	973			2,397
Net increase in fed funds purchased	—			330
Net cash provided (used) by financing activities	(89		)	(121,777		)
Net decrease in cash and cash equivalents	(1,757		)	(1,372		)
Cash and cash equivalents, beginning of period	33,672			19,562
Cash and cash equivalents, end of period	$	31,915		$	18,190
Cash paid during the period for:
Income taxes	$	—		$	—
Interest	$	1,363		$	2,912

See notes to condensed financial statements.

7

HCSB FINANCIAL CORPORATION

NOTE 1 — BASIS OF PRESENTATION

HCSB Financial Corporation (the “Company,” which may be referred to as “we,” “us,” or “our”) was incorporated on June 10, 1999 to become a holding company for Horry County State Bank (the “Bank”).  The Bank is a state chartered bank which commenced operations on January 4, 1988.  From our 11 branch locations, we offer a full range of deposit services, including checking accounts, savings accounts, certificates of deposit, money market accounts, and IRAs, as well as a broad range of non-deposit investment services.

HCSB Financial Trust I (the “Trust”) is a special purpose subsidiary organized for the sole purpose of issuing trust preferred securities.  The operations of the Trust have not been consolidated in these financial statements.

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, 2012 and for the interim periods ended March 31, 2012 and 2011 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, 2012 are not necessarily indicative of the results that may be expected for the year ending December 31, 2012.  The financial information as of December 31, 2011 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 2011 Annual Report.

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.

As of February, 2011, the Federal Reserve Bank of Richmond, the Company’s primary federal regulatory, has required the Company to defer dividend payments on the 12,895 shares of the Series T Preferred Stock issued to the U.S. Treasury in March 2009 pursuant to the CPP and interest payments on the $6,000,000 of trust preferred securities issued in December 2004.  Therefore, for each quarterly period beginning in February 2011, the Company notified the U.S. Treasury of our deferral of quarterly dividend payments on the 12,895 shares of Series T Preferred Stock and also informed the Trustee of the $6,000,000 of trust preferred securities of our deferral of a quarterly interest payments.  The amount of each of our quarterly interest payments was $161,000, and as of March 31, 2012, the Company had $806,000 accrued on our dividend payments due on our Series T Preferred Stock issued to the U.S. Treasury.  Because we have deferred these five payments, we are prohibited from paying any dividends on our common stock until all deferred payments have been made in full.  As a result of our financial condition and these restrictions on the Company, including the restrictions on our Bank’s ability to pay dividends to the Company, there was no stock dividend declared in 2010, 2011, or the first three months of 2012.

NOTE 2 — REGULATORY MATTERS AND GOING CONCERN CONSIDERATIONS

Consent Order with the Federal Deposit Insurance Corporation and South Carolina Board of Financial Institutions

On February 10, 2011, the Bank entered into a Consent Order (the “Consent Order”) with the FDIC and the South Carolina Board of Financial Institutions (the “State Board”).   The Consent Order conveys specific actions needed to address the Bank’s current financial condition, primarily related to capital planning, liquidity/funds management, policy and planning issues, management oversight, loan concentrations and classifications, and non-performing loans.  A summary of the requirements of the Consent Order and the Bank’s status on complying with the Consent Order is as follows:

Requirements of the Consent Order	Bank’s Compliance Status
Achieve and maintain, by July 10, 2011, Total Risk Based capital at least equal to 10% of risk-weighted assets and Tier 1 capital at least equal to 8% of total assets.	The Bank did not meet the capital ratios as specified in the Consent Order and, as a result, submitted a revised capital restoration plan to the FDIC on July 15, 2011. The revised capital restoration plan was determined by the FDIC to be insufficient and, as a result, we submitted

8

	a further revised capital restoration plan to the FDIC on September 30, 2011. We received the FDIC’s non-objection to the further revised capital restoration plan on December 6, 2011. The Bank is working diligently to increase its capital ratios in order to strengthen its balance sheet and satisfy the commitments required under the Consent Order. The Bank has engaged independent third parties to assist the Bank in its efforts to increase its capital ratios. In addition to continuing to search for additional capital, the Bank is also searching for a potential merger partner. While the Bank is pursuing both of these approaches simultaneously, though given the lack of a market for bank mergers, particularly in the Southeast, as a result of the current economic and regulatory climate, management believes that in the short-term the more realistic opportunity will be to raise additional capital.
Submit, by April 11, 2011, a written capital plan to the supervisory authorities.	We believe we have complied with this provision of the Consent Order.
Establish, by March 12, 2011, a plan to monitor compliance with the Consent Order, which shall be monitored by the Bank’s Directors’ Committee.	We believe we have complied with this provision of the Consent Order. The Directors’ Committee meets monthly and each meeting includes reviews and discussions of all areas required in the Consent Order.
Develop, by May 11, 2011, a written analysis and assessment of the Bank’s management and staffing needs.	We believe we have complied with this provision of the Consent Order. In 2011, the Bank engaged an independent third party to perform an assessment of the Bank’s staffing needs to ensure the Bank has an appropriate organizational structure with qualified management in place. The Board of Directors has reviewed all recommendations regarding the Bank’s organizational structure.
Notify the supervisory authorities in writing of the resignation or termination of any of the Bank’s directors or senior executive officers.	We believe we have complied with this provision of the Consent Order.
Eliminate, by March 12, 2011, by charge-off or collection, all assets or portions of assets classified “Loss” and 50% of those assets classified “Doubtful.”	The Bank is in full compliance with requirement to eliminate all loans classified “Loss” and reduce by 50% all assets classified “Doubtful” by March 13, 2011, and reduce all classified assets by specific percentages over a period of two years. Assets classified in the Report of Examination conducted as of June 30, 2010 have been reduced by 44.2%, which is slightly less than the target reduction of 45% by February 9, 2012 as stated in the Consent Order. Management has allocated additional resources to the handling of non-accrual loans, loans in liquidation, and the disposition of OREO.
Review and update, by April 11, 2011, its policy to ensure the adequacy of the Bank’s allowance for loan and lease losses, which must provide for a review of the Bank’s allowance for loan and lease losses at least once each calendar quarter.	We believe we have complied with this provision of the Consent Order.
Submit, by April 11, 2011, a written plan to the	We believe we have complied with this provision of the

9

supervisory authorities to reduce classified assets, which shall include, among other things, a reduction of the Bank’s risk exposure in relationships with assets in excess of $750,000 which are criticized as “Substandard” or “Doubtful”.	Consent Order. Assets classified in the Report of Examination conducted as of June 30, 2010 have been reduced by 44.2%, which is slightly less than the target reduction of 45% by February 9, 2012 as stated in the Consent Order.
Revise, by April 11, 2011, its policies and procedures for managing the Bank’s Adversely Classified Other Real Estate Owned.	We believe we have complied with this provision of the Consent Order.
Not extend any additional credit to any borrower who has a loan or other extension of credit from the Bank that has been charged-off or classified, in whole or in part, “Loss” or “Doubtful” and is uncollected. In addition, the Bank may not extend any additional credit to any borrower who has a loan or other extension of credit from the Bank that has been criticized, in whole or in part, “Substandard” and is uncollected, unless the Bank’s board of directors determines that failure to extend further credit to a particular borrower would be detrimental to the best interests of the Bank.	We believe we have complied with this provision of the Consent Order. In the second quarter of 2010, the Bank engaged the services of an independent firm to perform an extensive review of the Bank’s credit portfolio and help management implement a more comprehensive lending and collection policy and more enhanced loan review.
Perform, by April 11, 2011, a risk segmentation analysis with respect to the Bank’s Concentrations of Credit and develop a written plan to systematically reduce any segment of the portfolio that is an undue concentration of credit.	We believe we have complied with this provision of the Consent Order.
Review, by April 11, 2011 and annually thereafter, the Bank’s loan policies and procedures for adequacy and, based upon this review, make all appropriate revisions to the policies and procedures necessary to enhance the Bank’s lending functions and ensure their implementation.	We believe we have complied with this provision of the Consent Order. As noted above, the Bank engaged the services of an independent firm to perform an extensive review of the Bank’s credit portfolio and help management implement a more comprehensive lending and collection policy and more enhanced loan review.
Adopt, by May 11, 2011, an effective internal loan review and grading system to provide for the periodic review of the Bank’s loan portfolio in order to identify and categorize the Bank’s loans, and other extensions of credit which are carried on the Bank’s books as loans, on the basis of credit quality.	We believe we have complied with this provision of the Consent Order. As noted above, the Bank engaged the services of an independent firm to perform an extensive review of the Bank’s credit portfolio and help management implement a more comprehensive lending and collection policy and more enhanced loan review.
Review and update, by May 11, 2011, its written profit plan to ensure the Bank has a realistic, comprehensive budget for all categories of income and expense, which must address, at minimum, goals and strategies for improving and sustaining the earnings of the Bank, the major areas in and means by which the Bank will seek to improve the Bank’s operating performance, realistic and comprehensive budgets, a budget review process to monitor income and expenses of the Bank to compare actual figure with budgetary projections, the operating assumptions that form the basis for and adequately support major projected income and expense components of the plan, and coordination of the Bank’s loan, investment, and operating policies and budget and profit planning with the funds management policy.	We believe we have complied with this provision of the Consent Order. The Bank has engaged an independent third party to assist management with a strategic plan to help restructure its balance sheet, increase capital ratios, return to profitability and maintain adequate liquidity.
Review and update, by May 11, 2011, its written plan	We believe we have complied with this provision of the

10

addressing liquidity, contingent funding, and asset liability management.	Consent Order. In 2011, the Bank engaged an independent third party to assist management in its development of a strategic plan that achieves all requirements of the Consent Order. The strategic plan reflects the Bank’s plans to restructure its balance sheet, increase capital ratios, return to profitability, and maintain adequate liquidity. The Board of Directors has reviewed and adopted the Bank’s strategic plan.
Eliminate, by March 12, 2011, all violations of law and regulation or contraventions of policy set forth in the FDIC’s safety and soundness examination of the Bank in November 2009.	We believe we have complied with this provision of the Consent Order.
Not accept, renew, or rollover any brokered deposits unless it is in compliance with the requirements of 12 C.F.R. § 337.6(b).	Since entering into the Consent Order, the Bank has not accepted, renewed, or rolled-over any brokered deposits.
Limit asset growth to 5% per annum.	We believe we have complied with this provision of the Consent Order.
Not declare or pay any dividends or bonuses or make any distributions of interest, principal, or other sums on subordinated debentures without the prior approval of the supervisory authorities.	We believe we have complied with this provision of the Consent Order.
The Bank shall comply with the restrictions on the effective yields on deposits as described in 12 C.F.R. § 337.6.	We believe we have complied with this provision of the Consent Order.
Furnish, by March 12, 2011 and within 30 days of the end of each quarter thereafter, written progress reports to the supervisory authorities detailing the form and manner of any actions taken to secure compliance with the Consent Order.	We believe we have complied with this provision of the Consent Order, and we have submitted the required progress reports to the supervisory authorities.
Submit, by March 12, 2011, a written plan to the supervisory authorities for eliminating its reliance on brokered deposits.	We believe we have complied with the provision of the Consent Order.
Adopt, by April 11, 2011, an employee compensation plan after undertaking an independent review of compensation paid to all of the Bank’s senior executive officers.	We believe we have complied with the provision of the Consent Order.
Prepare and submit, by May 11, 2011, its written strategic plan to the supervisory authorities.	We believe we have complied with this provision of the Consent Order. In 2011, the Bank engaged an independent third party to assist management in its development of a strategic plan that achieves all requirements of the Consent Order. The Board of Directors has reviewed and adopted the Bank’s strategic plan.

There can be no assurance that the Bank will be able to comply fully with the provisions of the Consent Order, and the determination of the Bank’s compliance will be made by the FDIC and the State Board.  However, we believe we are currently in substantial compliance with the Consent Order except for the requirements to (i) achieve and maintain, by July 10, 2011, Total Risk Based capital at least equal to 10% of risk-weighted assets and Tier 1 capital at least equal to 8% of total assets, and (ii) eliminate, by March 12, 2011, by charge-off or collection, all assets or portions of assets classified “Loss” and 50% of those assets classified “Doubtful.”  Should we fail to comply with the capital requirements in the Consent Order, or suffer a continued deterioration in our financial condition, the

11

Bank may be subject to being placed into a federal conservatorship or receivership by the FDIC, with the FDIC appointed as conservator or receiver.  In addition, the supervisory authorities may amend the Consent Order based on the results of their ongoing examinations.

At March 31, 2012, the Bank was categorized as “significantly undercapitalized.”  Our losses during 2010 and 2011 have adversely impacted our capital.  As a result, we have been pursuing a plan through which we intend to achieve the capital requirements set forth under the Consent Order and have ceased to grow the Bank.  Our plan to increase our capital ratios includes, among other things, the sale of assets, reduction in total assets, reduction of overhead expenses, and reduction of dividends as the primary means of improving the Bank’s capital position, as well as raising additional capital at either the Bank or the holding company level and attempting to find a merger partner for the Company or the Bank.  Pursuant to the requirements under the Consent Order, we submitted our capital plan to the FDIC for review.  The FDIC directed us to revise the capital plan and, in addition, to develop a capital restoration plan, which we resubmitted in September 2011.  We received the FDIC’s non-objection to the revised capital restoration plan on December 6, 2011.

We anticipate that we will need to raise a material amount of capital to return the Bank to an adequate level of capitalization.  As a result, with the assistance of our financial advisors, we are currently exploring a number of strategic alternatives to strengthen the capital level of the Bank.  We note that there are no assurances that we will be able to raise this capital on a timely basis or at all.

We are also working diligently to improve asset quality and to reduce the Bank’s investment in commercial real estate loans as a percentage of Tier 1 capital.  The Company is reducing its reliance on brokered deposits and is committed to improving the Bank’s capital position.

Written Agreement

On May 9, 2011, the Company entered into the Written Agreement with the Federal Reserve Bank of Richmond.  The Written Agreement is designed to enhance the Company’s ability to act as a source of strength to the Bank.

The Written Agreement contains provisions similar to those in the Bank’s Consent Order.  Specifically, pursuant to the Written Agreement, the Company agreed, among other things, to seek the prior written approval of the Federal Reserve Bank of Richmond before undertaking any of the following activities:

·declaring or paying any dividends,

·directly or indirectly taking dividends or any other form of payment representing a reduction in capital from the Bank,

·making any distributions of interest, principal or other sums on subordinated debentures or trust preferred securities,

·directly or indirectly, incurring, increasing or guarantying any debt, and

·directly or indirectly, purchasing or redeeming any shares of its stock.

The Company also agreed to comply with certain notice provisions set forth in the Federal Deposit Insurance Act and Board of Governors’ Regulations in appointing any new director or senior executive officer, or changing the responsibilities of any senior executive officer so that the officer would assume a different senior executive officer position.  The Company is also required to comply with certain restrictions on indemnification and severance payments pursuant to the Federal Deposit Insurance Act and FDIC regulations.

We believe we are currently in substantial compliance with the Written Agreement.

12

Going Concern Considerations

The going concern assumption is a fundamental principle in the preparation of financial statements. It is the responsibility of management to assess the Company’s ability to continue as a going concern. In assessing this assumption, the Company has taken into account all available information about the future, which is at least, but is not limited to, twelve months from the balance sheet date of March 31, 2012. The Company has a history of profitable operations and sufficient sources of liquidity to meet its short-term and long-term funding needs. However, the Bank’s financial condition has suffered during 2010, 2011 and the first three months of 2012 from the extraordinary effects of what may ultimately be the worst economic downturn since the Great Depression.

