UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

x Annual Report Under Section 13 or 15(d) of The Securities Exchange Act of 1934

For The Fiscal Year December 31, 2009

Commission file number: 333-117053

CommunitySouth Financial Corporation

(Exact name of registrant as specified in its charter)

South Carolina

(State or other jurisdiction of
incorporation or organization)

20-0934786

(I.R.S. Employer Identification
No.)

6602 Calhoun Memorial Highway
Easley, South Carolina		29640
(Address of principal executive offices)		(Zip Code)

Issuer’s telephone number: (864) 306-2540

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

Securities registered pursuant to Section 12(g) of the Exchange Act: Common Stock

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

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x

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

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

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

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

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

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

The estimated aggregate market value of the Common Stock held by non-affiliates (shareholders holding less than 5% of an outstanding class of stock, excluding directors and executive officers) of the Company on June 30, 2009 was $7,225,843.

The number of shares outstanding of the registrant’s common stock, as of February 18, 2010 was 4,698,697.

DOCUMENTS INCORPORATED BY REFERENCE

Proxy Statement for the Annual Meeting of Shareholders Part III (Portions of Items 9-14)
to be held on May 18, 2010

Transitional Small Business Disclosure Format. (Check one): Yes o No x

Part I

Item 1. Description of Business.

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. 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,” “will,” “expect,” “anticipate,” “believe,” “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 below under Item 1A- Risk Factors and the following:

·	our efforts to raise capital or otherwise increase our regulatory capital ratios;
·	the effects of our efforts to raise capital on our balance sheet, liquidity, capital, and profitability;
·	our ability to retain our existing customers, including our deposit relationships;
·	our ability to comply with the terms of the Consent Order and the Memorandum of Understanding between the Bank and its supervisory authorities within the timeframes specified;
·	the rate of delinquencies and amounts of loans charged-off;
·	our rapid growth through 2008 and short operating history;
·	reduced earnings due to higher credit losses generally and specifically because losses in the sectors of our loan portfolio secured by real estate are greater than expected due to economic factors, including declining real estate values, decreasing 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;
·	the amount of our real estate based loans, and the weakness in the commercial real estate market;
·	our reliance on available secondary funding sources such as Federal Reserve Bank discount window borrowings, sales of securities and loans, and secured federal funds lines of credit from correspondent banks, to meet our liquidity needs;
·	significant increases in competitive pressure in the banking and financial services industries;
·	changes in the interest rate environment which could reduce anticipated or actual margins;
·	changes in political conditions or the legislative or regulatory environment;
·	general economic conditions, either nationally or regionally and especially in our primary service area, becoming less favorable than expected resulting in, among other things, a deterioration in credit quality;
·	changes occurring in business conditions and inflation;
·	changes in technology;
·	changes in deposits flows;
·	changes in monetary and tax policies;
·	the lack of seasoning of our loan portfolio, especially given our rapid loan growth through 2008;
·	adequacy of the level of our allowance for loan losses;
·	increased funding costs due to market illiquidity, increased competition for funding, and/or regulatory requirements;
·	adverse changes in asset quality and resulting credit risk-related losses and expenses, including the risk of further impairment to the value of our collateral on loans for which we have already taken specific reserves;
·	loss of consumer confidence and economic disruptions resulting from terrorist activities or other military actions;
·	changes in the securities markets; and
·	other risks and uncertainties detailed from time to time in our filings with the Securities and Exchange Commission (the “SEC”).

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

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

General

CommunitySouth Financial Corporation (the “Company”) was incorporated in South Carolina in March 2004 for purposes of operating as a bank holding company. Our wholly-owned subsidiary, CommunitySouth Bank and Trust (the “Bank”), commenced business on January 18, 2005, and is primarily engaged in the business of accepting savings, demand, and time deposits and providing mortgage, consumer and commercial loans to the general public.

Marketing Focus

Most of the banks in Anderson, Greenville, Pickens and Spartanburg Counties are now local branches of large regional banks. Although size gives the larger banks certain advantages in competing for business from large corporations, including higher lending limits and the ability to offer services in all of South Carolina, we believe we have a niche in the community banking market in our market area. As a result, we generally do not attempt to compete for the banking relationships of large corporations, but concentrate our efforts on small- to medium-sized businesses and professional concerns. The Bank advertises to emphasize the Company’s local ownership, community bank nature, and ability to provide more personalized service than its competition.

Location and Service Area

Our main office is located at 6602 Calhoun Memorial Highway, Easley, South Carolina 29640. Our telephone number is (864) 306-2540. Our site is approximately 1.2 acres in size, and the building is approximately 10,000 square feet. We have five full service branch sites in addition to the main office. The branch sites are in the towns of Anderson, Greenville, Greer, Mauldin and Spartanburg, South Carolina. Our full service branches service the entire upstate of South Carolina, which we refer to as the “Upstate,” but primarily the counties of Anderson, Greenville, Pickens and Spartanburg. The Upstate is generally the northwest portion of South Carolina along the I-85 corridor between Atlanta, Georgia and Charlotte, North Carolina.

Like much of the Upstate, Pickens County’s primary source of economic growth is manufacturing. With its access to applied automobile materials research and technology at Clemson University and location in the automobile hub of the southeast, the area is also developing a reputation among leaders in the automobile industry. Major employers in the area include Clemson University, Pickens County Schools, and Palmetto Health Alliance.

Anderson County is located along the I-85 corridor west of Pickens County. Significant industries in Anderson include manufacturers of automotive products, plastics, metal products, industrial machinery, publishing and textiles.

Greenville County is located east of Pickens County and is South Carolina’s most populous county with over 407,000 residents. Greenville is also one of the state’s wealthiest counties, with a per capita income of $30,814 in 2005, compared to the state average of $27,185. Greenville County is the home to more corporate headquarters than any other region in South Carolina.

Spartanburg County is also located east of Greenville County and has an economic history rooted in agriculture and textiles. BMW Manufacturing Corporation calls Spartanburg home. It began its assembly operation in Spartanburg in 1994. The amenities and opportunities Spartanburg County offers are wide-ranging from housing, education, healthcare, shopping, recreation, and culture. We believe these factors make the quality of life in the area attractive. Additionally, Spartanburg’s mild climate and location and access to the mountains, the coast, and larger cities such as Atlanta and Charlotte add to the attractiveness of the area.

However, the Upstate has been negatively affected by the economic challenges of the past two years. Unemployment has been rising in our markets and property values have declined. Unemployment rates at November 30, 2009 for the following counties were Greenville, 10.5%; Spartanburg, 12.5%; Anderson, 12.7%; and Laurens, 12.0%. The average state unemployment rate for South Carolina at November 30, 2009 was 12.3% compared to 10.0% for the United States. Continued higher levels of unemployment will continue to impact credit quality. As a result, we are spending significant time on credit solutions for our customers and managing and disposing of other real estate owned as effectively as possible. The weakening in the state and local economies has also negatively affected our ability to generate local deposits.

Our Current Business Strategy

As a result of this weakening in the local economy and its effect on us, we are currently focusing our efforts in the following areas:

· increasing and strengthening our capital position;

· decreasing concentrations in our loan portfolio;

· reducing operating expenses;

· enhancing funds management and liquidity; and

· enhancing our bank’s relationship culture.

For a more detailed description of our business strategy, see Management’s Discussion and Analysis of Financial Condition and Results of Operation under the subsection entitled Current Business Strategy.

Lending Activities

Presented below are our general lending activities. However, due to the Bank’s efforts to restructure the balance sheet, during 2009 the Bank strictly limited any new lending.

General. We emphasize a range of lending services, including real estate, commercial, and equity-line and consumer loans to individuals, small- to medium-sized businesses, and professional concerns that are located in or conduct a substantial portion of their business in our Bank’s market area.

Real Estate Loans. A significant portion of our loan portfolio is secured by real estate. As of December 31, 2009, approximately 90.3% of our loans had real estate as the primary or secondary component of collateral. Real estate loans generally fall into one of three categories: construction real estate loans, mortgage loans, or acquisition and development (A&D) loans. Each of these categories is discussed in more detail below, including their specific risks. Interest rates for all categories may be fixed or adjustable. We generally charge an origination fee for each loan. Since January 2009, we have effectively ceased making any new commercial real estate loans and we are decreasing the existing level of these loans through the normal sale of real estate by borrowers and by encouraging borrowers who are not full relationship clients of the Bank to seek other financing when their loans mature.

Real estate loans are subject to the same general risks as other loans. Real estate loans are also sensitive to fluctuations in the value of the real estate securing the loan. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. The recent downturn in the real estate market has resulted in increased loan delinquencies, defaults and foreclosures, primarily in our residential real estate construction and development portfolio. These loans carry a higher degree of risk than long-term financing of existing real estate since repayment is dependent on the ultimate completion of the project or home and usually on the sale of the property or permanent financing. Slow housing conditions have affected some of these borrowers’ ability to sell the completed projects in a timely manner and we believe that these trends are likely to 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. If real estate values continue to decline, it is also more likely that we would be required to increase our allowance for loan losses. If, during a period of reduced real estate values, we are required to liquidate the property collateralizing a loan to satisfy the debt or to increase the allowance for loan losses, it could materially reduce our profitability and adversely affect our financial condition.

On first and second mortgage loans, we generally do not advance more than regulatory limits. We require a valid mortgage lien on all real property loans along with a title lien policy which insures the validity and priority of the lien. We also require borrowers to obtain hazard insurance policies and flood insurance, if applicable. Additionally, certain types of real estate loans have specific risk characteristics that vary according to the collateral type securing the loan and the terms and repayment sources for the loan.

We have the ability to originate some real estate loans for sale into the secondary market. We can limit our interest rate and credit risk on these loans by locking the interest rate for each loan with the secondary investor and receiving the investor’s underwriting approval prior to originating the loan.

· Real Estate Loans - Mortgage. Mortgage real estate loans generally have terms of five years or less, although payments may be structured on a longer amortization basis. Inherent in mortgage real estate loans’ credit risk is the risk that the primary source of repayment, the operating commercial real estate company or residential borrower, will be unable to service the debt. If a real estate loan is in default, we also run the risk that the value of the real estate securing the loan will decrease, and thereby be insufficient to satisfy the loan. To mitigate these risks, we evaluate each borrower on an individual basis and attempt to determine their business risks and credit profile. We attempt to reduce credit risk in the real estate portfolio by emphasizing loans on owner-occupied office/residential and retail buildings where the loan-to-value ratio is established by independent appraisals. We typically review the personal financial statements of the principal owners/borrower and require their personal guarantees. These reviews often reveal secondary sources of payment and liquidity to support a loan request.

· Real Estate Loans - Construction. We have made adjustable and fixed rate residential and commercial construction loans to builders and developers and to consumers who wish to build their own home. The term of construction and development loans generally is limited to 18 months, although payments may be structured on a longer amortization basis. Most loans mature and require payment in full upon the sale of the property. Construction loans generally carry a higher degree of risk than long term financing of existing properties. Repayment usually depends on the ultimate completion of the project within cost estimates and on the sale of the property. Specific risks include:

· cost overruns;

· mismanaged construction;

· inferior or improper construction techniques;

· economic changes or downturns during construction;

· a downturn in the real estate market;

· rising interest rates which may prevent sale of the property; and

· failure to sell completed projects in a timely manner.

We attempt to reduce risk by obtaining personal guarantees where possible, and by keeping the loan-to-value ratio of the completed project below specified percentages. We also reduce risk by selling participations in larger loans to other institutions when possible.

· Real Estate Loans — Acquisition and Development. A significant portion of our real estate loan portfolio is considered A&D loans, most of these are on properties located in the Upstate of South Carolina and Western North Carolina. A&D loans are typically comprised of loans to borrowers for real estate to be developed (into properties such as sub-divisions or spec houses) and contain all of the risk and risk mitigating factors described for mortgages and construction loans above. These loans are generally repaid with the proceeds from the sale of the developed property.

Commercial Loans. We make loans for commercial purposes in various lines of businesses. Equipment loans typically are made for a term of five years or less at fixed or variable rates, with the loan fully amortized over the term and secured by the financed equipment. Working capital loans typically have terms not exceeding one year and are usually secured by accounts receivable, inventory, or personal guarantees of the principals of the business. For loans secured by accounts receivable or inventory, principal is typically repaid as the assets securing the loan are converted into cash, and in other cases principal is due at maturity. Trade letters of credit, standby letters of credit, and foreign exchange are handled through a correspondent bank as agent for the Bank. Commercial loans primarily have risk that the primary source of repayment, the borrowing business, will be unable to service the debt. Often this occurs as the result of changes in local economic conditions or in the industry in which the borrower operates which impact cash flow or collateral value.

Consumer Loans. We make a variety of loans to individuals for personal and household purposes, including secured and unsecured installment loans and revolving lines of credit such as credit cards. Installment loans typically carry balances of less than $50,000 and are amortized over periods up to 60 or more months. Consumer loans are offered on a single maturity basis where a specific source of repayment is available. Revolving loan products typically require monthly payments of interest and a portion of the principal.

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

We also offer home equity loans. Our underwriting criteria for and assessment of the risks associated with home equity loans and lines of credit are generally the same as those for first mortgage loans. Home equity lines of credit typically have terms of 10 years or less, carry balances less than $125,000, and may extend up to 90% of the available equity of each property.

We also have the ability to offer small business loans utilizing government enhancements such as the Small Business Administration’s 7(a) program and SBA’s 504 and “LowDoc” programs. These loans will typically be partially guaranteed by the government which may help to reduce the Bank’s risk. Government guarantees of SBA loans will not exceed 80% of the loan value, and will generally be less.

Relative Risks of Loans. Each category of loan has a different level of credit risk. Real estate loans typically are generally safer than loans secured by other assets because the value of the underlying security, real estate, is generally ascertainable and ordinarily does not fluctuate as much as some other assets. However, during the current economic and real estate market downturn, this has not been the case. The fluctuation of real estate values has increased the historically stable risk associated with loans collateralized by real estate. Nevertheless, certain real estate loans are less risky than others. Residential real estate loans are generally the least risky type of real estate loans, followed by commercial real estate loans and construction and development loans. The prolonged weakening in the real estate market starting in 2008 has affected all categories of our real estate loans and has resulted in decreases in real estate values and in an increase in our nonperforming loans. Commercial loans, which can be secured by real estate or other assets, or which can be unsecured, are generally more risky than real estate loans, but less risky than consumer loans. Finally, consumer loans, which can also be secured by real estate or other assets, or which can also be unsecured, are generally considered to be the most risky of these categories of loans. Any type of loan which is unsecured is generally more risky than secured loans. These levels of risk are general in nature, and many factors including the creditworthiness of the borrower or the particular nature of the secured asset may cause any type of loan to be more or less risky than another. Additionally, these levels of risk are limited to an analysis of credit risk, and they do not take into account other risk factors associated with making loans such as the interest rate risk inherent in long-term, fixed-rate loans.

Loan Approval and Review. Our loan approval policies provide for various levels of officer lending authority. When the amount of aggregate loans to a single borrower exceeds that individual officer’s lending authority, the loan request is considered and approved by an officer with a higher lending limit, the management loan committee or the board of directors’ loan committee. We do not make any loans to any director of the Bank unless the loan is approved by the board of directors of the Bank and is made on terms not more favorable to the person than would be available to a person not affiliated with the Bank. We adhere to Federal National Mortgage Association and Federal Home Loan Mortgage Corporation guidelines in our mortgage loan review process, but we may choose to alter this policy in the future.

Lending Limits. Our lending activities are subject to a variety of lending limits imposed by federal law. In general, we are subject to a legal limit on loans to a single borrower equal to 15% of the Bank’s capital and unimpaired surplus. Different limits may apply based on the type of loan or the nature of the borrower, including the borrower’s relationship to the Bank. These limits will increase or decrease as the Bank’s capital increases or decreases.

Banking Services

We offer a full range of deposit services that are typically available in most banks and savings and loan associations, including checking accounts, NOW accounts, commercial accounts, savings accounts, and other time deposits of various types, ranging from daily money market accounts to longer-term certificates of deposit. The transaction accounts and time certificates are tailored to our principal market area at rates competitive to those offered in the upstate South Carolina region. In addition, we offer certain retirement account services, including IRAs.

Other Banking Services

We also offer safe deposit boxes, cashier’s checks, banking by mail, direct deposit of payroll and social security checks, U.S. Savings Bonds, and travelers checks. Our Bank is associated with the Star and Plus ATM networks that may be used by our customers throughout the country. We believe that by being associated with a shared network of ATMs, we will be better able to serve our customers and will be able to attract customers who are accustomed to the convenience of using ATMs. We also offer a debit card and credit card services through a correspondent bank as an agent for the Bank.

Competition

The banking business is highly competitive. We compete as a financial intermediary with other commercial banks, savings banks, credit unions, finance companies, and money market mutual funds operating in Anderson, Greenville, Pickens and Spartanburg Counties. The competition among the various financial institutions is based upon a variety of factors, including interest rates offered on deposit accounts, interest rates charged on loans, credit and service charges, the quality of services rendered, the convenience of banking facilities and, in the case of loans to large commercial borrowers, relative lending limits. In addition to banks and savings associations, we compete with other financial institutions including securities firms, insurance companies, credit unions, leasing companies and finance companies. Size gives larger banks certain advantages in competing for business from large corporations. These advantages include higher lending limits and the ability to offer services in other areas of South Carolina. As a result, we do not generally attempt to compete for the banking relationships of large corporations, but concentrate our efforts on small- to medium-sized businesses and individuals. We believe we have competed effectively in this market by offering quality and personal service.

Employees

As of December 31, 2009, we had 79 full-time employees and 10 part-time employees.

SUPERVISION AND REGULATION

Both the Company and the Bank are subject to extensive state and federal banking regulations that impose restrictions on and provide for general regulatory oversight of their operations. These laws generally are intended to protect depositors and not shareholders. The following summary is qualified by reference to the statutory and regulatory provisions discussed. Changes in applicable laws or regulations may have a material effect on our business and prospects. Our operations may be affected by legislative changes and the policies of various regulatory authorities. 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.

The following discussion is not intended to be a complete list of all the activities regulated by the banking laws or of the impact of such laws and regulations on our operations. It is intended only to briefly summarize some material provisions.

CommunitySouth Financial Corporation

We own 100% of the outstanding capital stock of the Bank, and therefore we are considered to be a bank holding company under the federal Bank Holding Company Act of 1956 (the “Bank Holding Company Act”). As a result, we are primarily subject to the supervision, examination and reporting requirements of the Board of Governors of the Federal Reserve (the “Federal Reserve”) under the Bank Holding Company Act and its regulations promulgated thereunder. As a bank holding company located in South Carolina, the South Carolina Board of Financial Institutions also regulates and monitors all significant aspects of our operations.

