UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

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FORM 10-K

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þ Annual report under Section 13 or 15(d) of the Securities Exchange Act of 1934

For fiscal year ended December 31, 2010

o Transition report under Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from to

Commission File Number 000-28333

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COASTAL BANKING COMPANY, INC.

(A South Carolina Corporation)

IRS Employer Identification Number: 58-2455445

36 Sea Island Parkway, Beaufort, South Carolina 29907

Telephone Number: (843) 522-1228

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

Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01 par value.

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

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

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

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

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

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

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

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

The aggregate value of the voting common equity held by nonaffiliates as of June 30, 2010, the last business day of the registrant’s most recently completed second fiscal quarter, was $8,848,753 based on the price at which the common stock last sold on such day. This price reflects inter-dealer prices without retail mark up, mark down, or commissions, and may not represent actual transactions.

2,588,707 shares of common stock were outstanding as of March 17, 2011.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s Proxy Statement for the 2011 Annual Meeting of Shareholders, to be held on May 25, 2011, are incorporated by reference into Part III.

TABLE OF CONTENTS

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PART I.

ITEM 1.	Business		3
ITEM 1A.	Risk Factors		21
ITEM 1B.	Unresolved Staff Comments		30
ITEM 2.	Properties		31
ITEM 3.	Legal Proceedings		31
ITEM 4.	Reserved		31

PART II.

ITEM 5.	Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities		32
ITEM 6.	Selected Financial Data		32
ITEM 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operation		33
ITEM 7A.	Quantitative and Qualitative Disclosures About Market Risks		59
ITEM 8.	Financial Statements and Supplementary Data		60
ITEM 9.	Changes In and Disagreements With Accountants on Accounting and Financial Disclosure		101
ITEM 9A.	Controls and Procedures		101
ITEM 9B.	Other Information		101

PART III.

ITEM 10.	Directors, Executive Officers, and Corporate Governance		102
ITEM 11.	Executive Compensation		102
ITEM 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters		102
ITEM 13.	Certain Relationships and Related Transactions, and Director Independence		103
ITEM 14.	Principal Accountant Fees and Services		103
ITEM 15.	Exhibits		103

PART I.

ITEM 1. BUSINESS

This Report contains statements which constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended and the Securities Exchange Act of 1934, as amended. These statements are based on many assumptions and estimates and are not guarantees of future performance. Our actual results may differ materially from those projected 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 include, but are not limited to those described below under “Item 1A. Risk Factors.”

General

Coastal Banking Company, Inc. (the “Company”) is organized under the laws of the State of South Carolina for the purpose of operating as a bank holding company for CBC National Bank (the “Bank”). The Bank commenced business on May 10, 2000 as Lowcountry National Bank. The Company acquired First National Bank of Nassau County, which began its operations in 1999, through its merger with First Capital Bank Holding Corporation on October 1, 2005. On October 27, 2006, the Company acquired the Meigs, Georgia office of the Bank through merger of Cairo Banking Co. with and into the Bank. On August 10, 2008, Lowcountry National Bank and First National Bank of Nassau County merged into one charter. Immediately after the merger, the name of the surviving bank was changed to CBC National Bank and the main office relocated to 1891 South 14th Street, Fernandina Beach, Nassau County, Florida. The Bank’s branches continue to do business under the trade names “Lowcountry National Bank,” “First National Bank of Nassau County,” and “The Georgia Bank” in their respective markets. The Bank provides full commercial banking services to customers throughout Beaufort County, South Carolina; Nassau County, Florida; and Thomas County, Georgia and is subject to regulation by the Office of the Comptroller of the Currency (the “OCC”) and the Federal Deposit Insurance Corporation (the “FDIC”). The Bank also has loan production offices in Savannah, Georgia and Jacksonville, Florida, as well as a mortgage banking office in Atlanta, Georgia. The Company is subject to regulation by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”).

On August 26, 2009, the Bank entered into a formal agreement with the OCC (the “Agreement”). The Agreement contains certain operational and financial restrictions, which address the concerns identified in the Bank’s report of examination. Under the terms of the Agreement, the Bank has prepared and provided written plans and/or reports on the following items: reducing the high level of credit risk in the Bank; taking immediate and continuing action to protect the Bank’s interest in criticized assets; ensuring the Bank’s adherence to its written profit plan to improve and sustain earnings; limiting brokered deposits, excluding reciprocal CDARS, that would cause the Bank’s level of brokered deposits to be in excess of ten percent of total deposits; and establishing a Compliance Committee to monitor the Bank’s adherence to the Agreement.

On January 27, 2010, pursuant to a request by the Federal Reserve Bank of Richmond, the board of directors of Coastal Banking Company, Inc. adopted a resolution, which provided that the Company must obtain prior approval of the Federal Reserve Board before incurring additional debt, purchasing or redeeming its capital stock, or declaring or paying dividends, excluding dividends on preferred stock related to our participation in the TARP Capital Purchase Program (“CPP”).

On November 17, 2010, the Company entered into a Memorandum of Understanding (the “MOU”), an informal enforcement action, with the Federal Reserve Bank of Richmond in lieu of the board resolution adopted on January 27, 2010. The terms of the MOU are substantially similar to those of the board resolution and require the Company to obtain prior approval of the Federal Reserve Board before incurring additional debt, purchasing or redeeming its capital stock, or declaring or paying cash dividends, including dividends on its TARP preferred stock, and paying interest on its trust preferred securities. Additionally, the MOU requires the Company to comply with banking regulations that prohibit certain indemnification and severance payments and require prior approval of any appointment of new directors or the hiring or change in position of any senior executive officers of the Company. The MOU also requires the submission of quarterly progress reports.

Location and Service Area

Our primary service areas consist of the areas within a 20 mile radius of the main offices of Lowcountry National Bank in Beaufort County, South Carolina, First National Bank of Nassau County in Nassau County, Florida, and The Georgia Bank in Thomas County, Georgia. The primary service area of Lowcountry National Bank covers a large portion of Beaufort County, including Beaufort, Bluffton, Burton, Callawassie Island, Coosaw, Dataw Island, Harbor Island, Hilton Head Island, Hunting Island, Fripp Island, Ladys Island, Port Royal, Spring Island, St. Helena Island, and Sun City, South Carolina. The primary service area of First National Bank of Nassau County includes the communities of Amelia Island, Fernandina Beach, O’Neil and Yulee, Florida. The primary service area of The Georgia Bank is Thomas County, Georgia. The Bank also serves the Savannah, Georgia; Atlanta, Georgia; and Jacksonville, Florida market areas through loan production offices.

Lending Activities

General: We emphasize a range of lending services, including real estate, commercial and consumer loans to individuals and small- to medium-sized business and professional firms that are located in or conduct a substantial portion of their business in the Bank’s market areas.

Loan Underwriting: The fundamental objective of our underwriting policies and procedures are to establish minimum requirements for borrower creditworthiness, application documentation and credit analysis upon which a decision to extend credit is based. The key principals of our underwriting policies are consistent across all types of loans with variations to specific procedures driven by characteristics such as the loan amount, purpose, collateral type and repayment terms.

Our underwriting policies require that we independently gather and verify sufficient documentation to establish a borrower or guarantor’s credit worthiness, level of financial reserves, capacity to repay the loan and the value of any collateral. Credit worthiness is validated with personal or business credit reports from independent credit reporting agencies. The level of financial reserves is established from independent verifications of deposits, investments or other assets. Capacity to repay the loan is based on verifiable earnings capacity as shown on up to three years of financial statements and/or tax returns, banking activity levels, operating statements, rent rolls or independent verification of employment. Finally, as to the value of collateral, we obtain appraisals from independent, professionally designated property appraisers and will make personal inspections of the subject collateral for larger balance loans.

Once the appropriate documentation has been gathered, the analysis phase of the underwriting process is completed. This includes determination of debt to income ratios, loan to value ratios, debt coverage ratios, global cash flow analysis, stress tests to measure the impact of increasing interest rates or falling collateral values and assessment of industry specific or general economic trends on the borrower’s ability to repay the loan. Our policy establishes minimum acceptable levels for these credit metrics based on the objective to produce investment grade loans. Further, our maximum acceptable loan to collateral value percentages are less than or equal to applicable regulatory guideline maximums. In the case of acquisition and development loans or construction loans, we also obtain and review project budgets, periodic inspection reports by qualified engineering firms and site visits by account officers not less than quarterly. In all cases, the underwriting documentation and analysis is completed as part of the initial credit decision process; however, for loans that involve additional extensions of credit or periodic renewals, the underwriting documentation is updated and re-analyzed not less than annually.

Our written loan underwriting policy provides general guidance on the appropriate underwriting considerations, objectives and documentation. To augment the general policy guidance, we establish target criteria to define an acceptable level of credit underwriting risk. It is important to note that these criteria are designated as targets rather than absolute limits to allow for a degree of judgment in the underwriting process so that consideration can be given to other compensating factors. The following is a summary of our more critical target underwriting criteria by major loan categories in use as of December 31, 2010. Where noted, DTI refers to debt to income ratio and NADA refers to National Automobile Dealers Association.

Loan Product Type	Max. Loan to Value		Max. Loan to Cost	Min. Debt Service Coverage Ratio	Max. Term	Amortization Period
Commercial and Financial
Accounts Receivable	75% of eligible accts.		75% of eligible accts.	N/A	12 mos.	N/A
Inventory	50% of qualified inventory		50% of qualified inventory	N/A	12 mos.	N/A
Equipment	80% of cost or appraised value		80% of cost or appraised value	1.25	60 mos.	60 mos.
Real Estate - commercial
Construction	70-80%	80-90%		N/A	24 mos.	N/A
Undeveloped land	65%	65%		N/A	12 mos.	N/A
Improved lot	75%	75%		N/A	24 mos.	N/A
Land Development	80%	80%		N/A	24 mos.	N/A
Real Estate - residential
Construction	80%	100%		N/A	24 mos.	N/A
Undeveloped land	65%	65%		N/A	12 mos.	N/A
Improved lot	75%	75%		N/A	24 mos.	N/A
Land Development	80%	90%		N/A	24 mos.	N/A
Real Estate – mortgage, commercial	75%		85%	1.25	60 mos.	25 yrs.
Real Estate – mortgage, residential	80%		80%	40% DTI	30 yrs.	30 yrs.
Consumer Installment Loans
Automobiles – New	90% of Cost		90%	40% DTI	72 mos.	72 mos.
Automobiles - Used	100% of NADA loan value		100% of NADA loan value	40% DTI	60 mos.	60 mos.
Recreational Equipment	80% of cost or 90% of NADA loan value		80% of cost or 90% of NADA loan value	40% DTI	60 mos.	60 mos.
Aircraft	80% of cost		80% of cost	40% DTI	60 mos.	120 mos.
Home Equity (Term)	89%		89%	40% DTI	60 mos.	180 mos.
Home Equity Line of Credit	89%		89%	40% DTI	120 mos.	Interest Only Monthly
Other Loans
Secured by Certificates of Deposit	100%		100%	N/A	Term of C.D.	Term of C.D.
Secured by Listed Stock	70%		70%	N/A	36 mos.	36 mos.
Unsecured	N/A		N/A	36% DTI	24 mos.	24 mos.

Generally, we require a minimum credit score of 680 for secured loans and a minimum credit score of 700 for unsecured loans.

These criteria are monitored on an ongoing basis and adjusted as needed to manage the risk profile of different loan categories based on changes to economic conditions and loan category concentration levels within the Company’s overall loan portfolio. Our policy is generally not to originate hybrid loans, which we define as loans having one or more underwriting characteristics that are inconsistent with investment grade loans, such as limited documentation, LTVs in excess of 100%, negative interest amortization, high debt to income ratios or poor borrower credit. We have never originated payment option ARMs which allow for negative interest amortization or subprime loans, either for retention in our portfolio or for sale in the secondary market. In the case of residential loans, we do not originate loans with any underwriting characteristic that are contrary with the underwriting guidelines of Federal National Mortgage Association, Federal Home Loan Mortgage Corporation, the Federal Housing Authority, or the Veterans Administration.

Loan Approval and Review: The Bank’s loan approval policies provide for various levels of officer lending authority. When the amount of aggregate loans to a single borrower exceeds an individual officer’s lending authority, the loan request will be considered and approved by an officers’ loan committee with a higher lending limit or the directors’ loan committee, which has the authority to approve loans up to the legal lending limit of the Bank. The Bank may not make any loans to any director or executive officer of the Bank that, in the aggregate, exceeds $500,000 unless approved by the board of directors of the Bank and made on terms not more favorable to such person than would be available to a person not affiliated with the Bank. The bank’s mortgage loan review process currently adheres to guidelines from the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation, and where applicable the Federal Housing Administration and Veterans Administration, but the Bank reserves the right to alter this policy in the future. The bank currently sells mortgage loans on the secondary market, but has, on occasion, chosen to hold them in the portfolio.

Lending Limits: The Bank’s lending activities are subject to a variety of lending limits imposed by federal law. In general, the Bank is 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 in certain circumstances 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. Based upon CBC National Bank’s capitalization of $38,526,000 as of December 31, 2010, the Bank has a self-imposed loan limit of $5,000,000, which represents 84% of our regulatory legal lending limit of $5,957,000. Based upon the Bank’s current lending limit, unless the Bank is able to sell participations in its loans to other financial institutions, the Bank will be unable to meet all of the lending needs of loan customers requiring aggregate extensions of credit above this limit.

Real Estate and Mortgage Loans: Loans secured by first or second mortgages on real estate make up approximately 95% of the Bank’s loan portfolio. These loans generally fall into one of three categories: commercial real estate loans, construction and development loans, or residential real estate loans. Each of these categories is discussed in more detail below, including their specific risks. Home equity loans are not included because they are classified as consumer loans, which are discussed below. Interest rates for all categories may be fixed or adjustable, and will more likely be fixed for shorter-term loans. The bank has not in the past and does not have plans in the future to originate loans that would be considered sub-prime or that allow for negative amortization. The bank generally charges origination fees for each loan.

Real estate loans are subject to the same general risks as other loans. They are particularly sensitive to fluctuations in the value of real estate. Fluctuations in the value of real estate, as well as other factors arising after a loan has been made, could negatively affect a borrower’s cash flow, creditworthiness, and ability to repay the loan.

Through our wholesale mortgage banking office, we originate residential real estate loans for sale into the secondary market. We limit our interest rate and credit risk on these loans by locking the interest rate for each loan in a forward sale commitment with the secondary market investor and then selling the loan to that investor after the loan is funded.

Commercial Real Estate Loans: Commercial real estate loans generally have terms of five years or less, although payments may be structured on a longer amortization basis. We evaluate each borrower on an individual basis and attempt to determine its business risks and credit profile. We attempt to reduce credit risk in the commercial real estate portfolio by emphasizing loans on owner-occupied office and retail buildings where the loan-to-value ratio, established by independent appraisals, does not exceed 80%. We generally require that debtor cash flow exceed 125% of monthly debt service obligations. We typically review all of the personal financial statements of the principal owners at the time we originate the loan and annually thereafter. We also require borrowers to execute personal guarantees at the time of origination. These reviews of personal financial statements generally reveal secondary sources of payment and liquidity to support a loan request.

Construction and Development Real Estate Loans: We offer 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 eighteen months, although payments may be structured on a longer amortization basis. Most loans will mature and require payment in full upon the sale of the property. Construction and development loans generally carry a higher degree of risk than long term financing of existing properties. Repayment depends on the ultimate completion of the project and usually 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 may also reduce risk by selling participations in larger loans to other institutions when possible.

Residential Real Estate Loans: Residential real estate loans generally have longer terms of up to 30 years. We offer fixed and adjustable rate mortgages in conforming loan amounts. We have a limited amount of interest only loans, but we do not offer negative amortization loans. We have limited credit risk on these loans as most are sold to third parties soon after closing.

Commercial Loans: Our bank makes loans for commercial purposes in various lines of businesses. Commercial loans are generally considered to have greater risk than first or second mortgages on real estate because they may be unsecured, or if they are secured, the value of the security may be more difficult to assess and monitor than real estate.

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 and with a loan-to-value ratio of 80% or less. We focus our efforts on commercial loans with principal amounts less than $500,000. Working capital loans typically have terms not exceeding one year and usually are secured by accounts receivable, inventory, and personal guarantees of the principals of the business. For loans secured by accounts receivable or inventory, principal typically is repaid as the assets securing the loan are converted into cash, and in other cases principal typically will be due at maturity. While trade letters of credit and standby letters of credit are processed by the Bank, foreign exchange services are handled through a correspondent bank as agent for the Bank.

We offer small business loans utilizing government enhancements such as the Small Business Administration’s (“SBA”) 7(a) program and 504 programs. These loans typically are partially guaranteed by the government, which reduces the Bank’s risk. Government guarantees of SBA loans generally do not exceed 75% of the loan value; however, the American Reinvestment and Recovery Act of 2009 increased this guarantee to as much as 90% on a temporary basis.

The larger banks in the Beaufort County and Nassau County areas make proportionately more loans to medium to large-sized businesses than we do. Many of the Bank’s commercial loans are made to small- to medium-sized businesses, which may be less able to withstand competitive, economic, and financial conditions than larger borrowers.

Consumer Loans: The Bank makes a variety of loans to individuals for personal and household purposes, including secured and unsecured installment loans and revolving lines of credit. Installment loans typically carry balances of less than $50,000 and are amortized over periods up to 72 months. Consumer loans may be 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 they may be unsecured, or if they are secured, the value of the security may be more difficult to assess and monitor than real estate.

We also offer home equity loans. Our underwriting criteria for and the risks associated with home equity loans and lines of credit generally are the same as those for first mortgage loans. Home equity lines of credit typically have terms of 15 years or less, carry balances less than $125,000, and may extend up to 89.9% of the available equity of each property.

Deposits: The Bank offers a wide range of commercial and consumer deposit accounts, including checking accounts, money market accounts, a variety of certificates of deposit, and individual retirement accounts. The primary sources of deposits are residents of, and businesses and their employees located in, our primary market areas. Deposits are obtained through personal solicitation by officers and directors, direct mail solicitations and advertisements published in the local media. To attract deposits, the Bank offers a broad line of competitively priced deposit products and services.

Supervision and Regulation

Both the Company and the Bank are subject to extensive state and federal banking laws and regulations that impose restrictions on and provide for general regulatory oversight of their operations. These laws and regulations are generally intended to protect depositors and not shareholders. Legislation and regulations authorized by legislation influence, among other things:

●	how, when, and where we may expand geographically;

●	into what product or service market we may enter;

●	how we must manage our assets; and

●	under what circumstances money may or must flow between the parent bank holding company and the subsidiary bank.

Set forth below is an explanation of the major pieces of legislation affecting our industry and how that legislation affects our actions. 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, and legislative changes and the policies of various regulatory authorities may significantly affect our operations. We cannot predict the effect that fiscal or monetary policies, or new federal or state legislation may have on our business and earnings in the future.

Coastal Banking Company, Inc.