The effects of the current economic environment are being felt across many industries, with financial services and residential real estate being particularly hard hit. The Bank, with a loan portfolio consisting of a concentration in commercial real estate loans, has seen a decline in the value of the collateral securing its portfolio as well as rapid deterioration in its borrowers’ cash flow and ability to repay their outstanding loans to the Bank. As a result, the Bank’s level of nonperforming assets increased substantially during 2010 and 2011.  However, the Bank’s nonperforming assets began to stabilize during the first three months of 2012, as the Bank’s nonperforming assets equaled $86,449,000, or 16.11% of assets, as of March 31, 2012 as compared to $86,894,000, or 16.22% of assets, as of December 31, 2011. However, our level of impaired loans increased to $81,141,000 at March 31, 2012 compared to $80,410,000 at December 31, 2011. For the three months ended March 31, 2012, the Bank recorded a $1,318,000 provision to increase the allowance for loan losses to a level which, in management’s best judgment, adequately reflected the increased risk inherent in the loan portfolio as of March 31, 2012. Nevertheless, given the current economic climate, management recognizes the possibility of further deterioration in the loan portfolio for the remainder of 2012.  For the three months ended March 31, 2012, we recorded net loan charge-offs of $1,806,000, or 0.50% of average loans, as compared to net loan charge-offs of $6,969,000, or 1.58% of average loans, for the three months ended March 31, 2011.

The Company and the Bank operate in a highly regulated industry and must plan for the liquidity needs of each entity separately. A variety of sources of liquidity are available to the Bank to meet its short-term and long-term funding needs. Although a number of these sources have been limited following execution of the Consent Order, management has prepared forecasts of these sources of funds and the Bank’s projected uses of funds during 2012 in an effort to ensure that the sources available are sufficient to meet the Bank’s projected liquidity needs for this period.

The Company relies on dividends from the Bank as its primary source of liquidity. The Company is a legal entity separate and distinct from the Bank. Various legal limitations restrict the Bank from lending or otherwise supplying funds to the Company to meet its obligations, including paying dividends. In addition, the terms of the Consent Order described below further limits the Bank’s ability to pay dividends to the Company to satisfy its funding needs.

Management believes the Bank’s liquidity sources are adequate to meet its needs for at least the next 12 months, but if the Bank is unable to meet its liquidity needs, then the Bank may be placed into a federal conservatorship or receivership by the FDIC, with the FDIC appointed conservator or receiver.

The Company will also need to raise substantial additional capital to increase capital levels to meet the standards set forth by the FDIC. As a result of the recent downturn in the financial markets, the availability of many sources of capital (principally to financial services companies) has become significantly restricted or has become increasingly costly as compared to the prevailing market rates prior to the volatility. Management cannot predict when or if the capital markets will return to more favorable conditions. Management is actively evaluating a number of capital sources, asset reductions and other balance sheet management strategies to ensure that the Bank’s projected level of regulatory capital can support its balance sheet.

There can be no assurances that the Company will be successful in its efforts to raise additional capital during 2012, or at all. An equity financing transaction would result in substantial dilution to the Company’s current shareholders and could adversely affect the market price of the Company’s common stock. It is difficult to predict if these efforts will be successful, either on a short-term or long-term basis. Should these efforts be unsuccessful, due to the regulatory restrictions which exist that restrict cash payments between the Bank and the Company, the Company may be unable to realize its assets and discharge its liabilities in the normal course of business.

As a result of management’s assessment of the Company’s ability to continue as a going concern, the accompanying consolidated financial statements for the Company have been prepared on a going concern basis, which

13

contemplates the realization of assets and the discharge of liabilities in the normal course of business for the foreseeable future, and does not include any adjustments to reflect the possible future effects on the recoverability or classification of assets.

NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Management’s Estimates - In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the balance sheet date and income and expenses for the period.  Actual results could differ significantly from those estimates.

Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses, including valuation allowances for impaired loans, and the carrying amount of real estate acquired in connection with foreclosures or in satisfaction of loans.  Management must also make estimates in determining the estimated useful lives and methods for depreciating premises and equipment.

While management uses available information to recognize losses on loans and foreclosed real estate, future additions to the allowance may be necessary based on changes in local economic conditions.  In addition, regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowances for losses on loans and foreclosed real estate.  Such agencies may require the Company to recognize additions to the allowances based on their judgments about information available to them at the time of their examination.  Because of these factors, it is reasonably possible that the allowances for losses on loans and foreclosed real estate may change materially in the near term.

Investment Securities - Investment securities available-for-sale by the Company are carried at amortized cost and adjusted to their estimated fair value for reporting purposes.  The unrealized gain or loss is recorded in shareholders’ equity net of the deferred tax effects.  Management does not actively trade securities classified as available-for-sale, but intends to hold these securities for an indefinite period of time and may sell them prior to maturity to achieve certain objectives.  Reductions in fair value considered by management to be other than temporary are reported as a realized loss and a reduction in the cost basis in the security.  The adjusted cost basis of securities available-for-sale is determined by specific identification and is used in computing the realized gain or loss from a sales transaction.

Nonmarketable Equity Securities - Nonmarketable equity securities include the Company’s investments in the stock of the Federal Home Loan Bank (the “FHLB”).  The FHLB stock is carried at cost because the stock has no quoted market value and no ready market exists.  Investment in FHLB stock is a condition of borrowing from the FHLB, and the stock is pledged to collateralize the borrowings.  Dividends received on FHLB stock are included as a separate component in interest income.

Loans Receivable - Loans receivable are stated at their unpaid principal balance.  Interest income on loans is computed based upon the unpaid principal balance.  Interest income is recorded in the period earned.

The accrual of interest income is generally discontinued when a loan becomes contractually 90 days past due as to principal or interest.  Management may elect to continue the accrual of interest when the estimated net realizable value of collateral exceeds the principal balance and accrued interest.

Loan origination, commitment fees, and certain direct loan origination costs (principally salaries and employee benefits) are deferred and amortized to income over the contractual life of the related loans or commitments, adjusted for prepayments, using the straight-line method.

Loans are defined as impaired when it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement.  All loans are subject to this criteria except for smaller balance homogeneous loans that are collectively evaluated for impairment and loans measured at fair value or at the lower of cost or fair value.  The Company considers its consumer installment portfolio, credit card loans, and home equity lines as such exceptions.  Therefore, loans within the real estate and commercial loan portfolios are reviewed individually.

Impairment of a loan is measured based on the present value of expected future cash flows discounted at the loan’s

14

NOTE 3 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - continued

effective interest rate or the fair value of the collateral if the loan is collateral dependent.  When management determines that a loan is impaired, the difference between the Company’s investment in the related loan and the present value of the expected future cash flows, or the fair value of the collateral, is charged off with a corresponding entry to the allowance for loan losses.  The accrual of interest is discontinued on an impaired loan when management determines the borrower may be unable to meet payments as they become due.

Concentrations of Credit Risk - Financial instruments, which potentially subject the Company to concentrations of credit risk, consist principally of loans receivable, investment securities, federal funds sold and amounts due from banks.

The Company makes loans to individuals and small businesses for various personal and commercial purposes primarily throughout Horry County in South Carolina and Columbus and Brunswick counties in North Carolina.  The Company’s loan portfolio is not concentrated in loans to any single borrower or a relatively small number of borrowers.  However, the loan portfolio does include a concentration in loans secured by residential and commercial real estate and commercial and industrial non-real estate loans.  These loans are especially susceptible to being adversely effected by the current economic downturn.  The current downturn in the real estate market has resulted in an increase in loan delinquencies, defaults and foreclosures, and we believe these trends are likely to continue, especially in the Myrtle Beach area.  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 commercial real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended.  If real estate values in our market areas continue to decline, it is also more likely that we would be required to increase our allowance for loan losses.

In addition to monitoring potential concentrations of loans to particular borrowers or groups of borrowers, industries and geographic regions, management monitors exposure to credit risk from concentrations of lending products and practices such as loans that subject borrowers to substantial payment increases (e.g. principal deferral periods, loans with initial interest-only periods, etc.), and loans with high loan-to-value ratios. Additionally, there are industry practices that could subject the Company to increased credit risk should economic conditions change over the course of a loan’s life.  For example, the Company makes variable rate loans and fixed rate principal-amortizing loans with maturities prior to the loan being fully paid (i.e. balloon payment loans).  These loans are underwritten and monitored to manage the associated risks.  Therefore, management believes that these particular practices do not subject the Company to unusual credit risk.

The Company’s investment portfolio consists principally of obligations of the United States, its agencies or its corporations and general obligation municipal securities.  In the opinion of management, there is no concentration of credit risk in its investment portfolio.  The Company places its deposits and correspondent accounts with and sells its federal funds to high quality institutions.  Management believes credit risk associated with correspondent accounts is not significant.

Allowance for Loan Losses - The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings.  Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed.  Subsequent recoveries, if any, are credited to the allowance.  The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experiences, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions.  This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.  Management’s judgments about the adequacy of the allowance are based on numerous assumptions about current events, which

15

NOTE 3 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - continued

management believes to be reasonable, but which may or may not prove to be accurate.  Thus, there can be no assurance that loan losses in future periods will not exceed the current allowance amount or that future increases in the allowance will not be required.  No assurance can be given that management’s ongoing evaluation of the loan portfolio in light of changing economic conditions and other relevant circumstances will not require significant future additions to the allowance, thus adversely affecting the operating results of the Company.

The allowance is subject to examination by regulatory agencies, which may consider such factors as the methodology used to determine adequacy and the size of the allowance relative to that of peer institutions, and other adequacy tests.  In addition, such regulatory agencies could require the Company to adjust its allowance based on information available to them at their examination.

The methodology used to determine the reserve for unfunded lending commitments, which is included in other liabilities, is inherently similar to that used to determine the allowance for loan losses adjusted for factors specific to binding commitments, including the probability of funding and historical loss ratio.

Premises, Furniture and Equipment - Premises, furniture and equipment are stated at cost less accumulated depreciation.  The provision for depreciation is computed by the straight-line method.  Rates of depreciation are generally based on the following estimated useful lives:  buildings - 40 years; furniture and equipment - three to 25 years.  The cost of assets sold or otherwise disposed of and the related accumulated depreciation is eliminated from the accounts, and the resulting gains or losses are reflected in the income statement.

Maintenance and repairs are charged to current expense as incurred, and the costs of major renewals and improvements are capitalized.

Other Real Estate Owned - Other real estate owned includes real estate acquired through foreclosure.  Other real estate owned is initially recorded at the lower of cost (principal balance of the former loan plus costs of improvements) or fair value, less estimated costs to sell.

Any write-downs at the dates of acquisition are charged to the allowance for loan losses.  Expenses to maintain such assets, subsequent write-downs, and gains and losses on disposal are included in other expenses.

Income and Expense Recognition - The accrual method of accounting is used for all significant categories of income and expense.  Immaterial amounts of insurance commissions and other miscellaneous fees are reported when received.

Income Taxes - Amounts provided for income taxes are based on income reported for financial statement purposes. Deferred income taxes are provided for the temporary differences between the financial reporting basis and the tax basis of the Company’s assets and liabilities.  Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized.  As of March 31, 2012, our gross deferred tax asset was $18,099,023.  However, as of March 31, 2012, due to the Company’s recent financial results, the uncertainty involved in projecting near-term profitability, and evaluation of appropriate tax planning strategies, management has provided a 100% valuation allowance for our deferred tax asset in the amount of $18,099,023.  This valuation allowance reflects management’s estimate that the deferred tax asset is not more-likely-than-not to be realized.

The Company believes that its income tax filing positions taken or expected to be taken in its tax returns will more likely than not be sustained upon audit by the taxing authorities and does not anticipate any adjustments that will result in a material adverse impact on the Company’s financial condition, results of operations, or cash flow.  Therefore, no reserves for uncertain income tax positions have been recorded.

Net Income (Loss) Per Common Share - Basic income (loss) per common share is calculated by dividing net income (loss) by the weighted-average number of shares outstanding during the year.  Diluted net income per share is computed based on net income divided by the weighted average number of common and potential common shares.  Retroactive recognition has been given for the effects of all stock dividends and splits in computing the weighted-average number of shares.  The only potential common share equivalents are those related to stock options

16

NOTE 3 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES —( continued)

and restricted stock awards.  Stock options that are anti-dilutive are excluded from the calculation of diluted net income per share.

Comprehensive Income - Accounting principles generally require recognized income, expenses, gains, and losses to be included in net income.  Although certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income.

Statements of Cash Flows- For purposes of reporting cash flows, the Company considers certain highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.  Cash equivalents include amounts due from banks, federal funds sold, and time deposits with other banks with maturities of three months or less.

Off-Balance-Sheet Financial Instruments - In the ordinary course of business, the Company enters into off-balance-sheet financial instruments consisting of commitments to extend credit and letters of credit.  These financial instruments are recorded in the financial statements when they become payable by the customer.

Recently Issued Accounting Pronouncements — The following is a summary of recent authoritative pronouncements that could impact the accounting, reporting, and / or disclosure of financial information by the Company.

ASU 2011-04 was issued in May 2011 to amend the Fair Value Measurement topic of the ASC by clarifying the application of existing fair value measurement and disclosure requirements and by changing particular principles or requirements for measuring fair value or for disclosing information about fair value measurements.  The amendments will be effective for the Company beginning January 1, 2012 but are not expected to have a material effect on the financial statements.

The Comprehensive Income topic of the ASC was amended in June 2011.  The amendment eliminates the option to present other comprehensive income as a part of the statement of changes in stockholders’ equity.  The amendment requires consecutive presentation of the statement of net income and other comprehensive income and requires an entity to present reclassification adjustments from other comprehensive income to net income on the face of the financial statements.  The amendments were applicable to the Company on January 1, 2012 and have been applied retrospectively.  In December 2011, the topic was further amended to defer the effective date of presenting reclassification adjustments from other comprehensive income to net income on the face of the financial statements.  Companies should continue to report reclassifications out of accumulated other comprehensive income consistent with the presentation requirements in effect prior to the amendments while FASB redeliberates future requirements.

17

NOTE 3 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - continued

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.

Risks and Uncertainties - In the normal course of its business, the Company encounters two significant types of risks: economic and regulatory.  There are three main components of economic risk:  interest rate risk, credit risk and market risk.  The Company is subject to interest rate risk to the degree that its interest-bearing liabilities mature or reprice at different speeds, or on different basis, than its interest-earning assets.  Credit risk is the risk of default on the Company’s loan portfolio that results from borrower’s inability or unwillingness to make contractually required payments.  Market risk reflects changes in the value of collateral underlying loans receivable and the valuation of real estate held by the Company.

The Company is subject to the regulations of various governmental agencies.  These regulations can and do change significantly from period to period.  The Company also undergoes periodic examinations by the regulatory agencies, which may subject it to further changes with respect to asset valuations, amounts of required loss allowances and operating restrictions from the regulators’ judgments based on information available to them at the time of their examination.

Additionally, the Company is subject to certain regulations due to our participation in the U.S. Treasury’s CPP.  Pursuant to the terms of the CPP Purchase Agreement between us and the Treasury, we adopted certain standards for executive compensation and corporate governance for the period during which the Treasury holds the equity issued pursuant to the CPP Purchase Agreement, including the common stock which may be issued pursuant to the CPP Warrant.  These standards generally apply to our named executive officers. The standards include (1) ensuring that incentive compensation for senior executives does not encourage unnecessary and excessive risks that threaten the value of the financial institution; (2) required clawback of any bonus or incentive compensation paid to a senior executive based on statements of earnings, gains or other criteria that are later proven to be materially inaccurate; (3) prohibition on making golden parachute payments to senior executives; (4) prohibition on providing tax gross-up provisions; and (5) agreement not to deduct for tax purposes executive compensation in excess of $500,000 for each senior executive.  In particular, the change to the deductibility limit on executive compensation will likely increase the overall cost of our compensation programs in future periods and may make it more difficult to attract suitable candidates to serve as executive officers.