Permitted Activities. Under the Bank Holding Company Act, a bank holding company is generally permitted to engage in, or acquire direct or indirect control of more than 5% of the voting shares of any company engaged in, the following activities:

· banking or managing or controlling banks;

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

· any activity that the Federal Reserve determines to be so closely related to banking as to be a proper incident to the business of banking.

Activities that the Federal Reserve has found to be so closely related to banking as to be a proper incident to the business of banking include:

· factoring accounts receivable;

· making, acquiring, brokering or servicing loans and usual related activities;

· leasing personal or real property;

· operating a non-bank depository institution, such as a savings association;

· trust company functions;

· financial and investment advisory activities;

· conducting discount securities brokerage activities;

· underwriting and dealing in government obligations and money market instruments;

· providing specified management consulting and counseling activities;

· performing selected data processing services and support services;

· acting as agent or broker in selling credit life insurance and other types of insurance in connection with credit transactions; and

· performing selected insurance underwriting activities.

As a bank holding company we also can elect to be treated as a “financial holding company,” which would allow us to engage in a broader array of activities. In sum, a financial holding company can engage in activities that are financial in nature or incidental or complementary to financial activities, including insurance underwriting, sales and brokerage activities, providing financial and investment advisory services, underwriting services and limited merchant banking activities. We have not sought financial holding company status, but may elect such status in the future as our business matures. If we were to elect in writing for financial holding company status, each insured depository institution we control would have to be well capitalized, well managed and have at least a satisfactory rating under the CRA (discussed below).

The Federal Reserve has the authority to order a bank holding company or its subsidiaries to terminate any of these activities or to terminate its ownership or control of any subsidiary when it has reasonable cause to believe that the bank holding company’s continued ownership, activity or control constitutes a serious risk to the financial safety, soundness or stability of it or any of its bank subsidiaries.

Change in Control. In addition, and subject to certain exceptions, the Bank Holding Company Act and the Change in Bank Control Act, together with regulations promulgated there under, require Federal Reserve approval prior to any person or company acquiring “control” of a bank holding company. Control is conclusively presumed to exist if an individual or company acquires 25% or more of any class of voting securities of a bank holding company. Following the relaxing of these restrictions by the Federal Reserve in September 2008, control will be rebuttably presumed to exist if a person acquires more than 33% of the total equity of a bank or bank holding company, of which it may own, control or have the power to vote not more than 15% of any class of voting securities.

Source of Strength. In accordance with Federal Reserve Board policy, we are expected to act as a source of financial strength to the Bank and to commit resources to support the Bank in circumstances in which we might not otherwise do so. Under the Bank Holding Company Act, the Federal Reserve Board may require a bank holding company to terminate any activity or relinquish control of a nonbank subsidiary, other than a nonbank subsidiary of a bank, upon the Federal Reserve Board’s determination that such activity or control constitutes a serious risk to the financial soundness or stability of any depository institution subsidiary of the bank holding company. Further, federal bank regulatory authorities have additional discretion to require a bank holding company to divest itself of any bank or nonbank subsidiaries if the agency determines that divestiture may aid the depository institution’s financial condition. Further, any loans by a bank holding company to a subsidiary bank are subordinate in right of payment to deposits and certain other indebtedness of the subsidiary bank. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank at a certain level would be assumed by the bankruptcy trustee and entitled to priority payment.

Capital Requirements. The Federal Reserve Board imposes certain capital requirements on the bank holding company under the Bank Holding Company Act, including a minimum leverage ratio and a minimum ratio of “qualifying” capital to risk-weighted assets. These requirements are essentially the same as those that apply to the Bank and are described below under “CommunitySouth Bank and Trust - Capital Regulations.” Subject to our capital requirements and certain other restrictions, we are able to borrow money to make a capital contribution to the Bank, and these loans may be repaid from dividends paid from the Bank to the Company. Our ability to pay dividends depends on the Bank’s ability to pay dividends to us, which is subject to regulatory restrictions as described below in “CommunitySouth Bank and Trust— Dividends.” We are also able to raise capital for contribution to the Bank by issuing securities without having to receive regulatory approval, subject to compliance with federal and state securities laws.

South Carolina State Regulation. As a South Carolina bank holding company under the South Carolina Banking and Branching Efficiency Act, we are subject to limitations on sale or merger and to regulation by the South Carolina Board of Financial Institutions. We are not required to obtain the approval of the South Carolina Board of Financial Institutions prior to acquiring the capital stock of a national bank, but we must notify them at least 15 days prior to doing so. We must receive the South Carolina Board of Financial Institution’s approval prior to engaging in the acquisition of a South Carolina state chartered bank or another South Carolina bank holding company.

CommunitySouth Bank and Trust

The Bank operates as a state chartered bank incorporated under the laws of the State of South Carolina and is subject to examination by the South Carolina Board of Financial Institutions. Deposits in the Bank are insured by the Federal Deposit Insurance Corporation (“FDIC”) up to a maximum amount, which is currently $100,000 for each non-retirement depositor and $250,000 for certain retirement-account depositors. However, the FDIC has increased the coverage up to $250,000 for each non-retirement depositor through December 13, 2013, and the Bank is participating in the FDIC’s Temporary Liquidity Guarantee Program (discussed below in greater detail) which, in part, fully insures non-interest bearing transaction accounts.

The South Carolina Board of Financial Institutions and the FDIC regulate or monitor virtually all areas of the Bank’s operations, including:

· security devices and procedures;

· adequacy of capitalization and loss reserves;

· loans;

· investments;

· borrowings;

· deposits;

· mergers;

· issuances of securities;

· payment of dividends;

· interest rates payable on deposits;

· interest rates or fees chargeable on loans;

· establishment of branches;

· corporate reorganizations;

· maintenance of books and records; and

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

The South Carolina Board of Financial Institutions requires the Bank to maintain specified capital ratios and imposes limitations on the Bank’s aggregate investment in real estate, bank premises, and furniture and fixtures. The South Carolina Board of Financial Institutions also requires the Bank to prepare quarterly reports on the Bank’s financial condition in compliance with its minimum standards and procedures.

All insured institutions must undergo regular on site examinations by their appropriate banking agency. The cost of examinations of insured depository institutions and any affiliates may be assessed by the appropriate agency against each institution or affiliate as it deems necessary or appropriate. Insured institutions are required to submit annual reports to the FDIC, their federal regulatory agency, and their state supervisor when applicable. The FDIC has developed a method for insured depository institutions to provide supplemental disclosure of the estimated fair market value of assets and liabilities, to the extent feasible and practicable, in any balance sheet, financial statement, report of condition or any other report of any insured depository institution. The FDIC Improvement Act (the “FDICIA”) also requires the federal banking regulatory agencies to prescribe, by regulation, standards for all insured depository institutions and depository institution holding companies relating, among other things, to the following:

· internal controls;

· information systems and audit systems;

· loan documentation;

· credit underwriting;

· interest rate risk exposure; and

· asset quality.

Prompt Corrective Action. As an insured depository institution, the bank is required to comply with the capital requirements promulgated under the Federal Deposit Insurance Act and the regulations thereunder, which set forth five capital categories, each with specific regulatory consequences. Under these regulations, the categories are:

· Well Capitalized — The institution exceeds the required minimum level for each relevant capital measure. A well capitalized institution is one (i) having a total capital ratio of 10% or greater, (ii) having a tier 1 capital

ratio of 6% or greater, (iii) having a leverage capital ratio of 5% or greater and (iv) that is not subject to any order or written directive to meet and maintain a specific capital level for any capital measure.

· Adequately Capitalized — The institution meets the required minimum level for each relevant capital measure. No capital distribution may be made that would result in the institution becoming undercapitalized. An adequately capitalized institution is one (i) having a total capital ratio of 8% or greater, (ii) having a tier 1 capital ratio of 4% or greater and (iii) having a leverage capital ratio of 4% or greater or a leverage capital ratio of 3% or greater if the institution is rated composite 1 under the CAMELS (Capital, Assets, Management, Earnings, Liquidity and Sensitivity to market risk) rating system.

· Undercapitalized — The institution fails to meet the required minimum level for any relevant capital measure. An undercapitalized institution is one (i) having a total capital ratio of less than 8% or (ii) having a tier 1 capital ratio of less than 4% or (iii) having a leverage capital ratio of less than 4%, or if the institution is rated a composite 1 under the CAMELS rating system, a leverage capital ratio of less than 3%.

· Significantly Undercapitalized — The institution is significantly below the required minimum level for any relevant capital measure. A significantly undercapitalized institution is one (i) having a total capital ratio of less than 6% or (ii) having a tier 1 capital ratio of less than 3% or (iii) having a leverage capital ratio of less than 3%.

· Critically Undercapitalized — The institution fails to meet a critical capital level set by the appropriate federal banking agency. A critically undercapitalized institution is one having a ratio of tangible equity to total assets that is equal to or less than 2%.

If the FDIC determines, after notice and an opportunity for hearing, that the bank is in an unsafe or unsound condition, the regulator is authorized to reclassify the bank to the next lower capital category (other than critically undercapitalized) and require the submission of a plan to correct the unsafe or unsound condition.

If the bank is not well capitalized, it cannot accept brokered deposits without prior FDIC approval. In addition, a bank that is undercapitalized cannot offer an effective yield in excess of 75 basis points on interest paid on deposits (including brokered deposits, if approval is granted for the bank to accept them) of comparable size and maturity in either such institution’s normal market area or in the market area in which such deposits would otherwise be accepted. Thus, for deposits in its own normal market area, an undercapitalized institution must offer rates that are not in excess of 75 basis points over the average local rates. For non-local deposits, the institution must offer rates that are not in excess of 75 basis points over either (1) the institution’s own local rates or (2) the applicable non-local rates. In other words, the institution must adhere to the prevailing rates in its own normal market area for all deposits (whether local or non-local) and also must adhere to the prevailing rates in the non-local area for any non-local deposits. Thus, the institution will be unable to outbid non-local institutions for non-local deposits even if the non-local rates are lower than the rates in the institution’s own normal market area.

Moreover, if the bank becomes less than adequately capitalized, it must adopt a capital restoration plan acceptable to the FDIC. The bank also would become subject to increased regulatory oversight, and would be increasingly restricted in the scope of its permissible activities. Each company having control over an undercapitalized institution also must provide a limited guarantee that the institution will comply with its capital restoration plan. Except under limited circumstances consistent with an accepted capital restoration plan, an undercapitalized institution may not grow. 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. 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 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.

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 the Bank to become undercapitalized, it could not pay a management fee or dividend to us.

As of December 31, 2009, the Bank was deemed to be “undercapitalized.” As described further below, on February 23, 2010, the Bank entered into a Consent Order (the “Consent Order”) with the FDIC and the South Carolina Board of Financial Institutions which, among other things, requires the Bank to achieve and maintain Total Risk Based capital at least equal to 10% of risk-weighted assets and Tier 1 at least equal to 8% of total assets within 120 days from the effective date of the order.

Transactions with Affiliates and Insiders. The Company is a legal entity separate and distinct from the Bank and its other subsidiaries. Various legal limitations restrict the Bank from lending or otherwise supplying funds to the Company or its non-bank subsidiaries. The Company and the Bank are subject to Sections 23A and 23B of the Federal Reserve Act and Federal Reserve Regulation W.

Section 23A of the Federal Reserve Act places limits on the amount of loans or extensions of credit to, or investments in, or certain other transactions with, affiliates and on the amount of advances to third parties collateralized by the securities or obligations of affiliates. The aggregate of all covered transactions is limited in amount, as to any one affiliate, to 10% of the Bank’s capital and surplus and, as to all affiliates combined, to 20% of the Bank’s capital and surplus. Furthermore, within the foregoing limitations as to amount, each covered transaction must meet specified collateral requirements. The Bank is forbidden to purchase low quality assets from an affiliate.

Section 23B of the Federal Reserve Act, among other things, prohibits an institution from engaging in certain transactions with certain affiliates unless the transactions are on terms substantially the same, or at least as favorable to such institution or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies.

Regulation W generally excludes all non-bank and non-savings association subsidiaries of banks from treatment as affiliates, except to the extent that the Federal Reserve Board decides to treat these subsidiaries as affiliates. The regulation also limits the amount of loans that can be purchased by a bank from an affiliate to not more than 100% of the bank’s capital and surplus.

The Bank is also subject to certain restrictions on extensions of credit to executive officers, directors, certain principal shareholders, and their related interests. Such extensions of credit (i) must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with third parties and (ii) must not involve more than the normal risk of repayment or present other unfavorable features.

Branching. Under current South Carolina law, we may open branch offices throughout South Carolina with the prior approval of the South Carolina Board of Financial Institutions. In addition, with prior regulatory approval, the Bank will be able to acquire existing banking operations in South Carolina. Furthermore, federal legislation has been passed that permits interstate branching by banks if allowed by state law, and interstate merging by banks. However, South Carolina law, with limited exceptions, currently permits branching across state lines only through interstate mergers.

Anti-Tying Restrictions. Under amendments to the Bank Holding Company Act and Federal Reserve regulations, a bank is prohibited from engaging in certain tying or reciprocity arrangements with its customers. In general, a bank may not extend credit, lease, sell property, or furnish any services or fix or vary the consideration for these on the condition that (i) the customer obtain or provide some additional credit, property, or services from or to the bank, the bank holding company or subsidiaries thereof or (ii) the customer may not obtain some other credit, property, or services from a competitor, except to the extent reasonable conditions are imposed to assure the soundness of the credit extended. Certain arrangements are permissible: a bank may offer combined-balance products and may otherwise offer more favorable terms if a customer obtains two or more traditional bank products; and certain foreign transactions are exempt from the general rule. A bank holding company or any bank affiliate also is subject to anti-tying requirements in connection with electronic benefit transfer services.

Community Reinvestment Act. The Community Reinvestment Act requires that, in connection with examinations of financial institutions within their respective jurisdictions, a financial institution’s primary regulator, which is the FDIC for the Bank, shall evaluate the record of each financial institution in meeting the credit needs of its local community, including low

and moderate income neighborhoods. These factors are also considered in evaluating mergers, acquisitions, and applications to open a branch or facility. Failure to adequately meet these criteria could impose additional requirements and limitations on our Bank. Additionally, we must publicly disclose the terms of various Community Reinvestment Act-related agreements.

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

Consumer Protection Regulations. Activities of the Bank are subject to a variety of statutes and regulations designed to protect consumers. Interest and other charges collected or contracted for by the Bank are subject to state usury laws and federal laws concerning interest rates. The Bank’s loan operations are also subject to federal laws applicable to credit transactions, such as the:

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

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

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

· The Fair Credit Reporting Act of 1978, as amended by the Fair and Accurate Credit Transactions Act, governing the use and provision of information to credit reporting agencies, certain identity theft protections and certain credit and other disclosures;

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

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

The deposit operations of the Bank also are subject to:

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

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

Enforcement Powers. The Bank and its “institution-affiliated parties,” including its management, employees, agents, independent contractors, and consultants such as attorneys and accountants and others who participate in the conduct of the financial institution’s affairs, are subject to potential civil and criminal penalties for violations of law, regulations or written orders of a government agency. These practices can include the failure of an institution to timely file required reports or the filing of false or misleading information or the submission of inaccurate reports. Civil penalties may be as high as $1,000,000 a day for such violations. Criminal penalties for some financial institution crimes have been increased to 20 years. In addition, regulators are provided with greater flexibility to commence enforcement actions against institutions and institution-affiliated parties. Possible enforcement actions include the termination of deposit insurance. Furthermore, banking agencies’ power to issue cease-and-desist orders were expanded. Such orders may, among other things, require affirmative action to correct any harm resulting from a violation or practice, including restitution, reimbursement, indemnifications or guarantees against loss. A financial institution may also be ordered to restrict its growth, dispose of certain assets, rescind agreements or contracts, or take other actions as determined by the ordering agency to be appropriate.

Anti-Money Laundering. Financial institutions must maintain anti-money laundering programs that include established internal policies, procedures, and controls; a designated compliance officer; an ongoing employee training program; and testing of the program by an independent audit function. The Company and the Bank are also prohibited from

entering into specified financial transactions and account relationships and must meet enhanced standards for due diligence and “knowing your customer” in their dealings with foreign financial institutions and foreign customers. Financial institutions must take reasonable steps to conduct enhanced scrutiny of account relationships to guard against money laundering and to report any suspicious transactions, and recent laws provide law enforcement authorities with increased access to financial information maintained by banks. Anti-money laundering obligations have been substantially strengthened as a result of the USA Patriot Act, enacted in 2001 and renewed in 2006. Bank regulators routinely examine institutions for compliance with these obligations and are required to consider compliance in connection with the regulatory review of applications. The regulatory authorities have been active in imposing “cease and desist” orders and money penalty sanctions against institutions found to be violating these obligations.

USA PATRIOT Act. The USA PATRIOT Act became effective on October 26, 2001, amended, in part, the Bank Secrecy Act, and provides, in part, for the facilitation of information sharing among governmental entities and financial institutions for the purpose of combating terrorism and money laundering by enhancing anti-money laundering and financial transparency laws, as well as enhanced information collection tools and enforcement mechanics for the U.S. government, including: (i) requiring standards for verifying customer identification at account opening; (ii) rules to promote cooperation among financial institutions, regulators, and law enforcement entities in identifying parties that may be involved in terrorism or money laundering; (iii) reports by nonfinancial trades and businesses filed with the Treasury Department’s Financial Crimes Enforcement Network for transactions exceeding $10,000; and (iv) filing suspicious activities reports by brokers and dealers if they believe a customer may be violating U.S. laws and regulations and requires enhanced due diligence requirements for financial institutions that administer, maintain, or manage private bank accounts or correspondent accounts for non-U.S. persons. Bank regulators routinely examine institutions for compliance with these obligations and are required to consider compliance in connection with the regulatory review of applications.

Under the USA PATRIOT Act, the Federal Bureau of Investigation (“FBI”) can send our banking regulatory agencies lists of the names of persons suspected of involvement in terrorist activities. The Bank can be requested to search its records for any relationships or transactions with persons on those lists. If the Bank finds any relationships or transactions, it must file a suspicious activity report and contact the FBI.

The Office of Foreign Assets Control (“OFAC”), which is a division of the U.S. Department of the Treasury, is responsible for helping to insure that United States entities do not engage in transactions with “enemies” of the United States, as defined by various Executive Orders and Acts of Congress. OFAC has sent, and will send, our banking regulatory agencies lists of names of persons and organizations suspected of aiding, harboring or engaging in terrorist acts. If the Bank finds a name on any transaction, account or wire transfer that is on an OFAC list, it must freeze such account, file a suspicious activity report and notify the FBI. The Bank has appointed an OFAC compliance officer to oversee the inspection of its accounts and the filing of any notifications. The Bank actively checks high-risk OFAC areas such as new accounts, wire transfers and customer files. The Bank performs these checks utilizing software, which is updated each time a modification is made to the lists provided by OFAC and other agencies of Specially Designated Nationals and Blocked Persons.