Because the Company owns all of the capital stock of the Bank, it is a bank holding company under the federal Bank Holding Company Act of 1956, as amended. As a result, we are primarily subject to the supervision, examination, and reporting requirements of the Bank Holding Company Act and the regulations of the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”). As a bank holding company located in South Carolina, the South Carolina Board of Financial Institutions also regulates and monitors our operations.

Memorandum of Understanding. On November 17, 2010, the Company entered into a Memorandum of Understanding (the “Memorandum”), an informal enforcement action, with the Federal Reserve Bank of Richmond. The terms of the Memorandum are substantially similar to those of the resolution adopted by the Board of Directors on January 27, 2010, pursuant to a request by the Federal Reserve Board. Generally, the Memorandum requires the Company to obtain prior approval of the Federal Reserve Board before incurring additional debt, purchasing or redeeming its capital stock, or declaring or paying cash dividends to common shareholders, including dividends on its TARP preferred stock and interest on its trust preferred securities. Additionally, the Memorandum requires the Company to comply with banking regulations that prohibit certain indemnification and severance payments and require prior approval of any appointment of new directors or the hiring or change in position of any senior executive officers of the Company. The Memorandum also requires the submission of quarterly progress reports.

Acquisitions of Banks. The Bank Holding Company Act requires every bank holding company to obtain the Federal Reserve Board’s approval in advance of:

●	acquiring direct or indirect ownership or control of any voting shares of any bank if, after the acquisition, the bank holding company will directly or indirectly own or control more than 5% of the bank’s voting shares;

●	acquiring all or substantially all of the assets of any bank; or

●	merging or consolidating with any other bank holding company.

Additionally, the Bank Holding Company Act provides that the Federal Reserve Board may not approve any of these transactions if it would result in or tend to create a monopoly, substantially lessen competition, or otherwise function as a restraint of trade, unless the anticompetitive effects of the proposed transaction are clearly outweighed by the public interest in meeting the convenience and needs of the community to be served. The Federal Reserve Board is also required to consider the financial and managerial resources and future prospects of the bank holding companies and banks concerned and the convenience and needs of the community to be served. The Federal Reserve Board’s consideration of financial resources generally focuses on capital adequacy, which is discussed below.

Under the Bank Holding Company Act, if we are adequately capitalized and adequately managed, we may purchase a bank located outside of South Carolina, Georgia or Florida. However, the laws of the other state may impose restrictions on the acquisition of a bank that has only been in existence for a limited amount of time or that would result in specified concentrations of deposits. For example, South Carolina law prohibits a bank holding company from acquiring control of a bank until the target bank has been incorporated for five years. Because CBC National Bank has been chartered for more than five years, this restriction would not limit our ability to be acquired.

Change in Bank Control. Subject to various exceptions, the Bank Holding Company Act and the Change in Bank Control Act, together with related regulations, require Federal Reserve Board 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. Control is also presumed to exist, although rebuttable, if a person or company acquires 10% or more, but less than 25%, of any class of voting securities and either:

●	the bank holding company has registered securities under Section 12 of the Securities Exchange Act of 1934, as amended; or

●	no other person owns a greater percentage of that class of voting securities immediately after the transaction.

Our common stock is registered under Section 12 of the Securities Exchange Act of 1934, as amended. The regulations provide a procedure for challenging the rebuttable presumption of control.

Permitted Activities. The Bank Holding Company Act has generally prohibited a bank holding company from engaging in activities other than banking or managing or controlling banks or other permissible subsidiaries and from acquiring or retaining direct or indirect control of any company engaged in any activities other than those determined by the Federal Reserve Board to be closely related to banking or managing or controlling banks as to be a proper incident thereto. Provisions of the Gramm-Leach-Bliley Act have expanded the permissible activities of a bank holding company that qualifies as a financial holding company. Under the regulations implementing the Gramm-Leach-Bliley Act, a financial holding company may engage in additional activities that are financial in nature or incidental or complementary to financial activity. Those activities include, among other activities, certain insurance and securities activities.

To qualify to become a financial holding company, the Bank and any other depository institution subsidiary of the Company must be well capitalized and well managed and must have a Community Reinvestment Act rating of at least “satisfactory.” Additionally, the Company must file an election with the Federal Reserve Board to become a financial holding company and must provide the Federal Reserve Board with 30 days’ written notice prior to engaging in a permitted financial activity. The Company does not meet the qualification standards applicable to financial holding companies at this time.

Support of Subsidiary Institution. Under Federal Reserve Board policy, we are expected to act as a source of financial strength for the Bank and to commit resources to support the Bank. In addition, pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), the federal banking regulators are required to issue, within two years of enactment, rules that require a bank holding company to serve as a source of financial strength for any depository institution subsidiary. This support may be required at times when, without this Federal Reserve Board policy or the impending rules, we might not be inclined to provide it. In addition, any capital loans made by us to the Bank will be repaid only after the Bank’s deposits and various other obligations are repaid in full. In the unlikely event of our bankruptcy, any commitment that we give to a bank regulatory agency to maintain the capital of the Bank will be assumed by the bankruptcy trustee and entitled to a priority of payment.

Non-Bank Subsidiary Examination and Enforcement. As a result of the Dodd-Frank Act, all non-bank subsidiaries not currently regulated by a state or federal agency will now be subject to examination by the Federal Reserve Board in the same manner and with the same frequency as if its activities were conducted by the lead bank subsidiary. These examinations will consider whether the activities engaged in by the non-bank subsidiary pose a material threat to the safety and soundness of its insured depository institution affiliates, are subject to appropriate monitoring and control, and comply with applicable laws. Pursuant to this authority, the Federal Reserve Board may also take enforcement action against non-bank subsidiaries.

CBC National Bank

Because the Bank is chartered as a national bank, it is primarily subject to the supervision, examination, and reporting requirements of the National Bank Act and the regulations of the OCC. The OCC regularly examines the Bank’s operations and has the authority to approve or disapprove mergers, the establishment of branches and similar corporate actions. The OCC also has the power to prevent the continuance or development of unsafe or unsound banking practices or other violations of law. Because the Bank’s deposits are insured by the FDIC to the maximum extent provided by law, it is also subject to certain FDIC regulations and the FDIC also has examination authority and back-up enforcement power over the Bank. The Bank is also subject to numerous state and federal statutes and regulations that affect the Bank’s business, activities, and operations.

Formal Agreement. On August 26, 2009, the Bank entered into a formal agreement with the OCC (the “Agreement”). The Agreement contains certain operational and financial restrictions, which address the concerns identified in the Bank’s report of examination.

Under the terms of the Agreement, the Bank has prepared and provided written plans and/or reports to the regulators that address the following items: reducing the high level of credit risk in the Bank, taking immediate and continuing action to protect the Bank’s interest in criticized assets, ensuring the Bank’s adherence to its written profit plan to improve and sustain earnings, limiting brokered deposits, excluding reciprocal CDARS, that would cause the Bank’s level of brokered deposits to be in excess of ten percent of total deposits, and establishing a Compliance Committee to monitor the Bank’s adherence to the Agreement.

Branching. National banks are required by the National Bank Act to adhere to branching laws applicable to state banks in the states in which they are located. Under South Carolina, Georgia and Florida law, the Bank may open branch offices throughout each respective state with the prior approval of the OCC. In addition, with prior regulatory approval, the Bank may acquire branches of existing banks located in South Carolina, Georgia and Florida. Prior to the enactment of the Dodd-Frank Act, the Bank and any other national- or state-chartered bank were generally permitted to branch across state lines by merging with banks in other states if allowed by the applicable states’ laws. However, interstate branching is now permitted for all national- and state-chartered banks as a result of the Dodd-Frank Act, provided that a state bank chartered by the state in which the branch is to be located would also be permitted to establish a branch.

Prompt Corrective Action. The Federal Deposit Insurance Corporation Improvement Act of 1991 establishes a system of prompt corrective action to resolve the problems of undercapitalized financial institutions. Under this system, the federal banking regulators have established five capital categories: Well Capitalized, Adequately Capitalized, Undercapitalized, Significantly Undercapitalized, and Critically Undercapitalized, in which all institutions are placed. The federal banking agencies have also specified by regulation the relevant capital levels for each category.

As a bank’s capital position deteriorates, federal banking regulators are required to take various mandatory supervisory actions and are authorized to take other discretionary actions with respect to institutions in the three undercapitalized categories. The severity of the action depends upon the capital category in which the institution is placed. Generally, subject to a narrow exception, the banking regulator must appoint a receiver or conservator for an institution that is critically undercapitalized. As of December 31, 2010, the Bank was considered well capitalized.

A “well-capitalized” bank is one that is not required to meet and maintain a specific capital level for any capital measure, pursuant to any written agreement, order, capital directive, or other remediation, and significantly exceeds all of its capital requirements, which include maintaining a total risk-based capital ratio of at least 10%, a Tier 1 risk-based capital ratio of at least 6%, and a Tier 1 leverage ratio of at least 5%. Generally, a classification as well capitalized will place a bank outside of the regulatory zone for purposes of prompt corrective action. However, a well-capitalized bank may be reclassified as “adequately capitalized” based on criteria other than capital, if the federal regulator determines that a bank is in an unsafe or unsound condition, or is engaged in unsafe or unsound practices, which requires certain remedial action.

An “adequately-capitalized” bank meets the required minimum level for each relevant capital measure, including a total risk-based capital ratio of at least 8%, a Tier 1 risk-based capital ratio of at least 4% and a Tier 1 leverage ratio of at least 4%. A bank that is adequately capitalized is prohibited from directly or indirectly accepting, renewing or rolling over any brokered deposits, absent applying for and receiving a waiver from the applicable regulatory authorities. Institutions that are not well capitalized are also prohibited, except in very limited circumstances where the FDIC permits use of a higher local market rate, from paying yields for deposits in excess of 75 basis points above a national average rate for deposits of comparable maturity, as calculated by the FDIC. In addition, all institutions are generally prohibited from making capital distributions and paying management fees to controlling persons if, subsequent to such distribution or payment, the institution would be undercapitalized. Finally, an adequately-capitalized bank may be forced to comply with operating restrictions similar to those placed on undercapitalized banks.

An “undercapitalized” bank fails to meet the required minimum level for any relevant capital measure. A bank that reaches the undercapitalized level is likely subject to a formal agreement, consent order or another formal supervisory sanction. An undercapitalized bank is not only subject to the requirements placed on adequately-capitalized banks, but also becomes subject to the following operating and managerial restrictions, which:

●	prohibit capital distributions;

●	prohibit payment of management fees to a controlling person;

●	require the bank to submit a capital restoration plan within 45 days of becoming undercapitalized;

●	require close monitoring of compliance with capital restoration plans, requirements and restrictions by the primary federal regulator;

●	restrict asset growth by requiring the bank to restrict its average total assets to the amount attained in the preceding calendar quarter;

●	prohibit the acceptance of employee benefit plan deposits;

●	require prior approval by the primary federal regulator for acquisitions, branching and new lines of business; and

●	prohibit any material changes in accounting methods.

Finally, an undercapitalized institution may be required to comply with operating restrictions similar to those placed on significantly-undercapitalized institutions.

A “significantly-undercapitalized” bank has a total risk-based capital ratio less than 6%, a Tier 1 risk-based capital less than 3%, and a Tier 1 leverage ratio less than 3%. In addition to being subject to the restrictions applicable to undercapitalized institutions, significantly undercapitalized banks may become subject to the following additional restrictions, which:

●	require the sale of enough capital stock so that the bank is adequately capitalized or, if grounds for conservatorship or receivership exist, the merger or acquisition of the bank;

●	restrict affiliate transactions;

●	further restrict growth, including a requirement that the bank reduce its total assets;

●	restrict or prohibit all activities that are determined to pose an excessive risk to the bank;

●	require the bank to elect new directors, dismiss directors or senior executive officers, or employ qualified senior executive officers to improve management;

●	prohibit the acceptance of deposits from correspondent banks, including renewals and rollovers of prior deposits;

●	require prior approval of capital distributions by holding companies;

●	require holding company divestiture of the financial institution, bank divestiture of subsidiaries and/or holding company divestiture of other affiliates; and

●	require the bank to take any other action the federal regulator determines will “better achieve” prompt corrective action objectives.

Finally, without prior regulatory approval, a significantly undercapitalized institution must restrict the compensation paid to its senior executive officers, including the payment of bonuses and compensation that exceeds the officer’s average rate of compensation during the 12 calendar months preceding the calendar month in which the bank became undercapitalized.

A “critically-undercapitalized” bank has a Tier 1 leverage ratio that is equal to or less than 2%. In addition to the appointment of a receiver in not more than 90 days, or such other action as determined by an institution’s primary federal regulator, an institution classified as critically undercapitalized is subject to the restrictions applicable to undercapitalized and significantly-undercapitalized institutions, and is further prohibited from doing the following without the prior written regulatory approval:

●	entering into material transactions other than in the ordinary course of business;

●	extending credit for any highly leveraged transaction;

●	amending the institution’s charter or bylaws, except to the extent necessary to carry out any other requirements of law, regulation or order;

●	making any material change in accounting methods;

●	engaging in certain types of transactions with affiliates;

●	paying excessive compensation or bonuses, including golden parachutes;

●	paying interest on new or renewed liabilities at a rate that would increase the institution’s weighted average cost of funds to a level significantly exceeding the prevailing rates of its competitors; and

●	making principal or interest payment on subordinated debt 60 days or more after becoming critically undercapitalized.

In addition, a bank’s primary federal regulator may impose additional restrictions on critically-undercapitalized institutions consistent with the intent of the prompt corrective action regulations. Once an institution has become critically undercapitalized, subject to certain narrow exceptions such as a material capital remediation, federal banking regulators will initiate the resolution of the institution.

FDIC Insurance Assessments. The Bank’s deposits are insured by the Deposit Insurance Fund (the “DIF”) of the FDIC up to the maximum amount permitted by law, which was permanently increased to $250,000 by the Dodd-Frank Act. The FDIC uses the DIF to protect against the loss of insured deposits if an FDIC-insured bank or savings association fails. Pursuant to the Dodd-Frank Act, the FDIC must take steps, as necessary, for the DIF reserve ratio to reach 1.35% of estimated insured deposits by September 30, 2020. The Bank is thus subject to FDIC deposit premium assessments.

Currently, the FDIC uses a risk-based assessment system that assigns insured depository institutions to one of four risk categories based on three primary sources of information – supervisory risk ratings for all institutions, financial ratios for most institutions, including the Bank, and long-term debt issuer ratings for large institutions that have such ratings. For institutions assigned to the lowest risk category, the annual assessment rate ranges between 7 and 16 cents per $100 of domestic deposits. For institutions assigned to higher risk categories, assessment rates range from 17 to 77.5 cents per $100 of domestic deposits. These ranges reflect a possible downward adjustment for unsecured debt outstanding and possible upward adjustments for secured liabilities and, in the case of institutions outside the lowest risk category, brokered deposits.

On September 29, 2009, the FDIC announced a uniform three basis point-increase effective January 1, 2011, and on November 12, 2009, adopted a rule requiring nearly all FDIC-insured depository institutions, including the Bank, to prepay their DIF assessments for the fourth quarter of 2009 and for the following three years on December 30, 2009. At that time, the FDIC indicated that the prepayment of DIF assessments was in lieu of additional special assessments; however, there can be no guarantee that continued pressures on the DIF will not result in additional special assessments being collected by the FDIC in the future.

On October 19, 2010, the FDIC adopted a new DIF Restoration Plan that foregoes the uniform three basis point-increase scheduled to take effect on January 1, 2011. The FDIC indicated that this change was based on revised projections calling for lower than previously expected DIF losses for the period 2010 through 2014, continued stresses on the earnings of insured depository institutions, and the additional time afforded to reach the DIF reserve ratio required by the Dodd-Frank Act. The FDIC will pursue further rulemaking in 2011 regarding the method that will be used to reach the required 1.35% reserve ratio by September 30, 2020 and plans to offset the effect of this statutory requirement on insured depository institutions with total consolidated assets of less than $10 billion.

On February 7, 2011, pursuant to another element of the Dodd-Frank Act, the FDIC adopted regulations anticipated to become effective April 1, 2011 that amend current regulations to redefine the “assessment base” used for calculating deposit insurance assessments. Rather than the current system, whereby the assessment base is calculated by using an insured depository institution’s domestic deposits less a few allowable exclusions, the new assessment base will be calculated using the average consolidated total assets of an insured depository institution less the average tangible equity of such institution. Under the new rules, the FDIC defines tangible equity as Tier 1 capital. The FDIC will continue to utilize a risk-based assessment system in which institutions will be subject to assessment rates ranging from 2.5 to 45 basis points, subject to adjustments for unsecured debt and, in the case of small institutions outside the lowest risk category and certain large and highly complex institutions, brokered deposits. The final rules eliminate adjustments for secured liabilities.

The new rules retain the FDIC Board’s flexibility to, without further notice-and-comment rulemaking, adopt rates that are higher or lower than the stated base assessment rates, provided that the FDIC cannot (i) increase or decrease the total rates from one quarter to the next by more than two basis points, or (ii) deviate by more than two basis points from the stated base assessment rates. Although the Dodd-Frank Act requires that the FDIC eliminate its requirement to pay dividends to depository institutions when the reserve ratio exceeds a certain threshold, the FDIC’s new rule establishes a decreasing schedule of assessment rates that would take effect when the DIF reserve ratio first meets or exceeds 1.15%. If the DIF reserve ratio meets or exceeds 1.15%, base assessment rates would range from 1.5 to 40 basis points; if the DIF reserve ratio meets or exceeds 2%, base assessment rates would range from 1 to 38 basis points; and if the DIF reserve ratio meets or exceeds 2.5%, base assessment rates would range from 0.5 to 35 basis points. All base assessment rates would continue to be subject to adjustments for unsecured debt and brokered deposits.

The FDIC also collects a deposit-based assessment from insured financial institutions on behalf of The Financing Corporation (“FICO”). The funds from these assessments are used to service debt issued by FICO in its capacity as a financial vehicle for the Federal Savings & Loan Insurance Corporation. The FICO assessment rate is set quarterly and in 2010 ranged from 1.06 cents to 1.04 cents per $100 of assessable deposits. These assessments will continue until the debt matures between 2017 and 2019.

The FDIC may terminate its insurance of deposits if it finds that the institution has engaged in unsafe and 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.

FDIC Temporary Liquidity Guarantee Program. On October 14, 2008, the FDIC announced that its Board of Directors, under the authority to prevent “systemic risk” in the U.S. banking system, approved the Temporary Liquidity Guarantee Program (“TLGP”). The purpose of the TLGP is to strengthen confidence and encourage liquidity in the banking system. The TLGP is composed of two components, the Debt Guarantee Program and the Transaction Account Guarantee Program, and institutions had the opportunity to opt-out of either or both components of the TLGP.

The Debt Guarantee Program: Under the TLGP, the FDIC guaranteed certain newly issued senior unsecured debt issued by participating financial institutions through October 31, 2009. The annualized fee that the FDIC assessed to guarantee the senior unsecured debt varied by the length of maturity of the debt. For debt with a maturity of 180 days or less (excluding overnight debt), the fee was 50 basis points; for debt with a maturity between 181 days and 364 days, the fee was 75 basis points, and for debt with a maturity of 365 days or longer, the fee was 100 basis points. The Bank did not issue any debt outstanding pursuant to the program.