Legislation that has been adopted after we closed on our sale of Series T Preferred Stock and the Warrant to the U.S. Treasury for $12.9 million pursuant to the CPP on March 6, 2009, or any legislation or regulations that may be implemented in the future, may have a material impact on the terms of our CPP transaction with the Treasury.   If we determine that any such legislation or any regulations, in whole or in part, alter the terms of our CPP transaction with the Treasury in ways that we believe are adverse to our ability to effectively manage our business, then it is possible that we may seek to unwind, in whole or in part, the CPP transaction by repurchasing some or all of the preferred stock and warrants that we sold to the Treasury pursuant to the CPP.  If we were to repurchase all or a portion of such preferred stock or warrants, then our capital levels could be materially reduced.

NOTE 4 — EARNINGS (LOSSES) PER SHARE

A reconciliation of the numerators and denominators used to calculate basic and diluted earnings (losses) per share is as follows:

	Three Months Ended March 31, 2012
	Income			Average Shares	Per Share
(Dollars in thousands, except share amounts)	(Numerator)			(Denominator)	Amount
Basic loss per share
Loss available to common shareholders	$	(471	)	3,738,337	$	(0.13	)
Effect of dilutive securities
Stock options	—			—
Diluted loss per share
Loss available to common shareholders plus assumed conversions	$	(471	)	3,738,337	$	(0.13	)

18

	Three Months Ended March 31, 2011
	Income			Average Shares	Per Share
(Dollars in thousands, except share amounts)	(Numerator)			(Denominator)	Amount
Basic loss per share
Loss available to common shareholders	$	(7,887	)	3,754,868	$	(2.10	)
Effect of dilutive securities
Stock options	—			—
Diluted loss per share
Loss available to common shareholders plus assumed conversions	$	(7,887	)	3,754,868	$	(2.10	)

NOTE 5 -  INVESTMENT PORTFOLIO

Investment securities available-for-sale increased from $100,207,000 at December 31, 2011 to $118,037,000 at March 31, 2012 as a result of management’s concerted effort to increase the yield on our earning assets while maintaining the Bank’s liquidity position.  This represents an increase of $17,830,000, or 17.79%, from December 31, 2011 to March 31, 2012.

Management classifies investment securities as either held-to-maturity or available-for-sale based on their intentions and the Company’s ability to hold them until maturity.  In determining such classifications, securities that management has the positive intent and the Company has the ability to hold until maturity are classified as held-to-maturity and carried at amortized cost.  All other securities are designated as available-for-sale and carried at estimated fair value with unrealized gains and losses included in shareholders’ equity on an after-tax basis.  As of March 31, 2012, all securities were classified as available-for-sale.

Securities available-for-sale consisted of the following:

	Amortized		Gross Unrealized				Estimated
(Dollars in thousands)	Cost		Gains		Losses		Fair Value
March 31, 2012
Government-sponsored enterprises	$	51,548	$	126	$	229	$	51,445
Mortgage-backed securities	59,023		279		2,485		56,817
Obligations of state and local governments	9,141		634		—		9,775
Total	$	119,712	$	1,039	$	2,714	$	118,037

	Amortized		Gross Unrealized				Estimated
(Dollars in thousands)	Cost		Gains		Losses		Fair Value
December 31, 2011
Government-sponsored enterprises	$	42,010	$	165	$	33	$	42,142
Mortgage-backed securities	50,706		177		3,677		47,206
Obligations of state and local governments	10,302		558		1		10,859
Total	$	103,018	$	900	$	3,711	$	100,207

The following is a summary of maturities of securities available-for-sale as of March 31, 2012.  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.

19

	Estimated
(Dollars in thousands)	Fair Value
Due in less than one year	$	—
Due after one year but within five years	—
Due after five years but within ten years	14,923
Due after ten years	103,114
Total	$	118,037

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 March 31, 2012 and December 31, 2011:

Securities Available for Sale

	March 31, 2012
	Less than twelve months				Twelve months or more				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
(Dollars in thousands)	Value		losses		Value		losses		Value		losses
Government-sponsored enterprises	$	32,765	$	229	$	—	$	—	$	32,765	$	229
Mortgage-backed securities	14,785		978		20,928		1,507		35,713		2,485
Obligations of state and local governments	—		—		—		—		—		—
Total	$	47,550	$	1,207	$	20,928	$	1,507	$	68,478	$	2,714

	December 31, 2011
	Less than twelve months				Twelve months or more				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
(Dollars in thousands)	Value		losses		Value		losses		Value		losses
Government-sponsored enterprises	$	11,967	$	33	$	—	$	—	$	11,967	$	33
Mortgage-backed securities	17,653		1,132		20,750		2,545		38,403		3,677
Obligations of state and local governments	1,576		1		—		—		1,576		1
Total	$	31,196	$	1,166	$	20,750	$	2,545	$	51,946	$	3,711

At March 31, 2012, the Bank had nine individual securities, or 17.73% 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, 2012 and 2011, investment securities with a book value of $41,617,000 and $106,749,000, respectively, and a market value of $41,717,000 and $105,570,000, respectively, were pledged to secure deposits.

Proceeds from sales of available-for-sale securities were $2,289,000 and $94,232,000 for the periods ended March 31, 2012 and March 31, 2011, respectively.  Gross realized gains on sales of available-for-sale securities as of March 31, 2012 were $72,000 and gross realized losses were $0.  As of March 31, 2011, gross realized gains on sales of available-for-sale securities were $1,993,000 and gross realized losses were $178,000.

20

NOTE 6 - LOAN PORTFOLIO

The Company has experienced a decline in its loan portfolio throughout 2012 of $16,148,000, as a result of a decline in loan demand in our marketplace, to $350,847,000 as of March 31, 2012.  Management has concentrated on improving the credit quality of the loan portfolio. The loan-to-deposit ratio is used to monitor a financial institution’s potential profitability and efficiency of asset distribution and utilization.  Generally, a higher loan-to-deposit ratio is indicative of higher interest income since loans typically yield a higher return than other interest-earning assets.  The loan-to-deposit ratios were 71.63% and 74.77% at March 31, 2012 and December 31, 2011, respectively.  The loans-to-total borrowed funds ratio was 65.15% and 68.14% at March 31, 2012 and December 31, 2011, respectively.

The following table sets forth the composition of the loan portfolio by category at March 31, 2012 and December 31, 2011 and highlights the Company’s general emphasis on mortgage lending.

	March 31,		December 31,
(Dollars in thousands)	2012		2011
Residential	$	159,552	$	163,502
Commercial Real Estate	132,309		142,485
Commercial	50,938		52,273
Consumer	8,048		8,735
Total gross loans	$	350,847	$	366,995

The primary component of our loan portfolio is loans collateralized by real estate, which made up approximately 83.18% of our loan portfolio at March 31, 2012.  These loans are secured generally by first or second mortgages on residential, agricultural or commercial property.  Commercial real estate loans declined $10.2 million, or 7.1%, as we continue to seek to reduce our commercial real estate loan portfolio to improve our credit quality and reduce our concentration in commercial real estate.  We anticipate decreasing our amount of commercial real estate loans throughout the remainder of 2012 in accordance with our strategic plan.  There are no foreign loans, and agricultural loans, as of March 31, 2012, were $9,719,000.  There are no significant concentrations of loans in any particular individuals or industry or group of related individuals or industries.

Provision and Allowance for Loan Losses

An allowance for loan losses is maintained at a level deemed appropriate by management to adequately provide for known and inherent losses in the loan portfolio.  The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings.  Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed.  Subsequent recoveries, if any, are credited to the allowance.

In evaluating the adequacy of the Company’s loan loss reserves, management identifies loans believed to be impaired. A loan is considered impaired when, based on current information and events, it is probable that we will be unable to collect the scheduled payments of principal or interest when due, according to the contractual 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 the composition of the loan portfolio with the purpose of identifying any concentrations of risk, and an analysis of historical loan charge-offs and recoveries. 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 internal factors such as changes in lending staff, loan policy and underwriting guidelines, and loan seasoning and quality, and external factors such as national and local economic trends and conditions.

21

NOTE 6 - LOAN PORTFOLIO (continued)

	Three months ended
	March 31,
(Dollars in thousands)	2012			2011
Balance, January 1	$	21,178		$	14,489
Provision for loan losses for the period	1,318			8,550
Net loans charged-off for the period	(1,806		)	(6,969		)
Balance, end of period	$	20,690		$	16,070

The following chart details the activity within our allowance for loan losses as of March 31, 2012 and December 31, 2011:

March 31, 2012				Commercial
(Dollars in thousands)	Commercial			Real Estate			Consumer			Residential			Total
Allowance for loan losses:
Beginning balance	$	3,239		$	10,240		$	103		$	7,596		$	21,178
Charge-offs	(284		)	(408		)	(20		)	(1,284		)	(1,996		)
Recoveries	88			92			4			6			190
Provisions	278			(104		)	10			1,134			1,318
Ending balance	$	3,321		$	9,820		$	97		$	7,452		$	20,690
Ending balances:
Individually evaluated for impairment	$	1,981		$	7,011		$	11		$	3,640		$	12,643
Collectively evaluated for impairment	$	1,340		$	2,809		$	86		$	3,812		$	8,047
Total	$	3,321		$	9,820		$	97		$	7,452		$	20,690
Loans receivable:
Ending balance - total	$	50,938		$	132,309		$	8,048		$	159,552		$	350,847
Ending balances:
Individually evaluated for impairment	$	7,238		$	47,490		$	149		$	26,264		$	81,141
Collectively evaluated for impairment	$	43,700		$	84,819		$	7,899		$	133,288		$	269,706

22

December 31, 2011				Commercial
(Dollars in thousands)	Commercial			Real Estate			Consumer			Residential			Total
Allowance for loan losses:
Beginning balance	$	1,822		$	7,237		$	131		$	5,299		$	14,489
Charge-offs	(3,484		)	(10,769		)	(193		)	(5,389		)	(19,835		)
Recoveries	136			543			29			545			1,253
Provisions	4,765			13,229			136			7,141			25,271
Ending balance	$	3,239		$	10,240		$	103		$	7,596		$	21,178
Ending balances:
Individually evaluated for impairment	$	1,827		$	6,605		$	—		$	4,191		$	12,623
Collectively evaluated for impairment	$	1,412		$	3,635		$	103		$	3,405		$	8,555
Total	$	3,239		$	10,240		$	103		$	7,596		$	21,178
Loans receivable:
Ending balance - total	$	52,273		$	142,485		$	8,735		$	163,502		$	366,995
Ending balances:
Individually evaluated for impairment	$	7,036		$	52,957		$	44		$	20,373		$	80,410
Collectively evaluated for impairment	$	45,237		$	89,528		$	8,691		$	143,129		$	286,585

23

The following chart summarizes delinquencies and nonaccruals, by portfolio class, as of March 31, 2012 and December 31, 2011.

(Dollars in thousands)

													Recorded
													Investments
	30-59 Days		60-89 Days		Nonaccrual		Total Past				Total Loans		90 Days and
March 31, 2012	Past Due		Past Due		Loans		Due		Current		Receivable		Accruing
Commercial	$	300	$	292	$	2,817	$	3,409	$	47,529	$	50,938	$	—
Commercial real estate:
Construction	1,714		201		20,693		22,608		38,618		61,226		—
Other	1,595		—		9,658		11,253		59,830		71,083		—
Real Estate:
Other	940		1,905		10,218		13,063		146,489		159,552		—
Consumer:
Other	136		51		82		269		6,916		7,185		—
Revolving credit	8		1		—		9		854		863		—
Total	$	4,693	$	2,450	$	43,468	$	50,611	$	300,236	$	350,847	$	—

													Recorded
													Investments
	30-59 Days		60-89 Days		Nonaccrual		Total Past				Total Loans		90 Days and
December 31, 2011	Past Due		Past Due		Loans		Due		Current		Receivable		Accruing
Commercial	$	743	$	117	$	2,076	$	2,936	$	49,261	$	52,273	$	76
Commercial real estate:
Construction	224		1,239		20,659		22,122		44,755		$	66,877	—
Other	—		341		9,342		9,683		65,925		$	75,608	—
Real Estate:
Residential	2,331		1,321		12,585		16,237		147,265		$	163,502	—
Consumer:
Other	159		58		20		237		7,594		$	7,831	—
Revolving credit	17		6		—		$	23	881		$	904	—
Total	$	3,474	$	3,082	$	44,682	$	51,238	$	315,681	$	366,995	$	76

24

NOTE 6 — LOAN PORTFOLIO - continued

Credit Risk Management

Another method used to monitor the loan portfolio is credit grading.  Credit risk entails both general risk, which is inherent in the process of lending, and risk that is specific to individual borrowers.  The management of credit risk involves the processes of loan underwriting and loan administration.  The Company seeks to manage credit risk through a strategy of making loans within the Company’s primary marketplace and within the Company’s limits of expertise.  Although management seeks to avoid concentrations of credit by loan type or industry through diversification, a substantial portion of the borrowers’ ability to honor the terms of their loans is dependent on the business and economic conditions in Horry County in South Carolina and Columbus and Brunswick Counties in North Carolina.  A continuation of the economic downturn or prolonged recession could result in a further deterioration of the quality of our loan portfolio and reduce our level of deposits, which in turn would have a negative impact on our business.  Additionally, since real estate is considered by the Company as the most desirable nonmonetary collateral, a significant portion of the Company’s loans are collateralized by real estate; however, the cash flow of the borrower or the business enterprise is generally considered as the primary source of repayment.  Generally, the value of real estate is not considered by the Company as the primary source of repayment for performing loans.  The Company also seeks to limit total exposure to individual and affiliated borrowers.  The Company seeks to manage risk specific to individual borrowers through the loan underwriting process and through an ongoing analysis of the borrower’s ability to service the debt as well as the value of the pledged collateral.

The Company’s loan officers and loan administration staff are charged with monitoring the Company’s loan portfolio and identifying changes in the economy or in a borrower’s circumstances which may affect the ability to repay the debt or the value of the pledged collateral.  In order to assess and monitor the degree of risk in the Company’s loan portfolio, several credit risk identification and monitoring processes are utilized.  The Company assesses credit risk initially through the assignment of a risk grade to each loan based upon an assessment of the borrower’s financial capacity to service the debt and the presence and value of any collateral.  Commercial loans are individually graded at origination and credit grades are reviewed on a regular basis in accordance with our loan policy.  Consumer loans are assigned a “pass” credit rating unless something within the loan warrants a specific classification grade.

Credit grading is adjusted during the life of the loan to reflect economic and individual changes having an impact on the borrowers’ abilities to honor the terms of their commitments.  Management uses the risk grades as a tool for identifying known and inherent losses in the loan portfolio and for determining the adequacy of the allowance for loan losses.

25

NOTE 6 — LOAN PORTFOLIO - continued

The following table summarizes management’s internal credit risk grades, by portfolio class, as of March 31, 2012 and December 31, 2011.