Privacy and Credit Reporting. Financial institutions are required to disclose their policies for collecting and protecting confidential information. Customers generally may prevent financial institutions from sharing nonpublic personal financial information with nonaffiliated third parties except under narrow circumstances, such as the processing of transactions requested by the consumer or when the financial institution is jointly sponsoring a product or service with a nonaffiliated third party. Additionally, financial institutions generally may not disclose consumer account numbers to any nonaffiliated third party for use in telemarketing, direct mail marketing or other marketing to consumers. It is the Bank’s policy not to disclose any personal information unless required by law.

Like other lending institutions, the Bank utilizes credit bureau data in its underwriting activities. Use of such data is regulated under the Federal Credit Reporting Act on a uniform, nationwide basis, including credit reporting, prescreening, sharing of information between affiliates, and the use of credit data. The Fair and Accurate Credit Transactions Act of 2003 (the “FACT Act”) authorizes states to enact identity theft laws that are not inconsistent with the conduct required by the provisions of the FACT Act.

Payment of Dividends. A South Carolina state bank may not pay dividends from its capital. All dividends must be paid out of undivided profits then on hand, after deducting expenses, including reserves for losses and bad debts. The Bank is authorized to pay cash dividends up to 100% of net income in any calendar year without obtaining the prior approval of the South Carolina Board of Financial Institutions, provided that the Bank received a composite rating of one or two at the last

federal or state regulatory examination. The Bank must obtain approval from the South Carolina Board of Financial Institutions prior to the payment of any other cash dividends. In addition, under the FDICIA, the Bank may not pay a dividend if, after paying the dividend, the Bank would be undercapitalized. As described further below, on February 23, 2010, the Bank entered into the Consent Order with the FDIC and the South Carolina Board of Financial Institutions which, among other things, prohibits the Bank from declaring or paying any dividends or making any distributions of interest, principal, or other sums on subordinated debentures without the prior approval of the supervisory authorities.

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

· allowing check truncation without making it mandatory;

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

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

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

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

· requiring the re-crediting of funds to an individual’s account on the next business day after a consumer proves that the financial institution has erred.

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

Insurance of Accounts and Regulation by the FDIC. Our deposits are insured up to applicable limits by the Deposit Insurance Fund of the FDIC. The Deposit Insurance Fund is the successor to the Bank Insurance Fund and the Savings Association Insurance Fund, which were merged effective March 31, 2006. As insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of and to require reporting by FDIC insured institutions. It also may prohibit any FDIC insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious risk to the insurance fund. The FDIC also has the authority to initiate enforcement actions against savings institutions, after giving the Office of Thrift Supervision an opportunity to take such action, and may terminate the deposit insurance if it determines that the institution has engaged in unsafe or unsound practices or is in an unsafe or unsound condition.

Under regulations effective January 1, 2007, the FDIC adopted a new risk-based premium system that provides for quarterly assessments based on an insured institution’s ranking in one of four risk categories based upon supervisory and capital evaluations. For deposits held as of March 31, 2009, institutions are assessed at annual rates ranging from 12 to 50 basis points, depending on each institution’s risk of default as measured by regulatory capital ratios and other supervisory measures. Effective April 1, 2009, assessments will take into account each institution’s reliance on secured liabilities and brokered deposits. This will result in assessments ranging from 7 to 77.5 basis points. We anticipate our future insurance costs to be higher than in previous periods.

FDIC insured institutions are required to pay a Financing Corporation assessment, in order to fund the interest on bonds issued to resolve thrift failures in the 1980s. For the first quarter of 2009, the Financing Corporation assessment equaled 1.14 basis points for domestic deposits. These assessments, which may be revised based upon the level of deposits, will continue until the bonds mature in the years 2017 through 2019.

The FDIC may terminate the deposit insurance of any insured depository institution, including the Bank, if it determines after a hearing that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition

to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC. It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance, if the institution has no tangible capital. If insurance of accounts is terminated, the accounts at the institution at the time of the termination, less subsequent withdrawals, shall continue to be insured for a period of six months to two years, as determined by the FDIC.

Proposed Legislation and Regulatory Action. New regulations and statutes are regularly proposed that contain wide-ranging proposals for altering the structures, regulations, and competitive relationships of the nation’s financial institutions. We cannot predict whether or in what form any proposed regulation or statute will be adopted or the extent to which our business may be affected by any new regulation or statute.

Recent Legislative and Regulatory Initiatives to Address Financial and Economic Crises. The Congress, Treasury Department and the federal banking regulators, including the FDIC, have taken broad action since early September 2008 to address volatility in the U.S. banking system.

In October 2008, the Emergency Economic Stabilization Act of 2008 (“EESA”) was enacted. The EESA authorizes the Treasury Department to purchase from financial institutions and their holding companies up to $700 billion in mortgage loans, mortgage-related securities and certain other financial instruments, including debt and equity securities issued by financial institutions and their holding companies in a troubled asset relief program (“TARP”). The purpose of TARP is to restore confidence and stability to the U.S. banking system and to encourage financial institutions to increase their lending to customers and to each other. The Treasury Department has allocated $250 billion towards the TARP Capital Purchase Program (“CPP”). Under the CPP, Treasury will purchase debt or equity securities from participating institutions. The TARP also will include direct purchases or guarantees of troubled assets of financial institutions. Participants in the CPP are subject to executive compensation limits and are encouraged to expand their lending and mortgage loan modifications.

EESA also increased FDIC deposit insurance on most accounts from $100,000 to $250,000. This increase is in place until the end of 2013 and is not covered by deposit insurance premiums paid by the banking industry.

Following a systemic risk determination, the FDIC established the Temporary Liquidity Guarantee Program (“TLGP”) on October 14, 2008. The TLGP includes the Transaction Account Guarantee Program (“TAGP”), which provides unlimited deposit insurance coverage through December 31, 2009 for noninterest-bearing transaction accounts (typically business checking accounts) and certain funds swept into noninterest-bearing savings accounts. This has been extended until June 30, 2010. Institutions participating in the TLGP pay a 10 basis points fee (annualized) on the balance of each covered account in excess of $250,000, while the extra deposit insurance is in place. The TLGP also includes the Debt Guarantee Program (“DGP”), under which the FDIC guarantees certain senior unsecured debt of FDIC-insured institutions and their holding companies. The unsecured debt must be issued on or after October 14, 2008 and not later than June 30, 2009, and the guarantee is effective through the earlier of the maturity date or June 30, 2012. On March 17, 2009, the FDIC adopted an interim rule that extends the DGP and imposes surcharges on existing rates for certain debt issuances. This extension allowed institutions that had issued guaranteed debt before April 1, 2009 to issue guaranteed debt during the extended issuance period that ended on October 31, 2009. For such institutions, the guarantee on debt issued on or after April 1, 2009, will expire no later than December 31, 2012. The DGP coverage limit is generally 125% of the eligible entity’s eligible debt outstanding on September 30, 2008 and scheduled to mature on or before June 30, 2009 or, for certain insured institutions, 2% of their liabilities as of September 30, 2008. Depending on the term of the debt maturity, the nonrefundable DGP fee ranges from 60 to 110 basis points (annualized) for covered debt outstanding until the earlier of maturity or June 30, 2012 and 75 to 125 basis points (annualized) for covered debt outstanding until after June 30, 2012. The TAGP and DGP are in effect for all eligible entities, unless the entity opted out on or before December 5, 2008. We participate in the TAGP and the DGP.

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

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

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

The second plan is the Securities Program, which is administered by the Treasury Department and involves the creation of public-private investment funds to target investments in eligible residential mortgage-backed securities and commercial mortgage-backed securities issued before 2009 that originally were rated AAA or the equivalent by two or more nationally recognized statistical rating organizations, without regard to rating enhancements (collectively, “Legacy Securities”). Legacy Securities must be directly secured by actual mortgage loans, leases or other assets, and may be purchased only from financial institutions that meet TARP eligibility requirements. The Treasury Department received over 100 unique applications to participate in the Legacy Securities PPIP and in July 2009 selected nine public-private investment fund managers. As of December 31, 2009, public-private investment funds have completed initial and subsequent closings on approximately $6.2 billion of private sector equity capital, which was matched 100% by the Treasury Department, representing $12.4 billion of total equity capital. The Treasury Department has also provided $12.4 billion of debt capital, representing $24.8 billion of total purchasing power. As of December 31, 2009, public-private investment funds have drawn-down approximately $4.3 billion of total capital which has been invested in certain non-agency residential mortgage backed securities and commercial mortgage backed securities and cash equivalents pending investment.

On May 22, 2009, the FDIC levied a one-time special assessment on all banks due on September 30, 2009. In addition, on November 12, 2009, the FDIC issued a final rule to require banks to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012 and to increase assessment rates effective on January 1, 2011.

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.

Item 1A. Risk Factors.

Our business, financial condition, and results of operations could be harmed by any of the following risks, or other risks that have not been identified or which we believe are immaterial or unlikely. Shareholders should carefully consider the risks described below in conjunction with the other information in this Form 10-K and the information incorporated by reference in this Form 10-K, including our consolidated financial statements and related notes.

There is substantial doubt about our ability to continue as a going concern.

We have prepared the consolidated financial statements contained in this Report assuming that the Company will be able to continue as a going concern, which contemplates the realization of assets and the discharge of liabilities in the normal course of business for the foreseeable future. However, as a result of recurring losses, as well as uncertainties associated with the Bank’s ability to increase its capital levels to meet regulatory requirements, management has concluded that there is substantial doubt about the Company’s ability to continue as a going concern. In its report dated February 26, 2010, our independent registered public accounting firm stated that these uncertainties raise substantial doubt about our ability to continue as a going concern. Our financial statements do not include any adjustments that might be necessary if we are unable to continue as a going concern. If we are unable to continue as a going concern, our shareholders will likely lose all of their investment in the Company. See Management’s Discussion and Analysis of Financial Condition and Results of Operations for management’s discussion of our financial condition at December 31, 2009.

We need to raise additional capital that may not be available to us.

Regulatory authorities require us to maintain adequate levels of capital to support our operations. As described above, we are undercapitalized and have an immediate need to raise capital. In addition, even if we succeed in raising this capital, we may need to raise additional capital in the future due to additional losses or regulatory mandates. The ability to raise additional capital, if needed, will depend in part on conditions in the capital markets at that time, which are outside our control, and on our financial performance. Accordingly, additional capital may not be raised, if and when needed, on terms acceptable to us, or at all. If we cannot raise additional capital when needed, our ability to increase our capital ratios could be materially impaired and we could face additional regulatory challenges. In addition, if we issue additional equity capital, it may be at a lower price and in all cases our existing shareholders’ interest would be diluted.

Liquidity needs at our Bank level could adversely affect our financial condition and results of operation.

Traditionally, the primary sources of funds of our Bank subsidiary have been customer deposits and loan repayments. As of December 31, 2009, we had brokered deposits of $202.8 million, representing 53.85% of our total deposits, of which $79.7 million are scheduled to mature in the third quarter of 2010 and $94.9 million are scheduled to mature in the fourth quarter of 2010. Because of the limitations on brokered deposits imposed by the Consent Order and our undercapitalized status, 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 (“FHLB”) advances and federal funds lines of credit from correspondent banks. However, FHLB has informed us that due to our financial condition we are not currently permitted to receive any more advances. As a result, we must limit our growth, raise additional capital, or sell assets, which could materially and adversely affect our financial condition and results of operations. Additionally, deposit levels may be affected by a number of factors, including rates paid by competitors, general interest rate levels, regulatory capital requirements, returns available to customers on alternative investments and general economic conditions. Because the Bank is not well capitalized, it is subject to the 75-basis-point interest rate cap that it can pay on deposits, as more fully described above. Because of this interest rate cap, we may not be able to attract sufficient deposits to meet our liquidity needs. If this were to occur, the Bank may be placed into a federal conservatorship or receivership by the FDIC, with the FDIC appointed as conservator or receiver.

We have sustained losses from a decline in credit quality and may see further losses.

Our ability to generate earnings is significantly affected by our ability to properly originate, underwrite, and service loans. We have sustained losses primarily because borrowers, guarantors, or related parties have failed to perform in accordance with the terms of their loans and we failed to detect or respond to deterioration in asset quality in a timely manner. We could sustain additional losses for these reasons. Problems with credit quality or asset quality could cause our interest income and net interest margin to decrease, which could adversely affect our business, financial condition, and results of operations. We have recently identified credit deficiencies with respect to certain loans in our loan portfolio which are primarily related to the downturn in the residential housing industry. As a result of the decline of the residential housing market, property values for this type of collateral have declined substantially. In response to this determination, we increased our loan loss reserve throughout 2009 to a total loan loss reserve of $13.0 million at December 31, 2009 to address the risks inherent within our loan portfolio. Recent developments, including further deterioration in the South Carolina real estate market as a whole, may cause management to adjust its opinion of the level of credit quality in our loan portfolio. Such a determination may lead to an additional increase in our provisions for loan losses, which could also adversely affect our business, financial condition, and results of operations.

We may have higher loan losses than we have allowed for in our allowance for loan losses.

Our loan losses could exceed our allowance for loan losses. Our average loan size has increased in recent years over historic levels, and reliance on our historic allowance for loan losses may not be adequate. In addition, our non-performing assets have increased dramatically over the past 12 months due to the severe housing downturn and real estate market deterioration in each of our market areas. As of December 31, 2009, we had $45.3 million in loans on our classified list. Classified loans are loans graded as substandard, doubtful, or loss. Also as of December 31, 2009, $29.9 million, or 10.9% of our loan portfolio was comprised of either loans not accruing interest or loans past due 90 days or more (and $34.2 million , or 12.4% of our loan portfolio was comprised of either loans not accruing interest or loans past due 30 days or more). Industry

experience shows that a portion of loans will become delinquent and a portion of loans will require partial or entire charge-off. Regardless of the underwriting criteria utilized, losses may be experienced as a result of various factors beyond our control, including:

·	cost overruns;

·	declining property values;

·	mismanaged construction;

·	inferior or improper construction techniques;

·	economic changes or downturns during construction;

·	rising interest rates that may prevent sale of the property; and

·	failure to sell completed projects or units in a timely manner.

The occurrence of any of the preceding risks could result in the deterioration of one or more of these loans which could significantly increase our percentage of nonperforming assets. An increase in nonperforming loans may result in a loss of earnings from these loans, an increase in the related provision for loan losses and an increase in charge-offs, all of which could have a material adverse effect on our financial condition and results of operations. As of December 31, 2009, our non-performing assets were $42.4 million. If the current economic conditions continue for a prolonged period of time, it is very likely that the level of nonperforming assets will rise to higher levels in 2010, requiring additional provisions for loan losses.

In addition, while we generally underwrite the loans in our portfolio in accordance with our own internal underwriting guidelines and regulatory supervisory guidelines, in certain circumstances we have made loans which exceed either our internal underwriting guidelines, supervisory guidelines, or both. As of December 31, 2009, approximately $18.1 million of our loans, or 109% of our Company’s capital, had loan-to-value ratios that exceeded regulatory supervisory guidelines, of which 16 loans totaling approximately $6.2 million had loan-to-value ratios of 100% or more. At December 31, 2008, $22.9 million of our loans, or 65% of our Company’s capital, exceeded the supervisory loan to value ratio. The number of loans in our portfolio with loan-to-value ratios in excess of supervisory guidelines, our internal guidelines, or both could increase the risk of delinquencies and defaults in our portfolio.

We have become subject to enforcement actions that will require us to take certain actions.

On June 29, 2009, the Bank entered into a Memorandum of Understanding (the “MOU”) with the Commissioner of Banking of the South Carolina Board of Financial Institutions and the Regional Director of the FDIC’s Atlanta Regional Office. The MOU required the Bank to, among other things, (1) submit a capital plan to the supervisory authorities for returning to a “well-capitalized” designation; (2) develop specific plans and proposals for the reduction and improvement of assets which are subject to adverse classification and past due loans; (3) implement a plan to decrease the concentration of commercial real estate loans; (4) develop and implement an improved loan review program; and (5) review overall liquidity objectives and develop plans and procedures aimed at improving liquidity and reducing reliance on volatile liabilities to fund longer-term assets. In addition, the Bank may not pay dividends without the prior written consent of each supervisory authority. Since entering into the MOU, the Bank has been actively pursuing the corrective actions required by the MOU in an effort to ensure that the requirements of the MOU are met in a timely manner.

The FDIC completed a safety and soundness examination of the Bank in the fourth quarter of 2009. Based on the Bank’s current financial condition, the Bank entered into the Consent Order with the FDIC and the South Carolina Board of Financial Institutions on February 23, 2010, which contains, among other things, a requirement that our Bank achieve and maintain minimum capital requirements that exceed the minimum regulatory capital ratios for “well capitalized” banks. Under this enforcement action, the Bank may no longer accept, renew, or roll over brokered deposits. In addition, under the Consent Order, we no longer meet the regulatory requirements to be eligible for expedited processing of branch applications and certain other regulatory approvals, and we are required to obtain FDIC approval before making certain

payments to departing executives and before adding new directors or senior executives. Our regulators have considerable discretion in whether to grant required approvals, and no assurance can be given that such approvals would be forthcoming. In addition, we are required to take certain other actions in the areas of capital, liquidity, asset quality, and interest rate risk management, as well as to file periodic reports with the FDIC and the South Carolina Board of Financial Institutions regarding our progress in complying with the Consent Order. The Consent Order supersedes the MOU. Any material failure to comply with the terms of the Consent Order could result in further enforcement action by the FDIC. While we intend to take such actions as may be necessary to comply with the requirements of the Consent Order and subsequence FDIC guidance, we may be unable to comply fully with the deadlines or other terms of the Consent Order. For further discussion of the Consent Order, please see below.

Our Bank may become subject to a federal conservatorship or receivership if it cannot comply with the Consent Order, or if its condition continues to deteriorate.

As noted above, the Bank executed a Consent Order with the FDIC and the South Carolina Board of Financial Institutions. The Consent Order requires the Bank to, among other things, implement a plan to achieve and maintain minimum capital requirements, including provisions for contingency funding arrangements. The condition of our loan portfolio may continue to deteriorate in the current economic environment and thus continue to deplete our capital and other financial resources. Should we fail to comply with the capital and liquidity funding requirements in the Consent Order, or suffer a continued deterioration in our financial condition, we may be subject to being placed into a federal conservatorship or receivership by the FDIC, with the FDIC appointed as conservator or receiver. If these events occur, we probably would suffer a complete loss of the value of our ownership interest in the Bank and we subsequently may be exposed to significant claims by the FDIC. Federal conservatorship or receivership would also result in a complete loss of your investment.