The Transaction Account Guarantee Program: Under the TLGP, the FDIC fully guaranteed funds in noninterest bearing deposit accounts held at participating FDIC-insured institutions, regardless of dollar amount. The temporary guarantee was originally scheduled to expire at the end of 2009, but was subsequently extended to December 31, 2010. Pursuant to the Dodd-Frank Act, beginning on the scheduled termination date for the Transaction Account Guarantee Program, or TAGP, and continuing through December 31, 2012, unlimited insurance coverage will be provided for funds held in noninterest bearing transaction accounts, including Interest on Lawyer Trust Accounts (IOLTAs). During the TAGP extension period, the FDIC imposed a surcharge between 15 and 25 basis points on the daily average balance in excess of $250,000 held in noninterest bearing transaction accounts. Pursuant to the Dodd-Frank Act, however, institutions are no longer separately assessed for the additional coverage, and the unlimited insurance is included in assessments for the overall insurance program. One distinction from this new insurance and the TAGP, is the exclusion of minimal interest-bearing NOW accounts, which were previously covered under the TAGP.

Allowance for Loan and Lease Losses. The Allowance for Loan and Lease Losses (the “ALLL”) represents one of the most significant estimates in the Bank’s financial statements and regulatory reports. Because of its significance, the Bank has developed a system by which it develops, maintains, and documents a comprehensive, systematic, and consistently applied process for determining the amounts of the ALLL and the provision for loan and lease losses. “The Interagency Policy Statement on the Allowance for Loan and Lease Losses,” issued on December 13, 2006, encourages all banks to ensure controls are in place to consistently determine the ALLL in accordance with GAAP, the Bank’s stated policies and procedures, management’s best judgment, and relevant supervisory guidance. Consistent with supervisory guidance, the Bank maintains a prudent and conservative, but not excessive, ALLL, that is at a level that is appropriate to cover estimated credit losses on individually evaluated loans determined to be impaired as well as estimated credit losses inherent in the remainder of the loan and lease portfolio. The Bank’s estimate of credit losses reflects consideration of all significant factors that affect the collectability of the portfolio as of the evaluation date. See “Management’s Discussion and Analysis – Critical Accounting Policies.”

Commercial Real Estate Lending. The Bank’s lending operations may be subject to enhanced scrutiny by federal banking regulators based on its concentration of commercial real estate loans. On December 6, 2006, the federal banking regulators issued final guidance to remind financial institutions of the risk posed by commercial real estate (“CRE”) lending concentrations. CRE loans generally include land development, construction loans, and loans secured by multifamily property, and nonfarm, nonresidential real property where the primary source of repayment is derived from rental income associated with the property. The guidance prescribes the following guidelines for its examiners to help identify institutions that are potentially exposed to significant CRE risk and may warrant greater supervisory scrutiny:

●	total reported loans for construction, land development and other land represent 100% or more of the institutions total capital, or

●	total commercial real estate loans represent 300% or more of the institution’s total capital, and the outstanding balance of the institution’s commercial real estate loan portfolio has increased by 50% or more.

Enforcement Powers. The Financial Institution Reform Recovery and Enforcement Act (“FIRREA”) expanded and increased civil and criminal penalties available for use by the federal regulatory agencies against depository institutions and certain “institution-affiliated parties.” Institution-affiliated parties primarily include management, employees, and agents of a financial institution, as well as independent contractors and consultants such as attorneys and accountants and others who participate in the conduct of the financial institution’s affairs. 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 $1,100,000 per 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 regulatory 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. The Dodd-Frank Act increases regulatory oversight, supervision and examination of banks, bank holding companies and their respective subsidiaries by the appropriate regulatory agency.

Community Reinvestment Act. The Community Reinvestment Act requires that, in connection with examinations of financial institutions within their respective jurisdictions, the federal banking agencies evaluate the record of each financial institution in meeting the credit needs of its local community, including low- and moderate-income neighborhoods. These facts are also considered in evaluating mergers, acquisitions, and applications to open a branch or facility. Failure to adequately meet these criteria could impose additional requirements and limitations on the Bank. Additionally, the Bank must publicly disclose the terms of various Community Reinvestment Act-related agreements.

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

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

●	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;

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

●	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;

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

●	National Flood Insurance Act and Flood Disaster Protection Act, requiring flood insurance to extend or renew certain loans in flood plains;

●	Real Estate Settlement Procedures Act, requiring certain disclosures concerning loan closing costs and escrows, and governing transfers of loan servicing and the amounts of escrows in connection with loans secured by one-to-four family residential properties;

●	Soldiers’ and Sailors’ Civil Relief Act of 1940, as amended, governing the repayment terms of, and property rights underlying, secured obligations of persons currently on active duty with the United States military;

●	Talent Amendment in the 2007 Defense Authorization Act, establishing a 36% annual percentage rate ceiling, which includes a variety of charges including late fees, for certain types of consumer loans to military service members and their dependents;

●

Bank Secrecy Act, as amended by the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “USA PATRIOT Act”), imposing requirements and limitations on specific financial transactions and account relationships, intended to guard against money laundering and terrorism financing;

●	sections 22(g) and 22(h) of the Federal Reserve Act which set lending restrictions and limitations regarding loans and other extensions of credit made to executive officers, directors, principal shareholders and other insiders; and

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

The Bank’s deposit operations are subject to federal laws applicable to depository accounts, such as the following:

●	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;

●	Truth-In-Savings Act, requiring certain disclosures for consumer deposit accounts;

●

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

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

As part of the overall conduct of the business, the Company and the Bank must comply with:

●	privacy and data security laws and regulations at both the federal and state level; and

●	anti-money laundering laws, including the USA Patriot Act.

The Consumer Financial Protection Bureau. The Dodd-Frank Act creates the Consumer Financial Protection Bureau (the “Bureau”) within the Federal Reserve Board. The Bureau is tasked with establishing and implementing rules and regulations under certain federal consumer protection laws with respect to the conduct of providers of certain consumer financial products and services. The Bureau has rulemaking authority over many of the statutes governing products and services offered to bank consumers. In addition, the Dodd-Frank Act permits states to adopt consumer protection laws and regulations that are more stringent than those regulations promulgated by the Bureau and state attorneys general are permitted to enforce consumer protection rules adopted by the Bureau against state-chartered institutions.

Capital Adequacy

The Company and the Bank are required to comply with the capital adequacy standards established by the Federal Reserve Board, in the case of the Company, and the OCC, in the case of the Bank. The Federal Reserve Board has established a risk-based and a leverage measure of capital adequacy for bank holding companies. The Bank is also subject to risk-based and leverage capital requirements adopted by its primary regulator, which are substantially similar to those adopted by the Federal Reserve Board for bank holding companies. However, because the Company has less than $500 million in consolidated assets, we are exempt from calculating our risk-based capital ratios on a consolidated holding company basis.

The risk-based capital standards are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and bank holding companies, to account for off-balance-sheet exposure and to minimize disincentives for holding liquid assets. Assets and off-balance-sheet items, such as letters of credit and unfunded loan commitments, are assigned to broad risk categories, each with appropriate risk weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance-sheet items.

The minimum guideline for the ratio of total capital to risk-weighted assets, and classification as adequately capitalized, is 8%. A bank that fails to meet the required minimum guidelines is classified as undercapitalized and subject to operating and management restrictions. A bank, however, that exceeds its capital requirements and maintains a ratio of total capital to risk-weighted assets of 10% is classified as well capitalized.

Total capital consists of two components: Tier 1 capital and Tier 2 capital. Tier 1 capital generally consists of common stockholders’ equity, minority interests in the equity accounts of consolidated subsidiaries, qualifying noncumulative perpetual preferred stock, and a limited amount of qualifying cumulative perpetual preferred stock, less goodwill and other specified intangible assets. Tier 1 capital must equal at least 4% of risk-weighted assets. Tier 2 capital generally consists of subordinated debt, other preferred stock and hybrid capital, and a limited amount of loan loss reserves. The total amount of Tier 2 capital is limited to 100% of Tier 1 capital. At December 31, 2010 the Bank’s ratio of total capital to risk-weighted assets was 14.50% and the Bank’s ratio of Tier 1 capital to risk-weighted assets was 13.24%.

In addition, the Federal Reserve Board has established minimum leverage ratio guidelines for bank holding companies, which are intended to further address capital adequacy. These guidelines provide for a minimum ratio of Tier 1 capital to average assets, less goodwill and other specified intangible assets, of 3% for bank holding companies that meet specified criteria, including having the highest regulatory rating and implementing the Federal Reserve Board’s risk-based capital measure for market risk. All other bank holding companies generally are required to maintain a leverage ratio of at least 4%. At December 31, 2010, the Bank’s leverage ratio was 8.57%. The guidelines also provide that bank holding companies experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels without reliance on intangible assets. The Federal Reserve Board considers the leverage ratio and other indicators of capital strength in evaluating proposals for expansion or new activities.

In addition to the foregoing regulatory capital requirements, in light of current market conditions and the Bank’s current risk profile, the Bank has determined that it must achieve and maintain a minimum ratio of total capital to risk-weighted assets of 12% and a minimum leverage ratio of 8% to be considered well capitalized under these market conditions and its risk profile.

Through a provision known as the "Collins Amendment," the Dodd-Frank Act establishes certain regulatory capital deductions with respect to hybrid capital instruments, such as trust preferred securities, that will effectively disallow the inclusion of such instruments in Tier 1 capital if such capital instrument is issued on or after May 19, 2010. However, preferred shares issued to the U.S. Department of the Treasury (the “Treasury”) pursuant to the TARP Capital Purchase Program (“TARP CPP”) or TARP Community Development Capital Initiative are exempt from the Collins Amendment and are permanently includable in Tier 1 capital. In addition, securities issued prior to May 19, 2010 by bank holding companies with less than $15 billion in total consolidated assets as of December 31, 2009 will not be subject to these required capital deductions. Finally, bank holding companies subject to the Federal Reserve Board's Small Bank Holding Company Policy Statement as in effect on May 19, 2010 - generally, holding companies with less than $500 million in consolidated assets - are exempt from the trust preferred treatment changes required by the Dodd-Frank Act.

Failure to meet capital guidelines could subject a bank or bank holding company to a variety of enforcement remedies, including issuance of a capital directive, the termination of deposit insurance by the FDIC, a prohibition on accepting brokered deposits, and certain other restrictions on its business. As described above, significant additional restrictions can be imposed on FDIC-insured depository institutions that fail to meet applicable capital requirements. See “Prompt Corrective Action” above.

The OCC, the Federal Reserve Board, and the FDIC have authority to compel or restrict certain actions if the Bank’s capital should fall below adequate capital standards as a result of operating losses, or if its regulators otherwise determine that it has insufficient capital. Among other matters, the corrective actions may include, removing officers and directors; and assessing civil monetary penalties; and taking possession of and closing and liquidating the Bank.

Generally, the regulatory capital framework under which the Company and the Bank operate is in a period of change with likely legislation or regulation that will continue to revise the current standards and very likely increase capital requirements for the entire banking industry. Pursuant to the Dodd-Frank Act, bank regulators are required to establish new minimum leverage and risk-based capital requirements for certain bank holding companies and systematically important non-bank financial companies. The new minimum thresholds will not be lower than existing regulatory capital and leverage standards applicable to insured depository institutions and may, in fact, be higher once established.

Payment of Dividends

The Company is a legal entity separate and distinct from the Bank. The principal source of the Company’s cash flow, including cash flow to pay dividends to its shareholders, are dividends that the Bank pays to the Company as the Bank’s sole shareholder. Statutory and regulatory limitations apply to the Bank’s payment of dividends to the Company as well as to the Company’s payment of dividends to its shareholders. If, in the opinion of the OCC, the Bank were engaged in or about to engage in an unsafe or unsound practice, the OCC could require that the Bank stop or refrain from engaging in the practice. The federal banking agencies have indicated that paying dividends that deplete a depository institution’s capital base to an inadequate level, would be an unsafe and unsound banking practice.

The Bank is required by federal law to obtain prior approval of the OCC for payments of dividends if the total of all dividends declared by the Bank in any year will exceed (1) the total of the Bank’s net profits for that year, plus (2) the Bank’s retained net profits of the preceding two years, less any required transfers to surplus. The payment of dividends by the Company and the Bank may also be affected by other factors, such as the requirement to maintain adequate capital above regulatory guidelines. As of the date of this Annual Report on Form 10-K, pursuant to the Memorandum entered into by the Company with the Federal Reserve Board, the Company is prohibited from declaring and paying cash dividends on common shares outstanding without prior regulatory approval.

When the Company received its capital investment from the Treasury under the TARP CPP on December 5, 2008, the Company became subject to additional limitations on the payment of dividends. These limitations require, among other things, that (i) all dividends for the securities purchased under the TARP CPP be paid before other dividends can be paid and (ii) the Treasury must approve any increases in common dividends for three years following the Treasury’s investment. In addition, pursuant to the MOU, the Company may not pay any dividends on its preferred stock issued pursuant to the TARP CPP without prior regulatory approval.

Furthermore, the Federal Reserve Board clarified its guidance on dividend policies for bank holding companies through the publication of a Supervisory Letter, dated February 24, 2009. As part of the letter, the Federal Reserve Board encouraged bank holding companies, particularly those that had participated in the CPP, to consult with the Federal Reserve Board prior to dividend declarations, and redemption and repurchase decisions even when not explicitly required to do so by federal regulations. The Federal Reserve Board has indicated that CPP recipients, such as the Company, should consider and communicate in advance to regulatory staff how proposed dividends, capital repurchases and capital redemptions are consistent with its obligation to eventually redeem the securities held by the Treasury. This new guidance is largely consistent with prior regulatory statements encouraging bank holding companies to pay dividends out of net income and to avoid dividends that could adversely affect the capital needs or minimum regulatory capital ratios of the bank holding company and its subsidiary bank.

Any future determination relating to our dividend policy will be made at the discretion of the Board of Directors and will depend on many of the statutory and regulatory factors mentioned above.

Restrictions on Transactions with Affiliates

The Company and the Bank are subject to the provisions of Section 23A of the Federal Reserve Act. Section 23A places limits on the amount of:

●	a bank’s loans or extensions of credit to affiliates;

●	a bank’s investment in affiliates;

●	assets a bank may purchase from affiliates, except for real and personal property exempted by the Federal Reserve Board;

●	loans or extensions of credit to third parties collateralized by the securities or obligations of affiliates; and

●	a bank’s guarantee, acceptance, or letter of credit issued on behalf of an affiliate.

The total amount of the above transactions is limited in amount, as to any one affiliate, to 10% of a bank’s capital and surplus and, as to all affiliates combined, to 20% of a bank’s capital and surplus. In addition to the limitation on the amount of these transactions, each of the above transactions must also meet specified collateral requirements. The Bank must also comply with other provisions designed to avoid taking low-quality assets.

The Company and the Bank are also subject to the provisions of Section 23B of the Federal Reserve Act which, among other things, prohibit an institution from engaging in the above transactions with affiliates unless the transactions are on terms substantially the same, or at least as favorable to the institution or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies.

The Dodd-Frank Act enhances the requirements for certain transactions with affiliates under Section 23A and 23B, including an expansion of the definition of “covered transactions” and increasing the amount of time for which collateral requirements regarding covered transactions must be maintained.

The Bank is also subject to restrictions on extensions of credit to its executive officers, directors, principal shareholders, and their related interests. These extensions of credit (1) 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 (2) must not involve more than the normal risk of repayment or present other unfavorable features. Effective July 21, 2011, an insured depository institution will be prohibited from engaging in asset purchases or sales transactions with its officers, directors or principal shareholders unless on market terms and, if the transaction represents greater than 10% of the capital and surplus of the bank, has been approved by a majority of the disinterested directors.

Limitations on Senior Executive Compensation

In June of 2010, federal banking regulators issued guidance designed to help ensure that incentive compensation policies at banking organizations do not encourage excessive risk-taking or undermined the safety and soundness of the organization. In connection with this guidance, the regulatory agencies announced that they will review incentive compensation arrangements as part of the regular, risk-focused supervisory process. Regulatory authorities may also take enforcement action against a banking organization if its incentive compensation arrangement or related risk management, control, or governance processes pose a risk to the safety and soundness of the organization and the organization is not taking prompt and effective measures to correct the deficiencies. To ensure that incentive compensation arrangements do not undermine safety and soundness at insured depository institutions, the incentive compensation guidance sets forth the following key principles:

●	Incentive compensation arrangements should provide employees incentives that appropriately balance risk and financial results in a manner that does not encourage employees to expose the organization to imprudent risk;

●	Incentive compensation arrangements should be compatible with effective controls and risk management; and

●	Incentive compensation arrangements should be supported by strong corporate governance, including active and effective oversight by the board of directors.

Due to the Company’s participation in the TARP Capital Purchase Program, it is subject to additional executive compensation limitations. For example, the Company must meet the following standards:

●	Ensure that senior executive incentive compensation packages do not encourage excessive risk;

●	Subject senior executive compensation to “clawback” if the compensation was based on inaccurate financial information or performance metrics;

●	Prohibit any golden parachute payments to senior executive officers; and

●	Agree not to deduct more than $500,000 from taxable income for a senior executive officer’s compensation.

The Dodd-Frank Act

The Dodd-Frank Act has had a broad impact on the financial services industry, including significant regulatory and compliance changes previously discussed and including, among other things, (i) enhanced resolution authority of troubled and failing banks and their holding companies; (ii) increased regulatory examination fees; and (iii) numerous other provisions designed to improve supervision and oversight of, and strengthening safety and soundness for, the financial services sector. Additionally, the Dodd-Frank Act establishes a new framework for systemic risk oversight within the financial system to be distributed among new and existing federal regulatory agencies, including the Financial Stability Oversight Council, the Federal Reserve Board, the OCC and the FDIC.

Many of the requirements called for in the Dodd-Frank Act will be implemented over time and most will be subject to implementing regulations over the course of several years. Given the uncertainty associated with the manner in which the provisions of the Dodd-Frank Act will be implemented by the various regulatory agencies and through regulations, the full extent of the impact such requirements will have on financial institutions’ operations is unclear. The changes resulting from the Dodd-Frank Act may impact the profitability of our business activities, require changes to certain of our business practices, impose upon us more stringent capital, liquidity and leverage ratio requirements or otherwise adversely affect our business. These changes may also require us to invest significant management attention and resources to evaluate and make necessary changes in order to comply with new statutory and regulatory requirements.

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 financial institutions operating and doing business in the United States. 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.

Effect of Governmental Monetary Policies

The Bank’s earnings are affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. The Federal Reserve Board’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 affect the levels of bank loans, investments and deposits through its control over the issuance of United States government securities, its regulation of the discount rate applicable to member banks, and its influence over reserve requirements to which member banks are subject. Neither the Company nor the Bank can predict the nature or impact of future changes in monetary and fiscal policies.