March 31, 2012			Commercial
(Dollars in thousands)	Residential		Real Estate		Commercial		Consumer		Total
Grade 1 - Minimal	$	—	$	���	$	2,033	$	901	$	2,934
Grade 2 - Modest	9,567		5,172		1,856		63		16,658
Grade 3 - Average	5,650		2,813		6,569		296		15,328
Grade 4 - Satisfactory	99,741		69,769		26,710		5,826		202,046
Grade 5 - Watch	7,025		1,438		1,353		390		10,206
Grade 6 - Special Mention	9,462		5,080		2,907		305		17,754
Grade 7 - Substandard	28,107		46,119		9,288		267		83,781
Grade 8 - Doubtful			1,918		222				2,140
Grade 9 - Loss	—		—		—		—		—
Total Loans	$	159,552	$	132,309	$	50,938	$	8,048	$	350,847

December 31, 2011			Commercial
(Dollars in thousands)	Residential		Real Estate		Commercial		Consumer		Total
Grade 1 - Minimal	$	—	$	45	$	2,261	$	1,058	$	3,364
Grade 2 - Modest	11,294		6,371		1,755		77		19,497
Grade 3 - Average	4,806		3,230		5,919		333		14,288
Grade 4 - Satisfactory	102,105		75,075		28,869		6,258		212,307
Grade 5 - Watch	3,624		2,001		1,569		464		7,658
Grade 6 - Special Mention	12,216		7,360		2,480		243		22,299
Grade 7 - Substandard	29,269		46,425		9,194		302		85,190
Grade 8 - Doubtful	188		1,978		226				2,392
Grade 9 - Loss	—		—		—		—		—
Total Loans	$	163,502	$	142,485	$	52,273	$	8,735	$	366,995

Loans graded one through four are considered “pass” credits.  As of March 31, 2012, approximately 67.54% of the loan portfolio had a credit grade of Prime, Good, Acceptable or Acceptable with Care.  For loans to qualify for this grade, they must be performing relatively close to expectations, with no significant departures from the intended source and timing of repayment.

Loans with a credit grade of “watch” and “special mention” are not considered classified; however, they are categorized as a watch list credit, and are considered potential problem loans.  This classification is utilized by us when we have an initial concern about the financial health of a borrower.  These loans are designated as such in order to be monitored more closely than other credits in our portfolio.  We then gather current financial information about the borrower and evaluate our current risk in the credit.  We will then either reclassify the loan as “substandard” or back to its original risk rating after a review of the information.  There are times when we may leave the loan on the watch list, if, in management’s opinion, there are risks that cannot be fully evaluated without the passage of time, and we determine to review the loan on a more regular basis.  Loans on the watch list are not considered problem loans until they are determined by management to be classified as substandard.  As of March 31, 2012, we had loans totaling $27,960,000 on the watch list.  Watch list loans are considered potential problem loans and are monitored as they may develop into problem loans in the future.

Loans graded “substandard” or greater are considered classified credits.  At March 31, 2012, classified loans totaled $85,921,000, with $76,144,000 being collateralized by real estate.  Classified credits are evaluated for impairment on a quarterly basis.

A loan is considered impaired when, based on current information and events, it is probable that we will be unable

26

to collect the scheduled payments of principal or interest when due, according to the contractual terms of the loan agreement.  Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due.  Impairment is measured on a loan-by-loan basis by calculating either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.  Any resultant shortfall is charged to provision for loan losses and is classified as a specific reserve.  When an impaired loan is ultimately charged-off, the charge-off is taken against the specific reserve.

At March 31, 2012, impaired loans totaled $81,141,000, all of which were valued on a nonrecurring basis at the lower of cost or market value of the underlying collateral.   Market values were obtained using independent appraisals, updated in accordance with our reappraisal policy, or other market data such as recent offers to the borrower.  At March 31, 2012, the recorded investment in impaired loans was $81,141,000 compared to $69,519,000 at March 31, 2011.

The following chart details our impaired loans, which includes TDRs totaling $55,643,000 and $55,105,000, by category as of March 31, 2012 and December 31, 2011, respectively:

			Unpaid				Average		Interest
March 31, 2012	Recorded-		Principal		Related		Recorded		Income
(Dollars in thousands)	Investment		Balance		Allowance		Investment		Recognized
With no related allowance recorded:
Commercial	$	2,160	$	2,160	$	—	$	2,158	$	18
Commercial real estate	14,289		14,289		—		13,610		120
Residential	11,200		11,200		—		11,764		113
Consumer	62		62		—		53		—
Total	$	27,711	$	27,711	$	—	$	27,585	$	251
With a related allowance recorded:
Commercial	$	5,078	$	5,188	$	1,981	$	5,097	$	43
Commercial real estate	33,201		35,748		7,011		35,596		152
Residential	15,064		15,302		3,640		15,915		88
Consumer	87		87		11		43		1
Total	$	53,430	$	56,325	$	12,643	$	56,651	$	284
Total
Commercial	$	7,238	$	7,348	$	1,981	$	7,255	$	61
Commercial real estate	47,490		50,037		7,011		49,206		272
Residential	26,264		26,502		3,640		27,679		201
Consumer	149		149		11		96		1
Total	$	81,141	$	84,036	$	12,643	$	84,236	$	535

27

			Unpaid					Average		Interest
December 31, 2011	Recorded-		Principal			Related		Recorded		Income
(Dollars in thousands)	Investment		Balance			Allowance		Investment		Recognized
With no related allowance recorded:
Commercial	$	2,140	$	2,155		$	—	$	1,529	$	63
Commercial real estate	12,820		12,931			—		14,238		441
Residential	11,297		12,329			—		9,711		457
Consumer	44		44			—		45		3
Total	$	26,301	$	27,459		$	—	$	25,523	$	964
With a related allowance recorded:
Commercial	$	4,896	$	5,005		$	1,827	$	3,573	$	195
Commercial real estate	32,912		35,444			6,605		30,273		383
Residential	16,301		16,527		��	4,191		15,583		320
Consumer	—		—			—		—		—
Total	$	54,109	$	56,976		$	12,623	$	49,429	$	898
Total
Commercial	$	7,036	$	7,160		$	1,827	$	5,102	$	258
Commercial real estate	45,732		48,375			6,605		44,511		824
Residential	27,598		28,856			4,191		25,294		777
Consumer	44		44			—		45		3
Total	$	80,410	$	84,435		$	12,623	$	74,952	$	1,862

TDRs are loans which have been restructured from their original contractual terms and include concessions that would not otherwise have been granted outside of the financial difficulty of the borrower.  We only restructure loans for borrowers in financial difficulty that have designed a viable business plan to fully pay off all obligations, including outstanding debt, interest and fees, either by generating additional income from the business or through liquidation of assets.  Generally, these loans are restructured to provide the borrower additional time to execute upon their plans.

With respect to restructured loans, we grant concessions by (1) reduction of the stated interest rate for the remaining original life of the debt, or (2) extension of the maturity date at a stated interest rate lower than the current market rate for new debt with similar risk.  We do not generally grant concessions through forgiveness of principal or accrued interest.  Restructured loans where a concession has been granted through extension of the maturity date generally include extension of payments in an interest only period, extension of payments with capitalized interest and extension of payments through a forbearance agreement.  These extended payment terms are also combined with a reduction of the stated interest rate in certain cases.

Success in restructuring loans has been mixed but it has proven to be a useful tool in certain situations to protect collateral values and allow certain borrowers additional time to execute upon defined business plans.  In situations where a TDR is unsuccessful and the borrower is unable to follow through with terms of the restricted agreement, the loan is placed on nonaccrual status and continues to be written down to the underlying collateral value.

Our policy with respect to accrual of interest on loans restructured in a TDR follows relevant supervisory guidance.  That is, if a borrower has demonstrated performance under the previous loan terms and shows capacity to perform under the restructured loan terms, continued accrual of interest at the restructured interest rate is likely.  If a borrower was materially delinquent on payments prior to the restructuring but shows capacity to meet the restructured loan terms, the loan will likely continue as nonaccrual going forward.  Lastly, if the borrower does not perform under the restructured terms, the loan is placed on nonaccrual status.

We will continue to closely monitor these loans and will cease accruing interest on them if management believes that the borrowers may not continue performing based on the restructured note terms.  If, after previously being classified as a TDR, a loan is restructured a second time, then that loan is automatically placed on nonaccrual status.  Our policy with respect to nonperforming loans requires the borrower to make a minimum of six consecutive payments in accordance with the loan terms before that loan can be placed back on accrual status.  Further, the

28

borrower must show capacity to continue performing into the future prior to restoration of accrual status.  To date, we have not restored any nonaccrual loan classified as a TDR to accrual status.

The following is a summary of information pertaining to our TDRs:

	March 31,		December 31,
(Dollars in thousands)	2012		2011
Nonperforming TDRs	$	32,957	$	30,582
Performing TDRs:
Commercial	4,141		4,178
Commercial real estate - construction	10,429		11,874
Residential	8,072		8,427
Consumer	44		44
Total performing TDRs	$	22,686	$	24,523
Total TDRs	$	55,643	$	55,105

The following table summarizes how loans that were considered TDRs during the first quarter and TDRs that have subsequently defaulted during the first quarter.  Defaulted loans are those loans that are greater than 29 days past due.

	For the quarter ended					For the quarter ended
	March 31, 2012					March 31, 2012
	TDRs that are in compliance with the terms of the agreement					TDRs that are susbequently defaulted
(Dollars in thousands except contracts)	Number of contracts	Pre- modification outstanding recorded investment		Post- modification outstanding recorded investment		Number of contracts	Pre- modification outstanding recorded investment		Post- modification outstanding recorded investment
Commercial real estate	1	$	38	$	38	1	$	740	$	740
Residential	2	561		561		1	208		208
Commercial and industrial	2	191		191		1	607		607
Total loans	5	$	790	$	790	3	$	1,555	$	1,555

All of the five modifications that were done during the first quarter of 2012 were term concessions.

29

NOTE 7 — OTHER REAL ESTATE OWNED

Transactions in other real estate owned for the periods ended March 31, 2012 and December 31, 2011:

	March 31,			December 31,
(Dollars in thousands)	2012			2011
Balance, beginning of year	$	15,665		$	16,891
Additions	1,737			12,040
Sales	(1,404		)	(11,023		)
Write-downs	—			(2,243		)
Balance, end of period	$	15,998		$	15,665

NOTE 8 — DEPOSITS

As of March 31, 2012, total deposits decreased by $1,062,000, or 0.22%, from December 31, 2011.  The largest decrease was in other time deposits, which decreased $15,244,000 from $144,672,000 at December 31, 2011, due to the maturity of a portion of our brokered CDs. Expressed in percentages, noninterest-bearing deposits increased 1.16% and interest-bearing deposits decreased 0.33%.

The adverse economic environment has also placed greater pressure on our deposits, and we have taken steps to decrease our reliance on brokered deposits, while at the same time the competition for local deposits among banks in our market has been increasing.  We generally obtain out-of-market time deposits of $100,000 or more through brokers with whom we maintain ongoing relationships.  However, due to the Consent Order, we may not accept, renew or roll over brokered deposits unless a waiver is granted by the FDIC.  As of March 31, 2012, we had brokered deposits of $57,708,000, representing 11.79% of our total deposits as compared to $75,586,000, representing 15.40% of our total deposits as of December 31, 2011. We must find other sources of liquidity to replace these deposits as they mature.  Secondary sources of liquidity may include proceeds from Federal Home Loan Bank advances, Qwickrate CDs, and federal funds lines of credit from correspondent banks.

Balances within the major deposit categories as of March 31, 2012 and December 31, 2011 are as follows:

	March 31,		December 31,
(Dollars in thousands)	2012		2011
Noninterest-bearing transaction accounts	$	37,459	$	37,029
Interest-bearing transaction accounts	45,737		44,989
Savings and money market savings accounts	131,971		132,602
Certificate of deposits	274,624		276,233
Total deposits	$	489,791	$	490,853

30

NOTE 9 — ADVANCES FROM THE FEDERAL HOME LOAN BANK

Advances from the FHLB consisted of the following at March 31, 2012:

	Interest		Loan
(Dollars in thousands)	Rate		Balances
Advances maturing on:
December 8, 2014	3.24	%	5,000
September 4, 2018	3.60	%	2,000
September 10, 2018	3.45	%	5,000
September 18, 2018	2.95	%	5,000
August 20, 2019	3.86	%	5,000
Total			$	22,000

Interest is payable quarterly except for the advances that are fixed rate credits in the amount of $5,000,000, 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 FHLB has the option to convert the rates to floating except for those advances that are fixed rate credits in the amount of $5,000,000.   Also on these dates, the FHLB has the option to call the advances.  All advances are subject to early termination with two days notice.  As of March 31, 2012, $5,000,000 were fixed rate credits and $17,000,000 were convertible advances.

At March 31, 2012, the Company had pledged as collateral our portfolio of first mortgage loans on one-to-four family residential properties aggregating approximately $14,485,000, our commercial real estate loans totaling approximately $21,528,000, our home equity lines of credit of $14,850,000, and our multifamily loans of $480,000.  We have also pledged our investment in FHLB stock of $3,789,000, which is included in nonmarketable equity securities, and $5,762,000 of our securities portfolio. The Company has $4,670,000 in excess borrowing capacity with the FHLB that is available if liquidity needs should arise. As a result of negative financial performance indicators, there is also a risk that the Bank’s ability to borrow from the FHLB could be curtailed or eliminated, although to date the Bank has not been denied advances from the FHLB or had to pledge additional collateral for its borrowings.

NOTE 10 — JUNIOR SUBORDINATED DEBENTURES

On December 21, 2004, HCSB Financial Trust I (the “Trust”), a non-consolidated subsidiary of the Company, issued and sold a total of 6,000 trust preferred securities, with $1,000 liquidation amount per capital security (the “Capital Securities”), to institutional buyers in a pooled trust preferred issue.  The Capital Securities, which are reported on the consolidated balance sheet as junior subordinated debentures, generated proceeds of $6 million.  The Trust loaned these proceeds to the Company to use for general corporate purposes.  The junior subordinated debentures qualify as Tier 1 capital under Federal Reserve Board guidelines, subject to limitations.  Debt issuance costs, net of accumulated amortization, from junior subordinated debentures totaled $83,111 and $86,777 at March 31, 2012 and 2011, respectively, and are included in other assets on the consolidated balance sheet.  Amortization of debt issuance costs from junior subordinated debentures totaled $917 for the periods ended March 31, 2012 and 2011.  Due to diminishing cash available at the holding company level, the Company has deferred interest payments in the amount of approximately $215,000 on the trust preferred securities since February 2011.

NOTE 11 — SUBORDINATED DEBENTURES

On July 31, 2010, the Company completed a private placement of subordinated promissory notes that totaled $12,062,011.  The notes bear interest at the rate of 9% per annum payable semiannually on April 5th and October 5th and are callable by the Company four years after the date of issuance and mature 10 years from the date of issuance.  After October 5, 2014 and until maturity, the notes bear interest at a rate equal to the current Prime Rate in effect, as published by the Wall Street Journal, plus 3%, provided, that the rate of interest shall not be less than 8% per annum or more than 12% per annum.  The subordinated notes have been structured to fully count as Tier 2 regulatory capital on a consolidated basis.

The Company was prohibited by the Federal Reserve Bank of Richmond from paying interest due on the subordinated notes for the payment period ended April 5, 2012.  In addition, the Federal Reserve Bank of Richmond may prohibit the Company from making interest payments on the subordinated notes in the future given the financial

31

condition of the Bank.

NOTE 12 — FAIR VALUE MEASUREMENTS

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.

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.

Repurchase Agreements — The carrying value of these instruments is a reasonable estimate of fair value.

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 at a floating rate.

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.