We may face damage to our reputation and business as a result of negative publicity, including an increase in deposit outflows.

We believe that approximately $9.1million, or 2.4%, of our deposits are above FDIC insurance limits as of December 31, 2009, and these deposits are particularly susceptible to withdrawal based on negative publicity about our current financial condition. Although the increase in the FDIC insurance limit of $250,000 per depositor from $100,000 per depositor is in place through December 31, 2013, we cannot predict whether the limit will be maintained or reduced when it expires. Negative public opinion could adversely affect our ability to keep and attract customers, expose us to litigation, and raise withdrawal levels beyond the capacity of our currently available liquidity, which would result in a takeover of the Bank by the FDIC.

A significant portion of our loan portfolio is secured by real estate, and the recent weakening of the local real estate market could continue to hurt our business.

A significant portion of our loan portfolio is secured by real estate. As of December 31, 2009, approximately 90% of our loans had real estate as the primary or secondary component of collateral. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. The recent downturn in the real estate market has resulted in increased loan delinquencies, defaults and foreclosures, primarily in our residential real estate construction and development portfolio. These loans carry a higher degree of risk than long-term financing of existing real estate since repayment is dependent on the ultimate completion of the project or home and usually on the sale of the property or permanent financing. Slow housing conditions have affected some of these borrowers’ ability to sell the completed projects in a timely manner and we believe that these trends are likely to 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. If real estate values continue to decline, it is also more likely that we would be required to increase our allowance for loan losses. If, during a period of reduced real estate values, we are required to liquidate the property collateralizing a loan to satisfy the debt or to increase the allowance for loan losses, it could materially reduce our profitability and adversely affect our financial condition.

This prolonged weakening in the residential real estate market in 2008 and 2009 has resulted in an increase in our nonperforming loans, and there is a risk that this trend will continue, which could result in a net loss of earnings and an increase in our provision for loan losses and loan charge-offs, all of which could have a material adverse effect on our

financial condition and results of operations. This weakened market has resulted and may continue to result in an increase in the number of borrowers who default on their loans and a reduction in the value of the collateral securing their loans could have an adverse effect on our profitability and asset quality. If we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, our earnings and capital could be adversely affected. Acts of nature, including hurricanes, tornados, earthquakes, fires and floods, which may cause uninsured damage and other loss of value to real estate that secures these loans, may also negatively impact our financial condition.

Although we believe that the combination of specific reserves in the allowance for loan losses and established impairments of these loans will be adequate to account for the current risk associated with the loans secured by real estate in our portfolio as of December 31, 2009, there can be no assurances in this regard.

We are unable to continue making interest payments on our subordinated debentures.

Due to diminishing cash available at the holding company level, if we are unable to raise additional capital, we will have to discontinue paying interest on the subordinated debentures after the March 2010 payments due to lack of funds. As a result of this development and our financial condition, we expect that the debt markets will be unavailable to us as a potential source of capital at least until such time as we are able to meet these obligations.

We have only recently adopted our new business plan and may not be able to implement it effectively.

Our future performance will depend on our ability to implement our new business plan successfully. This implementation will involve a variety of complex tasks, including reducing our level of non-performing assets by continuing to aggressively work problem credits, exploring a bulk sale of loans or OREO, and possibly requiring significant write-downs to facilitate disposition of nonperforming assets. We also plan to continue to increase core deposits, reduce our dependency on wholesale funding (brokered CD’s and FHLB borrowings) and increase low-cost deposit accounts (DDA’s, NOW, etc.). These actions should help expand our net interest margin and future earnings without requiring additional capital. Any failure or delay in executing these initiatives, whether due to regulatory delays or for other reasons, some of which may be beyond our control, is likely to impede, and could ultimately preclude, our successful implementation of our business plan and could materially adversely affect our business, financial condition, and results of operations.

Our historical results of operations may not be indicative of our future operating results.

We have historically grown at a rapid rate through 2008, but in the current economic climate, we do not plan to grow our business as we have in the past and we have decided to contract our business in the near term by selling some of our assets. Consequently, our historical results of operations will not necessarily be indicative of our future operating results. Various factors, such as economic conditions, regulatory and legislative considerations, and competition, may also impede our ability to maintain our market presence as we shrink our balance sheet. As we implement our plans to deleverage our balance sheet by reducing our assets, our business, financial condition, and results of operations may be adversely affected because a high percentage of our operating costs are fixed expenses. We may not experience a decrease in these costs in proportion to or as quickly as the decrease in our assets.

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

Negative developments over the last two and a half years in the global credit and securitization markets have resulted in uncertainty in the financial markets in general with the expectation of the general economic downturn continuing into 2010. As a result of this “credit crunch,” commercial as well as consumer loan portfolio performances have deteriorated at many institutions and the competition for deposits and quality loans has increased significantly. In addition, the values of real estate collateral supporting many commercial loans and home mortgages have declined and may continue to decline. Global securities markets, and bank holding company stock prices in particular, have been negatively affected, as has the ability of banks and bank holding companies to raise capital or borrow in the debt markets. As a result, significant new federal laws and regulations relating to financial institutions, including, without limitation, the EESA and the Treasury Department’s CPP, have been adopted. Furthermore, the potential exists for additional federal or state laws and regulations regarding, among other matters, lending and funding practices and liquidity standards, and bank regulatory agencies are expected to be active in responding to concerns and trends identified in examinations, including the expected issuance of many formal enforcement

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

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

There can be no assurance that the government actions that have been taken over the last 18 months, including EESA and the Recovery Act, will achieve their purpose. The failure of the financial markets to stabilize, or a continuation or worsening of the current financial market conditions, could have a material adverse affect on our business, our financial condition, the financial condition of our customers, our common stock trading price, as well as our ability to access credit. It could also result in declines in our investment portfolio which could be “other-than-temporary impairments.”

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

Our success significantly depends upon the growth in population, income levels, deposits, and housing starts in our markets. The current economic downturn has negatively affected the markets in which we operate and, in turn, the quality of our loan portfolio. If the communities in which we operate do not grow or if prevailing economic conditions locally or nationally remain unfavorable, our business may not succeed. A continuation of the economic downturn or prolonged recession would likely result in the continued deterioration of the quality of our loan portfolio and reduce our level of deposits, which in turn would hurt our business. Interest received on loans represented approximately 88% of our interest income for the year ended December 31, 2009. If the economic downturn continues or a prolonged economic recession occurs in the economy as a whole, borrowers will be less likely to repay their loans as scheduled. Moreover, in many cases the value of real estate or other collateral that secures our loans has been adversely affected by the economic conditions and could continue to be negatively affected. Unlike many larger institutions, we are not able to spread the risks of unfavorable local economic conditions across a large number of diversified economies. A continued economic downturn could, therefore, result in losses that materially and adversely affect our business.

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

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

We are exposed to changes in the regulation of financial services companies.

Proposals for further regulation of the financial services industry are continually being introduced in the Congress of the United States of America and the General Assembly of the State of South Carolina. The agencies regulating the financial services industry also periodically adopt changes to their regulations. On September 7, 2008, the Treasury Department announced that Fannie Mae (along with Freddie Mac) had been placed into conservatorship under the control of the newly created Federal Housing Finance Agency. On October 3, 2008, EESA was signed into law, on October 14, 2008 the Treasury Department announced the CPP under EESA, and on February 17, 2009 the Recovery Act was signed into law. It is possible that additional legislative proposals may be adopted or regulatory changes may be made that would have an adverse effect on our business. See “Risk Factors — We are subject to extensive regulation that could restrict our activities” below.

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

As a member institution of the FDIC, we are required to pay semi-annual deposit insurance premium assessments to the FDIC. During the year ended December 31, 2009, we paid $1.1 million in deposit insurance assessments. Due to the recent failure of several unaffiliated FDIC insurance depository institutions, and the FDIC’s new TLGP, the deposit insurance

premium assessments paid by all banks will likely increase. In addition, new FDIC requirements shift a greater share of any increase in such assessments onto institutions with higher risk profiles, including banks with heavy reliance on brokered deposits, such as our Bank. Continued increases in this expense would have a material adverse effect on our financial condition.

Changes in prevailing interest rates may reduce our profitability.

Our results of operations depend in large part upon the level of our net interest income, which is the difference between interest income from interest-earning assets, such as loans and mortgage-backed securities, and interest expense on interest-bearing liabilities, such as deposits and other borrowings. Depending on the terms and maturities of our assets and liabilities, a significant change in interest rates could have a material adverse effect on our profitability. Many factors cause changes in interest rates, including governmental monetary policies and domestic and international economic and political conditions. While we intend to manage the effects of changes in interest rates by adjusting the terms, maturities, and pricing of our assets and liabilities, our efforts may not be effective and our financial condition and results of operations could suffer.

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

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

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

The Sarbanes-Oxley Act of 2002, and the related rules and regulations promulgated by the Securities and Exchange Commission that are now applicable to us, have increased the scope, complexity, and cost of corporate governance, reporting, and disclosure practices.

We face strong competition for customers, which could prevent us from obtaining customers and the interest rate that we can pay to attract customers is subject to the national deposit rate cap restrictions.

The banking business is highly competitive, and we experience competition in our market from many other financial institutions. We compete with commercial banks, credit unions, savings and loan associations, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market funds, and other mutual funds, as well as other super-regional, national, and international financial institutions that operate offices in our primary market areas and elsewhere. We compete with these institutions both in attracting deposits and in making loans. In addition, we have to attract our client base from other existing financial institutions and from new residents. Many of our competitors are well-established, larger financial institutions. These institutions offer some services, such as extensive and established branch networks, that we do not currently provide. There is a risk that we will not be able to compete successfully with other financial institutions in our market, and that we may have to pay higher interest rates to attract deposits, resulting in reduced profitability. In addition, competitors that are not depository institutions are generally not subject to the extensive regulations that apply to us. Also, the Bank is under the national deposit rate cap restrictions imposed on banks that are considered less than well capitalized, which means that we may be prohibited from paying the same interest rates on deposits as some of our competitors that are well capitalized.

The costs of being an SEC registered company are proportionately higher for smaller companies such as CommunitySouth Financial Corporation because of the requirements imposed by the Sarbanes-Oxley Act.

The Sarbanes-Oxley Act of 2002 and the related rules and regulations promulgated by the SEC have increased the scope, complexity, and cost of corporate governance, reporting, and disclosure practices. These regulations are applicable to our Company. We have experienced, and expect to continue to experience, increasing compliance costs, including costs related to internal controls, as a result of the Sarbanes-Oxley Act. These necessary costs are proportionately higher for a

company of our size and will affect our profitability more than that of some of our larger competitors.

Item 2. Properties.

Our main office is located at 6602 Calhoun Memorial Highway, Easley, South Carolina 29640. Our site is approximately 1.2 acres in size, and the building is approximately 10,000 square feet. We own our main office and lease all others. We have five full service branch sites in addition to the main office. The branch sites are in the towns of Anderson, Greenville, Greer, Mauldin and Spartanburg, South Carolina. Our full service branches service the entire upstate of South Carolina, but primarily the counties of Anderson, Greenville, Pickens and Spartanburg.

We have a ten year lease that began in November 2005 for our Spartanburg office. The office is located at 531 East Main Street, Spartanburg, S.C. 29302.

We have a ten year lease that began in November 2005 for our Mauldin office. The office is located at 787 East Butler Road, Mauldin, S.C. 29662.

We have a ten year lease that began in June 2006 for our Anderson office. The office is located at 1510 North Main Street, Anderson, S.C. 29621.

We have a ten year lease that began in November 2006 for our Greer office. The office is located at 530 West Wade Hampton Blvd., Greer, S.C. 29650.

We have a three year lease that began in May 2007 for our Loan Operations center. The operations center is located at 6606 Calhoun Memorial Highway, Easley, S.C. 29640.

We have a ten year lease that began in October 2007 for our Greenville office. The office is located at 2415 Laurens Road, Greenville, S.C. 29607.

We believe that all of our properties are adequately covered by insurance.

Item 3. Legal Proceedings.

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

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

At a special meeting of the shareholders on November 18, 2009, our shareholders approved the proposal to amend our articles of incorporation to increase the number of authorized shares of common stock from 10 million shares to 35 million shares. The shareholders voted on the proposal as indicated below:

	Votes	% of Outstanding Common Shares
Votes For	3,419,747	72.78	%
Votes Against	327,927	6.98	%
Abstain	—	—

Part II

On January 16, 2006, the Company effected a 5-for-4 stock split in the form of a stock dividend for shareholders of record as of December 15, 2005. On January 16, 2007, the Company effected a 5-for-4 stock split in the form of a stock dividend for shareholders of record as of December 15, 2006. All per share data has been adjusted for all periods prior to the splits.

Since March 15, 2006, our common stock has been quoted on the OTC Bulletin Board under the symbol “CBSO.” Quotations on the OTC Bulletin Board reflect inter-dealer prices, without retail mark-up, mark-down, or commissions, and may not represent actual transactions. Transactions of our common stock did not begin to occur on the OTC Bulletin Board until March 16, 2006.

The following is a summary of the high and low bid prices for our common stock reported by the OTC Bulletin Board for the periods indicated (the bid prices have been adjusted for all stock splits):

2009	High		Low
First Quarter	$	3.20	$	1.10
Second Quarter	3.00		1.30
Third Quarter	2.00		1.50
Fourth Quarter	1.80		0.40

2008	High		Low
First Quarter	$	10.00	$	7.30
Second Quarter	9.00		5.50
Third Quarter	7.00		2.53
Fourth Quarter	5.50		1.75

Our articles of incorporation authorize us to issue up to 35,000,000 shares of common stock, of which 4,698,697 shares were outstanding as of December 31, 2009. We had approximately 897 shareholders of record as of December 31, 2009.

We have not declared or paid any cash dividends on our common stock since our inception. For the foreseeable future we do not intend to declare cash dividends. We intend to retain earnings to grow our business and strengthen our capital base. Our ability to pay dividends depends on the ability of the Bank to pay dividends to us. As a South Carolina state chartered bank, the Bank may only pay dividends out of its net profits, after deducting expenses, including losses and bad debts. In addition, the Bank is prohibited from declaring a dividend on its shares of common stock unless its surplus equals or exceeds its stated capital. At December 31, 2009, the Bank had a deficit of $19,057,000. In addition, pursuant to the terms of the Consent Order with the FDIC and the South Carolina Board of Financial Institutions, the Bank may not pay dividends without prior written consent of each supervisory authority.

The following table sets forth the equity compensation plan information at December 31, 2009. All option and warrant information has been adjusted to reflect all prior stock splits and dividends.

Equity Compensation Plan Information

Plan Category	(A) Number of securities to be issued upon exercise of outstanding options, warrants and rights	(B) Weighted-average exercise price of outstanding options, warrants and rights		(C) Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column(a))

Equity compensation plans approved by security holders	756,033	$	6.99	230,693

Equity compensation plans not approved by security holders	171,404	$	6.40	0

Total	927,437	$	6.88	230,693

(1) The shares available for issuance is currently set at 21% of our outstanding shares. On January 16, 2006 the Company adopted a resolution that terminated the “evergreen” provision of the Company’s 2005 Stock Incentive Plan. As a result, the number of shares of common stock issuable under the plan shall not be further increased in connection with any future share issuances by the Company.

(2) Each of our organizers received, for no additional consideration, a warrant to purchase one share of common stock for $10.00 per share for every two shares they purchased in the offering, up to a maximum of 10,000 shares per organizer. The warrants are represented by separate warrant agreements. The warrants vested on May 18, 2005, 120 days after the date of the opening of the Bank, and they are exercisable in whole or in part during the 10 year period following that date. If the South Carolina Board of Financial Institutions or the FDIC issues a capital directive or other order requiring the Bank to obtain additional capital, the warrants will be forfeited, if not immediately exercised.

Item 6. Selected Financial Data.

Selected Financial Data

The following selected financial data for the five years ended December 31, 2009 was derived from the consolidated financial statements and other data of the Company and its subsidiary, the Bank. The selected financial data should be read in conjunction with the consolidated financial statements of the Company, including the accompanying notes, included elsewhere herein.

On January 16, 2006 the Company effected a 5-for-4 stock split in the form of a stock dividend for shareholders of record as of December 15, 2005. On January 16, 2007, the Company effected a 5-for-4 stock split in the form of a stock dividend for shareholders of record as of December 15, 2006. All share and per share data has been adjusted for all periods prior to the splits.

(Dollars in thousands except per share data)	2009			2008			2007			2006			2005
Income Statement Data:
Interest income — loans	$	16,959		$	20,163		$	21,403		$	13,644		$	4,544
Interest income — investments	2,269			2,547			1,813			1,041			441
Total interest income	19,228			22,710			23,216			14,685			4,985
Interest expense — deposits	(8,599		)	(12,580		)	(13,069		)	(7,281		)	(1,863		)
Net interest income	10,629			10,130			10,147			7,404			3,122
Provision for loan losses	(16,990		)	(7,168		)	(1,188		)	(1,532		)	(1,558		)
Net interest income after provision for loan losses	(6,361		)	2,962			8,959			5,872			1,564
Non-interest income	2,723			1,392			1,575			842			321
Non-interest expense	(13,670		)	(9,510		)	(8,184		)	(5,197		)	(2,680		)
Income (loss) before income taxes	(17,308		)	(5,156		)	2,350			1,517			(795		)
Income tax (expense) benefit	(988		)	1,806			(782		)	(360		)	179
Net income (loss)	$	(18,296	)	$	(3,350	)	$	1,568		$	1,157		$	(616	)

Balance Sheet Data:
Total assets	$	421,534		$	387,816		$	377,867		$	248,273		$	136,826
Earning assets	411,384			374,939			361,890			235,959			133,285
Investment securities, available for sale (1)	103,638			47,602			24,844			100			—
Other investments (2)	1,599			1,805			447			271			83
Loans (3)	275,104			320,907			302,934			217,664			115,704
Allowance for loan losses	(12,963		)	(8,088		)	(4,214		)	(3,091		)	(1,558		)
Deposits	376,563			296,643			327,664			217,031			106,972
Shareholders’ equity	8,671			28,528			31,471			29,695			28,286

Per-Share Data:
Net income (loss) — basic	$	(3.89	)	$	(0.71	)	$	0.33		$	0.25		$	(0.13	)
Net income (loss) — diluted	(3.89		)	(0.71		)	0.31			0.22			(0.13		)
Book value	1.85			6.07			6.70			6.32			6.04

Return on Equity and Assets:
Return on average assets	(4.55		)%	(0.87		)%	0.50		%	0.59		%	(0.77		)%
Return on average equity	(70.79		)%	(10.91		)%	5.12		%	4.08		%	(2.24		)%
Average equity to average assets ratio	6.43		%	7.99		%	9.76		%	14.53		%	34.55		%

(1) Marketable securities are stated at fair value.