Employees

As of December 31, 2010, we had 124 full-time employees and 18 part-time employees.

ITEM 1A. RISK FACTORS

We are subject to regulatory actions by our primary regulatory authorities to address asset quality and related issues.

We entered into a formal agreement (the “Agreement”) with the Office of the Comptroller of the Currency (the “OCC”) to address asset quality and related issues. Under the terms of the Agreement, the Bank has prepared and provided written plans and/or reports to the regulators that address the following items: reducing the high level of risk in the Bank, taking immediate and continuing action to protect its interest in criticized assets, ensuring the Bank’s adherence to its written profit plan to improve and sustain earnings, limiting brokered deposits, excluding reciprocal CDARS, that would cause the Bank’s level of brokered deposits to be in excess of ten percent of total deposits, and establishing a Compliance Committee to monitor the Bank’s adherence to the Agreement. Although management continues to address the regulatory concerns cited in the Agreement, there is no assurance that we will be able to maintain compliance with the Agreement in the future. If we are unable to comply, we could be subject to other regulatory sanctions that could ultimately result in more severe penalties.

Additionally, we entered into a Memorandum of Understanding (MOU) with the Federal Reserve Bank of Richmond on November 17, 2010. The terms of the MOU are substantially similar to the terms of the resolution the Board of Directors of Coastal Banking Company, Inc. adopted on January 27, 2010, pursuant to a request by the Federal Reserve Board. Generally, the MOU requires the Company to obtain prior approval of the Federal Reserve Bank before incurring additional debt, purchasing or redeeming its capital stock, or declaring or paying cash dividends, including dividends related to its common stock and TARP preferred stock, and interest on its trust preferred securities. Additionally, the MOU requires the Company to comply with banking regulations that prohibit certain indemnification and severance payments and require prior approval of any appointment of new directors or the hiring or change in position of any senior executive officers of the Company. The MOU also requires the submission of quarterly progress reports.

Compliance with the terms of the formal agreement, including the adoption and implementation of the plans and policies discussed above, and the MOU will require significant time and attention from our management team, which may increase our costs, impede the efficiency of our internal business processes and adversely affect our profitability in the near-term. If we are unable to implement our plans in a timely manner or otherwise comply with our commitments outlined above, or if we fail to adequately resolve any other matters any of our regulators may require us to address in the future, we could become subject to more stringent supervisory actions. The terms of any such supervisory action could have a material negative effect on our business, operating flexibility, or financial condition.

We have incurred operating losses and cannot assure you that we will be profitable in the future.

Excluding the charges of $1.8 million for deferred tax asset valuation allowance in 2010, and $10.4 million for impairment of Goodwill in 2009, we have incurred a net operating loss of $2.0 million, or $0.99 per share, for the year ended December 31, 2010 and a net operating loss of $4.1 million, or $1.83 per share, for the year ended December 31, 2009, due in both cases primarily to credit losses and associated costs, including a significant provision for loan losses and elevated losses on other real estate owned. Although we have taken steps to reduce our credit exposure which has contributed to the year over year reduction in operating losses, we likely will continue to have a higher than normal level of non-performing assets and charge-offs throughout 2011 and, possibly, into 2012, which would continue to adversely impact our overall financial condition and results of operations.

We may experience increased delinquencies and credit losses, which could have a material adverse effect on our capital, financial condition and results of operations.

Like other lenders, we face the risk that our customers will not repay their loans. A customer’s failure to repay us is usually preceded by missed monthly payments. In some instances, however, a customer may declare bankruptcy prior to missing payments, and, following a borrower filing bankruptcy, a lender’s recovery of the credit extended is often limited. Since most of our loans are secured by collateral, we may attempt to seize the collateral when and if customers default on their loans. However, the value of the collateral may not equal the amount of the unpaid loan, and we may be unsuccessful in recovering the remaining balance from our customers. Rising delinquencies and rising rates of bankruptcy in our market area generally and among our customers specifically can be precursors of future charge-offs and may require us to increase our allowance for loan and lease losses. Higher charge-off rates and an increase in our allowance for loan and lease losses may hurt our overall financial performance if we are unable to increase revenue to compensate for these losses and may also increase our cost of funds.

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

Negative developments since 2008 in the global credit and derivative markets have resulted in uncertainty in the financial markets in general with the expectation of the general economic downturn continuing in 2011. 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. If these negative trends continue, our business operations and financial results will continue to be negatively affected.

The impact of the current economic environment on performance of other financial institutions in our primary market area, actions taken by our competitors to address the current economic downturn, and public perception of and confidence in the economy generally, and the banking industry specifically, may present significant challenges for us and could adversely affect our performance.

We are operating in a challenging and uncertain economic environment, including generally uncertain national conditions and local conditions in our markets. Financial institutions continue to be affected by sharp declines in the real estate market and constrained financial markets. While we are taking steps to decrease and limit our exposure to real estate construction loans, we nonetheless retain direct exposure to the real estate markets, and we are affected by these events. Continued declines in real estate values and financial stress on borrowers as a result of the uncertain economic environment, including job losses, could have an adverse effect on our borrowers or their customers, which could adversely affect our financial condition and results of operations.

The impact of recent events relating to residential and commercial real estate markets has not been limited to those directly involved in the real estate industry, but rather it has impacted a number of related businesses such as building materials suppliers, equipment leasing firms, and real estate attorneys, among others. All of these affected businesses have banking relationships and when their businesses suffer from recession, the banking relationship suffers as well.

In addition, the market value of the real estate securing our loans as collateral has been adversely affected by the slowing economy and unfavorable changes in economic conditions in our market areas and could be further adversely affected in the future. As of December 31, 2010, approximately 95% of our loans receivable were secured by real estate. If we continue to experience increased payment delinquencies, foreclosures or losses caused by the adverse market and economic conditions, including the downturn in the real estate market, in our markets then the value of our assets, revenues, results of operations and financial condition could be further adversely affected.

The overall deterioration in economic conditions may subject us to increased regulatory scrutiny in the current environment. In addition, further deterioration in national and local economic conditions in our markets could drive losses beyond that which is provided for in our allowance for loan losses, resulting in the following other consequences: increased loan delinquencies, problem assets and foreclosures; decline in demand for our products and services; decrease in deposits, adversely affecting our liquidity position; and decline in value of collateral, reducing our customers’ borrowing power and the value of assets and collateral associated with our existing loans. As a community bank, we are less able to spread the risk of unfavorable economic conditions than larger or more regional banks. Moreover, we cannot give any assurance that we will benefit from any market growth or favorable economic conditions in our primary market areas even if they do occur.

Continued weakness in residential property values and mortgage loan markets could adversely affect us.

We have a significant number of one-to-four family residential loans, which are secured principally by single-family residences. Loans of this type are generally smaller in size and geographically dispersed throughout our market area. Losses on our residential loan portfolio are difficult to predict because of a number of variables, including interest rates, unemployment rates, economic conditions, and collateral values. Additionally, weakness in the secondary market for residential lending could have an adverse impact upon our profitability. Pricing may change rapidly, impacting the value of loans in our portfolio. This weakness has been most pronounced in residential construction and development loans; however, turmoil in the mortgage markets, combined with the ongoing correction in real estate markets, could result in further price reductions in single family home prices and lack of liquidity in refinancing markets. These factors could adversely impact the quality of our residential construction and residential mortgage portfolio in various ways, including creating discrepancies in value between the original appraisal and the value at time of sale, and decreasing the value of the collateral securing our mortgage loans.

We are subject to risks in the event of certain borrower default, which could have an adverse impact on our liquidity position and results of operations.

We may be required to repurchase mortgage loans or indemnify mortgage loan purchasers as a result of certain borrower defaults, which could adversely affect our liquidity position, results of operations, and financial condition. When we sell mortgage loans, we are required to make customary representations and warranties to the purchaser about the mortgage loans and the manner in which the loans were originated. In the event of a breach of any of the representations and warranties related to a loan sold, we could be liable for damages to the investor up to and including a “make whole” demand that involves, at the investor’s option, either reimbursing the investor for actual losses incurred on the loan or repurchasing the loan in full. Our maximum exposure to credit loss in the event of make whole loan repurchase claim would be the unpaid principal balance of the loan to be repurchased along with any premium paid by the investor when the loan was purchased and other minor collection cost reimbursements. While we have taken steps to enhance our underwriting policies and procedures, these steps might not be effective and might not lessen the risks associated with loans sold in the past. If repurchase demands increase, our liquidity position, results of operations, and financial condition could be adversely affected.

We make and hold in our portfolio a significant number of land acquisition and development and construction loans, which pose more credit risk than other types of loans typically made by financial institutions.

We offer land acquisition and development, and construction loans for builders and developers. As of December 31, 2010, we had $35 million, or 13%, of our total loan portfolio represented by loans for which the related property is neither presold nor preleased. These land acquisition and development, and construction loans are considered more risky than other types of loans. The primary credit risks associated with land acquisition and development and construction lending are underwriting, project risks, and market risks. Project risks include cost overruns, borrower credit risk, project completion risk, general contractor credit risk, and environmental and other hazard risks. Market risks are risks associated with the sale of the completed residential units. They include affordability risk, which means the risk that borrowers cannot obtain affordable financing, product design risk, and risks posed by competing projects. There can be no assurance that losses in our land acquisition and development and construction loan portfolio will not exceed our reserves, which could adversely impact our earnings. Given the current economic environment, the non-performing loans in our land acquisition and development and construction portfolio are not likely to improve in 2011, and these non-performing loans could result in a material level of charge-offs, which will negatively impact our capital and earnings.

The deterioration in the residential mortgage market may continue to spread to commercial real estate credits, which may result in increased financial and regulatory risks and greater losses and non-performing assets, each of which may have an adverse affect on our business operations.

The losses that were initially associated with subprime residential mortgages rapidly spread into the residential mortgage market generally. If the losses in the residential mortgage market continue to spread to commercial real estate credits, then we may be forced to take greater losses or retain more non-performing assets. In addition, in general commercial real estate, or CRE, is cyclical and poses risks of possible loss due to concentration levels and similar risks of the asset class. As of December 31, 2010, approximately 39% of our loan portfolio consisted of CRE loans. The Agreement with the OCC requires that we continue to adhere to a written program to reduce the high level of credit risk at the Bank, including instituting procedures to strengthen credit underwriting in our CRE portfolio and, if excessive, plans to limit growth of our CRE concentration. We could also be required to further increase our allowance for possible loan losses and capital levels as a result of CRE lending exposures, which could have an adverse impact on our results of operations and financial condition.

The amount of other real estate owned (“OREO”) may increase significantly, resulting in additional losses, and costs and expenses that will negatively affect our operations.

At December 31, 2009, we had a total of $18.2 million of OREO, and at December 31, 2010, we had a total of $14.5 million of OREO, reflecting a $3.7 million or 20% decrease from year-end 2009 to year-end 2010. Although we experienced a decrease in the balance of OREO during 2010, it is possible that the balance of OREO could increase in 2011 and future years. This level of OREO is due to, among other things, the continued deterioration of the residential and commercial real estate markets and the tightening of the credit market. As the amount of OREO increases, our losses, and the costs and expenses to maintain the real estate likewise increase. Any additional increase in losses, and maintenance costs and expenses due to OREO may have material adverse effects on our business, financial condition, and results of operations. Such effects may be particularly pronounced in the current market of reduced real estate values and excess inventory, which may continue to make the disposition of OREO properties more difficult, increase maintenance costs and expenses, and may reduce our ultimate realization from any OREO sales.

Our use of appraisals in deciding whether to make a loan on or secured by real property or how to value such loan in the future may not accurately describe the net value of the real property collateral that we can realize.

In considering whether to make a loan secured by real property, we generally require an appraisal of the property. However, an appraisal is only an estimate of the value of the property at the time the appraisal is made, and, as real estate values in our market area have experienced changes in value in relatively short periods of time, this estimate might not accurately describe the net value of the real property collateral after the loan has been closed. If the appraisal does not reflect the amount that may be obtained upon any sale or foreclosure of the property, we may not realize an amount equal to the indebtedness secured by the property. The valuation of the property may negatively impact the continuing value of such loan and could adversely affect our operating results and financial condition.

Our allowance for loan losses may not be adequate to cover actual loan losses, which may require us to materially increase our allowance, which would adversely impact our financial condition and results of operations.

We maintain an allowance for estimated loan losses that we believe is adequate for absorbing any probable losses in our loan portfolio. Management determines the provision for loan losses based upon an analysis of general market conditions, credit quality of our loan portfolio, and performance of our customers relative to their financial obligations with us. As a result of a difficult real estate market and the deterioration of asset quality since 2008, we have increased our allowance as a percentage of our outstanding loan portfolio from 1.59% at December 31, 2008 to 2.20% at December 31, 2009 and 2.25% as of December 31, 2010. It may be necessary to further increase our allowance during 2011. We employ an outside vendor specializing in credit risk management to evaluate our loan portfolio for risk grading, which can result in changes in our allowance for estimated loan losses. The determination of the appropriate level of the allowance for loan and lease losses involves a high degree of subjectivity and requires that significant estimates of current risk be made, using existing qualitative and quantitative information, all of which may undergo material changes. The amount of future losses is susceptible to changes in economic, operating, and other conditions, including changes in interest rates, that may be beyond our control, and such losses may exceed the allowance for estimated loan losses. Additionally, federal banking regulators, as an integral part of their supervisory function, periodically review the allowance for estimated loan losses. If these regulatory agencies require us to increase the allowance for estimated loan losses, it would have a negative effect on our results of operations and financial condition. Although management believes that the allowance for estimated loan losses is adequate to absorb any probable losses on existing loans that may become uncollectible, we are consistently adjusting our loan portfolio and underwriting standards to reflect current market conditions, we can provide no assurance that our methodology will not change and that the allowance will prove sufficient to cover actual loan losses in the future.

Changes in the interest rate environment could reduce our net interest income, which could reduce our profitability.

As a financial institution, our earnings significantly depend on our net interest income, which is the difference between the interest income that we earn on interest-earning assets, such as investment securities and loans, and the interest expense that we pay on interest-bearing liabilities, such as deposits and borrowings. Therefore, any change in general market interest rates, including changes in the Federal Reserve Board’s fiscal and monetary policies, affects us more than non-financial institutions and can have a significant effect on our net interest income and total income. Our assets and liabilities may react differently to changes in overall market rates or conditions because there may be mismatches between the repricing or maturity characteristics of the assets and liabilities. As a result, an increase or decrease in market interest rates could have material adverse effects on our net interest margin and results of operations.

In addition, we cannot predict whether interest rates will continue to remain at present levels. Changes in interest rates may cause significant changes, up or down, in our net interest income. Depending on our portfolio of loans and investments, our results of operations may be adversely affected by changes in interest rates.

In addition to the impact on net interest income, any significant increase in prevailing interest rates could adversely affect other aspects of our business. As rates increase, payments on variable rate loans will increase, which could make it more difficult for borrowers to keep the loans current, possibly increasing loan default rates. At the same time, our mortgage banking business could be negatively impacted because higher interest rates tend to reduce customer demand for refinancings and purchase money mortgage originations.

Negative publicity about financial institutions, generally, or about the Company or the Bank, specifically, could damage our reputation and adversely impact its business operations and financial results.

Reputation risk, or the risk to our business from negative publicity, is inherent in our business. Negative publicity can result from the actual or alleged conduct of financial institutions, generally, or the Company or the Bank, specifically, in any number of activities, including corporate governance and actions taken by government regulators in response to those activities. Negative publicity can adversely affect our ability to keep and attract customers and can expose us to litigation and regulatory action, any of which could negatively affect our business operations or financial results.

We are subject to liquidity risk in our operations.

Liquidity risk is the possibility of being unable, at a reasonable cost and within acceptable risk tolerances, to pay obligations as they come due, to capitalize on growth opportunities as they arise, or to pay regular dividends because of an inability to liquidate assets or obtain adequate funding on a timely basis. Liquidity is required to fund various obligations, including credit obligations to borrowers, mortgage originations, withdrawals by depositors, repayment of debt, dividends to shareholders, operating expenses, and capital expenditures. Liquidity is derived primarily from retail deposit growth and retention, principal and interest payments on loans and investment securities, net cash provided from operations, and access to other funding sources. Our access to funding sources in amounts adequate to finance our activities could be impaired by factors that affect us specifically or the financial services industry in general. Factors that could detrimentally affect our access to liquidity sources include a decrease in the level of our business activity due to a market downturn or adverse regulatory action against us, including the MOU we entered into with the Federal Reserve Bank of Richmond, which requires us to seek prior approval before incurring any additional debt. Our ability to borrow could also be impaired by factors that are not specific to us, such as a severe disruption in the financial markets or negative views and expectations about the prospects for the financial services industry as a whole, given the recent turmoil faced by banking organizations in the domestic and worldwide credit markets. Currently, we have access to liquidity to meet our current anticipated needs; however, our access to additional borrowed funds could become limited in the future, and we may be required to pay above market rates for additional borrowed funds, if we are able to obtain them at all, which may adversely affect our results of operations.

As of December 31, 2010, we had approximately $18.2 million in brokered deposits, which represented approximately 5% of our total deposits. At times, the cost of brokered deposits exceeds the cost of deposits in our local market. In addition, the cost of brokered deposits can be volatile. In accordance with our formal agreement, we are required to limit brokered deposits, excluding reciprocal CDARS, that would cause the Bank’s level of brokered deposits to be in excess of ten percent of total deposits. This limitation, coupled with potential cost increases discussed above, could adversely affect our liquidity and ability to support demand for loans.

The FDIC Deposit Insurance assessments that we are required to pay may continue to materially increase in the future, which would have an adverse effect on our earnings.

As a member institution of the FDIC, we are assessed a quarterly deposit insurance premium. Failed banks nationwide have significantly depleted the insurance fund and reduced the ratio of reserves to insured deposits. As a result, we may be required to pay significantly higher premiums or additional special assessments that could adversely affect our earnings.

On April 1, 2009, the FDIC modified the risk-based assessments to account for each institution’s unsecured debt, secured liabilities and use of brokered deposits. Starting with the second quarter of 2009, assessment rates were increased and currently range from 7 to 77.5 basis points (annualized).

On October 19, 2010, the FDIC adopted a new DIF Restoration Plan, which requires the DIF to attain a 1.35% reserve ratio by September 30, 2020 and foregoes the uniform three basis point-increase scheduled to take effect on January 1, 2011. In addition, the FDIC modified the method by which assessments are determined and, effective April 1, 2011, adjusted assessment rates, which will range from 2.5 to 45 basis points (annualized), subject to adjustments for unsecured debt and, in the case of small institutions outside the lowest risk category and certain large and highly complex institutions, brokered deposits. Further increased FDIC assessment premiums, due to our risk classification, emergency assessments, or implementation of the modified DIF reserve ratio, could adversely impact our earnings.

If we are required to take an additional valuation allowance to our deferred tax asset in the future, our earnings and capital position may be adversely impacted.