32

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

					Fair Value Measurements
					Quoted		Significant
					market		other		Significant
					price in		observable		unobservable
	Carrying		Estimated		active markets		inputs		inputs
(Dollars in thousands)	Amount		Fair Value		(Level 1)		(Level 2)		(Level 3)
March 31, 2012
Financial Assets:
Cash and due from banks	$	31,915	$	31,915	$	31,915	$	—	$	—
Investment securities available-for-sale	118,037		118,037		2,626		115,411		—
Nonmarketable equity securities	3,975		3,975		3,975		—		—
Loans (net)	330,157		331,289		—		—		331,289
Accrued interest receivable	2,836		2,836		2,836		—		—
Financial Liabilities:
Demand deposit, interest-bearing transaction, and savings accounts	215,167		215,167		—		215,167		—
Certificates of deposit	274,624		273,418		—		273,418		—
Repurchase agreements	8,465		8,465		—		8,465		—
Advances from the Federal Home Loan Bank	22,000		22,697		—		22,697		—
Subordinated debentures	12,062		12,062		—		—		12,062
Junior subordinated debentures	6,186		6,186		—		6,186		—
Accrued interest payable	1,273		1,273		1,273		—		—

	Notional		Estimated
	Amount		Fair Value
Off-Balance Sheet Financial Instruments:
Commitments to extend credit	$	31,411	N/A
Standby letters of credit	$	516	N/A

The fair value estimates are made at a specific point in time based on relevant market and other information about the financial instruments.  Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on current economic conditions, risk characteristics of various financial instruments, and such other factors.  These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision.  Changes in assumptions could significantly affect the estimates.

Generally accepted accounting principles 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).

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.  Accounting principles 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.  There are three levels of inputs that may be used to measure fair value:

33

NOTE 12 — FAIR VALUE MEASUREMENTS (continued)

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. Treasury, other U.S. Government and agency mortgage-backed debt securities that are highly liquid and are actively traded in over-the-counter markets.

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 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.  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.

Investment 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.

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 using estimated fair value methodologies.  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, 2012, substantially all of the total impaired loans were evaluated based on the fair value of the collateral because such loans were considered collateral dependent.  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.

34

NOTE 12 — FAIR VALUE MEASUREMENTS (continued)

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 less estimated costs to sell.  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 Measurements on a Recurring Basis

Assets and liabilities measured at fair value on a recurring basis are as follows as of March 31, 2012:

	Quoted market price in		Significant other		Significant unobservable
	active markets		observable inputs		inputs
(Dollars in thousands)	(Level 1)		(Level 2)		(Level 3)
Mortgage-backed securities	$	2,626	$	54,191	$	—
Government-sponsored agencies	$	—	$	51,445	$	—
Obligation of State & Local governments	$	—	$	9,775	$	—
Total	$	2,626	$	115,411	$	—

Assets and liabilities measured at fair value on a recurring basis are as follows as of December 31, 2011:

	Quoted market price in		Significant other		Significant unobservable
	active markets		observable inputs		inputs
(Dollars in thousands)	(Level 1)		(Level 2)		(Level 3)
Mortgage-backed securities	$	—	$	47,206	$	—
Government-sponsored agencies	$	—	$	42,142	$	—
Obligation of State & Local governments	$	1,576	$	9,283	$	—
Total	$	1,576	$	98,631	$	—

35

NOTE 12 — FAIR VALUE MEASUREMENTS (continued)

Assets and Liabilities Measurements on a Non-Recurring Basis

Assets and liabilities recorded at fair value on a non-recurring basis are as follows as of March 31, 2012: 

	Quoted market price in		Significant other		Significant unobservable
	active markets		observable inputs		inputs
(Dollars in thousands)	(Level 1)		(Level 2)		(Level 3)
Impaired loans			$	—	$	68,498
Other real estate owned	$	—	$	—	$	15,998
Total	$	—	$	—	$	84,496

Assets and liabilities recorded at fair value on a non-recurring basis are as follows as of December 31, 2011:

	Quoted market price in		Significant other		Significant unobservable
	active markets		observable inputs		inputs
(Dollars in thousands)	(Level 1)		(Level 2)		(Level 3)
Impaired loans	$	—	$	—	$	67,787
Other real estate owned	$	—	$	—	$	15,665
Total	$	—	$	—	$	83,452

Level 3 Valuation Methodologies

The fair value of impaired loans is estimated using one of several methods, including collateral value and discounted cash flows and, in rare cases, the market value of the note.  Those impaired loans not requiring an allowance represent loans for which the net present value of the expected cash flows or fair value of the collateral less costs to sell exceed the recorded investments in such loans.  At March 31, 2012, a majority of the total impaired loans were evaluated based on the fair value of the collateral.  When the fair value of the collateral is based on an executed sales contract with an independent third party, the Company records the impaired loans as nonrecurring Level 1.  If the collateral is based on another observable market price or a current appraised value, the Company records the impaired loans as nonrecurring Level 2.  When an appraised value is not available or the Company 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.  Impaired loans can be evaluated for impairment using the present value of expected future cash flows discounted at the loan’s effective interest rate.  The measurement of impaired loans using future cash flows discounted at the loan’s effective interest rate rather than the market rate of interest is not a fair value measurement and is therefore excluded from fair value disclosure requirements.  Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly.

Foreclosed real estate is carried at fair value less estimated selling costs.  Fair value is generally based upon current appraisals, comparable sales, and other estimates of value obtained principally from independent sources, adjusted for selling costs.  When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the asset as nonrecurring Level 2.  However, the Company also considers other factors or recent developments which could result in adjustments to the collateral value estimates indicated in the appraisals such as changes in absorption rates or market conditions from the time of valuation.  In situations where management adjustments are significant to the fair value measurements in its entirety, such measurements are classified as Level 3 within the valuation hierarchy.

36

The following table presents quantitative information about level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at March 31, 2012.

	March 31,		Valuation	Unobservable	Range
(Dollars in thousands)	2012		Techniques	Inputs	(Weighted Avg)
Impaired loans
Commercial	$	5,257	Appraised Value / Discounted Cash Flows	Appraisals and/or sales of comparable properties / Independent quotes	0% - 27% (4.93%)
Commercial real estate	40,479		Appraised Value / Discounted Cash Flows	Appraisals and/or sales of comparable properties / Independent quotes	0% - 92% (7.91%)
Residential	22,624		Appraised Value / Discounted Cash Flows	Appraisals and/or sales of comparable properties / Independent quotes	0% - 90% (13.22%)
Consumer	138		Appraised Value / Discounted Cash Flows	Appraisals and/or sales of comparable properties / Independent quotes	2% - 4% (2.43%)
Other real estate owned
Commercial real estate	12,654		Appraised Value / Discounted Cash Flows	Appraisals and/or sales of comparable properties / Independent quotes	0% - 50% (9.09%)
Residential	3,344		Appraised Value / Discounted Cash Flows	Appraisals and/or sales of comparable properties / Independent quotes	0%
	$	84,496

37

NOTE 13 — 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 that are not otherwise disclosed herein.  On May 8, 2012, the shareholders of the Company approved an amendment to the Company’s Articles of Incorporation to increase our authorized shares of common stock from 10,000,000 shares to 500,000,000 shares.

38

CAUTIONARY STATEMENT REGARDING FORWARD LOOKING STATEMENTS

This report, including information included or incorporated by reference in this document, 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 may relate to our financial condition, results of operation, plans, objectives, or future performance.  These 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,” “believe,” “continue,” “assume,” “intend,” “plan,” 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 from those anticipated in any forward-looking statements include, but are not limited to, those described under the heading “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2011, 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, but not limited to, declining real estate values, increasing interest rates, increasing unemployment, or 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;

·our ability to comply with the terms of our Consent Order and Written Agreement and potential regulatory actions if we fail to comply;

·our ability to maintain appropriate levels of capital and to comply with our higher individual minimum capital ratios;

·the adequacy of the level of our allowance for loan losses and the amount of loan loss provisions required in future periods;

·results of examinations by the FDIC and the State Board and other regulatory authorities, including the possibility that any such regulatory authorities may, among other things, require us to increase our allowance for loan losses or write-down assets;

·the high concentration of our real estate-based loans collateralized by real estate in a weak commercial real estate market;

·increased funding costs due to market illiquidity, increased competition for funding, and/or increased regulatory requirements with regard to funding;

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

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

·changes in political conditions or the legislative or regulatory environment, including but not limited to the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) and regulations adopted thereunder, changes in federal and/or state tax laws or interpretations thereof by taxing authorities, changes in laws, rules or regulations applicable to companies that have participated in the U.S. Treasury’s CPP and other governmental initiatives affecting the financial services industry;

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

·changes occurring in business conditions and inflation;

·changes in deposit flows;

·changes in technology;

·changes in monetary and tax policies;

·the rate of delinquencies and amount of loans charged-off;

·the rate of loan growth and the lack of seasoning of our loan portfolio;

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

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

·changes in monetary and tax policies, including confirmation of the income tax refund claims received by the Internal Revenue Service (“IRS”);

·changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board and the Financial Accounting Standards Board;

·our ability to retain our existing customers, including our deposit relationships;

·changes in the securities markets; and

39

·other risks and uncertainties detailed from time to time in our filings with the SEC.

These risks are exacerbated by the developments over the last four years in national and international financial markets, and we are unable to predict what effect these uncertain market conditions will continue to have on our Company.  Beginning in 2008 and continuing through the present, the capital and credit markets experienced unprecedented levels of extended volatility and disruption.  There can be no assurance that these unprecedented developments will not continue to materially and adversely affect our business, financial condition and results of operations.

All forward-looking statements in this report are based on information available to us as of the date of this report.  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.

40

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, 2012 as compared to the quarter ended March 31, 2011 and also analyzes our financial condition as of March 31, 2012 as compared to December 31, 2011.  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 our financial statements and the other statistical information included in our filings with the SEC.

Current Economic Environment

Economic conditions, competition, and the monetary and fiscal policies of the Federal government significantly affect most financial institutions, including our Bank. Lending and deposit activities and fee income generation are influenced by levels of business spending and investment, consumer income, consumer spending and savings, capital market activities, and competition among financial institutions, as well as customer preferences, interest rate conditions and prevailing market rates on competing products in our market areas.

The first three months of 2012 continue to reflect the tumultuous economic conditions which have negatively impacted our clients’ liquidity and credit quality. Concerns regarding increased credit losses from the weakening economy have negatively affected capital and earnings of most financial institutions, including our Bank. Financial institutions have experienced significant declines in the value of collateral for real estate loans and heightened credit losses, which have resulted in record levels of non-performing assets, charge-offs and foreclosures.

Liquidity in the debt markets remains low in spite of efforts by the U.S. Treasury and the Federal Reserve to inject capital into financial institutions. The federal funds rate set by the Federal Reserve has remained at 0.25% since December 2008, following a decline from 4.25% to 0.25% during 2008 through a series of seven rate reductions.

Many analysists believe the weak economic conditions may improve marginally during the remainder of 2012. Nevertheless, financial institutions likely will continue to experience heightened credit losses and higher levels of non-performing assets, charge-offs and foreclosures. In light of these conditions, financial institutions also face heightened levels of scrutiny from federal and state regulators. These factors negatively influenced, and likely will continue to negatively influence, earning asset yields at a time when the market for deposits is intensely competitive. As a result, financial institutions experienced, and are expected to continue to experience, pressure on credit costs, loan yields, deposit and other borrowing costs, liquidity, and capital.

Effects of the Current Economic Environment on our Bank

Like many financial institutions across the United States and in South Carolina, our operations have been adversely affected by the current economic crisis.  Beginning in 2008 and continuing in 2009, we recognized that acquisition, development and construction real estate projects were slowing, guarantors were becoming financially stressed, and increasing credit losses were surfacing.  During 2009 through 2011, delinquencies over 90 days increased, resulting in an increase in nonaccrual loans, indicating significant credit quality deterioration and probable losses.  In particular, loans secured by real estate (approximately 83.4%, 82.4%, and 81.7% of our loans had real estate as a

41

primary or secondary component of collateral as of December 31, 2009, 2010, and 2011, respectively), including acquisition, development and construction projects, demonstrated stress given reduced cash flows of individual borrowers, limited bank financing and credit availability, and slow property sales.  This deterioration manifested itself in our borrowers in the following ways: (1) the cash flows from underlying properties supporting the loans decreased (e.g., slower property sales for development type projects or lower occupancy rates or rental rates for operating properties); (2) cash flows from the borrowers themselves and guarantors were under pressure given illiquid personal balance sheets and drainage by investing additional personal capital in the projects; and (3) fair values of real estate related assets declined, resulting in lower cash proceeds from sales or fair values declining to the point that borrowers were no longer willing to sell the assets at such deep discounts.

The cumulative result of the above was a significant increase in the level of our nonperforming assets during 2009, 2010, and 2011.  As of December 31, 2011, our nonperforming assets equaled $86.9 million, or 16.22% of assets, as compared to $74.2 million, or 9.43% of assets, as of December 31, 2010, and $29.6 million, or 3.91% of assets, as of December 31, 2009.  The increase in our nonperforming assets led to the increase in our provision for loan losses and other noninterest expenses, as well as in the amount of other real estate we own, which includes real estate acquired through foreclosure.  For the year ended December 31, 2011, we recorded a provision for loan losses of $25.3 million and net loan charge-offs of $18.6 million, or 4.53% of average loans, as compared to a $23.1 million provision for loan losses and net loan charge-offs of $16.1 million, or 3.33% of average loans, for the year ended December 31, 2010, and a $10.4 million provision for loan losses and net loan charge-offs of $7.3 million, or 1.54% of average loans, for the year ended December 31, 2009.  Our amount of other real estate owned was $15.7 million at December 31, 2011, compared to $16.9 million at December 31, 2010 and $6.4 million at December 31, 2009.

However, the economy has shown signs of stabilizing, which is reflected by the slight improvement in the levels of our nonperforming assets during the first quarter of 2012.  Our nonperforming assets declined $445,000 to $86.4 million, or 16.11% of assets, at March 31, 2012 compared to $86.9 million at December 31, 2011.  The slight decrease in our nonperforming assets led to a decline in our provision for loan losses and other noninterest expenses.  For the three months ended March 31, 2012, we recorded a provision for loan losses of $1.3 million compared to $8.6 million during the first quarter of 2011 and net loan charge-offs of $1.8 million, or 0.50% of average loans, compared to net loan charge-offs of $7.0 million, or 1.58% of average loans, during the first quarter of 2011.  Also, our net interest margin increased to 3.14% for the three months ended March 31, 2012 compared to 2.63% for the comparable period in 2011 due to decline in our cost of funds throughout 2011 and 2012.  In total, the above produced an improvement in our net loss from $7.7 million for the three months ended March 31, 2011 to a net loss of $256,000 for the three months ended March 31, 2012.  We believe that we have now identified the majority of our problem assets, but we will continue to monitor our loan portfolio very carefully and work aggressively to reduce our problem assets.

42

Recent Regulatory Developments

Consent Order with the Federal Deposit Insurance Corporation and South Carolina Board of Financial Institutions

On February 10, 2011, the Bank entered into the Consent Order with the FDIC and the State Board.   The Consent Order conveys specific actions needed to address the Bank’s current financial condition, primarily related to capital planning, liquidity/funds management, policy and planning issues, management oversight, loan concentrations and classifications, and non-performing loans.  For additional information on the Consent Order, see Note 2-”Regulatory Matters and Going Concern Considerations — Consent Order with the Federal Deposit Insurance Corporation and South Carolina Board of Financial Institutions” to our Consolidated Financial Statements.

Written Agreement

On May 9, 2011, the Company entered into the Written Agreement with the Federal Reserve Bank of Richmond.  The Written Agreement is designed to enhance the Company’s ability to act as a source of strength to the Bank.  For additional information on the Written Agreement, see Note 2-”Regulatory Matters and Going Concern Considerations — Written Agreement with the Federal Reserve Bank of Richmond” to our Consolidated Financial Statements.