(2) Non-marketable securities are stated at cost.

(3) Loans are stated at gross amounts before allowance for loan losses.

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

COMMUNITYSOUTH FINANCIAL CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS

Basis of Presentation

The following discussion should be read in conjunction with the Company’s Consolidated Financial Statements and the Notes thereto and the other financial data included elsewhere in this Annual Report on Form 10-K. The financial information provided below has been rounded in order to simplify its presentation. However, the ratios and percentages provided below are calculated using the detailed financial information contained in the Consolidated Financial Statements, the Notes thereto and the other financial data included elsewhere in this Annual Report on Form 10-K.

Overview

The following discussion describes our results of operations for the years ended December 31, 2009 and 2008 and also analyzes our financial condition as of December 31, 2009 and 2008. We received approvals from the FDIC, the Federal Reserve Board (“FRB”) and the South Carolina Board of Financial Institutions during January 2005, and commenced business on January 18, 2005.

The Company is a bank holding company headquartered in Easley, South Carolina. Our subsidiary, the Bank, opened for business on January 18, 2005. All Seasons Properties, LLC, a subsidiary of the Bank, was formed in 2009 for the purpose of holding and marketing repossessed assets. In addition to the main office in Easley, the Bank has five branch locations in the upstate region of South Carolina. We opened our Mauldin branch in the fourth quarter of 2005, our Spartanburg branch in the first quarter of 2006, our Anderson branch in the third quarter of 2006, our Greer branch in the fourth quarter of 2006 and our Greenville branch in the third quarter of 2007. The Bank provides banking services to domestic markets, principally in the Upstate of South Carolina. The deposits of the Bank are insured by the FDIC.

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.

Current Economic Environment

Markets in the United States, including our market areas, have experienced extreme volatility and disruption for more than 12 months. According to the National Bureau of Economic Research, the United States entered into an economic recession in December 2007. Dramatic slowdowns in the residential housing industry with falling home prices, increasing foreclosures, and rising unemployment levels have created strains on the loan portfolios of many financial institutions. Median home sales continued to decline during 2009 nationally and in our primary market area, South Carolina. As a result, the level of foreclosures by homebuilders and homeowners continued to increase. The national average unemployment rate and the unemployment rate in South Carolina continued to rise throughout 2009. As of December 31, 2009, the national average unemployment rate was 10.0% compared to 8.4% at December 31, 2008. As of December 31, 2009, the unemployment rate in South Carolina was 12.6% compared to 8.6% at December 31, 2008.

As a result of the current economic recession, many 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 financial institutions to fully recover the principal and interest owed. In addition, the rapidly deteriorating economic conditions in our country have evolved into a crisis of confidence in the safety and soundness of larger financial institutions, brokerage firms, and insurance companies, resulting in extreme liquidity pressure throughout the United States financial system for all financial companies including community financial institutions such as ours. This pressure has caused many banks to tighten lending standards, which has constrained the ability of businesses and consumers to obtain credit. Anxiety over liquidity and credit risk has grown in recent months and banks have curbed lending to each other, further limiting liquidity sources available to financial institutions.

The Effect 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 through 2009, we recognized that construction, acquisition, and development real estate projects were slowing, guarantors were becoming financially stressed, and increasing credit losses were surfacing. During 2009, delinquencies over 90 days increased resulting in an increase in non-accrual loans indicating significant credit quality deterioration and probable losses. In particular, loans secured by real estate, including acquisition, construction, and development 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: (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.

As of December 31, 2009, approximately 90.3% of our loans had real estate as a primary or secondary component of collateral. Included in our loans secured by real estate, we have approximately$37.8 million of A&D loans as of December 31, 2009, most of which are on properties located in the Upstate of South Carolina and Western North Carolina. A&D loans are typically comprised of loans to borrowers for real estate to be developed (into properties such as sub-divisions or spec houses). Normally, these loans are repaid with the proceeds from the sale of the developed property. The greater degree of strain on these types of loans and the significance to our overall loan portfolio has caused us to apply a greater degree of scrutiny in analyzing the ultimate collectability of amounts due. The majority of these borrowers are having financial difficulties. Our analysis has resulted in a significant provision expense in order to meet the estimated allowance for loan loss reserve requirement.

Included in our loans secured by real estate, we have approximately $40.6 million of acreage and finished or buildable lot loans as of December 31, 2009. These loans are comprised of loans to borrowers for raw land and lots in subdivisions that have utilities and are ready to be built on individually but not as part of an entire development project. These loans are generally repaid with the proceeds from the sale of the property. As with our A&D loans, many of these borrowers are also experiencing financial difficulties and the greater degree of strain on these types of loans and the significance to our overall loan portfolio has caused us to apply a greater degree of scrutiny in analyzing the ultimate collectability of amounts due. Our analysis has resulted in a significant provision expense in order to meet the estimated allowance for loan loss reserve requirement.

The result of the above was a significant increase in the level of our non-performing assets during 2009. As of December 31, 2009, our non-performing assets equaled $42.4 million, or 10.05% of assets, as compared to $10.3 million, or 2.67% of assets, as of December 31, 2008. The increase in our non-performing assets led to the increase in our provision for loan losses and other non-interest expenses. For the year ended December 31, 2009, we recorded a provision for loan losses of $17.0 million and net loan charge-offs of $12.1 million, or 3.97% of average loans, as compared to a $7.2 million provision for loan losses and net loan charge-offs of $3.3 million, or 1.04% of average loans, for the year ended December 31, 2008. In addition, our net interest margin decreased to 2.73% for the year ended December 31, 2009 from 2.74% for the year ended December 31, 2008. In total, the above reduced our 2009 earnings by more than $9.8 million compared to 2008. As a result, as of December 31, 2009, we are deemed to be “undercapitalized.”

The adverse economic environment has also placed greater pressure on our deposits, as we have been taking 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. As of December 31, 2009, we had brokered deposits of $202.8 million, representing 53.85% of our total deposits, of which $79.7 million are scheduled to mature in the third quarter of 2010 and $94.9 million are scheduled to mature in the fourth quarter of 2010. As a result of the limitations on brokered deposits imposed by the Consent Order and our “undercapitalized” designation (as described below), 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. However, the FHLB has informed us that due to our financial condition we are not

currently permitted to receive any more advances. As a result, we must limit our growth, raise additional capital, or sell assets, which could materially and adversely affect our financial condition and results of operations. Additionally, deposit levels may be affected by a number of factors, including rates paid by competitors, general interest rate levels, regulatory capital requirements, returns available to customers on alternative investments and general economic conditions. Because the Bank is not well capitalized, it is subject to the 75-basis-point interest rate cap that it can pay on deposits, as more fully described below. As a result of this interest rate cap, we may not be able to attract sufficient deposits to meet our liquidity needs. If this were to occur, the Bank may be placed into a federal conservatorship or receivership by the FDIC, with the FDIC appointed as conservator or receiver.

Memorandum of Understanding

As a result of the issues stemming from the economic downturn, on June 29, 2009 the Bank entered into the MOU with the Commissioner of Banking of the South Carolina Board of Financial Institutions and the Regional Director of the FDIC’s Atlanta Regional Office. The MOU requires the Bank to, among other things, (1) submit a capital plan to the supervisory authorities for returning to a “well-capitalized” designation; (2) develop specific plans and proposals for the reduction and improvement of assets which are subject to adverse classification and past due loans; (3) implement a plan to decrease the concentration of commercial real estate loans; (4) develop and implement an adequate loan review program; and (5) review overall liquidity objectives and develop plans and procedures aimed at improving liquidity and reducing reliance on volatile liabilities to fund longer-term assets. In addition, the Bank may not pay dividends without the prior written consent of each supervisory authority.

Since entering into the MOU, the Bank has been actively pursuing the corrective actions required by the MOU in an effort to ensure that the requirements of the MOU are met in a timely manner. For example:

· As of December 31, 2009, we are deemed to be “undercapitalized.” We have developed a capital plan for returning to a “well-capitalized” designation, and we submitted this plan to the FDIC and the South Carolina Board of Financial Institutions in July 2009. Our capital plan outlines how we intend to return our Bank’s risk-based capital ratio level over 10% by (i) reducing our overall amount of assets and, in particular, our amount of risk-based assets and (ii) raising additional capital. To reduce our amount of assets, we have sold assets such as our bank-owned life insurance and some of our available for sale securities. In addition, we are actively seeking buyers for part of our loan portfolio. As a result of these steps, during 2009 we decreased our amount of risk-based assets by $70.6 million. We are also exploring additional financing alternatives to strengthen the capital levels of the Bank.

· We have developed and implemented a plan to reduce our amount of classified loans by establishing an IMPAC committee (Improving Problem Asset Committee) to focus on the development of work-out plans for our other real estate owned (OREO) and classified loans and to explore approaches to provide additional capital to support our classified loans or to reduce the level of such loans, such as through the sale of loans to third parties. As a result, we have created a more risk-based loan review program, which we believe has enhanced the underwriting and monitoring of our loan portfolio.

· We have implemented a plan to decrease the concentration of our commercial real estate loans. Since January 2009, we have effectively ceased making any new commercial real estate loans and we are decreasing the existing level of these loans through the normal sale of real estate by borrowers and by encouraging borrowers who are not full relationship clients of the Bank to seek other financing when their loans mature. We are also actively seeking secondary market permanent financing for recently completed residential construction projects. As a result of these efforts, in 2009 our amount of commercial real estate loans decreased from $151.6 million at December 31, 2008 to $126.8 million at December 31, 2009.

· We have developed and implemented an improved loan review program, which includes the hiring of a new internal loan review officer and the engagement of a new external loan review firm for ongoing review and the establishment of a new system for tracking borrower financial statements and the structure of our watch reports. The new external review firm is active and since its engagement has been on site three times to evaluate the effectiveness of the program. The external review firm reviews both specific loans and the overall loan portfolio.

· On September 10, 2009, we submitted to the FDIC and the South Carolina State Board of Financial Institutions a revised Funds Management Policy to reflect our plan to continue to improve liquidity levels and reduce our reliance on brokered deposits and other non-core funding sources over the next 18 months. We grew rapidly in our initial

years of operations, which we funded with a combination of local deposits and wholesale funding, including brokered deposits. As of December 31, 2009, we are deemed to be “undercapitalized” and, as a result, can no longer accept, renew or roll over brokered deposits without the prior consent of the FDIC. Thus, we are actively focused on eliminating brokered deposits on our balance sheet. During 2009, we improved the Bank’s liquidity position by raising approximately $68 million in new local deposits.

In addition, in mid-February 2010 the Bank received a supervisory letter from the FDIC dated February 11, 2010, which provided for additional restrictions and mandatory actions to be taken by the Bank. These restrictions and actions were all substantially addressed by the subsequent Consent Order discussed below. However, in order to comply with supervisory letter, the Bank must prepare and submit to the FDIC a capital restoration plan no later than March 26, 2010, which submission date is sooner than a similar requirement under the Consent Order.

Consent Order

Following the FDIC’s safety and soundness examination of the Bank in the fourth quarter of 2009, the Bank entered into the Consent Order with the FDIC and the South Carolina Board of Financial Institutions on February 23, 2010. The Consent Order, which supersedes the MOU, conveys specific actions needed to address certain findings from the FDIC’s Report of Examination and to address the Bank’s current financial condition, primarily related to policy and planning issues, management oversight, loan concentrations and classifications, non-performing loans, liquidity/funds management, and capital planning.

Under the terms of the Consent Order, the Bank’s various sources of liquidity will be restricted. Based on information included in the FDIC’s report, the Bank’s credit risk rating at the FHLB has been negatively impacted, resulting in reduced borrowing capacity. This action also restricts the Bank’s ability to accept, renew, or roll over brokered deposits. In addition, the Bank’s ability to borrow funds from the Federal Reserve Bank Discount Window as a source of short-term liquidity is not guaranteed. The Federal Reserve Discount Window borrowing capacity has been curtailed to only overnight terms, contingent upon credit approval for each transaction.

In addition, the Consent Order requires the Bank to, among other things,

· establish, within 30 days from the effective date of the Consent Order, a plan to monitor compliance with the Consent Order, which shall be monitored by the Bank’s Board of Directors;

· ensure the Bank has qualified management in place to carry out the policies of the Bank’s Board of Directors and operate the Bank in a safe and sound manner;

· achieve and maintain, within 120 days from the effective date of the Consent Order, 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;

· determine, within 30 days of the last day of the calendar quarter, its capital ratios. If any capital measure falls below the established minimum, within 30 days provide a written plan describing the means and timing by which the Bank shall increase such ratios to or in excess of the established minimums;

· develop, within 45 days from the effective date of the Consent Order, a written analysis and assessment of the Bank’s management and staffing needs;

· establish, within 60 days from the effective date of the Consent Order, a comprehensive policy for determining 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;

· enhance, within 60 days from the effective date of the Consent Order, our written plan for the reduction of classified assets, which shall include, among other things, a reduction of the Bank’s risk position in each asset in excess of $250,000 that is classified as “Substandard” or “Doubtful”;

· 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 classified, 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;

· perform, within 45 days from the effective date of the Consent Order, a risk segmentation analysis with respect to the Bank’s Concentrations of Credit and a written plan to systematically reduce any segment of the portfolio that is an undue

concentration of credit;

· revise, within 60 days from the effective date of the Consent Order, the Bank’s 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;

· formulate and implement, within 60 days from the effective date of the Consent Order, a profit plan and 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, and the operating assumptions that form the basis for and adequately support major projected income and expense components of the plan;

· enhance, within 60 days from the effective date of the Consent Order, our written funds management plan addressing liquidity, contingent funding, and asset liability management;

· not accept, renew, or rollover any brokered deposits. The Bank must develop and submit to the FDIC, within 30 days from the effective date of the order, a plan for eliminating its reliance on brokered deposits. In addition, the Bank cannot offer an effective yield in excess of 75 basis points on interest paid on deposits (including brokered deposits, if approval is granted for the Bank to accept them) of comparable size and maturity in either the Bank’s normal market area or in the market area in which such deposits would otherwise be accepted. Thus, for deposits in the Bank’s own normal market area, the Bank must offer rates that are not in excess of 75 basis points over the average local rates. For non-local deposits, the Bank must offer rates that are not in excess of 75 basis points over either (1) the Bank’s own local rates or (2) the applicable non-local rates;

· 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; and

· furnish, by within 45 days from the effective date of the Consent Order and within 45 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.

Going Concern Considerations

Due to the conditions and events discussed above and elsewhere in this Annual Report on Form 10-K, substantial doubt exists as to our ability to continue as a going concern. We have determined that significant additional sources of liquidity and capital will be required for us to continue operations through 2010 and beyond. We have engaged financial advisors to assist the Company in its efforts to raise additional capital, sell assets, and explore other strategic alternatives to address our current and expected liquidity and capital deficiencies. To date, those efforts have not yielded any significant results. As a result of our financial condition, our regulators are continually monitoring our liquidity and capital adequacy. In addition, our regulators have various enforcement tools available to them, including the issuance of capital directives, orders to cease engaging in certain business activities, or the issuance of modified or additional orders or agreements.

Notwithstanding the above, accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the discharge of liabilities in the normal course of business for the foreseeable future, and do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets, or the amounts and classification of liabilities that may result should we be unable to continue as a going concern.

Current Business Strategy

In addition to the actions required by the MOU, we have been actively pursuing the corrective actions required by the Consent Order in an effort to ensure that the requirements of the Consent Order are met in a timely manner. Specifically, we are currently focusing our efforts in the following areas:

· Increasing and Strengthening Our Capital Position.

As of December 31, 2009, the Bank is deemed to be “undercapitalized.” Management has developed a plan to increase and preserve our capital with the goal of returning to and maintaining a “well-capitalized” status. These

initiatives include, among other things, restructuring the Bank’s balance sheet by limiting new loan activity and aggressively attempting to sell certain real estate-related loans and other assets. We also intend to raise additional capital through a planned capital raise in the first or second quarter of 2010. Additionally, we are actively evaluating a number of capital sources and balance sheet management strategies to ensure that our projected level of regulatory capital can support our balance sheet and meet or exceed minimum requirements.

· Managing and Improving Asset Quality.

The economic recession and the deterioration of the housing and real estate markets have had an adverse impact on the credit quality of our loan portfolio. In response, our Bank intends to significantly reduce the amount of its non-performing assets. Non-performing assets hurt our profitability because they reduce the balance of earning assets, may require additional loan loss provisions or write-downs, and require significant devotion of staff time and financial resources to resolve. We believe our asset quality plan aggressively addresses these issues. For example,

· In February of 2009, we restructured the credit administration and loan operations departments and hired a skilled chief credit officer to oversee the enhancement of our processes and procedures in this area.

· In June of 2009, we established an Improving Problem Asset Committee to assist Bank management in policy development, management strategy, and/or liquidation of problem assets. We are currently proactively seeking avenues to sell Bank-owned properties and problem assets to outside investors.

· In January of 2009, we implemented a process for the continuous review of all classified loans, watch loans, past due loans, relationships over $500,000, and any other potential risky loans and applied conservative risk grades.

· Throughout 2009, we conducted disciplined watch loan meetings to track and monitor progress, including the execution of workout plans, obtainment of current financial data, and detailed progress updates.

· Throughout 2009, we maintained an adequate reserve for loan losses given the risk profile of our Bank.

· In May of 2009, we implemented a risk-focused internal and external loan review program.

· During 2010, we plan to create a special assets division to focus our efforts and enhance staffing related to loan work-outs and collection processes.

· Decreasing Concentrations in Our Loan Portfolio.

We are focused on reducing our concentrations in commercial real estate (CRE), specifically acquisition development and construction loans, and residential construction loans. Since January 2009, we have effectively ceased making any new CRE loans while proactively decreasing the level of these existing loan types. We have worked to decrease our concentration by various means, including (1) through the normal sale of real estate by borrowers, (2) by seeking avenues to sell a portion of the CRE portfolio to outside investors, (3) by proactively seeking secondary market permanent financing for recently completed residential construction projects, and (4) encouraging transactional CRE customers to seek other financing when their loans mature. As a result of these efforts, our amount of CRE loans decreased 16% from $151.6 million of our total loan portfolio at December 31, 2008 to $126.8 million of our loan portfolio at December 31, 2009. We have also reduced our residential construction portfolio 84% from $33.8 million at December 31, 2008 to $5.5 million at December 31, 2009. We expect commercial real estate loan portfolio balances to continue to decrease in 2010 through the continued successful implementation of the plans outlined above.

· Reducing Operating Expenses.

We have always focused on controlling expenses and managing efficient overhead. During 2010, management intends to further reduce costs in a manner which does not impact the quality of our customer service. Given the prolonged economic recession, we have embarked on an extremely aggressive expense reduction campaign. Management has already reduced salary and benefits expenses by reducing staffing levels, freezing salaries at 2008 levels, and reducing compensation in several positions. Additionally, we will continue to renegotiate vendor contracts and implement several other cost-saving measures to reduce noninterest expenses. Reducing our level of nonperforming assets will also lower our operating costs.