Deferred income tax represents the tax impact of the differences between the book and tax basis of assets and liabilities. Deferred tax assets are assessed periodically by us to determine if they are realizable. Factors in our determination include the ability to carry back or carry forward net operating losses and the performance of the business including the ability to generate taxable income from a variety of sources and tax planning strategies. If, based on available information, it is more likely than not that the deferred income tax asset will not be realized, then a valuation allowance against the deferred tax asset must be established with a corresponding charge to income tax expense.

As of December 31, 2010, prior to any valuation allowance, net deferred tax assets totaling $3.8 million were recorded in the Company’s Consolidated Balance Sheets. Based on our projections of future taxable income over the next three years, cumulative tax losses over the previous three years, net operating loss carry forward limitations as discussed below and available tax planning strategies, we recorded a $1.8 million valuation allowance against the net deferred tax asset at December 31, 2010. Analysis of our ability to realize deferred tax assets requires us to apply significant judgment and is inherently subjective because it requires the future occurrence of circumstances that cannot be predicted with certainty. The determination of how much of the net operating losses we will be able to utilize and, therefore, how much of the valuation allowance that may be reversed and the timing is based on our future results of operations and the amount and timing of actual loan charge-offs and asset writedowns. The resulting loss could have a material adverse effect on our results of operations and financial condition and could also decrease the Bank's regulatory capital.

We may be required to raise additional capital in the future, but that capital may not be available when it is needed and could be dilutive to our existing shareholders, which could adversely affect our financial condition and results of operations.

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

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, including compliance with our formal agreement and MOU, is costly and restricts certain of our activities, including the declaration and payment of cash dividends to common shareholders, 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 and operations.

The laws and regulations applicable to the banking industry have recently changed and may continue to change, 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 Dodd-Frank Act was enacted on July 21, 2010. The implications of the Dodd-Frank Act, or its implementing regulations, on our business are unclear at this time, but it may adversely affect our business, results of operations and the underlying value of our common stock. The full effect of this legislation will not be even reasonably certain until implementing regulations are promulgated, which could take years in some cases. See “Supervision and Regulation”.

Some or all of the changes may result in greater reporting requirements, assessment fees, operational restrictions, capital requirements, and other regulatory burdens for either, or both, the Bank and the Company, and many of our non-bank competitors may remain free from such limitations. This could affect our ability to attract and maintain depositors, to offer competitive products and services, and to expand our business.

Congress may consider additional proposals to substantially change the financial institution regulatory system and to expand or contract the powers of banking institutions and bank holding companies. Such legislation may change existing banking statutes and regulations, as well as our current operating environment significantly. If enacted, such legislation could increase or decrease the cost of doing business, limit or expand our permissible activities, or affect the competitive balance among banks, savings associations, credit unions, and other financial institutions. We cannot predict whether new legislation will be enacted and, if enacted, the effect that it, or any regulations, would have on our business, financial condition, or results of operations.

Our financial condition and results of operations are affected by credit policies of monetary authorities, particularly the Federal Reserve Board. Actions by monetary and fiscal authorities, including the Federal Reserve Board, could have an adverse effect on our deposit levels, loan demand or business and earnings.

Our ability to pay cash dividends on common stock is limited and we may be unable to pay future dividends.

We make no assurances that we will pay any dividends in the future. Any future determination relating to dividend policy will be made at the discretion of our Board of Directors and will depend on a number of factors, including our future earnings, capital requirements, financial condition, future prospects, regulatory restrictions, and other factors that our Board of Directors may deem relevant. The holders of our common stock are entitled to receive dividends when, and if declared by our Board of Directors out of funds legally available for that purpose. As part of our consideration to pay cash dividends, we intend to retain adequate funds from future earnings to support the development and growth of our business. In addition, our ability to pay dividends is restricted by federal policies and regulations. It is the policy of the Federal Reserve Board that bank holding companies should pay cash dividends on common stock only out of net income available over the past year and only if prospective earnings retention is consistent with the organization’s expected future needs and financial condition. Further, our principal source of funds to pay dividends is cash dividends that we receive from the Bank. In addition, pursuant to the MOU we entered into with the Federal Reserve Bank of Richmond, we are prohibited from declaring and paying cash dividends without prior written approval from the Federal Reserve Board.

We have participated in the United States Department of the Treasury’s TARP CPP, our ability to pay cash dividends on common stock is further limited. Specifically, we may not pay cash dividends on common stock unless all dividends have been paid on the securities issued to the Treasury under the TARP CPP. The TARP CPP also restricts our ability to increase the amount of cash dividends on common stock, which potentially limits your opportunity for gain on your investment.

Finally, given the requirements under the MOU, we have elected to defer interest payments payable on our outstanding trust preferred securities. Accordingly, pursuant to the terms of the trust preferred securities, we are further restricted from paying dividends on our common stock and our TARP preferred stock, absent authorization from a majority of the holders of our outstanding trust preferred securities, until such time as the Company has paid all interest due and payable on the trust preferred securities.

We are dependent on key individuals and the loss of one or more of these key individuals could curtail our growth and adversely affect our prospects.

The success of our bank depends largely on the services of our chief executive officer. Michael G. Sanchez, the president and chief executive officer of Coastal Banking Company, Inc. and CBC National Bank, has extensive and long-standing ties within our industry. If we lose the services of Mr. Sanchez, our business and development could be materially and adversely affected.

Our success also depends, in part, on our continued ability to attract and retain experienced loan originators, as well as other management personnel. The loss of the services of several of such key personnel could adversely affect our growth strategy and prospects to the extent we are unable to replace such personnel.

Our ability to attract and retain the best key employees may be limited by the restrictions that we must place on the compensation of those employees due to our participation in the United States Department of the Treasury’s Troubled Assets Relief Program Capital Purchase Program (“TARP CPP”).

Participants in the TARP CPP must set specified limits on the compensation to certain senior executive officers. The limitations, which include a prohibition on any “golden parachute” payments and a “clawback” of any bonus that was based on materially inaccurate financial data or other performance metric, could limit our ability to attract and retain the best executive officers because other competing employers may not be subject to these limitations.

The United States Department of the Treasury, as a holder of our preferred stock, has rights that are senior to those of our common stockholders.

We have supported our capital operations by issuing a class of preferred stock to the United States Department of the Treasury under the TARP CPP. On December 5, 2008, we issued preferred stock to the Treasury under the TARP CPP totaling $9.95 million. The preferred stock has dividend rights that are senior to our common stock; therefore, we must pay dividends on the preferred stock before we can pay any dividends on our common stock. In the event of our bankruptcy, dissolution, or liquidation, the holders of our preferred stock must be satisfied before we can make any distributions to our common stockholders.

Our agreement with the United States Department of the Treasury under the TARP CPP is subject to unilateral change by the Treasury, which could adversely affect our business, financial condition, and results of operations.

Under the TARP CPP, the Treasury may unilaterally amend the terms of its agreement with us in order to comply with any changes in federal law. We cannot predict the effects of any of these changes and of the associated amendments.

We face strong competition for customers, which could prevent us from obtaining customers and may cause us to pay higher interest rates to attract customers and expose us to greater lending risks.

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. In addition, we compete with new entrants to our markets, both established and de novo institutions which have aggressively sought after market share. We compete with these institutions both in attracting deposits and in making loans. In addition, we have to attract our customer base from other existing financial institutions and from new residents. Many of our competitors are well-established, larger financial institutions. These institutions offer some services, such as extensive and established branch networks, that we do not provide. There 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.

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

We may seek to acquire other financial institutions or parts of those institutions in the future. We may also expand into new markets or lines of business or offer new products or services. These activities would involve a number of risks, including:

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

●

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

●

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

●

the risk of loss of key employees and customers.

Environmental liability associated with lending activities could result in losses.

In the course of our business, we may foreclose on and take title to properties securing our loans. If hazardous substances are discovered on any of these properties, we may be liable to governmental entities or third parties for the costs of remediation of the hazard, as well as for personal injury and property damage. Many environmental laws can impose liability regardless of whether we knew of, or were responsible for, the contamination. In addition, if we arrange for the disposal of hazardous or toxic substances at another site, we may be liable for the costs of cleaning up and removing those substances from the site, even if we neither own nor operate the disposal site. Environmental laws may require us to incur substantial expenses and may materially limit the use of properties that we acquire through foreclosure, reduce their value or limit our ability to sell them in the event of a default on the loans they secure. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability. Our loan policies require certain due diligence of high risk industries and properties with the intention of lowering our risk of a non-performing loan and/or foreclosed property.

Hurricanes or other adverse weather events could negatively affect our local economies or disrupt our operations, which could have an adverse effect on our business or results of operations.

The economy in our market areas are affected, from time to time, by adverse weather events, particularly hurricanes. Our market areas consist largely of coastal communities, and we cannot predict whether, or to what extent, damage caused by future hurricanes will affect our operations, our customers or the economies in our banking markets. However, weather events could cause a decline in loan originations, destruction or decline in the value of properties securing our loans, or an increase in the risks of delinquencies, foreclosures and loan losses, which would adversely affect our results of operations.

ITEM 1B. UNRESOLVED STAFF COMMENTS

Not applicable.

ITEM 2. PROPERTIES

Our main office is located at 1891 South 14th Street in Fernandina Beach, Florida. The Bank owns this 6,200 square foot main office, which is located on 1.28 acres of land. In addition, the Bank owns and occupies the 6,500 square foot office building on property adjacent to our main office for administrative use. In 2004, the Bank also purchased 1.16 acres of land at the corner of Lofton Square Boulevard and State Road 200 in Yulee, Florida for a future branch location. The Bank will be required to obtain regulatory approval before establishing a branch at this location. We conduct our banking business in Florida under the trade name “First National Bank of Nassau County.”

We conduct our South Carolina banking operation under the trade name “Lowcountry National Bank” through our branch locations in Beaufort, Bluffton and Port Royal. Our Beaufort, South Carolina branch is located at 36 Sea Island Parkway. The Bank owns this 5,800 square foot branch office building, which is located on 2.33 acres of land.

During 2002, the Bank established a loan production office to service the Bluffton area and in 2003 consolidated the office into a new, full-service branch at Moss Creek Village, Bluffton, South Carolina. The Bank leases the Moss Creek office, but has announced the closure of this office effective March 31, 2011 and will consolidate those deposit and loan accounts into the Port Royal, South Carolina branch.

In 2007, the Bank opened a branch in Port Royal, South Carolina, which adjoins the city of Beaufort. The 3,800 square foot branch is owned by the bank and was completed in March 2007 within the Port Royal Center, a multi-unit office complex. We also occupy 3,600 square feet of leased space in the second floor offices above the branch for executive and administrative use. The lease for this property is for a term of five years that will expire in 2012 with options to renew for subsequent five year periods.

The Meigs, Georgia branch operates under the name “The Georgia Bank.” The Bank owns the 3,300 square foot storefront office in Meigs, Georgia, which was acquired as part of the acquisition of the Meigs office on October 27, 2006.

The Bank also has loan production offices in Jacksonville, Florida and Savannah, Georgia, as well as a mortgage office in Atlanta, Georgia. All of these properties are leased, with the Atlanta lease expiring in 2012, and the Savannah lease expiring in 2011. The Jacksonville location is not under a lease contract, and may be canceled at any time with three months notice.

ITEM 3. LEGAL PROCEEDINGS

None.

ITEM 4. RESERVED

PART II.

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES

The Common Stock of Coastal Banking Company, Inc. is not listed on any exchange. However, the stock is quoted on the NASDAQ OTC Bulletin Board under the symbol “CBCO.OB.” There were approximately 620 shareholders of record on December 31, 2010. The following table sets forth the high and low bid prices as quoted on the OTC Bulletin Board during the periods indicated. The quotations reflect inter-dealer prices, without retail mark-up, mark-down, or commissions, and may not represent actual transactions.

	Years Ended December 31,
	2010				2009
	High		Low		High		Low
First quarter	$	3.60	$	2.67	$	6.20	$	3.25
Second quarter	$	3.64	$	3.01	$	6.25	$	3.50
Third quarter	$	3.33	$	2.00	$	4.00	$	3.25
Fourth quarter	$	2.50	$	1.80	$	3.75	$	2.56

Coastal Banking Company, Inc. has never declared or paid a cash dividend and does not expect to do so in the foreseeable future. The ability of Coastal Banking Company, Inc. to pay cash dividends is dependent upon receiving cash dividends from the Bank. However, federal banking regulations restrict the amount of cash dividends that can be paid to Coastal Banking Company, Inc. from the Bank. Further, pursuant to our issuance of 9,950 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A, to the Treasury under the TARP Capital Purchase Program (“CPP”), the preferred stock has dividend rights that are senior to those of our common stock. In addition, pursuant to the terms under which the preferred stock was issued, there are limitations on the payment of dividends on common stock. All of our outstanding shares of common stock are entitled to share equally in dividends from funds legally available when, and if, declared by the board of directors. In addition, pursuant to the MOU we entered into with the Federal Reserve Bank of Richmond, we are prohibited from declaring and paying cash dividends, including dividends on our common stock and our preferred stock pursuant to our participation in the TARP CPP, and interest on our trust preferred securities, without prior written approval from the Federal Reserve Board. Any future determination relating to our dividend policy will be made at the discretion of the Board of Directors.

The Company did not sell any unregistered shares nor did it repurchase any shares of its common stock during the fourth quarter of 2010.

ITEM 6. SELECTED FINANCIAL DATA

Not applicable.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

General

Coastal Banking Company, Inc. (in this Item 7, the “Company”) is a bank holding company headquartered in Beaufort, South Carolina organized to own all of the common stock of its subsidiary, CBC National Bank (in this Item 7, “Bank”). The principal activity of the Bank is to provide banking services for its domestic markets. The Bank’s primary markets are Beaufort County, South Carolina, Nassau County, Florida, and Thomas County, Georgia. The Bank is primarily regulated by the Office of the Comptroller of the Currency (“OCC”) and undergoes periodic examinations by this regulatory agency. The holding company is regulated by the Board of Governors of Federal Reserve System and also is subject to periodic examinations. The Bank commenced business on May 10, 2000 as Lowcountry National Bank at 36 Sea Island Parkway, Beaufort, South Carolina 29907. First National Bank of Nassau County opened for business July 26, 1999 and was acquired by the Company through the merger with its holding company, First Capital Bank Holding Corporation (“First Capital”) on October 1, 2005. On October 27, 2006 the Company acquired our Meigs, Georgia office through the merger of Cairo Banking Company, a Georgia state bank with and into First National Bank of Nassau County. On August 10, 2008, Lowcountry National Bank and First National Bank of Nassau County merged into one charter. Immediately after the merger, the name of the surviving bank was changed to CBC National Bank and the main office relocated to 1891 South 14th Street, Fernandina Beach, Nassau County, Florida. The Bank’s branches continue to do business under the trade names “Lowcountry National Bank,” “First National Bank of Nassau County,” and “The Georgia Bank” in their respective markets. The Company also has an investment in Coastal Banking Company Statutory Trust I (“Trust I”) and Coastal Banking Company Statutory Trust II (“Trust II”). Both trusts are special purpose subsidiaries organized for the sole purpose of issuing trust preferred securities.

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

We have included a number of tables to assist in our description of these measures. For example, the “Average Balances” table shows the average balance during 2010 and 2009 of each category of our assets and liabilities, as well as the yield we earned or the rate we paid with respect to each category. A review of this table shows that our loans typically provide higher interest yields than do other types of interest earning assets, which is why we intend to continue to direct a substantial percentage of our earning assets into our loan portfolio. Similarly, the “Volume/Rate Analysis” table helps demonstrate the impact of changing interest rates and changing volume of assets and liabilities during the years shown. We also track the sensitivity of our various categories of assets and liabilities to changes in interest rates, and to help demonstrate this sensitivity we have included a “Sensitivity Analysis Table.” Finally, we have included a number of tables that provide details about our investment securities, our loans, and our deposits.

Of course, there are risks inherent in all loans, so we maintain an allowance for loan losses to absorb possible losses on existing loans that may become uncollectible. We establish and maintain this allowance by charging a provision for loan losses against our operating earnings. In the following section we have included a detailed discussion of this process, as well as several tables describing our allowance for loan losses. See comments in the section entitled “Provision and Allowance for Loan Losses.”

In addition to earning interest on our loans and investments, we earn income through fees, gains on sales of loans and marketable securities, cash surrender value of life insurance and other service charges to our customers. We describe the various components of this noninterest income, as well as our noninterest expense, in the following discussion.

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

Forward-Looking Statements

This report contains “forward-looking statements” relating to, without limitation, future economic performance, plans and objectives of management for future operations, and projections of revenues and other financial items that are based on the beliefs of management, as well as assumptions made by and information currently available to management. The words “may,” “will,” “anticipate,” “should,” “would,” “believe,” “contemplate,” “expect,” “estimate,” “continue,” “may,” and “intend,” as well as other similar words and expressions of the future, are intended to identify forward-looking statements. Potential risks and uncertainties include, but are not limited to, those described under the heading Item 1A. “Risk Factors.”

Critical Accounting Policies

We have adopted various accounting policies, which govern the application of accounting principles generally accepted in the United States of America in the preparation of our financial statements. Our significant accounting policies are described in Note 1 in the footnotes to the consolidated financial statements at December 31, 2010 included elsewhere in this annual report.

We believe that the allowance for loan losses is a critical accounting policy that requires the most significant judgments and estimates used in preparation of our consolidated financial statements. Please refer to the portion of management’s discussion and analysis of financial condition and results of operations that addresses the allowance for loan losses for a description of our processes and methodology for determining the allowance for loan losses.

Intangible assets include goodwill and other identifiable assets, such as core deposits, resulting from acquisitions. Goodwill, in this context, is the excess of the purchase price in an acquisition transaction over the fair market value of the net assets acquired. Core deposit intangibles are amortized on a straight-line basis over such assets’ estimated expected life. Goodwill is not amortized but is tested annually for impairment or at any time an event occurs, or circumstances change, that may trigger a decline in the value of the reporting unit. Such impairment testing calculations include estimates. Furthermore, the determination of which intangible assets have finite lives is subjective as is the determination of the amortization period for such intangible assets. The Company tests for goodwill impairment by determining the fair market value for each reporting unit and comparing the fair market value to the carrying amount of the applicable reporting unit. If the carrying amount exceeds fair market value the potential for the impairment exists, and a second step of impairment testing is performed. In the second step, the fair market value of the reporting units’ goodwill is determined by allocating the reporting unit’s fair market value to all of its assets (recognized and unrecognized) and liabilities as if the reporting unit had been acquired in a business combination at the date of the impairment test. If the implied fair market value of reporting unit goodwill is less than its carrying amount, goodwill is impaired and is written-down to its fair market value. The loss recognized is limited to the carrying amount of goodwill. Once an impairment loss is recognized, future increases in fair market value will not result in the reversal of previously recognized losses. The Company performed its annual test of impairment in the fourth quarter of 2009 and determined that the entire balance of goodwill was impaired as of December 31, 2009. The entire balance was written off against current earnings and the carrying amount of goodwill was zero as of December 31, 2009. It is important to note that this impairment charge was a non-recurring expense that had no impact on current or future core operating earnings, cash flow, liquidity or risk based regulatory capital ratios.