The Written Agreement contains provisions similar to those in the Bank’s Consent Order.  Specifically, pursuant to the Written Agreement, the Company agreed, among other things, to seek the prior written approval of the FRB before undertaking any of the following activities:

·declaring or paying any dividends,

·      directly or indirectly taking dividends or any other form of payment representing a reduction in capital from the Bank,

·making any distributions of interest, principal or other sums on subordinated debentures or trust preferred securities,

·directly or indirectly, incurring, increasing or guarantying any debt, and

·directly or indirectly, purchasing or redeeming any shares of its stock.

The Company also agreed to comply with certain notice provisions set forth in the Federal Deposit Insurance Act and Board of Governors’ Regulations in appointing any new director or senior executive officer, or changing the responsibilities of any senior executive officer so that the officer would assume a different senior executive officer position.  The Company is also required to comply with certain restrictions on indemnification and severance payments pursuant to the Federal Deposit Insurance Act and FDIC regulations.

Our Strategic Plan

As a response to the general economic downturn, and more recently, to the terms of the Consent Order and the Written Agreement, we adopted a new strategic plan, which includes not only a search for additional capital but also a search for a potential merger partner.  We are continuing to pursue both of these approaches simultaneously, though given the lack of a market for bank mergers, particularly in the Southeast, as a result of the current economic and regulatory climate, we believe that in the short-term our more realistic opportunity will be to raise additional capital.  We believe that approximately $7.5 million in capital would return the Bank to “adequately capitalized” and $17.5 million in capital would return the Bank to “well capitalized” under regulatory guidelines on a pro forma basis as of March 31, 2012.  If we continue to decrease the size of the Bank or return the Bank to profitability, then we could achieve these capital ratios with less additional capital.  However, if we suffer additional loan losses or losses in our other real estate owned portfolio, then we would need additional capital to achieve these ratios.  There are no assurances that we will be able to raise this capital on a timely basis or at all.  If we cannot meet the minimum capital requirements set forth under the Consent Order and return the Bank to a “well capitalized” designation, or if we suffer a continued deterioration in our financial condition, we may be placed into a federal conservatorship or receivership by the FDIC.

We have also been taking a number of steps to stabilize the Bank’s financial condition, including steps to reduce expenses, decrease the size of the Bank, and improve asset quality.  We believe that with these steps the Bank’s financial condition is stabilizing, which will help the Bank as it continues its efforts to secure a merger partner or raise capital.

43

Decreasing the Bank’s Assets.  We reduced the Bank’s total assets from $787.4 million at December 31, 2010 to $536.7 million at March 31, 2012, as we believe this approach, in addition to raising new capital and reducing expenses, represents the quickest path to restoring the Bank’s capital levels, returning the Bank to profitability, and facilitating compliance with the terms of the Consent Order and the Written Agreement.  We will continue to evaluate strategies for reducing the Bank’s overall asset size, but do not have current plans for any material additional decrease.

Enhancing the Credit Quality of the Loan Portfolio.  During 2010, 2011, and 2012, we aggressively increased our reserves for losses and focused substantial time and effort on managing the liquidation of nonperforming assets.  We are working to hold our borrowers accountable for the principal and interest owed.  We have initiated workout plans for problem loans that are designed to promptly collect on or rehabilitate those problem loans in an effort to convert them to earning assets, and we are pursuing foreclosure in certain instances.  Additionally, we are marketing our inventory of foreclosed real estate, but given that we would likely be required to accept discounted sales prices below appraised value if we tried to dispose of these assets quickly, we have been taking a more measured and deliberate approach with these sales efforts.

As a result of these efforts, we believe credit quality indicators generally showed signs of stabilization during the second half of 2011 and first three months of 2012.  Primarily as a result of the stabilization and improvement in our loan portfolio, we incurred a net loss of $7.6 million during the previous nine months ended March 31, 2012 compared to a net loss of $21.6 million during the first six months of 2011.

Although we have generally curtailed new lending while we focus on restoring the Bank’s financial condition, we remain focused on disciplined underwriting practices and prudent credit risk management.  We performed an expanded internal loan review during June and July 2010, hired an independent firm to perform an independent review of our loan portfolio in June 2010 and February and July 2011, and substantially revised our lending policy and credit procedures in early 2011.  We expanded the scope and depth of the initial loan review performed by our loan officers on all loans, and we incorporated more objective measurements in our internal loan analysis which more accurately addresses each borrower’s probability of default.

Reducing ADC and CRE Loan Concentrations.  As a result of the current economic environment and its impact on acquisition, development and construction and commercial real estate loans, we have effectively ceased making any new loans of these types while proactively decreasing the level of these types of loans in our existing portfolio.  We have worked to decrease our concentration by various means, including (i) through the normal sale of real estate by borrowers and their resulting repayments of the borrowed funds, (ii) transfers of problem loans to other real estate owned or charge-off if loss is considered confirmed, and (iii) encouraging customers with these types of loans to seek other financing when their loans mature.  During the period from December 31, 2009 to March 31, 2012, we were able to decrease the Bank’s total CRE loan portfolio from $199.8 million to $132.3 million, or 33.7%.  If the above initiatives do not reduce our concentrations to acceptable levels, we may seek avenues to sell a portion of these types of loans to outside investors.

Increasing Operating Earnings.  Management is focused on increasing our operating earnings by implementing strategies to improve the core profitability of our franchise.  These strategies change the mix of our earning assets while reducing the size of our balance sheet.  Specifically, we are reducing the level of nonperforming assets, controlling our operating expenses, improving our net interest margin and increasing fee income.  We plan to reduce the amount of our nonperforming assets, which may require us to record additional provisions for loan losses to accomplish within this timeframe.  Additionally, we are carefully evaluating all renewing loans in our portfolio to ensure that we are focusing our capital and resources on our best relationship customers.

The benefits of reducing the size of our balance sheet include more disciplined loan and deposit pricing going forward, which we believe will result in an improvement in our net interest margin.  Additionally, we will seek to expand our net interest margin as our current loans and deposits reprice and renew.  We typically seek to put floors, or minimum interest rates, in our variable rate loans at origination or renewal.

Focusing on Reducing Noninterest Expenses and Collecting Noninterest Income.  We continue to review our noninterest income and noninterest expense categories for potential revenue enhancements and expense reductions.  We have implemented several initiatives to help reduce expenses and manage our overhead at an efficient level.  To achieve this goal, management and the Board have already reduced compensation expenses by, among other things, eliminating over 50 employment positions, eliminating salary increases and bonuses of any type since December 31, 2009, eliminating employer matching contributions to officer and employee 401(k) accounts and reducing the

44

percentage of health and dental insurance benefits paid by the Bank for all of its employees.  In addition, certain of the Bank’s senior officers have accepted salary reductions and forfeited certain retirement benefits and incentive compensation.   Management and the Board also determined in 2011, after careful review of hourly customer traffic counts, to reduce the hours of service on Friday afternoons.  All of these steps served to enable the Bank to reduce its compensation expenses by over $2.9 million from 2009 to 2011.  In addition, the Board has eliminated monthly director fees, and several directors who had elected to defer their director fees until retirement have forfeited their deferred fees entirely.

We also reduced marketing expenses incurred by the Bank at a savings of $670,577 in 2011 as compared to 2009.  We closed two branches in January 2012, and we continue to analyze other noninterest expenses for further opportunities for reductions.  We believe that reduction of our level of nonperforming assets will also significantly reduce our operating costs, which is evidenced by the fact that expenses related to nonperforming assets in 2011 were more than $1.5 million above similar expenses incurred in 2008 prior to the downturn in the local real estate market and the resulting rise in the level of nonperforming assets.

At the same time, we are focused on enhancing revenues from noninterest income sources, such as service charges, residential mortgage loan originations and fees earned from fiduciary activities, as well as from minimizing waivers of fees for late charges on loans and fees charged for insufficient funds checks presented for payment.  We will continue to look for additional strategies to increase fee-based income as we expect that these efforts will help to bolster our noninterest income levels.

Recent Legislative Developments

In response to the challenges facing the financial services sector, beginning in 2008 a multitude of new regulatory and governmental actions have been announced, including the EESA, the TARP, the American Recovery and Reinvestment Act of 2009 (the “Recovery Act”), the Dodd—Frank Act and related economic recovery programs. Some of the more recent actions include those described in our Annual Report on Form 10-K for the year ended December 31, 2011 as filed with the SEC.

In addition, on April 5, 2012, the Jumpstart Our Business Startup Act (the “JOBS Act”) was signed into law. The JOBS Act is intended to stimulate economic growth by helping smaller and emerging growth companies access the U.S. capital markets. The JOBS Act amends various provisions of, and adds new sections to, the Securities Act of 1933 and the Securities Exchange Act of 1934, as well as provisions of the Sarbanes-Oxley Act of 2002. In addition, under the JOBS Act, a bank or bank holding company is permitted to have 2,000 shareholders before being subject to public company requirements and to deregister from the SEC when its shareholder count falls below 1,200. The SEC has been directed to issue rules implementing these amendments by April 5, 2013. We are currently evaluating the effects that these amendments, as well as the full JOBS Act, will have on the Company.

Although it is likely that further regulatory actions will arise as the Federal government attempts to address the economic situation, we cannot predict the effect that fiscal or monetary policies, economic control, or new federal or state legislation may have on our business and earnings in the future.

Changes in Financial Condition and Results of Operations

Earnings Performance

During the first quarter of 2012, the Bank has experienced declines in net interest income of $687,000, or 14.91% over the comparable period in 2011.  The decline in our net interest income was partially the result of the decline in the average loan balance from $439,990,000 at March 31, 2011 to $358,202,000 at March 31, 2012 and due to an increase in nonaccrual loans.  The Bank plans on improving our net interest income by employing more of our liquid assets into our securities portfolio, which is a higher yielding earning asset, and by diligently working to improve the quality of our loan portfolio.  The Bank had a decrease in noninterest expenses of $2,619,000, or 41.24%, from $6,350,000 during the first quarter of 2011 to $3,731,000 for the comparable period in 2012.  During the first quarter of 2011, the Bank incurred penalties of $1,312,000 in the prepayment of $56,000,000 in FHLB advances in an effort to reduce the asset size of the Bank.  The Bank experienced a reduction in the net cost associated with our other real estate owned of $682,000, or 66.93%, between the two periods due to the real estate values stabilizing in our marketplace.  The improvement in real estate values and the overall quality of the loan portfolio has resulted in a reduction in our provision for loan losses of $7,232,000, or 84.58%, from $8,550,000 during the first quarter of 2011 to $1,318,000 during the comparable period in 2012.  Because of the combination of the above factors, the Bank

45

experienced a net loss of $256,000, a decrease of $7,420,000, from the first quarter of 2011. The above resulted in a loss per share of $0.13 for the quarter ended March 31, 2012 as compared to loss per share of $2.10 for the comparable period in 2011.

Net Interest Income

For the quarter ended March 31, 2012, net interest income was $3,922,000, a decrease of $687,000, or 14.91%, over the same period in 2011.  Interest income from loans, including fees, was $4,682,000 for the three months ended March 31, 2012, a decrease of $988,000, or 17.43%, over the three months ended March 31, 2011.  This decrease was attributable to the decrease in the average volume of our loan portfolio from March 31, 2011 of $439,990,000 to $358,202,000 as of March 31, 2012 and due to the loss of interest on nonaccrual loans.  Interest income on taxable securities totaled $727,000, a decrease of $955,000, or 56.78%, over the first quarter of 2011.  Our interest income on taxable securities decreased due to management’s decision to decrease the portfolio during 2011 from an average balance of $257,374,000 as of March, 31, 2011 to $104,167,000 as of March 31, 2012 to help reduce the Bank’s assets.  Interest expense for the three months ended March 31, 2012 was $1,621,000, compared to $2,981,000 for the same period in 2011, a decrease of $1,360,000, or 45.62%.  This decrease is attributable to our decrease in the cost of funding, which decreased from 1.73% as of March 31, 2011 to 1.30% as of March 31, 2012, particularly in the cost of our savings and certificate of deposits (CDs).  The net interest margin realized on earning assets was 3.13% for the three months ended March 31, 2012, as compared to 2.59% for the three months ended March 31, 2011.  The interest rate spread increased from 2.63% at March 31, 2011 to 3.14% at March 31, 2012.

The following is a three month ending average balance sheet for March 31, 2012 and 2011:

	Three months ended					Three months ended
	March 31, 2012					March 31, 2011
	Average			Yield/
(Dollars in thousands)	Balance			Rate
ASSETS
Loans	$	358,202		5.26	%	$	439,990		5.23	%
Securities	104,167			3.20	%	257,374			2.99	%
Nonmarketable Equity Securities	3,975			1.11	%	6,426			0.50	%
Fed funds sold and other (incl. FHLB)	36,483			0.22	%	7,914			0.72	%
Total earning assets	$	502,827		4.43	%	$	711,704		4.33	%
Cash and due from banks	1,245					6,936
Allowance for loan losses	(21,068		)			(14,655		)
Premises & equipment	22,425					23,371
Other assets	29,744					39,676
Total assets	$	535,173				$	767,032
LIABILITIES AND STOCKHOLDERS’ EQUITY
Transaction accounts	$	44,673		0.22	%	$	42,761		0.28	%
Savings	131,169			0.42	%	194,670			0.86	%
CDs	276,604			1.31	%	325,791			1.86	%
Other borrowings	29,434			3.36	%	115,352			2.63	%
Subordinate debt	12,062			9.14	%	12,062			9.01	%
Junior subordinated debentures	6,186			2.67	%	6,186			1.84	%
Total interest-bearing liabilities	$	500,128		1.30	%	$	696,822		1.73	%
Non-interest deposits	37,260					41,150
Other liabilities	2,444					2,743
Stockholders’ equity	(4,659		)			26,317
Total liabilities & equity	$	535,173				$	767,032

46

Provision and Allowance for Loan Losses

The Company maintains an allowance for loan losses with the intention of estimating the probable losses in the loan portfolio. 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 $20,690,000 and $16,070,000, or 5.90% and 3.77% of total loans, as of March 31, 2012 and 2011, respectively.

The provision for loan losses is the charge to operating expenses that management believes is necessary to maintain an adequate level of allowance for loan losses. For the three months ended March 31, 2012 and 2011, the provision was $1,318,000 and $8,550,000, respectively.  During the quarter ended March 31, 2012, the Bank recorded charge-offs of $1,996,000 and recoveries of $190,000.  Impaired loans at March 31, 2012 totaled $81,141,000.  Loans totaling $85,921,000 were considered classified loans, and $27,960,000 were criticized as of March 31, 2012.

Primarily as a result of the current economic downturn, our reserve for loan losses has increased significantly over the past two years. The Bank has had a history of good credit performance as measured by historical delinquency and charge-off rates. However, these historically satisfactory rates have been under pressure as the economy continues its extended downturn with respect to real estate values.  Many of our borrowers are unable to repay their loans, and the collateral securing these loans has, in some cases, declined below the loan balance with the drop in real estate values, making it difficult for us to fully recover the principal and interest owed.  This deterioration manifested itself in our borrowers in the following ways: (i) the cash flows from underlying properties supporting the loans decreased (e.g., slower property sales for development type projects or lower occupancy rates or rental rates for operating properties); (ii) cash flows from the borrowers themselves and guarantors were under pressure given illiquid personal balance sheets and drainage by investing additional personal capital in the projects; and (iii) fair values of real estate related assets declined, resulting in lower cash proceeds from sales or fair values declining to the point that borrowers were no longer willing to sell the assets at such deep discounts.