· Enhancing Funds Management and Liquidity.

We have grown rapidly since our inception through 2008, and have historically funded our asset growth with a combination of local deposits and wholesale funding, specifically brokered deposits. As of December 31, 2009, we had brokered deposits of $202.8 million, representing 53.85% of our total deposits, of which $79.7 million are scheduled to mature in the third quarter of 2010 and $94.9 million are scheduled to mature in the fourth quarter of

2010. Because of the limitations on brokered deposits imposed by the Consent Order and our undercapitalized status, the Bank may no longer accept, renew, or roll over brokered deposits. Thus, we must find other sources of liquidity to replace these deposits as they mature. We have amended our funds management policy to reflect our plan to continue to improve liquidity levels and reduce our use of brokered deposits and other non-core funding sources. Our funds management policy also includes our plan to reduce assets, certain loans, and other Bank-owned real estate. We plan to reduce our brokered deposit usage by executing on our comprehensive deposit acquisition program, which creates an environment of consistent deposit growth based on relationship-based banking, advocate-based selling and an aggressive, focused calling program. Our experienced team of bankers is actively cross-selling core deposits to our local depositors and borrowers, and is held accountable for production through twice-weekly sales meetings. Production is enhanced by our relationship-based culture training, which includes advanced customer service techniques and one-on-one coaching. We also plan to generate local deposits through a combination of competitive products and pricing, customer service excellence, and targeted marketing campaigns.

· Enhancing Our Bank’s Relationship Culture.

While the bulk of our strategic plan encompasses strategies to survive the prolonged economic recession, management recognizes that we must also place the Bank in the best position to thrive as we emerge from this recession. In this regard, planning has also centered on enhancing the Bank’s culture. We believe the enhancement of our culture will place the Bank in the best position possible to provide unmatched customer service and to take advantage of market opportunities through advocate-based selling and relationship banking strategies. Enhancement plans include, among others, the following:

· implementing consistent customer service and communication standards in all areas of the Bank;

· training and certifying the non-negotiables of relationship banking to all employees;

· ensuring all employees are engaged and motivated while enabling management to measure the enhancement of the culture by conducting quarterly employee engagement surveys;

· implementing consistent management standards for all supervisors resulting in internal and external advocacy;

· refining the Bank’s customer experience measurements, including branch mystery shopping and customer survey programs; and ensuring all programs evaluate and measure the Bank’s expectations and areas of focus.

We will continue to serve customers in all areas, including processing banking transactions, meeting customer deposit needs, and providing access to lines of credit. All customer deposits are fully insured to the highest limits set by the FDIC, which are $250,000 for individually titled accounts and $250,000 for individually titled IRA accounts. In addition, we participate in the FDIC Transaction Account Guarantee Program. Under this program, all non-interest bearing transaction accounts are fully guaranteed by the FDIC for the entire amount of the account. The guarantee also applies to interest bearing transaction accounts with interest rates of 0.50 percent or less. This program is in addition to and separate from the coverage available under the FDIC general deposit insurance rules.

However, should we fail to comply with the capital and liquidity funding requirements in the Consent Order, or suffer a continued deterioration in our financial condition, we may be subject to being placed into a federal conservatorship or receivership by the FDIC, with the FDIC appointed as conservator or receiver.

Recent Legislative and Regulatory Initiatives to Address Financial and Economic Crises

Markets in the United States and elsewhere have experienced extreme volatility and disruption for more than 12 months. These circumstances have exerted significant downward pressure on prices of equity securities and virtually all other asset classes, and have resulted in substantially increased market volatility, severely constrained credit and capital markets, particularly for financial institutions, and an overall loss of investor confidence. Loan portfolio performances have deteriorated at many institutions resulting from, among other factors, a weak economy and a decline in the value of the collateral supporting their loans. Dramatic slowdowns in the housing industry, due in part to falling home prices and increasing foreclosures and unemployment, have created strains on financial institutions. Many borrowers are now unable to repay their loans, and the collateral securing these loans has, in some cases, declined below the loan balance. In response to the challenges facing the financial services sector, several regulatory and governmental actions have recently been announced including:

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

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

· On October 14, 2008, the U.S. Treasury announced the creation of a new program, the Troubled Asset Relief Program (the “TARP”) Capital Purchase Program (the “CPP”) that encourages and allows financial institutions to build capital through the sale of senior preferred shares to the U.S. Treasury on terms that are non-negotiable;

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

· The Transaction Account Guarantee Program (“TAGP”), which provides unlimited deposit insurance coverage through December 31, 2009 for noninterest-bearing transaction accounts (typically business checking accounts) and certain funds swept into noninterest-bearing savings accounts. Institutions participating in the TLGP pay a 10 basis points fee (annualized) on the balance of each covered account in excess of $250,000, while the extra deposit insurance is in place. This program was extended until June 30, 2010.

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

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

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

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

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

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

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

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

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

· The second plan is the Securities Program, which is administered by the Treasury and involves the creation of public-private investment funds to target investments in eligible residential mortgage-backed securities and commercial mortgage-backed securities issued before 2009 that originally were rated AAA or the equivalent by two or more nationally recognized statistical rating organizations, without regard to rating enhancements (collectively, “Legacy Securities”). Legacy Securities must be directly secured by actual mortgage loans, leases or other assets, and may be purchased only from financial institutions that meet TARP eligibility requirements. The Treasury received over 100 unique applications to participate in the Legacy Securities PPIP and in July 2009 selected nine public-private investment fund managers. As of December 31, 2009, public-private investment funds have completed initial and subsequent closings on approximately $6.2 billion of private sector equity capital, which was matched 100% by Treasury, representing $12.4 billion of total equity capital. Treasury has also provided $12.4 billion of debt capital, representing $24.8 billion of total purchasing power. As of December 31, 2009, public-private investment funds have drawn-down approximately $4.3 billion of total capital which has been invested in certain non-agency residential mortgage-backed securities and commercial mortgage-backed securities and cash equivalents pending investment.

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

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

It is likely that further regulatory actions may arise as the Federal government continues to attempt to address the economic situation.

We are participating in the TAGP component of the TLGP. As a result of the enhancements to deposit insurance protection and the expectation that there will be demands on the FDIC’s deposit insurance fund, our deposit insurance costs have increased and will continue to increase significantly through the remainder of 2009 and throughout 2010. We have elected not to participate in the CPP. Regardless of our lack of participation, governmental intervention and new regulations under these programs could materially and adversely affect our business, financial condition and results of operations.

Proposed Legislation and Regulatory Action

Legislative and regulatory proposals regarding changes in banking, and the regulation of banks, federal savings institutions, and other financial institutions and bank and bank holding company powers are being considered by the executive branch of the federal government, Congress and various state governments. Certain of these proposals, if adopted, could significantly change the regulation or operations of banks and the financial services industry. New regulations and statutes are regularly proposed that contain wide-ranging proposals for altering the structures, regulations, and competitive relationships of the nation’s financial institutions. On June 17, 2009, the U.S. Treasury released a white paper entitled “Financial Regulatory Reform — A New Foundation: Rebuilding Financial Supervision and Regulation” (the “Proposal”) which calls for sweeping regulatory and supervisory reforms for the entire financial sector and seeks to advance the following six key objectives: (i) promote robust supervision and regulation of financial firms, (ii) establish comprehensive supervision of financial markets, (iii) protect consumers and investors from financial abuse, (iv) provide the government with additional powers to monitor

systemic risks, supervise and regulate financial products and markets, and to resolve firms that threaten financial stability, and (v) raise international regulatory standards and improve international cooperation.

The Proposal includes the creation of a new federal government agency, the National Bank Supervisor (“NBS”) that would charter and supervise all federally chartered depository institutions, and all federal branches and agencies of foreign banks. It is proposed that the NBS take over the responsibilities of the Office of the Comptroller of the Currency, which currently charters and supervises nationally chartered banks, and the responsibility for the institutions currently supervised by the Office of Thrift Supervision, which supervises federally chartered savings institutions and federal savings institution holding companies.

The Proposal also includes the creation of a new federal agency designed to enforce consumer protection laws. The Consumer Financial Protection Agency (“CFPA”) would have authority to protect consumers of financial products and services and to regulate all providers (bank and non-bank) of such services. The CFPA would be authorized to adopt rules for all providers of consumer financial services, supervise and examine such institutions for compliance, and enforce compliance through orders, fines, and penalties. The rules of the CFPA would serve as a “floor” and individual states would be permitted to adopt and enforce stronger consumer protection laws. If adopted as proposed, we may become subject to multiple laws affecting its provision of loans and other credit services to consumers, which may substantially increase the cost of providing such services.

On February 2, 2010, President Obama called on Congress to create a new Small Business Lending Fund. Under this proposal, $30 billion in TARP funds would be transferred to a new program outside of TARP to support small business lending. As proposed, only small- and medium-sized banks would qualify to participate in the program.

New regulations and statutes are regularly proposed that contain wide-ranging proposals for altering the structures, regulations, and competitive relationships of the nation’s financial institutions. We cannot predict whether or in what form any proposed regulation or statute will be adopted or the extent to which our business may be affected by any new regulation or statute.

Results of Operations

Results of operations are only presented for the years ended December 31, 2009 and 2008.

Net interest income increased $498,000, or 4.92%, to $10.6 million in 2009, up from $10.1 million in 2008. The primary component of interest income in 2009 was interest on loans, including fees, of $17.0 million, as compared to $20.2 million in 2008. The increase in net interest income was due primarily to a decrease in deposit rates, translating into lower interest expense.

The Company’s net interest spreads were 2.49% and 2.27% in 2009 and 2008, respectively. The Company’s net interest margins were 2.73% and 2.74% in 2009 and 2008, respectively. Yields on average earning assets decreased from 6.13% in 2008 to 4.93% in 2009. Rates on average interest bearing liabilities decreased from 3.86% in 2008 to 2.44% in 2009. These changes in yields and rates resulted in a net decrease in net interest spread of 22 basis points. Average shareholder equity was 7.3% of average interest bearing liabilities in 2009 and 9.5% of average interest bearing liabilities in 2008.

The provision for loan losses was $17.0 million in 2009, compared to $7.2 million in 2008. The charges to the provision were to maintain the allowance for loan losses at a level sufficient to cover estimated losses inherent in the loan portfolio, given the current economic downturn which has affected the entire banking industry. The Bank, like many community banks, has a significant amount of loans that directly or indirectly rely on the home building industry, which has also experienced an extremely turbulent second year.

Non-interest income increased $1.3 million, or 95.62%, to $2.7 million in 2009, up from non-interest income of $1.4 million in 2008. The increase is mainly attributable to gains on sale of investments totaling $1.2 million in 2009. Mortgage loan origination fees increased $239,000, or 50.85%, which was $709,000 for the year ended December 31, 2009. The increase is due to our increased volume in mortgage loan originations. Income from bank-owned life insurance was $51,000 in 2009, compared to income of $210,525 in 2008. The Company executed a sale of its Bank Owned Life Insurance in the first quarter of 2009. Service charges on deposit accounts increased $58,000, or 18.01%, to $380,000 in 2009, as compared to service charges on deposit accounts of $322,000 in 2008, due to the increased volume in deposit accounts.

Non-interest expense increased $4.2 million, or 43.73%, to $13.7 million in 2009, compared to non-interest expense of $9.5 million in 2008. Salaries and employee benefits increased $407,000 to $5.2 million for the year ended December 31, 2009. This increase is attributable to growth of the mortgage division. FDIC insurance premiums totaled $1.1 million for the year ended December 31, 2009 compared to $226,000 in 2008. The increase in the FDIC assessment includes increased annual premiums by the FDIC due to the increase in our deposit base and our current financial condition as well as a one-time FDIC insurance premium that equated to a $178,000 one time charge to the Bank in 2009. The Company also had a writedown to Other Real Estate Owned and Repossessed Collateral of $2.1 million for the year ended December 31, 2009. The Company’s efficiency ratio was 102.4% in 2009 compared to 82.5% in 2008. The efficiency ratio is defined as non-interest expense divided by the sum of net interest income and non-interest income, net of gains and losses on sales of assets. The deterioration in our efficiency ratio is primarily attributable to the increased expenses described above.

The Company’s net loss was $18.3 million in 2009, compared to net loss of $3.4 million in 2008. The significant increase in the net loss in 2009 was primarily due to the increase in the provision for loan losses which increased $9.8 million to $17.0 million from $7.2 million for the years ended December 31, 2009 and 2008, respectively. Return on average assets during 2009 was -4.55% compared to a return of -0.87% in 2008. Net loss in 2009 was after an income tax expense of $1.0 million and net loss in 2008 was after an income tax benefit of $1.8 million. The income tax expenses for 2009 and 2008 resulted in effective tax rates of -5.7% and 35.0%, respectively. The 2009 income tax benefit computed on the pretax loss was reduced by the $6.6 million expense of providing a 100% valuation allowance against the deferred tax assets. See Notes 1 and 13 to the consolidated financial statements for additional information about income taxes.

Net Interest Income

General. The largest component of the Company’s net income is its net interest income, which is the difference between the income earned on assets and interest paid on deposits and borrowings used to support such assets. Net interest income is determined by the yields earned on the Company’s interest-earning assets and the rates paid on its interest-bearing liabilities, as well as the relative amounts of interest-earning assets and interest-bearing liabilities. Net interest income divided by average interest-earning assets represents the Company’s net interest margin. The net interest spread is the difference between the yield we earn on our interest-earning assets and the rate we pay on our interest-bearing liabilities. If the general economic downturn continues, we anticipate continued changes in payment behavior causing a further reduction in net interest income in the future. If interest rates were to rise, we believe it would have a positive effect on our net interest income.

Rate/Volume Analysis. Net interest income can be analyzed in terms of the impact of changing interest rates and changing volumes. The following tables set forth the effect which the varying levels of interest-earning assets and interest-bearing liabilities and the applicable rates have had on changes in the net interest income for the periods presented.

	December 31, 2009 vs. 2008												December 31, 2008 vs. 2007
	Increase (decrease) Due to												Increase (decrease) Due to
							Rate /												Rate /
(Dollars in thousands)	Volume			Rate			Volume			Total			Volume			Rate			Volume			Total
Interest Income
Loans(1)	$	(621	)	$	(2,666	)	$	83		$	(3,204	)	$	4,067		$	(4,460	)	$	(847	)	$	(1,240	)
Investment securities (2)	991			(751		)	(323		)	(83		)	1,926			(72		)	(209		)	1,645
Federal funds	269			(219		)	(246		)	(196		)	(754		)	(454		)	298			(910		)
Total Interest Income	$	639		$	(3,636	)	$	(486	)	$	(3,483	)	$	5,239		$	(4,986	)	$	(758	)	$	(505	)

Interest Expense
Deposits	$	(46	)	$	488		$	(20	)	$	422		$	1,232		$	(2,549	)	$	(241	)	$	(1,558	)
Other borrowings	1,124			(5,032		)	(495		)	(4,403		)	1,076			—			(7		)	1,069
Total Interest Expense	$	1,078		$	(4,544	)	$	(515	)	$	(3,981	)	$	2,308		$	(2,549	)	$	(248	)	$	(489	)

Net Interest Income	$	(439	)	$	908		$	29		$	498		$	2,931		$	(2,437	)	$	(510	)	$	(16	)

(1) For the purpose of this table, loans include non-performing loans such as those in non-accrual and past due 90 days or more and still accruing interest.

(2) For the purpose of this table, the investment securities include marketable and non-marketable securities.

Average Balances, Income and Expenses and Rates. The following table sets forth, for the years ended December 31, 2009, 2008 and 2007, information related to the Company’s average balance sheet and its average yields on earning assets and average costs of interest-bearing liabilities. Such yields are derived by dividing income or expense by the average balance of the corresponding earning assets or interest-bearing liabilities. Average balances have been derived from the daily balances throughout the periods indicated.

	2009							2008							2007
	Average			Income /		Yield /		Average			Income /		Yield /		Average			Income /		Yield /
(Dollars in thousands)	Balance			Expense		Rate		Balance			Expense		Rate		Balance			Expense		Rate
Assets
Earning assets:
Loans (1)	$	305,472		$	16,959	5.55	%	$	315,175		$	20,163	6.40	%	$	264,844		$	21,403	8.08	%
Investment securities (2)	67,456			2,225		3.30	%	47,130			2,308		4.90	%	12,067			663		5.49	%
Federal funds sold and other	16,749			44		0.26	%	7,884			239		3.04	%	22,914			1,150		5.02	%
Total earning assets	389,677			19,228		4.93	%	370,189			22,710		6.13	%	299,825			23,216		7.74	%
Cash and due from banks	7,202							5,579							4,720
Premises and equipment	4,377							4,873							4,953
Other assets	9,550							8,944							7,856
Allowance for loan losses	(8,744		)					(5,528		)					(3,686		)
Total assets	$	402,062						$	384,057						$	313,668

Liabilities
Interest-bearing liabilities:
Repurchase agreements	$	30,000		$	976	3.25	%	$	28,525		$	700	2.46	%	$	2,315		$	63	2.72	%
Federal funds purchased	155			1		0.57	%	1,312			24		1.85	%	—			—		—	%
Other borrowings	10,018			576		5.75	%	11,855			407		3.43	%	—			—		—	%
Interest-bearing transaction accounts	18,247			219		1.20	%	15,300			324		2.12	%	11,520			196		1.70	%
Savings deposits	60,101			1,531		2.55	%	18,881			223		1.18	%	19,107			648		3.39	%
Time deposits	233,472			5,296		2.27	%	249,765			10,902		4.36	%	228,748			12,162		5.32	%
Total interest-bearing liabilities	351,993			8,599		2.44	%	325,638			12,580		3.86	%	261,690			13,069		4.99	%
Demand deposits	22,290							23,739							18,864
Accrued interest and other liabilities	1,935							3,535							2,492
Total liabilities	376,218							353,103							283,046
Shareholders’ equity	25,844							30,713							30,622
Total liabilities and shareholders’ equity	$	402,062						$	384,057						$	313,668

Net interest income				$	10,629						$	10,130						$	10,147
Net interest spread						2.49	%						2.27	%						2.75	%
Net interest margin						2.73	%						2.74	%						3.38	%

(1) There were $29.4 million, $9.9 million, and $35,172 of loans in non-accrual status as of December 31, 2009, 2008 and 2007, respectively. The effect of fees collected on loans in 2009, 2008 and 2007 totaled $158,000, $261,000 and $655,000, respectively, and increased the annualized yield on loans by 5 basis points from 5.50% for 2009, by 9 basis points from 6.31% for 2008, and by 25 basis points from 7.83% for 2007. The effect of such fees on the annualized yield on earning assets was an increase of 4 basis points from 4.89% in 2009, an increase of 7 basis points from 6.06% in 2008, and an increase of 22 basis points from 7.52% in 2007. The effects of such fees on net interest spread were an increase of 4 basis points from 2.45% for 2009, an increase of 7 basis points from 2.20% for 2008, and an increase of 22 basis points from 2.53% for 2007. The effects of such fees on net interest margin were an increase of 4 basis points from 2.69% for 2009, an increase of 17 basis points from 2.57% for 2008, and an increase of 21 basis points from 3.17% for 2007.