Income tax accounting guidance results in two components of income tax expense: current and deferred. Current income tax expense reflects taxes to be paid or refunded for the current period by applying the provisions of the enacted tax law to the taxable income or excess of deductions over revenues. The Company determines deferred income taxes using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is based on the tax effects of the differences between the book and tax bases of assets and liabilities, and enacted changes in tax rates and laws are recognized in the period in which they occur. Deferred income tax expense results from changes in deferred tax assets and liabilities between periods. Deferred tax assets are recognized if it is more likely than not, based on the technical merits, that the tax position will be realized or sustained upon examination. The term more likely than not means a likelihood of more than 50 percent; the terms examined and upon examination also include resolution of the related appeals or litigation processes, if any. A tax position that meets the more-likely-than-not recognition threshold is initially and subsequently measured as the largest amount of tax benefit that has a greater than 50 percent likelihood of being realized upon settlement with a taxing authority that has full knowledge of all relevant information. The determination of whether or not a tax position has met the more-likely-than-not recognition threshold considers the facts, circumstances, and information available at the reporting date and is subject to management’s judgment. Deferred tax assets may be reduced by deferred tax liabilities and a valuation allowance if, based on the weight of evidence available, it is more likely than not that some portion or all of a deferred tax asset will not be realized. During the year ended December 31, 2010, management determined that there is a low probability that the Company would realize the full deferred tax asset over the next three tax years through future taxable operating income. Therefore, a deferred tax valuation allowance of $1,826,000 has been recorded as of December 31, 2010 as the amount of the existing deferred tax asset that is not likely to be realized over the next three tax years.

Results of Operations

Overview

Net loss for 2010 was $3,807,000 or $1.70 per basic common share compared to net loss of $14,536,000 or $5.88 per basic common share in 2009. The previously noted nonrecurring charge for goodwill impairment represented $10,412,000 of the 2009 operating loss, or $4.05 per basic common share. Excluding the charges of $1,826,000 for deferred tax asset valuation allowance in 2010, and $10,412,000 for impairment of Goodwill in 2009, we have incurred a net operating loss of $1,981,000, or $0.99 per share, for the year ended December 31, 2010, and a net operating loss of $4,124,000, or $1.83 per share, for the year ended December 31, 2009. In total, our operating results depend to a large degree on net interest income, which is the difference between the interest income received from our investments, such as loans, investment securities, and federal funds sold, and interest expense, paid on deposit liabilities and other borrowings. Net interest income was $11,946,000 for the year ended December 31, 2010 compared to net interest income of $10,944,000 for the year ended December 31, 2009.

The provision for loan losses in 2010 was $2,696,000 compared to $7,771,000 in 2009. Although the provision for loan losses was 65% lower in 2010 than in 2009, it remains elevated due largely to weakness in our real estate markets, including the residential and commercial construction industries. The Bank has a concentration in residential single-family construction loans and residential development loans in Beaufort, South Carolina, Savannah, Georgia and in northeast Florida, principally Nassau, Duval and St. Johns Counties. These loan types are typically repaid as the completed lots or homes are sold; however, the nationwide deterioration in the housing market has affected our local markets and, as a result, caused our sources of repayment to slow and accelerated the devaluation of the underlying collateral securing the loans. The provision for loan losses reflects the amount calculated by our allowance for loan losses methodology, which takes into account deteriorating economic conditions and the underlying collateral value securing many of our loans. Of the $2,696,000 provision expense for 2010, 32% was related to construction loans, 50% was related to residential mortgage loans, 16% was related to commercial, financial and agricultural loans, and 2% was related to all other loans. In addition, of that same amount, 45% of provision expense was related to collateral properties in Florida, 48% was related to collateral properties in South Carolina, and 7% was related to collateral properties in Georgia.

Noninterest income for the year ended December 31, 2010 totaled $10,793,000, representing a $3,140,000 increase from December 31, 2009. This increase was associated with an increase in mortgage banking income of $1,547,000, an increase in SBA loan income of $600,000, and an increase in gain on sale of securities of $839,000, offset by a decrease in income from life insurance contracts of $207,000, and a decrease in service charges on deposits and other service charges, commissions and fees of $136,000. In addition, we recorded a nonrecurring loss on Silverton Financial Services stock of $507,000 during 2009.

Noninterest expenses in 2010 were $22,301,000, which represents a $5,285,000 decrease compared to the 2009 amounts. This decrease is primarily due to the Goodwill impairment charge of $10,412,000 recognized in 2009, offset by an increase in the costs associated with the wholesale mortgage division in Atlanta, Georgia, and an increase of $2,820,000 in costs associated with other real estate owned. The Company’s efficiency ratio, which is a measure of total noninterest expenses as a percentage of net interest income and noninterest income, decreased to 98.08% in 2010 from 148.33% in 2009 due in large part to the previously described decreases in noninterest expenses.

In 2010, we recognized income tax expense of $1,548,000 compared to an income tax benefit of $2,223,000 in 2009. Our effective tax rate was (68.5%) in 2010 and 13.3% in 2009. The fluctuation in effective tax rates reflects the impact of permanent book-to-tax differences from income on bank owned life insurance and municipal securities, as well as non tax deductible losses in 2009 including the Goodwill impairment charge and the loss on Silverton Financial Services stock. In addition, we recorded a valuation allowance of $1,826,000 in 2010 against our deferred tax asset.

Net Interest Income

For the year ended December 31, 2010, net interest income totaled $11,946,000, as compared to $10,944,000 for the same period in 2009, an improvement of $1,002,000 or 9.2% on a year over year basis. Interest income from loans, including fees, decreased $931,000 to $17,261,000 for the year ended December 31, 2010. The average balance of loans was $344,622,000 in 2010 compared to $359,541,000 in 2009. The weighted average rate earned on loans was 5.01% for 2010 compared to 5.06% in 2009. Interest income from securities decreased $1,608,000 on a tax equivalent basis. The average balance of investments was $53,896,000 in 2010 compared to $79,742,000 in 2009. The weighted average rate earned on investments was 4.15% for 2010 compared to 4.82% in 2009. This decrease in interest income was offset by decreased interest expense, which totaled $7,446,000 for the year ended December 31, 2010, compared to $10,812,000 in 2009. The net interest margin realized on earning assets and the interest rate spread were 2.98% and 2.84%, respectively, for the year ended December 31, 2010. For the year ended December 31, 2009, the net interest margin was 2.53% and the interest rate spread was 2.33%. Yields on interest earning assets decreased during the year by 15 basis points compared to a decrease in rates on interest bearing liabilities of 68 basis points during the year.

Average Balances and Interest Rates

The table below shows the average balance outstanding for each category of interest-earning assets and interest-bearing liabilities for 2010, 2009 and 2008, and the average rate of interest earned or paid thereon. Average balances have been derived from the daily balances throughout the period indicated.

	For the Years Ended December 31,
	2010									2009									2008
(In thousands)	Average Balance			Interest			Yield/ Rate			Average Balance			Interest			Yield/ Rate			Average Balance			Interest			Yield/ Rate
Assets:
Interest-earning assets:
Loans (including loan fees)	$	344,622		$	17,261			5.01	%	$	359,541		$	18,192			5.06	%	$	325,098		$	20,318			6.25	%
Taxable investments		47,870			1,882			3.93	%		65,326			3,006			4.60	%		65,702			3,328			5.07	%
Tax-free investments		6,026			352			5.84	%		14,416			836			5.80	%		16,699			988			5.92	%
Interest-bearing deposits in other banks		818			3			0.37	%		1,827			2			0.11	%		678			22			3.24	%
Federal funds sold		5,815			14			0.24	%		2,137			4			0.19	%		4,674			116			2.48	%
Total interest-earning assets		405,151			19,512			4.82	%		443,247			22,040			4.97	%		412,851			24,772			6.00	%
Other noninterest earning assets		31,723									37,335									30,782
Total assets	$	436,874								$	480,582								$	443,633
Liabilities and shareholders’ equity:
Interest-bearing liabilities:
Deposits:
Interest-bearing demand and savings deposits	$	121,426		$	1,332			1.10	%	$	106,662		$	1,573			1.47	%	$	101,895		$	2,442			2.40	%
Time deposits		216,298			4,441			2.05	%		248,386			7,467			3.01	%		228,355			10,117			4.43	%
Other borrowings		39,583			1,673			4.23	%		53,420			1,772			3.32	%		40,671			1,829			4.50	%
Total interest-bearing liabilities		377,307			7,446			1.97	%		408,468			10,812			2.65	%		370,921			14,388			3.88	%
Other noninterest bearing liabilities		24,098									27,160									27,055
Shareholders’ equity		35,469									44,954									45,657
Total liabilities and shareholders’ equity	$	436,874								$	480,582								$	443,633
Excess of interest-earning assets over interest bearing liabilities	$	27,844								$	34,779								$	41,930
Ratio of interest-earning assets to interest-bearing liabilities		107	%								109	%								111	%
Tax equivalent adjustment					(120	)								(284	)								(336	)
Net interest income				$	11,946								$	10,944								$	10,048
Net interest spread								2.84	%								2.33	%								2.12	%
Net interest margin								2.98	%								2.53	%								2.52	%

Non-accrual loans and the interest income recorded on these loans, if any, are included in the yield calculation for loans in all periods reported.

Amounts are presented on a tax equivalent basis.

Volume/Rate Analysis

Net interest income can also be analyzed in terms of the impact of changing rates and changing volume. The following table describes the extent to which changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities have affected our interest income and interest expense during the periods indicated. The effect of a change in average balance has been determined by applying the average rate in the earlier year to the change in average balance in the later year, as compared with the earlier year. The effect of a change in the average rate has been determined by applying the average balance in the earlier year to the change in the average rate in the later year, as compared with the earlier year.

	2010 Compared to 2009 Increase (decrease) due to changes in									2009 Compared to 2008 Increase (decrease) due to changes in
(In thousands)	Volume			Rate			Net Change			Volume			Rate			Net Change
Interest income on:
Loans (including loan fees)	$	(748	)	$	(183	)	$	(931	)	$	2,006		$	(4,132	)	$	(2,126	)
Taxable investments		(728	)		(396	)		(1,124	)		(19	)		(303	)		(322	)
Non-taxable investments		(490	)		6			(484	)		(133	)		(19	)		(152	)
Interest bearing deposits in other banks		(2	)		3			1			14			(34	)		(20	)
Federal funds sold		9			1			10			(41	)		(71	)		(112	)
Total interest income (tax equivalent basis)		(1,959	)		(569	)		(2,528	)		1,827			(4,559	)		(2,732	)
Interest expense on:
Interest-bearing demand and savings deposits		198			(439	)		(241	)		109			(978	)		(869	)
Time deposits		(876	)		(2,150	)		(3,026	)		827			(3,477	)		(2,650	)
Other borrowings		(520	)		421			(99	)		491			(548	)		(57	)
Total interest expense		(1,198	)		(2,168	)		(3,366	)		1,427			(5,003	)		(3,576	)
Net interest income (tax equivalent basis)	$	(761	)	$	1,599		$	838		$	400		$	444		$	844

Interest Rate Sensitivity and Asset Liability Management

Interest rate sensitivity measures the timing and magnitude of the repricing of assets compared with the repricing of liabilities and is an important part of asset/liability management of a financial institution. The objective of interest rate sensitivity management is to generate stable growth in net interest income, and to manage the risks associated with interest rate movements. Management constantly reviews interest rate risk exposure and the expected interest rate environment so that adjustments in interest rate sensitivity can be made on a timely basis. Since the assets and liabilities of the Company are primarily monetary in nature (payable in fixed, determinable amounts), the performance of the Company is affected more by changes in interest rates than by inflation. Interest rates generally increase as the rate of inflation increases, but the magnitude of the change in rates may not be the same.

Net interest income is the primary component of net income for financial institutions. Net interest income is affected by the timing and magnitude of repricing of as well as the mix of interest sensitive and noninterest sensitive assets and liabilities. “Gap” is a static measurement of the difference between the contractual maturities or repricing dates of interest sensitive assets and interest sensitive liabilities within the following twelve months. Gap is an attempt to predict the behavior of the Company’s net interest income in general terms during periods of movement in interest rates. In general, if the Company is asset sensitive, more of its interest sensitive assets are expected to reprice within twelve months than its interest sensitive liabilities over the same period. In a rising interest rate environment, assets repricing more quickly are expected to enhance net interest income. Alternatively, decreasing interest rates would be expected to have the opposite effect on net interest income since assets would theoretically be repricing at lower interest rates more quickly than interest sensitive liabilities. Although it can be used as a general predictor, gap as a predictor of movements in net interest income has limitations due to the static nature of its definition and due to its inherent assumption that all assets will reprice immediately and fully at the contractually designated time. At December 31, 2010, the Company, as measured by gap, and adjusted for its expectations of changes in interest bearing categories that might not move completely in tandem with changing interest rates, is asset sensitive when cumulatively measured at six months and slightly asset sensitive when cumulatively measured at one year. Management has several tools available to it to evaluate and affect interest rate risk, including deposit pricing policies and changes in the mix of various types of assets and liabilities. The Company also forecasts its sensitivity to interest rate changes not less than quarterly using modeling software.

The following table summarizes the amounts of interest-earning assets and interest-bearing liabilities outstanding at December 31, 2010, that are expected to mature, prepay, or reprice in each of the future time periods shown. Except as stated below, the amount of assets or liabilities that mature or reprice during a particular period was determined in accordance with the contractual terms of the asset or liability. Adjustable rate loans are included in the period in which interest rates are next scheduled to adjust rather than in the period in which they are due, and fixed-rate loans and mortgage-backed securities are included in the periods in which they are anticipated to be repaid based on scheduled maturities. The Bank’s savings accounts and interest-bearing demand accounts (NOW and money market deposit accounts) that are not contractually tied to an adjusting index are grouped into categories based on the Company’s historical repricing practices. Money market accounts which are contractually tied to repricing indexes reprice monthly and are grouped in the three month or less category. Many of these money market accounts are tied to a Treasury index.

At December 31, 2010

Maturing or Repricing in

(In thousands)	3 Months or Less			4 Months to 12 Months			1 to 5 Years			Over 5 Years			Total
Interest-earning assets:
Federal funds sold	$	185		$	—		$	—		$	—		$	185
Deposits in other banks		407			—			—			—			407
Investment securities		7,199			4,079			23,194			9,721			44,193
Loans held for sale		55,336			—			—			—			55,336
Loans		122,524			44,033			75,038			26,005			267,600
Total interest-earning assets		185,651			48,112			98,232			35,726			367,721
Interest-bearing liabilities:
Deposits:
Savings and demand deposits		—			50,298			70,500			1,778			122,576
Time deposits		50,220			104,236			50,045			25			204,526
FHLB advances		12,000			7,500			17,500			—			37,000
Junior subordinated debentures		3,093			4,124			—			—			7,217
Total interest-bearing liabilities		65,313			166,158			138,045			1,803			371,319
Interest sensitive difference per period	$	120,338		$	(118,046	)	$	(39,813	)	$	33,923		$	4,865
Cumulative interest sensitivity difference	$	120,338		$	2,292		$	(37,521	)	$	(3,598	)
Cumulative difference to total interest-earning assets		32.7	%		0.6	%		(10.2	)%		(1.0)	%

At December 31, 2010, the Company had $120,338,000 more assets than liabilities repricing or maturing within three months, which indicates that the Company is asset sensitive over this time horizon. When extended out to one year, the Company had $2,292,000 more assets than liabilities repricing or maturing, indicating the Company is asset sensitive over a one-year time period.

Certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities or periods of repricing, they may reflect changes in market interest rates differently. Additionally, certain assets, such as adjustable-rate mortgages, have features that restrict changes in interest rates, both on a short-term basis and over the life of the asset. Other factors which may affect the assumptions made in the table include options to call a security or borrowing, pre-payment rates, early withdrawal levels, and the ability of borrowers to service their debt. Management uses modeling techniques which attempt to quantify the impacts of interest rates on margin changes. These modeling techniques reflect the effects of these cited shortcomings including the effects of maturity changes that occur as a result of changes in interest rates. These modeling tools indicate that net interest margin would be slightly negatively impacted at twelve months given a 1% decrease in interest rates, and positively impacted at twelve months given a 1% increase in interest rates.

Impaired Loans

A loan is considered to be impaired when, in management’s judgment based on current information and events, it is probable that the loan’s principal or interest is not collectible in accordance with the terms of the original loan agreement. Impaired loans, when not material, will be carried in the balance sheet at a value not to exceed their observable market price or the fair value of the collateral if the repayment of the loan is expected to be provided solely by the underlying collateral. The carrying values of any materially impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, which is the contractual interest rate adjusted for any deferred loan fees or costs, premium or discount existing at the inception or acquisition of the loan.

Loans which management identifies as impaired generally will be non-performing loans. Non-performing loans include non-accrual loans or loans which are 90 days or more delinquent as to principal or interest payments. In some cases we continue to receive loan payments in accordance with loan terms from loans that are considered impaired because the underlying collateral value is insufficient to fully satisfy the debt. In these cases, the entire loan payment is applied to the unpaid principal balance of the loan. At December 31, 2010, the Company had $18,954,000 of loans that were impaired and non-performing, of which $3,823,000 continue to receive current payments in accordance with the loan terms. At December 31, 2009, the Company had $8,215,000 of impaired and non-performing loans, of which $268,000 continue to receive current payments in accordance with the loan terms. A loan that is on nonaccrual status may not necessarily be considered impaired if circumstances exist whereby the amount due may be collected without foreclosure and/or liquidation of collateral.

Loans exhibiting one or more of the following attributes are placed on a nonaccrual status:

a.)

Principal and/or interest is 90 days or more delinquent, unless the obligation is (i) well secured by collateral with a realizable value sufficient to discharge the debt including accrued interest in full; and (ii) in the process of collection, which is reasonably expected to result in repayment of the debt, or in its restoration to a current status.

b.)	A borrower’s financial condition has deteriorated to such an extent or some condition exists that makes collection of interest and/or principal in full unlikely in management’s opinion.

c.)	Foreclosure or legal action has been initiated as a result of default by the borrower on the terms of the debt.

The accrual of interest is discontinued on non-accrual loans and any previously accrued interest on such loans will be reversed against current income. Any subsequent interest income is recognized on a cash basis when received unless collectability of a significant amount of principal is in serious doubt. In such cases, collections are credited first to the remaining principal balance on a cost recovery basis. An impaired loan is not returned to accrual status unless principal and interest are current and the borrower has demonstrated the ability to continue making payments as agreed for a reasonable period of time, typically six months.

Potential Problem Loans

Management identifies and maintains a list of potential problem loans. These are loans that are not included in non-accrual status, or loans that are past due 90 days or more and still accruing interest. A loan is added to the potential problem list when management becomes aware of information about possible credit problems of borrowers that causes serious doubts as to the ability of such borrowers to comply with the current loan repayment terms. These loans are designated as such in order to be monitored more closely than other credits in the Bank’s portfolio. At December 31, 2010, the Company had $29,054,000 of potential problem loans. Potential problem loans at December 31, 2009 were $39,055,000.