We have expanded our internal loan review, which incorporates a comprehensive written analysis of all watch loans prepared by our lending officers and reviewed by our senior management team. We incorporated more objective measurements in our internal loan analysis which more accurately addresses each borrower’s probability of default.  Our expanded internal loan analysis confirmed that many of our borrowers are facing the increasing stress of declines in cash flows from the underlying properties and an increasing pressure of greatly reduced liquidity from having to invest personal funds into ongoing projects.

In evaluating the adequacy of the Company’s loan loss reserves, 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 the composition of the loan portfolio with the purpose of identifying any concentrations of risk, and an analysis of historical loan charge-offs and recoveries. 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 internal factors such as changes in lending staff, loan policy and underwriting guidelines, and loan seasoning and quality, and external factors such as national and local 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 an alternative source of repayment in the event of default by the borrower, and may deteriorate in value during the time the credit is extended. We determine the value of real estate collateral by using a current appraisal. When a real estate secured loan is added to the Bank’s watch list, we evaluate the adequacy of the existing appraisal. If the appraisal is adequate, no new appraisal will be needed, but if the appraisal is inadequate or out of date, a new appraisal will be ordered. For residential properties having a tax assessed value of $250,000 or greater, a new appraisal may also be required when title to a real estate parcel passes from a customer to the Bank. The Bank will use the new appraisal in determining the appropriate asset value

47

on the Bank’s financial statements. If real estate values continue to decline, it is also more likely that we would be required to increase our allowance for loan losses.

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.

Based on present information and an ongoing evaluation, management considers the allowance for loan losses to be adequate to meet presently known and inherent losses in the loan portfolio. Management’s judgment about the adequacy of the allowance is based upon a number of assumptions about future events which it believes to be reasonable but which may or may not be accurate. 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, especially considering the overall weakness in the commercial real estate market in our market areas. Additions to the allowance for loan losses would result in a decrease of our net income and, possibly, our capital.

Noninterest Income

Noninterest income during the three months ended March 31, 2012 was $871,000, a decrease of $1,744,000, or 66.69%, over the same period in 2011.  The decrease of $1,744,000 is largely a result of the realization of fewer gains on sale of securities, which decreased $1,743,000, or 96.03%, from $1,815,000 for the three months ended March 31, 2011 to $72,000 for the three months ended March 31, 2012.  There were also decreases in the income generated from the sale of residential mortgage loans in the secondary market of $105,000, or 67.74%, from $155,000 for the three months ended March 31, 2011 to $50,000 for the comparable period in 2012 due to the reduction in personnel in this area of the Bank.  There were also a reduction in the service charges on deposit accounts, which decreased $56,000, or 16.62%, to $281,000 for the three months ended March 31, 2012 due to the decline in the fee income generated from NSF fees.  These decreases were partially offset by increases in the gains on sale of assets.  The gains on sale of assets increased $170,000 for the three months ended March 31, 2012 due to the gains realized in the sale of our repossessions.

As previously reported, on July 21, 2010, the U.S. President signed into law the Dodd-Frank Act.  The Dodd-Frank Act calls for new limits on interchange transaction fees that banks receive from merchants via card networks like Visa, Inc. and MasterCard, Inc. when a customer uses a debit card.  In December 2010, the Federal Reserve Board issued a proposal to implement a provision in the Dodd-Frank Act that requires the Federal Reserve Board to set debit-card interchange fees. The proposed rule, if implemented in its current form, would result in a significant reduction in debit-card interchange revenue. Though the rule technically does not apply to institutions with less than $10 billion in assets, such as the Bank, there is concern that the price controls may harm community banks, which could be pressured by the marketplace to lower their own interchange rates.  Our ATM/Debit card fee income is included in other noninterest income and was $55,000 and $47,000 for the three months ended March 31, 2012 and 2011, respectively. We will continue to monitor the regulations as they are implemented and will review our policies, products and procedures to insure full compliance but also attempt to minimize any negative impact on our operations.

Noninterest Expense

Total noninterest expense for the three months ended March 31, 2012 was $3,731,000, a decrease of $2,619,000, or 41.24%, over the three months ended March 31, 2011.  The primary basis for the decline was the decrease in prepayment penalties on our FHLB borrowings of $1,312,000 during the quarter ended March 31, 2011 as a result of the prepayment of $56,000,000 of FHLB borrowings during 2011 due to management’s concerted effort to decrease the assets of the Bank to help improve its capital position.  The Bank also had a decrease in its net cost associated with the operation of our other real estate owned of $682,000, or 66.93%, from $1,019,000 for the three months ended March 31, 2011 to $337,000 for the comparable period in 2012.  During the first quarter of 2012, we had sales of our other real estate owned at approximately their book value, which resulted in fewer write-downs than in the first quarter of 2011.  There were also decreases in salaries and employee benefits of $314,000, or 15.91%, from $1,974,000 during the quarter ended March 31, 2011 to $1,660,000 for the same period in 2012. This was a result of a reduction in personnel during 2011.  Also, there was a reduction in our FDIC insurance premiums of $132,000 or 25.24%, from $523,000 for the period ended March 31, 2011 to $391,000 for the comparable period in 2012 due to the decrease in our deposits during 2011 and due to the change in the assessment calculation. The assessment base changed to an asset based calculation effective for the second quarter of 2011. There were also decreases in other

48

operating expenses of $101,000, or 12.23%, to $725,000 due to a reduction in general operating expenses of the Bank throughout 2011 and 2012.

Income Taxes

There was no income tax benefit for the three months ended March 31, 2012 and 2011.  During 2011, the Company provided for a full deferred tax valuation allowance based on our evaluation of the likelihood of our ability to utilize net operating losses in the near term.  Deferred tax assets are reduced by a valuation allowance, if based on the weight of evidence available, it is more likely than not that some portion or all of a deferred tax asset will not be realized.  Management has determined that it is more likely than not that the deferred tax asset related to continuing operations at March 31, 2012 will not be realized, and accordingly, has established a full valuation allowance in the amount of $18,099,023.

Assets and Liabilities

During the quarter ended March 31, 2012, total assets increased $1,046,000, or 0.20%, when compared to December 31, 2011.  The primary reason for the increase in assets was due to an increase in securities available-for-sale of $17,830,000 during the quarter ended March 31, 2012.  Total gross loans decreased during the quarter ended March 31, 2012 by $16,148,000, or 4.40%, to $350,847,000 due to pay-offs within our loan portfolio.  Total deposits decreased $1,062,000, or 0.22%, from the December 31, 2011 balance of $490,853,000, as a result of our decision to decrease the interest rates paid on our deposits and due to the maturity of a portion of our brokered CD portfolio.  Within the deposit area, interest-bearing deposits decreased $1,492,000, or 0.33%, and noninterest-bearing deposits increased $430,000, or 1.16%, during the quarter ended March 31, 2012.

Investment Securities

Investment securities available-for-sale increased from $100,207,000 at December 31, 2011 to $118,037,000 at March 31, 2012 as a result of management’s concerted effort to increase the Bank’s net interest margin and maintain its liquidity.  This represents an increase of $17,830,000, or 17.79%, from December 31, 2011 to March 31, 2012.

The following tables summarize the carrying value of investment securities as of the indicated dates and the weighted-average yields of those securities at March 31, 2012 and December 31, 2011.

Investment Securities Portfolio Composition

(Dollars in thousands)	March 31, 2012		December 31, 2011
Government-Sponsored Enterprises	$	51,445	$	42,142
Obligations of state and local governments	9,775		10,859
Mortgage-backed securities	56,817		47,206
Nonmarketable equity securities	3,975		3,975
Total securities	$	122,012	$	104,182

49

Investment Securities Portfolio Maturity Schedule

	Available-for-Sale
March 31, 2012	Fair
(Dollars in thousands)	Value		Yield
Government-Sponsored Enterprises due:
After five years but within ten years	$	11,029	2.96	%
After ten years	40,416		3.25	%
	51,445		3.19	%
Obligations of states and local government due:
After five years but within ten years	3,894		3.91	%
After ten years	5,881		4.38	%
	9,775		4.20	%
Mortgage-backed securities	56,817		2.58	%
Nonmarketable equity securities	3,975		1.23	%
	$	122,012	3.37	%

Loans

Net loans decreased $15,660,000, or 4.53%, from December 31, 2011 to March 31, 2012 as a result of management’s concerted effort to help improve the capital position of the Bank.  Balances within the major loans receivable categories are as follows:

	March 31,		December 31,
(Dollars in thousands)	2012		2011
Residential	$	159,552	$	163,502
Commercial Real Estate	132,309		142,485
Commercial	50,938		52,273
Consumer	8,048		8,735
Total gross loans	$	350,847	$	366,995

The following table presents the Company’s rate sensitivity of its loan portfolio at each of the time intervals indicated for the period ended March 31, 2012 and December 31, 2011 and may not be indicative of the Company’s rate sensitivity at other points in time:

	March 31,		December 31,
(Dollars in thousands)	2012		2011
One month or less	$	129,619	$	139,813
Over one through three months	15,980		10,365
Over three through twelve months	47,812		51,844
Over twelve months	157,436		164,973
Total	$	350,847	$	366,995

The rate characteristics of our loan portfolio consist of $99,045,000, or 28.23%, of floating interest rates and $251,802,000, or 71.77%, of fixed interest rates.

Risk Elements in the Loan Portfolio

The provision for loan losses is the charge to operating expenses that management believes is necessary to maintain an adequate level of allowance for loan losses.  The provision charged to expense was $1,318,000 for the three months ended March 31, 2012 compared to $8,550,000 for the comparable period in 2011.  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

50

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.

The Company maintains an allowance for loan losses with the intention of estimating the probable losses in the loan portfolio based on the information then available to management.  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 term 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 Company engaged the services of an independent firm in 2010 to assist management in achieving the desired improvement in the credit quality of the loan portfolio. The firm performed independent reviews of samples of the loan portfolio in July 2010 and in February 2011, and they performed another review in July, 2011. At the conclusion of each review, the firm reviews their findings and recommendations with management and subsequently provides a report to the Board of Directors. The firm assisted management with creation of a new and more thorough Credit Risk Management policy, which was adopted by the Board of Directors in April 2011. In addition, the firm has been instrumental in assisting management with an improved methodology of administering the Company’s watch loan process and reports. The firm has also assisted management with the implementation of a model and procedures designed to ascertain that the Company’s calculation of its ALLL is accurate and that the ALLL balance is adequate.

The Company has accomplished the reduction in the size of its loan portfolio through normal repayments of loans in accordance with contractual terms, charging off loans deemed uncollectible, the sale of loan participations and efforts designed to avoid funding new loans in sectors of the portfolio in which excessive concentrations already exist. For example, the Company does not presently consider for approval any request for a new loan to finance the purchase of or be collateralized by non-owner-occupied commercial real estate. The fact that loan demand has been reduced considerably within the Company’s market area has also assisted the Company in its efforts to reduce the size of its loan portfolio.

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

	March 31,		December 31,
(Dollars in thousands)	2012		2011
Loans: Nonaccrual loans	$	43,468	$	44,682
Loan identified by the internal review mechanism:
Criticized	$	27,960	$	29,957
Classified	$	85,921	$	87,582

Activity in the Allowance for Loan Losses is as follows:

51

	Three months ended
	March 31,
(Dollars in thousands)	2012			2011
Balance, January 1	$	21,178		$	14,489
Provision for loan losses for the period	1,318			8,550
Net loans charged-off for the period	(1,806		)	(6,969		)
Balance, end of period	$	20,690		$	16,070
Gross loans outstanding, end of period	$	350,847		$	412,259
Allowance for Loan Losses to loans outstanding	5.90		%	3.90		%

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.

Deposits

Our primary source of funds for loans and investments is our deposits.  As of March 31, 2012, total deposits had decreased by $1,062,000, or 0.22%, from December 31, 2011.  The largest decrease was in other time deposits, which decreased $15,244,000 to $129,428,000 at March 31, 2012.  Expressed in percentages, noninterest-bearing deposits increased 1.16% and interest-bearing deposits decreased 0.33%.

The adverse economic environment has also placed greater pressure on our deposits, and we have taken steps to decrease our reliance on brokered deposits, while at the same time the competition for local deposits among banks in our market has been increasing.  We generally obtain out-of-market time deposits of $100,000 or more through brokers with whom we maintain ongoing relationships.  However, due to the Consent Order, we may not accept, renew or roll over brokered deposits unless a waiver is granted by the FDIC.  As of March 31, 2012, we had brokered deposits of $57,708,000, representing 11.79% of our total deposits as compared to $87,767,000, representing 15.66% of our total deposits as of March 31, 2011. We must find other sources of liquidity to replace these deposits as they mature.  Secondary sources of liquidity may include proceeds from FHLB advances and federal funds lines of credit from correspondent banks.

The following table shows the average balance amounts and the average rates paid on deposits held by us for the three months ended March 31, 2012 and the year ended December 31, 2011.

	March 31, 2012				December 31, 2011
	Average				Average
(Dollars in thousands)	Balance		Rate		Balance		Rate
Noninterest-bearing demand	$	37,260	0.00	%	$	41,121	0.00	%
Interest-bearing transaction accounts	44,673		0.22	%	43,257		0.23	%
Money market and other savings accounts	131,169		0.42	%	162,966		0.60	%
Time deposits	276,604		1.31	%	288,675		1.70	%
Total deposits	$	489,706	0.87	%	$	536,019	1.12	%

At March 31, 2012 and December 31, 2011, the scheduled maturities of time deposits were as follows:

	March 31,		December 31,
(Dollars in thousands)	2012		2011
One month or less	$	14,459	$	16,770
Over one through three months	25,832		32,292
Over three through twelve months	126,629		115,708
Over twelve months	107,704		111,463
Total	$	274,624	$	276,233

52

Advances from the Federal Home Loan Bank

	Maximum				Weighted
	Outstanding				Average
	at any		Average		Interest
(Dollars in thousands)	Month End		Balance		Rate		Balance
March 31, 2012
Advances from Federal Home Loan Bank	$	22,000	$	22,000	3.39	%	$	22,000
December 31, 2011
Advances from Federal Home Loan Bank	$	112,200	$	49,618	3.39	%	$	22,000

Advances from the FHLB are collateralized by one-to-four family residential mortgage loans, certain commercial real estate loans, certain securities in the Bank’s investment portfolio and the Company’s investment in FHLB stock.  Although we expect to continue using FHLB advances as a secondary funding source, core deposits will continue to be our primary funding source.  We have $4,670,000 in excess with the FHLB that is available if liquidity needs should arise.  As a result of negative financial performance indicators, there is also a risk that the Bank’s ability to borrow from the FHLB could be curtailed or eliminated, although to date the Bank has not been denied advances from the FHLB or had to pledge additional collateral for its borrowings.

Liquidity

Liquidity measures our ability to meet current and future cash flow needs as they become due. The liquidity of a financial institution reflects its ability to accommodate possible outflows in deposit accounts, meet loan requests and commitments, maintain reserve requirements, pay operating expenses, provide funds for dividends and debt service, manage operations on an ongoing basis, capitalize on new business opportunities, and take advantage of interest rate market opportunities. The ability of a financial institution to meet its current financial obligations is a function of its balance sheet structure, its ability to liquidate assets, and its access to alternative sources of funds.

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 FHLB.  The level of liquidity is measured by the loans-to-total borrowed funds ratio, which was 65.15% at March 31, 2012 and 68.14% at December 31, 2011.

Unpledged securities available-for-sale, which totaled $76,320,000 at March 31, 2012, serve as a ready source of liquidity.  We also have a line of credit available with a correspondent bank to purchase federal funds for periods from one-to-fourteen day basis for general corporate purposes.  At March 31, 2012, unused lines of credit totaled $10,000,000, which the lender has required to be secured with securities as collateral.  The lender has reserved the right not to renew their respective lines.