(2) For the purpose of this table, the investment securities include marketable and non-marketable securities.

Interest Sensitivity. The Company monitors and manages the pricing and maturity of its assets and liabilities in order to diminish the potential adverse impact that changes in interest rates could have on its net interest income. The principal monitoring technique employed by the Company is the measurement of the Company’s interest sensitivity “gap”, which is the positive or negative dollar difference between assets and liabilities that are subject to interest rate repricing within a given period of time. Interest rate sensitivity can be managed by repricing assets or liabilities, selling securities available for sale, replacing an asset or liability at maturity, or adjusting the interest rate during the life of an asset or liability. Managing the amount of assets and liabilities repricing in this same time interval helps to hedge the risk and minimize the impact on net interest income of rising or falling interest rates.

The following table sets forth the Company’s interest rate sensitivity at December 31, 2009.

				After
				Three			One			Greater
	Within			Through			Through			Than
	Three			Twelve			Five			Five
(Dollars in thousands)	Months			Months			Years			Years			Total
Assets
Earning assets:
Loans, gross	$	152,129		$	20,166		$	96,875		$	5,934		$	275,104
Investment securities, available for sale	—			—			—			103,638			103,638
Other investments	—			—			—			1,599			1,599
Fed funds	31,043			—			—			—			31,043
Total earning assets	183,172			20,166			96,875			111,171			411,384

Liabilities
Interest-bearing liabilities:
Interest-bearing deposits:
Repurchase agreements	—			15,000			—			15,000			30,000
Other borrowings	—			—			—			4,325			4,325
Demand deposits	18,588			—			—			—			18,588
Savings deposits	82,295			—			—			—			82,295
Time deposits	19,968			229,363			4,520			—			253,851
Total interest-bearing liabilities	120,851			244,363			4,520			19,325			389,059
Period gap	$	62,321		$	(224,197	)	$	92,355		$	91,846		$	22,325
Cumulative gap	$	62,321		$	(161,876	)	$	(69,521	)	$	22,325
Ratio of cumulative gap to total earning assets	15.15		%	(39.35		)%	(16.90		)%	5.43		%

The above table reflects the balances of interest-earning assets and interest-bearing liabilities at the earlier of their repricing or maturity dates. Overnight federal funds are reflected at the earliest pricing interval due to the immediately available nature of the instruments. Scheduled payment amounts of fixed rate amortizing loans are reflected at each scheduled payment date. Scheduled payment amounts of variable rate amortizing loans are reflected at each scheduled payment date until the loan may be repriced contractually; the unamortized balance is reflected at that point. Interest-bearing liabilities with no contractual maturity, such as savings deposits and interest-bearing transaction accounts, are reflected in the earliest repricing period due to contractual arrangements which give the Company the opportunity to vary the rates paid on those deposits within a thirty-day or shorter period. Fixed rate time deposits, principally certificates of deposit, are reflected at their contractual maturity date.

The Company generally would benefit from increasing market rates of interest when it has an asset-sensitive gap position and generally would benefit from decreasing market rates of interest when it is liability-sensitive. The Company is cumulatively liability sensitive over the three-month to twelve-month period and asset sensitive over all periods greater than one year. However, the Company’s gap analysis is not a precise indicator of its interest sensitivity position. The analysis presents only a static view of the timing of maturities and repricing opportunities, without taking into consideration that changes in interest rates do not affect all assets and liabilities equally. Net interest income may be impacted by other significant factors in a given interest rate environment, including changes in the volume and mix of earning assets and interest-bearing liabilities.

Provision and Allowance for Loan Losses

General. The Company has developed policies and procedures for evaluating the overall quality of its credit portfolio and the timely identification of potential problem loans. On a quarterly basis, the Company’s Board of Directors reviews and approves the appropriate level for the Company’s allowance for loan losses based upon management’s recommendations, the results of the internal monitoring and reporting system, and an analysis of economic conditions in its market.

In addition to the Company’s portfolio review process, various regulatory agencies periodically review the Company’s allowance for loan losses. These agencies may require the Company to recognize additions to the allowance for loan losses based on their judgments and information available to them at the time of their examinations. While the Company uses available information to recognize inherent losses on loans, future adjustments to the allowance for loan losses may be necessary based on changes in economic conditions and other factors and the impact of such changes and other factors on the Bank’s borrowers.

Portions of the allowance for loan losses may be allocated for specific loans or portfolio segments. However, the entire allowance for loan losses is available for any loan that, in management’s judgment, should be charged-off. While management utilizes the best judgment and information available to it, the ultimate adequacy of the allowance for loan losses depends on a variety of factors beyond the Company’s control, including the performance of the Company’s loan portfolio, the economy, changes in interest rates, and the view of the regulatory authorities toward loan classifications.

Additions to the allowance for loan losses, which are expensed through the provision for loan losses on the Company’s income statement, are made periodically to maintain the allowance at an appropriate level based on management’s analysis of the estimated losses inherent in the loan portfolio. Loan losses and recoveries are charged or credited directly to the allowance. The amount of the provision is a function of the level of loans outstanding, the level of non-performing loans, historical loan loss experience, the amount of loan losses actually charged against the reserve during a given period, and current and anticipated economic conditions.

The Company’s allowance for loan losses is based upon judgments and assumptions about risk elements in the portfolio, economic conditions, and other factors affecting borrowers. The process includes identification and analysis of loss potential in various portfolio segments utilizing a credit risk grading process and specific reviews and evaluations of significant problem credits. However, there is no precise method of estimating credit losses, since any estimate of loan losses is necessarily subjective and the accuracy depends on the outcome of future events. In addition, due to our rapid growth over the past several years and our limited operating history, a large portion of the loans in our loan portfolio was originated recently. In general, loans do not begin to show signs of credit deterioration or default until they have been outstanding for some period of time, a process referred to as seasoning. As a result, a portfolio of more mature loans will usually behave more predictably than a newer portfolio. Because our loan portfolio is relatively new, the current level of delinquencies and defaults may not be representative of the level that will prevail when the portfolio becomes more seasoned, which may be higher than current levels. If charge-offs in future periods increase, we may be required to increase our provision for loan losses, which would decrease our net income and possibly our capital.

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. However, underlying assumptions may be impacted in future periods by changes in economic conditions, the impact of regulatory examinations, and the discovery of information with respect to borrowers, which was not known to management at the time of the issuance of the Company’s consolidated financial statements. Therefore, management’s assumptions may or may not prove valid. Thus, there can be no assurance that charge-offs in future periods will not exceed the allowance for loan losses or that additional increases in the allowance for loan losses will not be required, especially considering the overall weakness in the commercial real estate market in our market areas. Additionally, no assurance can be given that management’s ongoing evaluation of the loan portfolio, in light of changing economic conditions and other relevant factors, will not require significant future additions to the allowance for loan losses, thus adversely impacting the Company’s business, financial condition, results of operations, and cash flows.

The following table sets forth certain information with respect to the Company’s allowance for loan losses and the composition of charge-offs and recoveries for the five years ended December 31, 2009.

Allowance for Loan Losses

(Dollars in thousands)	2009			2008			2007			2006			2005
Total loans outstanding at end of period	$	275,104		$	320,907		$	302,934		$	217,644		$	115,704
Average loans outstanding	$	305,472		$	315,175		$	264,844		$	168,107		$	63,985
Balance of allowance for loan losses at beginning of year	$	8,088		$	4,214		$	3,091		$	1,558		$	—
Loans charged off:
Real estate — construction	6,871			3,112			15			—			—
Real estate — mortgage	3,985			120			—			—			—
Commercial and industrial	1,441			—			—			—			—
Consumer and other	243			62			54			—			—
Total loan losses	12,540			3,294			69			—			—
Recoveries of previous loan losses:
Real estate — construction	402			—			4			—			—
Real estate — mortgage	—			—			—			—			—
Commercial and industrial	1			—			—			—			—
Consumer and other	22			—			—			—			—
Total recoveries	425			—			4			—			—
Net charge-offs	12,115			3,294			65			—			—
Provision for loan losses	16,990			7,168			1,188			1,533			1,558
Balance of allowance for loan losses at end of year	$	12,963		$	8,088		$	4,214		$	3,091		$	1,558
Net charge-offs to average loans outstanding	3.97		%	1.05		%	0.02		%	—		%	—		%

Our allowance for loan losses totaled $13.0 million at December 31, 2009 compared with $8.1 million at December 31, 2008, representing 4.71% and 2.52% of gross loans, respectively. The December 31, 2009 allowance for loan losses, and, therefore indirectly the provision for loan losses for the year ended December 31, 2009, was determined based on the following specific factors, though not intended to be an all inclusive list:

· The impact of the ongoing depressed overall economic environment, including those within our geographic market,

· The cumulative impact of the extended duration of this economic deterioration on our borrowers, in particular those with real estate related loans,

· The declining asset quality trends in our loan portfolio,

· The increasing trend in the historical loan loss rates within our loan portfolio,

· The results of our internal and external loan reviews during the second, third and fourth quarters of 2009 resulting in loan downgrades,

· Our internal and external impaired loan analysis which identified:

· Increased stress on borrowers given increasing lack of liquidity, and limited bank financing and credit availability, and

· Continued downward trends in appraised values and market assumptions used to value real estate dependent loans.

Non-performing Assets

Non-performing Assets. There were $29.4 million and $9.9 million of non-accrual loans at December 31, 2009 and December 31, 2008, respectively. There were $5.3 million and $6,035 of loans past due 90 days or more and still accruing interest or restructured loans at December 31, 2009 and 2008, respectively. There was $6.7 million and $415,229 in Other Real Estate Owned at December 31, 2009 and 2008, respectively. There was $942,000 in Repossessed Collateral at December 31, 2009 and none at December 31, 2008.

The table below represents non-performing assets for the five years ended December 31, 2009.

(Dollars in thousands)	2009		2008		2007		2006		2005
Non-accrual loans	$	29,369	$	9,916	$	35	$	284	$	—
Loans past due 90 days or more and still accruing	560		6		—		—		—
Other Real Estate Owned and Repossessed Collateral	7,645		415		—		—		—
Restructured loans	4,789		—		—		—		—
Total non-performing assets	$	42,363	$	10,337	$	35	$	284	$	—

The increase of $19.5 million in non-performing loans from December 31, 2008 to December 31, 2009 is related primarily to continued deterioration in the Bank’s overall commercial real estate loan portfolio. The number of loans on non-accrual status has increased from 30 to 50 since December 31, 2008. The average non-accrual loan balance is $330,000 and $352,000 as of December 31, 2008 and December 31, 2009, respectively. 99.9% of the non-accrual loans are secured by real estate. $3.1 million of the allowance for loan loss has been specifically allocated to these relationships. This increase in non-performing loans is a direct result of the poor economic environment, as noted below, taking a toll on numerous borrowers’ ability to pay as scheduled. At this time, management is unable to determine the length of the economic downturn and therefore unable to determine the ultimate impact on the Bank’s A&D loan portfolio.

The Company’s policy with respect to non-performing assets is as follows. Accrual of interest will be discontinued on a loan when management believes, after considering economic and business conditions and collection efforts that the borrower’s financial condition is such that the collection of interest is doubtful. A delinquent loan will generally be placed in non-accrual status when it becomes 90 days or more past due unless the estimated net realizable value of collateral exceeds the principal balance and accrued interest. When a loan is placed in non-accrual status, all interest which has been accrued on the loan but remains unpaid is reversed and deducted from current earnings as a reduction of reported interest income. No additional interest will be accrued on the loan balance until the collection of both principal and interest becomes reasonably certain. When a problem loan is finally resolved, there may ultimately be an actual write-down or charge-off of the principal balance of the loan to the allowance for loan losses.

Potential Problem Loans. Potential problem loans are loans that are not included in impaired loans, but about which management has become aware of information about possible credit problems of the borrowers that causes doubt about their ability to comply with current repayment terms. At December 31, 2009 and December 31, 2008, the Company had identified $15.9 million and $424,844, respectively, of potential problem loans through its internal review procedures. The results of this internal review process are considered in determining management’s assessment of the adequacy of the allowance for loan losses.

Non-interest Income and Expense

Non-interest Income. The largest component of non-interest income was gain on sale of investments which totaled $1.2 million for the year ended December 31, 2009. There was no gain on sale of investments in 2008.

The following table sets forth the principal components of non-interest income for the years ended December 31, 2009 and 2008.

(Dollars in thousands)	2009		2008
Mortgage origination fees	$	709	$	470
Service charges on deposit accounts	380		322
Bank-owned life insurance	51		211
Gain on sale of investments	1,162		—
Other income	421		389
Total non-interest income	$	2,723	$	1,392

Non-interest Expense. Salaries and employee benefits comprised the largest component of non-interest expense which totaled $5.2 million and $4.8 million for the years ended December 31, 2009 and 2008, respectively. This increase is attributable to growth of the mortgage division. FDIC insurance premiums totaled $1.1 million for the year ended December 31, 2009 compared to $226,000 in 2008. The increase in the FDIC assessment includes increased annual premiums by the FDIC due to the increase in our deposit base and our current financial condition as well as a one-time FDIC insurance premium that equated to a $178,000 one time charge to the Bank in 2009. The Company also had a writedown to Other Real Estate Owned and Repossessed Collateral of $2.1 million for the year ended December 31, 2009.

The following table sets forth the primary components of non-interest expense for the years ended December 31, 2009 and 2008.

(Dollars in thousands)	2009		2008
Salaries and benefits	$	5,235	$	4,828
Net occupancy	682		638
Depreciation	735		718
Equipment maintenance and rental	210		194
Advertising	227		248
Professional fees	351		449
Office supplies	82		95
Telephone	146		148
Data processing	921		758
FDIC assessment	1,136		226
Writedown/loss on sale of other real estate owned	2,044		—
Writedown of repossessed collateral	174		—
Other	1,727		1,209
Total non-interest expense	$	13,670	$	9,511

Earning Assets

Loans. Loans are the largest category of earning assets and typically provide higher yields than the other types of earning assets. Loans also entail greater credit and liquidity risks than most of the Company’s other investments and short-term interest-earning cash and cash equivalents, which management attempts to control and counterbalance. Loans averaged $305.5 million and $315.2 million in 2009 and 2008, respectively. Total loans were $275.1 million and $320.9 million at December 31, 2009 and 2008, respectively.

The following table sets forth the composition of the loan portfolio by category for the five years ended December 31, 2009 and highlights the Company’s general emphasis on mortgage lending.

	2009					2008					2007					2006					2005
				Percent					Percent					Percent					Percent					Percent
(Dollars in thousands)	Amount			Of Total		Amount			Of Total		Amount			Of Total		Amount			Of Total		Amount			Of Total
Real estate — construction	$	81,128		29.49	%	$	129,777		40.44	%	$	124,016		40.94	%	$	69,021		31.71	%	$	35,742		30.89	%
Real estate — mortgage	167,296			60.81	%	154,838			48.25	%	149,369			49.31	%	128,709			59.13	%	68,965			59.60	%
Commercial and industrial	25,028			9.10	%	33,303			10.38	%	26,095			8.61	%	17,239			7.92	%	9,082			7.85	%
Consumer	1,652			0.60	%	2,989			0.93	%	3,454			1.14	%	2,695			1.24	%	1,915			1.66	%
Total loans, gross	275,104			100.00	%	320,907			100.00	%	302,934			100.00	%	217,664			100.00	%	115,704			100.00	%
Allowance for loan losses	(12,963		)			(8,088		)			(4,214		)			(3,091		)			(1,558		)
Net loans	$	262,141				$	312,819				$	298,720				$	214,573				$	114,146

The largest component of loans in the Company’s loan portfolio is real estate mortgage loans. At December 31, 2009 and 2008, real estate mortgage loans, which consist of first and second mortgages on single or multi-family residential dwellings, loans secured by commercial and industrial real estate and other loans secured by multi-family properties and farmland, totaled $167.3 million and $154.8 million, respectively and represented 60.81% and 48.25%, respectively of the total loan portfolio. In the context of this discussion, a “real estate mortgage loan” is defined as any loan, other than a loan for construction purposes, secured by real estate, regardless of the purpose of the loan. It is common practice for financial institutions in the Company’s market area to obtain a security interest in real estate whenever possible, in addition to any other available collateral. This collateral is taken to reinforce the likelihood of the ultimate repayment of the loan and tends to increase the magnitude of the real estate loan portfolio component. Real estate mortgage loans represent $10.9 million or 37.3% of our impaired loans.

The demand for residential and commercial real estate loans in the Upstate of South Carolina has been historically stable due to the historically low interest rate environment. Commercial real estate loans are generally viewed as having more risk of default than residential real estate loans. They are also typically larger than residential real estate loans and consumer loans and depend on cash flows from the owner’s business or the property to service the debt. Cash flows may be affected significantly by general economic conditions (including rising interest rates), a downturn in the local economy, or a decline in occupancy rates in the local economy where the property is located. Because our loan portfolio contains a number of commercial real estate loans with relatively large balances, the deterioration of one or a few of these loans could cause a significant increase in our level of non-performing loans. An increase in non-performing loans could result in a loss of earnings from these loans, an increase in the related provision for loan losses and an increase in charge-offs, all of which could have a material adverse effect on our financial condition and results of operations.

Real estate construction loans totaled $81.1 million and $129.8 million at December 31, 2009 and 2008, respectively. In the context of this discussion, a “real estate construction loan” is defined as any loan for construction purposes, secured by real estate. Real estate construction loans represent $28.5 million or 56.2% of our impaired loans.

Commercial and industrial loans totaled $25.0 million and $33.3 million at December 31, 2009 and 2008, respectively and comprised 9.10% and 10.38%, respectively of the total portfolio. In the context of this discussion, a “commercial and industrial loan” is defined as any loan for a non-consumer purpose, not secured by real estate.

The Company’s loan portfolio also includes consumer loans. At December 31, 2009 and 2008, consumer loans totaled $1.7 million and $3.0 million, respectively and represented 0.60% and 0.93%, respectively of the total loan portfolio.

The Company’s loan portfolio reflects the diversity of its upstate South Carolina market. The Company’s offices are located in Easley, Spartanburg, Mauldin, Greer, Anderson and Greenville, South Carolina. Management expects the area to remain stable with continued growth in the near future. The diversity of the economy creates opportunities for all types of lending. The Company does not engage in foreign lending.