Provision and Allowance for Loan Losses

The provision for loan losses is the charge to operating earnings that management believes is necessary to maintain the allowance for loan losses at an adequate level. The provision charged to expense was $2,696,000 for the year ended December 31, 2010 as compared to $7,771,000 for the year ended December 31, 2009. On a year over year basis, the provision expense decreased by 65% or $5,075,000. This decrease reflects the transfer of many problem loans to other real estate owned and a slowing of new problem loans. The decrease in provision expense from problem loans moving into OREO was partially offset by an increase in other real estate expenses for 2010, which will be discussed further below. The elevated levels in the provision for loan losses over the last few years is attributable to continued weakness in our real estate markets, primarily related to the housing industry. The Bank has a concentration in residential single-family construction loans and residential development loans in Beaufort, South Carolina, Savannah, Georgia and in northeast Florida, principally Nassau, Duval and St. Johns Counties. These loan types are typically repaid as the completed lots or homes are sold; however, the nationwide deterioration in the housing market caused our sources of repayment to slow and accelerated the devaluation of the underlying collateral securing many of our loans. The provision for loan losses reflects the amount calculated by our allowance for loan losses methodology, which takes into account deteriorating economic conditions and the underlying collateral value of some of our loans.

The loan portfolio decreased by $22,059,000 during the year ended December 31, 2010 as compared to a decrease of $14,760,000 in 2009. The allowance for loan losses was 2.25% of gross loans at December 31, 2010 as compared to 2.20% at December 31, 2009. There are risks inherent in making all loans, including risks with respect to the period of time over which loans may be repaid, risks resulting from changes in economic and industry conditions, risks inherent in dealing with individual borrowers, and, in the case of a collateralized loan, risks resulting from uncertainties about the future value of the collateral.

We have established an allowance for loan losses through a provision for loan losses charged to expense on our statement of earnings. Additions to the allowance for loan losses are made periodically to maintain the allowance at an appropriate level based on management’s analysis of the potential risk in the loan portfolio. The allowance for loan losses represents an amount, which we believe will be adequate to absorb probable losses on existing loans that may become uncollectible. Our judgment as to the adequacy of the allowance for loan losses is based upon a number of assumptions about future events, which we believe to be reasonable, but which may or may not prove to be accurate. To the extent that the recovery of loan balances has become collateral dependent, we obtain appraisals not less than annually, and then we reduce these appraised values for selling and holding costs to determine the liquidated value. Any shortfall between the liquidated value and the loan balance is charged against the allowance for loan losses in the month the related appraisal was received. Our losses will undoubtedly vary from our estimates, and there is a possibility that charge-offs can reduce this allowance. Our determination of the allowance for loan losses is based on evaluations of the collectability of loans, including consideration of factors such as the balance of impaired loans, the quality, mix, and size of our overall loan portfolio, economic conditions that may affect the borrower’s ability to repay, commercial and residential real estate market trends, the amount and quality of collateral securing the loans, our historical loan loss experience, and a review of specific problem loans. We also consider subjective issues such as changes in the lending policies and procedures, changes in the local/national economy, changes in volume or type of credits, changes in volume/severity of problem loans, quality of loan review and board of director oversight, concentrations of credit, and peer group comparisons.

We allocate the allowance for loan losses to specific categories of loans in our portfolio. See the table below for the allocation of loan losses and for a history of charge-offs by loan category, which may or may not be indicative of future charge-offs by category.

Allocation of the Allowance for Loan Losses

	December 31,
	2010					2009					2008					2007					2006
(In thousands)	Amount		% of Loans in Category			Amount		% of Loans in Category			Amount		% of Loans in Category			Amount		% of Loans in Category			Amount		% of Loans in Category
Commercial, Financial and Agricultural	$	543		4	%	$	346		4	%	$	252		3	%	$	284		4	%	$	107		4	%
Real Estate—Construction		358		23			741		24			764		32			1,048		46			1,864		47
Real Estate—Mortgage		4,042		72			4,241		71			2,566		63			1,999		48			1,350		47
Consumer		326		1			351		1			264		2			239		2			62		2
Unallocated		739		—			707		—			987		—			83		—			92		—
Total	$	6,008		100	%	$	6,386		100	%	$	4,833		100	%	$	3,653		100	%	$	3,475		100	%

Our policy is to review the allowance for loan losses using a reserve factor based on risk-rated categories of loans because there was relatively little charge-off activity prior to 2008. The overall objective is to apply percentages to the loans based on the relative inherent risk for that loan type and grade. Reserve factors are based on peer group data, information from regulatory agencies, and on the experience of the Bank’s lenders. The reserve factors will change depending on trends in national and local economic conditions, the depth of experience of the Bank’s lenders, delinquency trends, and other factors. Our general strategy is to maintain a minimum coverage of a certain percentage of gross loans until we have sufficient historical data and trends available. Periodically, we adjust the amount of the allowance based on changing circumstances. We charge recognized losses to the allowance and add subsequent recoveries back to the allowance for loan losses. There can be no assurance that charge-offs of loans in future periods will not exceed the allowance for loan losses as estimated at any point in time or that provisions for loan losses will not be significant to a particular accounting period. Thus, there is a risk that substantial additional increases in the allowance for loan losses could be required. Additions to the allowance for loan losses would result in a decrease of our net income and, possibly, our capital.

The following table summarizes information concerning the allowance for loan losses:

	For the Years Ended December 31,
(In thousands)	2010			2009			2008			2007			2006
Loans outstanding, end of year	$	267,600		$	289,659		$	304,419		$	281,291		$	291,820
Average loans outstanding	$	280,223		$	301,931		$	302,461		$	282,182		$	271,414
Allowance, beginning of year		6,386			4,833			3,653			3,475			2,863
Charge-offs:
Commercial, financial and agricultural		237			599			249			73			95
Real estate—construction		1,515			3,831			5,346			1			—
Real estate—mortgage		1,904			1,828			1,002			54			—
Consumer		71			6			66			25			27
Total charge-offs		3,727			6,264			6,663			153			122
Recoveries:
Commercial, financial and agricultural		1			2			16			19			—
Real estate—construction		263			10			—			—			—
Real estate—mortgage		377			19			—			—			—
Consumer		12			15			4			2			7
Total recoveries		653			46			20			21			7
Net charge-offs		3,074			6,218			6,643			132			115
Additions charged to operations		2,696			7,771			7,823			310			727
Allowance, end of year	$	6,008		$	6,386		$	4,833		$	3,653		$	3,475
Ratio of net charge-offs during the period to average loans outstanding during the period		1.10	%		2.06	%		2.20	%		0.05	%		0.04	%
Allowance for loan losses to loans, end of year		2.25	%		2.20	%		1.59	%		1.30	%		1.19	%

The following table summarizes past due and non-accrual loans, other real estate and repossessions, interest income recognized on non-accrual loans, and income that would have been reported on non-accrual loans as of December 31, 2010, 2009, 2008, 2007, and 2006.

	December 31,
(In thousands)	2010		2009		2008		2007		2006
Other real estate and repossessions	$	14,452	$	18,176	$	5,756	$	340	$	—
Accruing loans 90 days or more past due		—		105		801		69		10
Non-accrual loans		22,302		13,754		18,213		2,018		86
Interest income recognized on non-accrual loans		283		157		60		4		43
Interest on non-accrual loans which would have been reported		936		727		602		104		13

The following table summarizes restructured loans, interest income recognized on restructured loans, and income that would have been reported on non-accrual restructured loans as of December 31, 2010, 2009, 2008, 2007, and 2006. Restructured loans which were 90 days or more past due, non-accrual restructured loans, and interest on non-accrual restructured loans are included both in the restructured loan table below and also in the non-accrual loan table above.

	December 31,
(In thousands)	2010		2009		2008		2007		2006
Restructured loans which are current and performing as agreed	$	5,116	$	16,052	$	—	$	—	$	—
Restructured loans 30-89 days past due		373		—		—		—		—
Restructured loans 90 days or more past due		—		—		—		—		—
Non-accrual restructured loans		10,471		3,690		—		—		—
Total restructured loans	$	15,960	$	19,742	$	—	$	—	$	—
Interest income recognized on restructured loans		572		654		—		—		—
Interest on non-accrual restructured loans which would have been reported		340		85		—		—		—

Noninterest Income

Noninterest income was $10,793,000 for the year ended December 31, 2010, which was an increase of $3,140,000 or 41% from $7,653,000 earned during the year ended December 31, 2009. The largest factor in this year over year improvement occurred in mortgage banking income, which was $8,230,000 for the year ended December 31, 2010 compared to $6,683,000 for the year ended December 31, 2009. This increase to mortgage banking income was driven almost entirely by the results of the mortgage origination business in Atlanta, which is discussed in further detail below.

Service charges on deposit accounts decreased by 18% or $104,000 to a level of $462,000 for the year ended December 31, 2010. Income on life insurance contracts decreased by 72% or $206,000 to a level of $82,000 for 2010. SBA loan income increased by 366% or $599,000 to $763,000 for 2010 compared to $164,000 during 2009. The low level of SBA loan income during 2009 reflects the impact of a severe contraction in the volume and profit margins related to SBA loan sales during that year.

During 2010, we recorded net gains of $939,000 on sales of securities available for sale, compared to net gains of $1,000 during 2009. During 2009, we recorded a loss on our investment in Silverton Financial Services common stock of $507,000 and a gain of $99,000 on the early tender of one of our investment securities held to maturity.

Noninterest Expense

Total noninterest expense for the year ended December 31, 2010 was $22,301,000 as compared to $27,586,000 for 2009. Excluding the impact of the goodwill impairment in 2009, total noninterest expense was $17,174,000 for the year ended December 31, 2009. The year over year increase in noninterest operating expense of $5,127,000 is due largely to increased costs associated with higher mortgage lending volume and an increase in other real estate expenses. Mortgage loan expense, excluding mortgage division salaries and benefits, increased 144%, or $679,000, to $1,150,000 during 2010 compared to $471,000 during 2009. Other real estate expenses increased 147%, or $2,820,000, to $4,739,000 during 2010 compared to $1,919,000 during 2009.

Salaries and benefits totaled $9,512,000 for the year ended December 31, 2010, compared to $8,002,000 for the same period a year ago for an increase of $1,510,000. Excluding the mortgage banking division, the community banking division experienced an increase in salaries and benefits of $253,000 during 2010 compared to 2009.

Occupancy and equipment expense increased $194,000 to $1,404,000 for 2010 compared to $1,210,000 during 2009. This increase was due to expansion in the mortgage banking division in Atlanta. This increase was partially offset by a decrease in FDIC insurance expense of $181,000 during 2010 compared to the same period in 2009.

Mortgage Banking Activities

In the third quarter of 2007, First National Bank of Nassau County opened a residential mortgage lending division headquartered in Atlanta, Georgia to complement the existing retail residential mortgage lending activity conducted through other branch locations. This division originates and funds residential mortgage loans submitted by mortgage brokers, as well as loan applications submitted directly from borrowers, and then sells these mortgage loans in the secondary market. This lending channel subjects us to various risks, including credit, liquidity and interest rate risks. We reduce unwanted credit and liquidity risks by selling virtually all of the mortgage loans originated through this division. From time to time, we may decide to hold loans originated through this division as additions to our residential real estate loan portfolio. We determine whether the loans will be held in our portfolio or sold in the secondary market at the time of origination. We may subsequently change our intent to hold loans in portfolio and subsequently sell some or all of these loans from our portfolio as part of our corporate asset/liability management strategy.

While credit and liquidity risks have historically been relatively low for mortgage banking activities, interest rate risk can be substantial. Changes in interest rates will impact the value of mortgages held for sale (MHFS) as well as the associated income and loss reflected in mortgage banking noninterest income, the income and expense associated with instruments (economic hedges) used to hedge changes in the value of MHFS, and the value of derivative loan commitments extended to mortgage applicants.

Interest rates impact the amount and timing of loan origination activity because consumer demand for new mortgages and the level of refinancing activity are sensitive to changes in mortgage interest rates. Typically, a decline in mortgage interest rates will lead to an increase in mortgage origination activity. Given the time it takes for consumer behavior to fully react to interest rate changes, as well as the time required for processing a new application, providing the commitment, and selling the loan, loan origination activity will lag behind interest rate changes. The amount and timing of the impact on loan origination activity will depend on the magnitude, speed and duration of the change in interest rates.

As part of our mortgage banking activities, we enter into commitments to fund residential mortgage loans by a specified future date. A mortgage loan commitment is an interest rate lock that binds us to lend funds to a potential borrower at a specified interest rate and within a specified period of time, generally up to 60 days after inception of the rate lock, subject to the loan applicant satisfying the underwriting conditions required for approval of their loan application. These loan commitments are derivative loan commitments and the loans that result upon exercise of the loan commitments are held for sale. These derivative loan commitments are recognized at fair value in the balance sheet with changes in fair value recorded as part of mortgage banking noninterest income. We record no value for the loan commitment at inception. Subsequent to inception, however, we recognize the fair value of the derivative loan commitment based upon (i) estimated changes in the fair value of the underlying loan that would result from the exercise of that commitment and (ii) changes in the probability that the underlying loan will fund within the terms of the commitment (referred to as a pull through rate). The value of the underlying loan is affected primarily by changes in interest rates and the passage of time.

Outstanding derivative loan commitments expose us to the risk that the value of the loans underlying the commitments might decline due to increases in mortgage interest rates from inception of the rate lock to the funding of the loan. To effectively hedge this risk, we enter into forward sale contracts with secondary market investors to sell the underlying loans by a future date at an agreed upon price. During 2008 and most of 2009 these forward sale contracts were primarily on a ‘best efforts flow’ structure. Forward sales contracts are entered into concurrently with issuance of the derivative loan commitment and carry terms that match the terms of the underlying loan commitments. As a result, these forward sales commitments will experience changes in fair value that will fully offset the changes in fair value of the derivative loan commitments.

In the later half of 2009 and during 2010, we expanded our loan sales strategy from primarily best efforts, flow delivery to add the use of mandatory flow deliveries, mini bulk sales, and forward mortgage backed securities deliveries through assignment of trade transactions. These alternative loan sales strategies resulted in improved execution and thereby increased gain on sale of loans. These alternative sales strategies tend not to be as effective in hedging the interest rate risk as the concurrent flow forward sales commitments; however, we have experienced improved execution on the loan sales, which has more than compensated for the slight increase in interest rate risk from using less effective hedging techniques.

The primary source of direct income generated by this division is the gain on sale of mortgage loans which was $8,230,000 for 2010 compared to $6,683,000 during 2009. Attractive mortgage rates caused a surge in mortgage loan refinancing during the first half of 2009, leading to above average volume at the mortgage banking division, and thus, above average gains on sales. During the third quarter of 2010, mortgage rates experienced another low period, which led to above average funding volumes and gains on sale during the last half of 2010. The direct noninterest expenses incurred by the division were $6,478,000 during 2010, an increase of $2,289,000 over the 2009 expenses of $4,189,000. The largest contributor to this increase was in salaries and benefits, which were $4,292,000 during 2010, compared to $3,035,000 during 2009, and largely reflect the higher commissions and incentive compensation paid as a result of increased volume of loan originations in 2010 as compared to 2009.

Beyond the impact of the noninterest income and expense from this division, the Bank earns interest income at the respective note rates on the balance of loans originated by the division from the time the loan is funded until it is sold to a secondary market investor. The average outstanding daily balance of residential mortgage loans available for sale was $64,400,000 during 2010 and $57,610,000 during 2009. The interest income earned on these loans available for sale was $3,005,000 and $2,937,000 during the years ended December 31, 2010 and 2009, respectively.

Income Taxes

During 2010, we recognized income tax expense of $1,548,000 compared to an income tax benefit of ($2,223,000) during 2009. Our effective tax rate was (69%) in 2010 and 13% in 2009. The fluctuation in effective tax rates reflects the impact of permanent book-to-tax differences from the impact of the early redemption of several bank owned life insurance (BOLI) policies. The BOLI policy redemptions generated taxable income, but did not result in GAAP income upon redemption, which resulted in the recognition of a substantial tax expense on the taxable gain, but no corresponding GAAP income. In addition, we recorded a partial valuation allowance of $1,826,000 in 2010 against our deferred tax asset.

The Company accounts for income taxes in accordance with income tax accounting guidance (FASB ASC 740, Income Taxes). On January 1, 2009, the Company adopted the recent accounting guidance related to accounting for uncertainty in income taxes, which sets out a consistent framework to determine the appropriate level of tax reserves to maintain for uncertain tax positions.

The income tax accounting guidance results in two components of income tax expense: current and deferred. Current income tax expense reflects taxes to be paid or refunded for the current period by applying the provisions of the enacted tax law to the taxable income or excess of deductions over revenues. The Company determines deferred income taxes using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is based on the tax effects of the differences between the book and tax bases of assets and liabilities, and enacted changes in tax rates and laws are recognized in the period in which they occur.

Deferred income tax expense results from changes in deferred tax assets and liabilities between periods. Deferred tax assets are recognized if it is more likely than not, based on the technical merits, that the tax position will be realized or sustained upon examination. The term more likely than not means a likelihood of more than 50%; the terms examined and upon examination also include resolution of the related appeals or litigation processes, if any. A tax position that meets the more-likely-than-not recognition threshold is initially and subsequently measured as the largest amount of tax benefit that has a greater than 50% likelihood of being realized upon settlement with a taxing authority that has full knowledge of all relevant information. The determination of whether or not a tax position has met the more-likely-than-not recognition threshold includes an assessment of the facts, circumstances, and information available at the reporting date and is subject to management’s judgment. Deferred tax assets may be reduced by deferred tax liabilities and a valuation allowance if, based on the weight of evidence available, it is more likely than not that some portion or all of a deferred tax asset will not be realized.

Management has considered both negative and positive indicators in assessing the likelihood that the Company will realize the deferred tax asset through future taxable operating income.

The cumulative loss incurred by the Company in 2008, 2009, and 2010 was the primary negative factor considered by management. Additionally, general economic conditions in the Company’s primary markets and the potential for ongoing weakening asset quality were also evaluated as a potential negative factor.

Offsetting these negative factors were numerous positive factors considered by management including:

●	Prior to the losses in 2008, 2009 and 2010 from asset quality costs, the Company had a history of consistent earnings with cumulative pretax net income of $13,879,000 for the five year period ending December 31, 2007.

●	Over the last year, core earnings have increased to levels last attained in 2006, and so management is cautiously optimistic that more likely than not over the next two to five years taxable income will return to levels approaching those prior to 2008.

●

Management recommended and the Board of Directors authorized early redemptions of the majority of our bank owned life insurance policies during 2010. Liquidating these policies generated taxable income which was utilized to offset a portion of our net operating loss carry forward and decrease the related deferred tax asset in the process. The proceeds from liquidating these policies will be available to fund other earning assets, shifting approximately $210,000 of annual tax exempt earnings to a like amount of taxable earnings.