The Bank’s greatest source of liquidity resides in its unpledged securities portfolio.  This source of liquidity may be adversely impacted by changing market conditions, reduced access to borrowing lines, or increased collateral pledge requirements imposed by lenders.  The Bank has implemented a plan to address these risks and strengthen its liquidity position.  To accomplish the goals of this liquidity plan, the Bank will maintain cash liquidity at a minimum of 4% of total outstanding deposits and borrowings.  In addition to cash liquidity, the Bank will also maintain a minimum of 15% on balance sheet liquidity.  These objectives have been established by extensive contingency funding stress testing and analytics that indicate these target minimum levels of liquidity to be appropriate and prudent.

Comprehensive weekly and quarterly liquidity analyses serve management as vital decision-making tools by providing summaries of anticipated changes in loans, investments, core deposits, and wholesale funds.  These internal funding reports provide management with the details critical to anticipate immediate and long-term cash requirements, such as expected deposit runoff, loan and securities paydowns and maturities.  These liquidity analyses act as a cash forecasting tool and are subject to certain assumptions based on past market and customer trends.  Through consideration of the information provided in these reports, management is better able to maximize our earning opportunities by wisely and purposefully choosing our immediate, and more critically, our long-term funding sources.

53

To better manage our liquidity position, management also stress tests our liquidity position on a semi-annual basis under two scenarios:  short-term crisis and a longer-term crisis.  In the short term crisis, our institution would be cut off from our normal funding along with the market in general.  In this scenario, the Bank would replenish our funding through the most likely sources of funding that would exist in the order of price efficiency.  In the longer term crisis, the Bank would be cut off from several of our normal sources of funding as our Bank’s financial situation deteriorated.  In this crisis, we would not be able to utilize our federal funds borrowing lines and brokered CDs and would be allowed to utilize our unpledged securities to raise funds in the reverse repurchase market or borrow from the FHLB.  On a quarterly basis, management monitors the market value of our securities portfolio to ensure its ability to be pledged if liquidity needs should arise.

We believe our liquidity sources are adequate to meet our needs for at least the next 12 months.  However, if we are unable to meet our liquidity needs, the Bank may be placed into a federal conservatorship or receivership by the FDIC, with the FDIC appointed conservator or receiver.

Off-Balance Sheet Risk

Through the operations of our Bank, we have made contractual commitments to extend credit in the ordinary course of our business activities.  These commitments are legally binding agreements to lend money to our customers at predetermined interest rates for a specified period of time.  At March 31, 2012, we had issued commitments to extend credit of $31,411,000 and standby letters of credit of $516,000 through various types of commercial lending arrangements. At December 31, 2011, we had issued commitments to extend credit of $28,799,000 and standby letters of credit totaled $516,000.

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, 2012:

			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	$	278	$	2,012	$	13,909	$	16,199	$	15,212	$	31,411
Standby letters of credit	—		170		254		424		92		516
Total	$	278	$	2,182	$	14,163	$	16,623	$	15,304	$	31,927

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.

Capital Resources

Total shareholders’ equity increased from a deficit of $5,216,000 at December 31, 2011 to a deficit of $4,336,000 at March 31, 2012. The increase of $880,000 is primarily attributable to the net unrealized gain in fair market value on securities available-for-sale, which increased $1,136,000, or 40.41%.  Shareholders’ equity was also negatively impacted by the net loss experienced during the first quarter of 2012 of $256,000.

The following table shows the annualized return on average assets (net income (loss) divided by average total assets), annualized return on average equity (net income (loss) divided by average equity), and average equity to average assets ratio (average equity divided by average total assets) for the three months ended March 31, 2012 and the year ended December 31, 2011.

54

	March 31,			December 31,
(Dollars in thousands)	2012			2011
Return on average assets	$	(0.05	)%	(4.63	)%
Return on average equity			(1)		(1)
Equity to assets ratio	(0.87		)%	1.83	%

(1) We believe return on average equity is irrelevant at this time due to our negative average equity position.

The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices.  The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum ratios of Tier 1 and total capital as a percentage of assets and off-balance sheet exposures, adjusted for risk weights ranging from 0% to 100%.  Tier 1 capital consists of common shareholders’ equity, excluding the unrealized gain or loss on securities available-for-sale, minus certain intangible assets.  Tier 2 capital consists of the allowance for loan losses subject to certain limitations.  Total capital for purposes of computing the capital ratios consists of the sum of Tier 1 and Tier 2 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.

To be considered “well-capitalized,” the Bank must maintain total risk-based capital of at least 10%, Tier 1 capital of at least 6%, and a leverage ratio of at least 5%.  To be considered “adequately capitalized” under these capital guidelines, the Bank must maintain a minimum total risk-based capital of 8%, with at least 4% being Tier 1 capital.  In addition, Bank must maintain a minimum Tier 1 leverage ratio of at least 4%.  Further, pursuant to the terms of the Consent Order with the FDIC and the State Board, the Bank must achieve and maintain Tier 1 capital at least equal to 8% and total risk-based capital at least equal to 10%.

If a bank is not well capitalized, it cannot accept brokered deposits without prior FDIC approval. In addition, a bank that is not well capitalized cannot offer an effective yield in excess of 75 basis points over interest paid on deposits of comparable size and maturity in such institution’s normal market area for deposits accepted from within its normal market area, or national rate paid on deposits of comparable size and maturity for deposits accepted outside the bank’s normal market area. Moreover, the FDIC generally prohibits a depository institution from making any capital distributions (including payment of a dividend) or paying any management fee to its parent holding company if the depository institution would thereafter be categorized as undercapitalized. Undercapitalized institutions are subject to growth limitations (an undercapitalized institution may not acquire another institution, establish additional branch offices or engage in any new line of business unless determined by the appropriate federal banking agency to be consistent with an accepted capital restoration plan, or unless the FDIC determines that the proposed action will further the purpose of prompt corrective action) and are required to submit a capital restoration plan. The agencies may not accept a capital restoration plan without determining, among other things, that the plan is based on realistic assumptions and is likely to succeed in restoring the depository institution’s capital. In addition, for a capital restoration plan to be acceptable, the depository institution’s parent holding company must guarantee that the institution will comply with the capital restoration plan. The aggregate liability of the parent holding company is limited to the lesser of an amount equal to 5.0% of the depository institution’s total assets at the time it became categorized as undercapitalized or the amount that is necessary (or would have been necessary) to bring the institution into compliance with all capital standards applicable with respect to such institution as of the time it fails to comply with the plan. If a depository institution fails to submit an acceptable plan, it is categorized as significantly undercapitalized.

Significantly undercapitalized categorized depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become categorized as adequately capitalized, requirements to reduce total assets, and cessation of receipt of deposits from correspondent banks. The appropriate federal banking agency may take any action authorized for a significantly undercapitalized institution if an undercapitalized institution fails to submit an acceptable capital restoration plan or fails in any material respect to

55

implement a plan accepted by the agency. A critically undercapitalized institution is subject to having a receiver or conservator appointed to manage its affairs and for loss of its charter to conduct banking activities.

An insured depository institution may not pay a management fee to a bank holding company controlling that institution or any other person having control of the institution if, after making the payment, the institution would be undercapitalized. In addition, an institution cannot make a capital distribution, such as a dividend or other distribution, that is in substance a distribution of capital to the owners of the institution if following such a distribution the institution would be undercapitalized. Thus, if payment of such a management fee or the making of such would cause a bank to become undercapitalized, it could not pay a management fee or dividend to the bank holding company.

As of March 31, 2012, the Company was categorized as “critically undercapitalized” and the Bank was categorized as “significantly undercapitalized.”  Our losses for 2010 and 2011 have adversely impacted our capital.  As a result, we have been pursuing a plan to increase our capital ratios in order to strengthen our balance sheet and satisfy the commitments required under the Consent Order.  In addition, the Consent Order required us to achieve and maintain by July 10, 2011, Total Risk Based capital at least equal to 10% of risk-weighted assets and Tier 1 capital at least equal to 8% of total average assets.  We did not meet that requirement and, as a result, submitted a revised capital restoration plan to the FDIC on July 15, 2011.  The revised capital restoration plan was determined by the FDIC to be insufficient and, as a result, we submitted a further revised capital restoration plan to the FDIC on September 30, 2011.  We received the FDIC’s non-objection to the further revised capital restoration plan on December 6, 2011.  If we continue to fail to meet the capital requirements in the Consent Order in a timely manner, then this would result in additional regulatory actions, which could ultimately lead to the Bank being taken into receivership by the FDIC. Our auditors have noted that the uncertainty of our ability to obtain sufficient capital raises substantial doubt about our ability to continue as a going concern. Please refer to Note 2 — “Regulatory Matters Going Concern Considerations” located in the notes to our unaudited condensed consolidated financial statements.

56

The following table summarizes the capital ratios and the regulatory minimum requirements for the Company and the Bank.

	Actual				Minimum Requirement For Capital Adequacy Purposes				Minimum Capital Levels Set Forth in Regulatory Consent Order
(Dollars in thousands)	Amount		Ratio		Amount		Ratio		Amount			Ratio
March 31, 2012
The Company
Total capital (to risk-weighted assets)	$	6,680	1.71	%	$	31,236	8.00	%	N/A			N/A
Tier 1 capital (to risk-weighted assets)	3,340		0.86	%	15,618		4.00	%	N/A			N/A
Tier 1 capital (to average assets)	3,340		0.62	%	21,407		4.00	%	N/A			N/A
The Bank
Total capital (to risk-weighted assets)	$	20,759	5.32	%	$	31,243	8.00	%	$	39,054		10.00	%
Tier 1 capital (to risk-weighted assets)	15,682		4.02	%	15,622		4.00	%			(1)		(1)
Tier 1 capital (to average assets)	15,682		2.93	%	21,391		4.00	%	42,783			8.00	%
December 31, 2011
The Company
Total capital (to risk-weighted assets)	$	7,190	1.77	%	$	32,492	8.00	%	N/A			N/A
Tier 1 capital (to risk-weighted assets)	3,595		0.89	%	16,246		4.00	%	N/A			N/A
Tier 1 capital (to average assets)	3,595		0.67	%	21,540		4.00	%	N/A			N/A
The Bank
Total capital (to risk-weighted assets)	$	20,896	5.14	%	$	32,496	8.00	%	$	40,620		10.00	%
Tier 1 capital (to risk-weighted assets)	15,620		3.85	%	16,248		4.00	%			(1)		(1)
Tier 1 capital (to average assets)	15,620		2.90	%	21,516		4.00	%	43,032			8.00	%

(1) Minimum capital amounts and ratios presented as of March 31, 2012 and December 31, 2011, are amounts to be well-capitalized under the various regulatory capital requirements administered by the FDIC.  On February 10, 2011, the Bank became subject to a regulatory Consent Order with the FDIC.  Minimum capital amounts and ratios presented for the Bank as of March 31, 2012 and December 31, 2011, are the minimum levels set forth in the Consent Order.  No minimum Tier 1 capital to risk-weighted assets ratio was specified in the Consent Order.  Regardless of the Bank’s capital ratios, it is unable to be classified as “well-capitalized” while it is operating under the Consent Order with the FDIC.

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, 2011 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.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Not applicable.

57

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, 2012.  There have been no significant changes in our internal controls over financial reporting during the fiscal quarter ended March 31, 2012 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.

As of March 31, 2012 and the date of this Form 10-Q, we believe that we are not a party to, nor is any of our property the subject of, any pending material proceeding other than those that may occur in the ordinary course of our business, except that:

·On January 31, 2012, W. Vaughn Stanaland and Stanaland Stewart Company, LLC filed a lawsuit in the Court of Common Pleas for the Fifteenth Judicial District, State of South Carolina, County of Horry, Case No. 2012-CP-26-768.  The Complaint names the Bank as the defendant.  The Complaint alleges that the Bank promised to loan the plaintiff up to 90% of the amount that the plaintiff would invest in the Company’s subordinated promissory notes offering in the second and third quarters of 2010 if the plaintiff needed access to these funds prior to the maturity of the subordinated notes, and, once the plaintiff applied for the loan, the Bank denied the loan request.  The Complaint seeks rescission of the subordinated notes instrument, reformation of the contractual relationship between the parties, specific performance, declaratory and injunctive relief, actual damages, and punitive damages as allowed by law.  The Company believes that the claims asserted in the Complaint are without merit and that the proceeding will not have any material adverse effect on the financial condition or operations of Company.

·On April 26, 2012, Samuel C. Thomas, Jr. and Pamela A. Thomas filed a lawsuit in the Court of Common Pleas for the Fifteenth Judicial District, State of South Carolina, County of Horry, Case No. 2012-CP-26-3295.  The Complaint names the Company and the Bank and the current members of the Company’s Board of Directors as defendants.  The Complaint alleges that the plaintiffs were misled into investing in the Company’s subordinated promissory notes offering in the second and third quarters of 2010.  The Complaint alleges that the Bank promised to loan the plaintiff up to 90% of the amount that the plaintiff would invest in the subordinated notes offering if the plaintiff needed access to these funds prior to the maturity of the subordinated notes, and, once the plaintiff applied for the loan, the Bank denied the loan request.  The Complaint seeks actual damages, consequential damages, punitive damages as allowed by law, pre-judgment and post-judgment interest as allowed by law, penalties as mandated by statute, set-off against other obligations of the plaintiffs due to the Company and the Bank, attorney’s fees, and costs.

Item 1A. Risk Factors.

Not applicable

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

None

Item 3. Defaults Upon Senior Securities.

None

Item 4. Mine Safety Disclosures.

None

Item 5. Other Information.

None

58

Item 6. Exhibits.

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

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

32Section 1350 Certifications.

101The following materials from the Quarterly Report on Form 10-Q of HCSB Financial Corporation for the quarter ended March 31, 2012, formatted in eXtensible Business Reporting Language (XBRL): (i) Condensed Consolidated Balance Sheets, (ii) Condensed Consolidated Statements of Operations, (iii) Condensed Consolidated Statements of Comprehensive Income (Loss), (iv) Consolidated Statements of Shareholders’ Equity, (v) Condensed Consolidated Statements of Cash Flows and (vi) Notes to Unaudited Condensed Consolidated Financial Statements.(1)

(1)(1) As provided in Rule 406T of Regulation S-T, this information shall not be deemed “filed” or part of a registration statement or prospectus for purposes of Section 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934 or otherwise subject to liability under those sections.

59

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, 2012	By:	/s/ JAMES R. CLARKSON
			James R. Clarkson
			President and Chief Executive Officer
			(Principal Executive Officer)
Date:	May 14, 2012	By:	/s/ EDWARD L. LOEHR, JR.
			Edward L. Loehr, Jr.
			Chief Financial Officer
			(Principal Financial and Accounting Officer)

60

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.
101	The following materials from the Quarterly Report on Form 10-Q of HCSB Financial Corporation for the quarter ended March 31, 2012, formatted in eXtensible Business Reporting Language (XBRL): (i) Condensed Consolidated Balance Sheets, (ii) Condensed Consolidated Statements of Operations, (iii) Condensed Consolidated Statements of Comprehensive Income (Loss), (iv) Consolidated Statements of Shareholders’ Equity, (v) Condensed Consolidated Statements of Cash Flows and (vi) Notes to Unaudited Condensed Consolidated Financial Statements.(1)
(1)	As provided in Rule 406T of Regulation S-T, this information shall not be deemed “filed” or part of a registration statement or prospectus for purposes of Section 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934 or otherwise subject to liability under those sections.

61