The repayment of loans in the loan portfolio as they mature is also a source of liquidity for the Company. Due to the current economic downturn, all contractual maturities may not parallel actual payoffs due to the inability of borrowers to repay their loans. The following tables set forth the Company’s loans maturing within specified intervals at December 31, 2009 and 2008.

2009

			Over One
			Year
			Through		Over
	One Year		Five		Five
(Dollars in thousands)	or Less		Years		Years		Total
Real estate — construction	$	62,205	$	18,762	$	161	$	81,128
Real estate — mortgage	47,712		97,429		22,155		167,296
Commercial and industrial	14,690		10,017		321		25,028
Consumer	539		802		311		1,652
	$	125,146	$	127,010	$	22,948	$	275,104

Loans maturing after one year with:
Fixed interest rates							$	140,182
Floating interest rates							9,776
							$	149,958

2008

			Over One
			Year
			Through		Over
	One Year		Five		Five
(Dollars in thousands)	or Less		Years		Years		Total
Real estate — construction	$	76,579	$	51,914	$	1,284	$	129,777
Real estate — mortgage	24,951		106,620		23,267		154,838
Commercial and industrial	17,384		13,863		2,056		33,303
Consumer	686		1,641		662		2,989
	$	119,600	$	174,038	$	27,269	$	320,907

Loans maturing after one year with:
Fixed interest rates							$	169,843
Floating interest rates							31,464
							$	201,307

The information presented in the above table is based on the contractual maturities of the individual loans, including loans which may be subject to renewal at their contractual maturity. Renewal of such loans is subject to review and credit approval as well as modification of terms upon their maturity. Consequently, management believes this treatment presents fairly the maturity and repricing structure of the loan portfolio shown in the above table.

Investment Securities and Other Investments. The investment securities portfolio, which averaged $67.5 million and $47.1 million in 2009 and 2008, respectively, is a component of the Company’s total earning assets. At December 31, 2009 and 2008, the total investment securities portfolio was $105.2 million and $49.4 million, respectively. Investment securities were primarily marketable investments recorded at their fair value. Other investments consisted of FHLB stock recorded at cost.

The following table sets forth the amortized cost and fair value of the securities held by the Company for the three years ended December 31, 2009.

	2009				2008				2007
(Dollars in thousands)	Amortized Cost		Fair Value		Amortized Cost		Fair Value		Amortized Cost		Fair Value
U.S. government agencies	$	—	$	—	$	19,001	$	19,086	$	15,487	$	15,623
Mortgage-backed securities	104,672		103,538		27,768		28,416		9,014		9,121
Other securities	100		100		100		100		100		100
Other investments	1,599		1,599		1,805		1,805		447		447
Total investment securities portfolio	$	106,371	$	105,237	$	48,674	$	49,407	$	25,048	$	25,291

The following table sets forth securities maturing within specified intervals at December 31, 2009 and their weighted average yields.

					Over One				Over Five
					Year				Years
			Weighted-		Through		Weighted-		Through		Weighted-				Weighted-				Weighted-
	One Year		Average		Five		Average		Ten		Average		Over Ten		Average				Average
(Dollars in thousands)	or Less		Yield		Years		Yield		Years		Yield		Years		Yield		Total		Yield
U.S. government agencies	$	—	—	%	$	—	—	%	$	—	—	%	$	—	—	%	$	—	—	%
Mortgage-backed securities	—		—	%	—		—	%	—		—	%	104,672		3.10	%	104,672		3.10	%
Other securities	—		—	%	—		—	%	—		—	%	100		—	%	100		—	%
Other investments	—		—	%	—		—	%	—		—	%	1,599		—	%	1,599		—	%
	$	—	—	%	$	—	—	%	$	—	—	%	$	106,371	3.05	%	$	106,371	3.05	%

Short-Term Investments. Short-term investments, which consist primarily of federal funds sold, averaged $16.7 million and $7.9 million in 2009 and 2008, respectively with a weighted average yield of 0.26% and 3.04% in 2009 and 2008, respectively. These funds are an important source of the Company’s liquidity. Federal funds are generally invested in an earning capacity on an overnight basis. At December 31, 2009 and 2008, federal funds were $31.0 million and $4.6 million at an annualized overnight rate of 0.14% and 0.50%, respectively. The maximum outstanding balance of federal funds sold at any month end during the years 2009 and 2008 was $31.0 million and $16.4 million, respectively.

Other Real Estate Owned and Repossessed Assets

As of December 31, 2009 the Company had other real estate owned totaling $6.7 million compared to $415,000 as of December 31, 2008. Other real estate owned consists of approximately $2.2 million of residential properties, $4.0 million of land and approximately $481,000 of commercial real estate. Repossessed assets consist of approximately $902,000 of equipment and $40,000 of stock. Two properties were sold during the year ended December 31, 2009 resulting in a loss of $143,000 and two repossessed assets were sold during the year ended December 31, 2009 with no resulting loss. Subsequent to repossession, based on new market information, $2.1 million was charged to expense to write down the value of other real estate owned and repossessed assets.

Deposits

General. Average interest-bearing liabilities totaled $352.0 million and $325.8 million in 2009 and 2008, respectively. Average total deposits totaled $334.1 million and $307.7 million during 2009 and 2008, respectively. At December 31, 2009 and 2008 total deposits were $376.6 million and $296.6 million, respectively.

The following table sets forth the average deposits of the Company by category for the year ended December 31, 2009, 2008 and 2007.

	2009				2008				2007
			Average				Average				Average
(Dollars in thousands)	Amount		Rate		Amount		Rate		Amount		Rate
Non-interest bearing demand	$	22,290	—	%	$	23,739	—	%	$	18,864	—	%
Interest bearing demand	18,247		1.20	%	15,300		2.12	%	11,520		1.70	%
Savings	60,101		2.55	%	18,881		1.18	%	19,107		3.39	%
Time	233,472		2.27	%	249,765		4.36	%	228,748		5.32	%
Total	$	334,110			$	307,685			$	278,239

The following table sets forth the deposits of the Company by category as of December 31, 2009, 2008 and 2007.

	2009				2008				2007
			% of				% of				% of
(Dollars in thousands)	Amount		Deposits		Amount		Deposits		Amount		Deposits
Non-interest bearing demand	$	21,829	5.80	%	$	22,162	7.47	%	$	24,464	7.46	%
Interest bearing demand	18,588		4.94	%	16,449		5.55	%	13,721		4.19	%
Savings	82,295		21.85	%	14,461		4.87	%	24,634		7.52	%
Time deposits less than $100	30,054		7.98	%	32,111		10.82	%	59,528		18.17	%
Time deposits of $100 or over	21,014		5.58	%	25,162		8.49	%	47,118		14.38	%
Brokered deposits	202,783		53.85	%	186,298		62.80	%	158,199		48.28	%
Total	$	376,563	100.00	%	$	296,643	100.00	%	$	327,664	100.00	%

Core deposits, which exclude certificates of deposit of $100,000 or more and brokered deposits, provide a relatively stable funding source for the Company’s loan portfolio and other earning assets. The Company’s core deposits were $152.8 million and $85.2 million at December 31, 2009 and 2008, respectively, or 40.6% and 28.7%, respectively of total deposits. Certificates of deposit of $100,000 or more and brokered deposits are not considered core deposits because their retention can be expected to be heavily influenced by rates offered at renewal.

For the years ended December 31, 2009 and 2008, our non-core deposits included wholesale funding in the form of brokered CDs of $202.8 million and $186.3 million, respectively. We generally obtain out-of-market time deposits of $100,000 or more through brokers with whom we maintain ongoing relationships. The guidelines governing our participation in brokered CD programs are part of our Asset Liability Management Program Policy, which is reviewed, revised and approved annually by the Asset Liability Committee. These guidelines limit our brokered CDs to 65% of total deposits, dictate that our current interest rate risk profile determines the terms and that we only accept brokered CDs from approved correspondents. These guidelines allow us to take advantage of the attractive terms that wholesale funding can offer while mitigating the inherent related risk.

As of December 31, 2009, we had brokered deposits of $202.8 million, representing 53.85% of our total deposits, of which $79.7 million are scheduled to mature in the third quarter of 2010 and $94.9 million are scheduled to mature in the fourth quarter of 2010. Because of the limitations on brokered deposits imposed by the MOU, the Consent Order, and our “undercapitalized” status, 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. However, FHLB has informed us that due to our financial condition we are not currently permitted to receive any more advances. As a result, we must limit our growth, raise additional capital, or sell assets, which could materially and adversely affect our financial condition and results of operations.

In addition, because the Bank is “undercapitalized,” we cannot offer an effective yield in excess of 75 basis points on interest paid on deposits (including brokered deposits, if approval is granted for the Bank to accept them) of comparable size and maturity in either the Bank’s normal market area or in the market area in which such deposits would otherwise be accepted. Thus, for deposits in the Bank’s own normal market area, the Bank must offer rates that are not in excess of 75 basis points over the average local rates. For non-local deposits, the Bank must offer rates that are not in excess of 75 basis points over either (1) the Bank’s own local rates or (2) the applicable non-local rates. In other words, the Bank must adhere to the prevailing rates in its own normal market area for all deposits (whether local or non-local) and also must adhere to the prevailing rates in the non-local area for any non-local deposits. Thus, the Bank will be unable to outbid non-local institutions for non-local deposits even if the non-local rates are lower than the rates in the Bank’s own normal market area. Because of this interest rate cap, we may not be able to attract sufficient deposits to meet our liquidity needs. If this were to occur, the Bank may be placed into a federal conservatorship or receivership by the FDIC, with the FDIC appointed as conservator or receiver.

Deposits have been a primary source of funding. Management anticipates that deposits will continue to be the Company’s primary source of funding in the future. The Company’s loan-to-deposit ratio was 73.06% and 108.17% at December 31, 2009 and 2008, respectively. The maturity distribution of the Company’s time deposits of $100,000 or over at December 31, 2009 and 2008, is set forth in the following tables.

Maturities of Certificates of Deposit of $100,000 or More (Including Brokered Deposits)

			After		After
			Three		Six
	Within		Through		Through		After
	Three		Six		Twelve		Twelve
(Dollars in thousands)	Months		Months		Months		Months		Total
December 31, 2009
Brokered Deposits	$	6,800	$	21,269	$	174,714	$	—	$	202,783
Certificates of deposit of $100,000 or more	4,692		7,868		6,624		1,830		21,014
Total	$	11,492	$	29,137	$	181,338	$	1,830	$	223,797

December 31, 2008
Brokered Deposits	$	186,298	$	—	$	—	$	—	$	186,298
Certificates of deposit of $100,000 or more	1,782		11,231		10,494		1,655		25,162
Total	$	188,080	$	11,231	$	10,494	$	1,655	$	211,460

Of the Company’s time deposits of $100,000 or over as of December 31, 2009 and 2008, 5.14% and 88.94% had scheduled maturities within three months, respectively. As of December 31, 2009 and 2008, 99.18% and 99.22%, respectively, of the Company’s time deposits of $100,000 or over had maturities within twelve months.

Other Borrowings

The following table outlines our various sources of borrowed funds during the years ended December 31, 2009, 2008 and 2007, the amounts outstanding at the end of each period and the weighted-average interest rates paid for each borrowing source.

			Period-				Weighted- Average		Maximum Outstanding
	Ending		End		Average		Rate for		at any
(Dollars in thousands)	Balance		Rate		Balance		Year		Month End
December 31, 2009
Federal Home Loan Bank advances	$	—	—	%	$	5,384	1.34	%	$	25,000
Federal funds purchased	—		—	%	155		0.57	%	3,144
Federal reserve discount window	—		—	%	63		0.00	%	—
Securities sold under agreement to repurchase	30,000		3.24	%	30,000		3.25	%	30,000
Bank of Tennessee note payable	—		—	%	246		2.85	%	1,570
Subordinated debt	4,325		11.50	%	4,325		11.50	%	4,325

December 31, 2008
Federal Home Loan Bank advances	$	25,000	1.49	%	$	9,645	2.33	%	$	30,000
Federal funds purchased	—		—	%	1,312		1.85	%	9,491
Securities sold under agreement to repurchase	30,000		3.24	%	28,525		2.46	%	30,000
Bank of Tennessee note payable	1,570		3.25	%	916		3.71	%	1,570
Subordinated debt	4,325		11.50	%	1,294		11.50	%	4,325

December 31, 2007
Securities sold under agreement to repurchase	$	15,000	2.58	%	$	2,315	2.72	%	$	15,000

Subordinated Debt. During the third quarter of 2008, we commenced a subordinated debt offering to enhance and strengthen the levels of capital and liquidity at the holding company such that we could improve the levels of regulatory capital at the Bank. We raised $4.325 million in additional capital before we closed the offering on October 15, 2008. The subordinated notes were sold to a limited number of purchasers in a private offering, bear an interest rate of 11.5%, are callable after September 30, 2011, at a premium, and mature in 2018. The subordinated debt has been structured to fully count as Tier 2 regulatory capital on a consolidated basis.

Federal Home Loan Bank Advances, Fed Funds Lines of Credit and Federal Reserve Discount Window. Our other borrowings have traditionally included proceeds from FHLB advances and federal funds lines of credit from correspondent banks. As of December 31, 2009, the FHLB has informed us that due to our financial condition we are not currently permitted to receive any more advances. At December 31, 2009, we had federal funds lines of credit with unrelated banks totaling $5 million. These lines are available for general corporate purposes. These lines may be terminated at any time based on our financial condition. We also have credit availability through the Federal Reserve Discount Window. As of December 31, 2009, $5.9 million was available, based on qualifying collateral. The Federal Reserve Discount Window borrowing capacity has been curtailed to only overnight terms, contingent upon credit approval for each transaction. Availability of the Federal Reserve Discount Window may be terminated at any time by the Federal Reserve, and we can make no assurances that this funding source will continue to be available to us.

Capital

The FRB and bank regulatory agencies require bank holding companies and financial institutions to maintain capital at adequate levels based on a percentage of assets and off-balance sheet exposures, adjusted for risk weights ranging from 0% to 100%.

The FRB guidelines contain an exemption from the capital requirements for “small bank holding companies” which in 2006 were amended to cover most bank holding companies with less than $500 million in total assets that do not have a material amount of debt or equity securities outstanding registered with the SEC. Although our class of common stock is registered under Section 12 of the Securities Exchange Act, we believe that because our stock is not listed on any exchange or otherwise actively traded, the FRB will interpret its new guidelines to mean that we qualify as a small bank holding company. Nevertheless, our Bank remains subject to these capital requirements. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

Under the capital adequacy guidelines, regulatory capital is classified into two tiers. These guidelines require an institution to maintain a certain level of Tier 1 and Tier 2 capital to risk-weighted assets. Tier 1 capital consists of common shareholders’ equity, excluding the unrealized gain or loss on securities available for sale, minus certain intangible assets. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, are multiplied by a risk-weight factor of 0% to 100% based on the risks believed to be inherent in the type of asset. Tier 2 capital consists of Tier 1 capital plus the general reserve for loan losses, subject to certain limitations. We are also required to maintain capital at a minimum level based on total average assets, which is known as the Tier 1 leverage ratio.

At the Bank level, we are subject to various regulatory capital requirements administered by the federal banking agencies. Under the regulations adopted by the federal regulatory authorities, a bank will be categorized as:

· Well capitalized if the institution has a total risk-based capital ratio of 10.0% or greater, a Tier 1 risk-based capital ratio of 6.0% or greater, a leverage ratio of 5.0% or greater, and is not subject to any order or written directive by any such regulatory authority to meet and maintain a specific capital level for any capital measure.

· Adequately capitalized if the institution has a total risk-based capital ratio of 8.0% or greater, a Tier 1 risk-based capital ratio of 4.0% or greater, a leverage ratio of 4.0% or greater, and is not categorized as well capitalized.

· Undercapitalized if the institution has a total risk-based capital ratio that is less than 8.0%, a Tier 1 risk-based capital ratio of less than 4.0%, or a leverage ratio of less than 4.0%.

· Significantly undercapitalized if the institution has a total risk-based capital ratio of less than 6.0%, a Tier 1 risk-based capital ratio of less than 3.0%, or a leverage ratio of less than 3.0%.

· Critically undercapitalized if the institution’s tangible equity is equal to or less than 2.0% of average quarterly tangible assets.

In addition, an institution may be downgraded to, or deemed to be in, a capital category that is lower than indicated by its capital ratios if it is determined to be in an unsafe or unsound condition or if it receives an unsatisfactory examination rating with respect to certain matters. A bank’s capital category is determined solely for the purpose of applying prompt corrective action regulations, and the capital category may not constitute an accurate representation of a bank’s overall financial condition or prospects for other purposes.

If a bank is not well capitalized, it cannot accept brokered deposits without prior FDIC approval and, if approval is granted, cannot offer an effective yield in excess of 75 basis points on 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 FDIA 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 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 December 31, 2009, the Bank was categorized “undercapitalized” under the regulatory framework.

Analysis of Regulatory Capital and Capital Ratios

(Dollars in thousands)	2009			2008
Tier 1 capital	$	13,643		$	30,836
Tier 2 capital	3,558			4,369
Total qualifying capital	$	17,201		$	35,205

Risk-adjusted total assets (including off-balance sheet exposures)	$	275,206		$	345,829

Total risk-based capital ratio	6.25		%	10.18		%
Tier 1 risk-based capital ratio	4.96		%	8.92		%
Tier 1 leverage ratio	3.12		%	7.98		%

Our loss for 2009 has 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 that we entered into with the FDIC and the South Carolina Board of Financial Institutions on February 23, 2010. In addition, the Consent Order requires us to achieve and maintain, by May 24, 2010, 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.

Off-Balance Sheet Risk

Through its operations, the Bank has made contractual commitments to extend credit in the ordinary course of its business activities. These commitments are legally binding agreements to lend money to the Bank’s customers at predetermined interest rates for a specified period of time. At December 31, 2009 and 2008, the Bank had issued commitments, including standby letters of credit, to extend credit of $16.0 million and $39.7 million, respectively through various types of commercial lending arrangements.

The following tables set forth the length of time until maturity for unused commitments to extend credit at December 31, 2009 and 2008.

			After		After
			One		Three				Greater
	Within		Through		Through		Within		Than
	One		Three		Twelve		One		One
(Dollars in thousands)	Month		Months		Months		Year		Year		Total
December 31, 2009
Unused commitments to extend credit	$	2,397	$	1,117	$	4,385	$	7,899	$	6,552	$	14,451
Standby letters of credit	74		321		680		1,075		450		1,525
	$	2,471	$	1,438	$	5,065	$	8,974	$	7,002	$

CommunitySouth Financial CORP 10-K