●

The existing portfolio of marketable securities had an unrealized mark to market gain as of December 31, 2010 of $727,000, which could consume up to $247,000 of the deferred tax asset if the decision was made to sell securities from this portfolio and replace them with current market rate securities.

●	During 2010 we sold approximately $4.8 million of tax exempt municipal bonds, generating a taxable gain of $167,000, which allowed us to reinvest the proceeds of sale into securities that generate taxable income.

●	During 2010 we sold approximately $16.4 million of mortgage backed securities, generating a taxable gain of $772,000 and reducing the deferred tax asset by $262,000.

Based on the above analysis, management believes that there is a low probability that the Company would realize the full deferred tax asset over the next three tax years through future taxable operating income and implementation of tax strategies as described above. Therefore, a deferred tax valuation allowance of $1,826,000 has been recorded as of December 31, 2010 as the amount of the existing deferred tax asset that is not likely to be realized over the next three tax years. Management will continue to monitor the deferred tax asset and adjust the valuation allowance as needed to properly reflect any changes in the probability of future realization of the deferred tax asset.

Financial Condition

Total assets decreased from $463,097,000 at December 31, 2009 to $427,077,000 at December 31, 2010. The primary source of the decrease in assets was in our investment portfolio which decreased $22,795,000 during 2010, as a result of several security sales, calls, and maturities. Portfolio loans decreased $22,059,000, or 7.62% during 2010. Cash surrender value of bank owned life insurance decreased $5,499,000 during 2010 as the Company made a decision to redeem several policies. Other real estate owned decreased 20.49% to $14,452,000 at December 31, 2010. These decreases were offset by an increase of $16,656,000, or 112.17%, in loan sales receivable and an increase of $5,330,000 in loans held for sale. During 2010, total liabilities decreased $31,153,000, or 7.33%, when compared to December 31, 2009. During 2010, total deposits decreased $22,830,000, or 6.19%, and other borrowings decreased $8,237,000, or 18.21%.

Interest-Earning Assets

Loans

Gross loans totaled $267,600,000 at December 31, 2010, a decrease of $22,059,000, or 7.62%, since December 31, 2009. We continue to work to reduce our exposure to higher risk loans as evidenced by the $6,300,000, or 10.94%, decline in the balance of real estate construction, commercial loans during 2010. We also experienced a decline in real estate mortgage, residential loans, which decreased $9,132,000, or 8.08%, to $103,852,000 at December 31, 2010, and a decrease in real estate mortgage, commercial loans, which decreased $3,568,000, or 3.91%, to $87,758,000 at December 31, 2010. Balances and nonaccrual levels within the major loans receivable categories as of the last five year end periods were as follows:

	Loan Portfolio Mix as of December 31,
(In thousands)	2010				2009				2008				2007				2006
Commercial and financial	$	10,120	4	%	$	10,956	4	%	$	10,294	3	%	$	10,235	4	%	$	13,053	4	%
Agricultural		151	—	%		319	—	%		326	—	%		519	—	%		55	—	%
Real estate – construction, commercial		51,273	19	%		57,573	20	%		88,151	29	%		111,988	40	%		121,791	42	%
Real estate – construction, residential		12,094	4	%		13,063	4	%		15,166	5	%		17,619	6	%		16,250	6	%
Real estate – mortgage, farmland		—	—	%		—	—	%		199	—	%		94	—	%		14	—	%
Real estate – mortgage, commercial		87,758	33	%		91,326	32	%		81,360	27	%		68,281	24	%		72,001	25	%
Real estate – mortgage, residential		103,852	39	%		112,984	39	%		103,588	34	%		68,772	25	%		64,334	22	%
Consumer installment loans		2,145	1	%		3,293	1	%		5,223	2	%		2,626	1	%		3,339	1	%
Other		207	—	%		145	—	%		112	—	%		1,157	—	%		983	—	%
	$	267,600			$	289,659			$	304,419			$	281,291			$	291,820

	Loans on Nonaccrual as of December 31,
(In thousands)	2010				2009				2008				2007				2006
Commercial and financial	$	5	—	%	$	40	—	%	$	3	—	%	$	—	—	%	$	49	57	%
Agricultural		151	1	%		319	2	%		326	2	%		—	—	%		—	—	%
Real estate – construction, commercial		9,112	41	%		6,836	50	%		14,479	80	%		1,498	74	%		—	—	%
Real estate – construction, residential		75	—	%		526	4	%		249	1	%		—	—	%		—	—	%
Real estate – mortgage, farmland		—	—	%		—	—	%		—	—	%		—	—	%		—	—	%
Real estate – mortgage, commercial		4,284	19	%		2,831	21	%		2,424	13	%		502	25	%		—	—	%
Real estate – mortgage, residential		8,673	39	%		3,198	23	%		718	4	%		—	—	%		—	—	%
Consumer installment loans		2	—	%		4	—	%		14	—	%		18	1	%		37	43	%
Other		—	—	%		—	—	%		—	—	%		—	—	%		—	—	%
	$	22,302			$	13,754			$	18,213			$	2,018			$	86

As of December 31, 2010, maturities of loans in the indicated classifications were as follows:

(In thousands)	Real Estate - Construction		Real Estate – Mortgage, Commercial		Real Estate – Mortgage, Residential		All Other Loans		Total
Maturity
Within 1 year	$	25,678	$	22,008	$	14,575	$	5,838	$	68,099
1 to 5 years		26,639		34,854		18,140		4,261		83,894
Over 5 years		11,050		30,896		71,137		2,524		115,607
Totals	$	63,367	$	87,758	$	103,852	$	12,623	$	267,600

As of December 31, 2010, the interest terms of loans in the indicated classification for the indicated maturity ranges are as follows:

(In thousands)	Fixed Interest Rates		Variable Interest Rates		Total
Real estate – construction
Within 1 year	$	22,095	$	3,583	$	25,678
1 to 5 years		20,009		6,630		26,639
Over 5 years		3,881		7,169		11,050
Real estate – mortgage, commercial
Within 1 year		21,143		865		22,008
1 to 5 years		31,373		3,481		34,854
Over 5 years		5,598		25,298		30,896
Real estate – mortgage, residential
Within 1 year		13,047		1,528		14,575
1 to 5 years		14,898		3,242		18,140
Over 5 years		29,400		41,737		71,137
All other loans
Within 1 year		5,263		575		5,838
1 to 5 years		3,921		340		4,261
Over 5 years		246		2,278		2,524
	$	170,874	$	96,726	$	267,600

Risk Elements in the Loan Portfolio

As addressed above, loans on nonaccrual status increased by $8,548,000, or 62.2%, from $13,754,000 at December 31, 2009 to $22,302,000 at December 31, 2010. In addition to the level of loans on nonaccrual status, there are a number of other portfolio characteristics that management monitors and evaluates to assess the risk profile of the loan portfolio. The following is a summary of risk elements in the loan portfolio:

	Loans with Interest Only Payments
(In thousands)	December 31, 2010				December 31, 2009
Commercial and financial	$	5,413	9	%	$	6,330	7	%
Real estate – construction, commercial		22,407	37	%		30,230	35	%
Real estate – construction, residential		2,097	4	%		6,872	8	%
Real estate – mortgage, commercial		11,026	18	%		15,899	19	%
Real estate – mortgage, residential		19,136	31	%		24,481	29	%
Consumer installment loans		712	1	%		1,402	2	%
Other		156	––	%		145	––	%
	$	60,947			$	85,359

As shown above, we have a moderate concentration of interest only loans in our portfolio, and such loans are generally regarded as carrying a higher risk profile than fully amortizing loans. It is important to note that none of the interest only loans in our portfolio allow negative amortization, nor do we have any loans with capitalized interest reserves.

	Geographic Concentration of Loan Portfolio
	December 31, 2010
(In thousands)	Florida		Georgia		South Carolina		Other
Commercial and financial	$	6,149	$	372	$	3,488	$	111
Agricultural		––		151		––		––
Real estate – construction, commercial		16,206		6,892		26,247		1,928
Real estate – construction, residential		3,835		937		7,322		––
Real estate – mortgage, commercial		33,074		11,025		42,751		908
Real estate – mortgage, residential		34,577		30,189		38,617		469
Consumer installment loans		579		205		1,361		––
Other		32		125		50		––
	$	94,452	$	49,896	$	119,836	$	3,416

	Geographic Concentration of Loan Portfolio
	December 31, 2009
(In thousands)	Florida		Georgia		South Carolina		Other
Commercial and financial	$	6,335	$	569	$	3,938	$	114
Agricultural		––		319		––		––
Real estate – construction, commercial		19,018		8,775		29,780		––
Real estate – construction, residential		3,786		429		8,789		59
Real estate – mortgage, commercial		35,505		11,949		43,872		––
Real estate – mortgage, residential		46,989		21,788		39,803		4,404
Consumer installment loans		1,119		602		1,555		17
Other		––		145		––		––
	$	112,752	$	44,576	$	127,737	$	4,594

We also monitor and evaluate several other loan portfolio characteristics at a total portfolio level rather than by major loan category. These characteristics include:

Junior Liens – Loans secured by liens in subordinate positions tend to have a higher risk profile than loans secured by liens in the first or senior position. At December 31, 2010 the Company held $23,418,000 of loans secured by junior liens which represents approximately 8.8% of the total net portfolio of loans. Historical loss experience as measured by net loan charge offs was $414,000 in the year ended December 31, 2010 for all loans secured by junior liens for an annualized loss rate of 1.8%. At December 31, 2009 the Company held $22,588,000 of loans secured by junior liens, which represented approximately 7.8% of the total net loan portfolio. Net loan charge-offs was $561,000 in the year ended December 31, 2009 for all loans secured by junior liens for an annualized loss rate of 2.5%.

High Loan to Value Ratios – Typically the Company will not originate a new loan with a loan to value (LTV) ratio in excess of 100%. However, declines in collateral values can result in the case of an existing loan renewal with an LTV ratio in excess of 100% based on the current appraised value of the collateral. In such cases the borrower may be asked to pledge additional collateral or to renew the loan for a lesser amount. If the borrower lacks the ability to pay down the loan or provide additional collateral, but has the ability to continue to service the debt, the loan will be renewed with an LTV ratio in excess of 100%. At December 31, 2010 the loan portfolio included 29 loans with a balance of $10,855,000, or 4.1% of the net loan portfolio, with LTV ratios in excess of 100%. At December 31, 2009 the loan portfolio included 22 loans with a balance of $10,244,000, or 3.5% of the net loan portfolio with LTV ratios in excess of 100%.

Restructured Loans – The Company has followed a conservative approach by classifying any loan as restructured whenever the terms of a loan were adjusted to the benefit of any borrower in financial distress, regardless of the status of the loan at the time of restructuring. There are two primary categories of restructured loans based on the status and condition of the loan at the time of any such restructure, and these categories present very different risk profiles.

The first category is identified as performing restructured loans, which includes loans that are on accrual status because they were current or less than 90 days past due at the time of restructure. In many cases the borrower has never been delinquent, but for various reasons is experiencing financial distress that raises a doubt about the borrower’s continued ability to make payments under current terms. By adjusting the terms of the loan to better fit the borrower’s current financial condition, expectations are that this loan will avoid a future default. For regulatory purposes, these loans are only reported as restructured during the fiscal year in which the restructure occurred, after which the designation as a restructured loan is removed provided the borrower is paying in accordance with the restructured loan terms.

The second category is identified as nonperforming restructured loans, which is made up of loans that were in default at the time the loan terms were restructured. The expectation is that by adjusting the terms of such loans, the borrower may begin to make payments again based on the improved loan terms. These loans will stay on nonaccrual status as restructured loans until the borrower has demonstrated a willingness and ability to make payments in accordance with the new loan terms for a reasonable length of time, typically six months. Once these loans are returned to accrual status, they will be reported as performing restructured loans until the end of the fiscal year in which they were returned to accrual status after which the designation as a restructured loan is removed.

Although our experience with restructured loans has been limited to just the last few years, it appears that performing restructured loans perform better than non performing restructured loans, as evidenced by a lower delinquency recidivism rate. At December 31, 2010, the Company had 12 performing restructured loans with a balance of $5,116,000, which were current and paying in accordance with restructured terms, one past due restructured loan with a balance of $373,000, and 13 nonperforming restructured loans with a balance of $10,471,000. In total, as of December 31, 2010, these 26 restructured loans with a total balance of $15,960,000 represented 6% of the net loan portfolio balance. At December 31, 2009, the Company had 29 performing restructured loans with a balance of $16,052,000, which were current and paying in accordance with restructured terms, and 6 nonperforming restructured loans with a balance of $3,690,000. In total, as of December 31, 2009, these 35 restructured loans with a total balance of $19,742,000 represented 7% of the net loan portfolio balance.

Criticized or Classified Loans – Management evaluates all loan relationships periodically in order to assess the financial strength of the borrower and the value of any underlying collateral. Loans that are found to have a potential or actual weakness are identified as criticized or classified and subject to increased monitoring by management. This typically includes frequent contact with the borrower to actively manage the borrowing relationship as needed to rehabilitate or mitigate the weakness identified. At December 31, 2010 the Company had $51,072,000 in loans that were internally criticized or classified of which $34,437,000 or 67% were either current or less than 30 days past due. At December 31, 2009 the Company had $52,663,000 in loans that were internally criticized or classified of which $40,739,000 or 77% were either current or less than 30 days past due.

Loan Portfolio Performance Trends

Management monitors and evaluates several key metrics that provide indications of the risk profile within the loan portfolio. By following the trends in these key metrics we are able to establish patterns of improving or worsening performance in order to adjust our portfolio management and loss mitigation actions as needed. A discussion of the metrics tracked and recent trends follows:

(In thousands)	December 31, 2010		September 30, 2010		June 30, 2010		March 31, 2010		December 31, 2009		September 30, 2009		June 30, 2009		March 31, 2009
Portfolio loans, gross	$	267,600	$	277,611	$	284,604	$	285,972	$	289,659	$	299,270	$	305,669	$	305,240

Loans past due > 30 days and still accruing interest	$	2,135	$	6,063	$	4,884	$	5,844	$	2,032	$	2,832	$	3,345	$	2,782

Loans on nonaccrual	$	22,302	$	19,998	$	16,666	$	12,992	$	13,754	$	23,903	$	25,925	$	24,336
(as a % of loans, gross)		8.33%		7.20%		5.83%		4.54%		4.75%		7.99%		8.48%		7.97%

Net loan charge offs (recoveries)	$	535	$	1,553	$	863	$	123	$	2,072	$	1,485	$	473	$	2,188
(as a % of loans, gross)		0.20%		0.56%		0.30%		0.04%		0.72%		0.50%		0.15%		0.72%

Loans past due greater than 30 days and still accruing interest has proven to be a useful leading indicator of directional trends in future loan losses. As the level of this metric rises, expectations are for a comparable increase in loans moving into a nonaccrual status and ultimately foreclosure resulting in increased losses. This pattern can be observed in the schedule above where increases in loans past due greater than 30 days and still accruing are followed in future quarters with the same directional changes in the level of loans on nonaccrual. The level of loans past due greater than 30 days and still accruing interest was largely unchanged from $2,032,000 at December 31, 2009 to $2,135,000 at December 31, 2010. Management is carefully monitoring past due loans and remains concerned with the overall increase from 2009 levels. It is likely that the weakening loan quality experienced during 2009 and 2010 will continue to be an area of concern during 2011. As a result, management will continue to work aggressively to manage loan delinquency levels.

Loans on nonaccrual has been another leading indicator of potential future losses from loans. We typically place loans on nonaccrual status when they become 90 days past due. In addition to the interest lost when a loan is placed on nonaccrual status, there is an increased probability of a loan on nonaccrual moving into foreclosure with a potential loss outcome. As shown in the table above, the level of loans on nonaccrual peaked at $25,925,000 at June 30, 2009. Over the following three quarters, this measure declined by 50% to $12,992,000 at the end of the first quarter of 2010. However, since March 31, 2010, we have experienced three consecutive quarters of deterioration with the level of loans on nonaccrual increasing to $22,302,000 at December 31, 2010. As a result of the trends in this asset quality indicator, management increased loan monitoring and loss mitigation efforts.

Net loan charge offs or recoveries reflect our practice of charging recognized losses to the allowance and adding subsequent recoveries back to the allowance. During the three months ended December 31, 2010, we recorded charge offs net of recoveries of $535,000. This amount represented a decrease of $1,018,000, or 66% from the $1,553,000 in net charge offs recorded during the prior quarter ended September 30, 2010, and a decrease of $1,537,000, or 74% from the $2,072,000 net charge offs during the same quarter in the prior year.

Prior to the fourth fiscal quarter of 2008, we had very little charge off activity, and therefore, have little historical information upon which to base our current estimates. Accordingly, we continue to assess the implications of trends in recent charge off activity on potential future losses. The recent volatility in the level of quarterly net loan charge offs or recoveries makes it difficult to identify a specific trend or establish reliable future expectations. As a result, there can be no assurance that charge offs of loans in future periods will not increase or exceed the allowance for loan losses as estimated at any point in time or that provisions for loan losses will not be significant to a particular accounting period. Thus, there is a risk that substantial additional increases in the allowance for loan losses could be required, which would result in a decrease in our net income and possibly our capital.

In addition to considering the metrics described above, we evaluate the collectability of individual loans, the balance of impaired loans, economic conditions that may affect the borrower’s ability to repay, the amount and quality of collateral securing the loans and a review of specific problem loans. Based on this process and as shown below, the provision charged to expense was $250,000 for the three months ended December 31, 2010, as compared to $2,125,000 for the three months ended December 31, 2009. On a consecutive quarter basis, this provision level was $1,111,000, or 82%, lower than the $1,361,000 provision charged to expense during the quarter ended September 30, 2010.

(In thousands)	December 31, 2010			September 30, 2010			June 30, 2010			March 31, 2010		December 31, 2009		September 30, 2009			June 30, 2009		March 31, 2009
Provision during quarter ended	$	250		$	1,361		$	685		$	400	$	2,125	$	1,266		$	1,450	$	2,930

Provision added in excess of net charge offs	$	(285	)	$	(192	)	$	(178	)	$	277	$	53	$	(219	)	$	977	$	742

Allowance for loan losses	$	6,008		$	6,293		$	6,485		$	6,663	$	6,386	$	6,306		$	6,525	$	5,575
(as a % of loans, gross)		2.25%			2.27%			2.28%			2.33%		2.20%		2.11%			2.13%		1.83%

The difference between the amount of the provision for loan losses and net loan charge offs will result in expansion or shrinkage to the level of the allowance for loan losses. As shown above, during the three months ended December 31, 2010 the current provision for loan losses of $250,000 was less than net charge offs against the allowance of $535,000 by $285,000. The result was a decrease to the allowance for loan losses by $285,000 to a level of $6,008,000, or 2.25% of gross loans outstanding at December 31, 2010, as compared to $6,386,000, or 2.20% of gross loans outstanding at December 31, 2009.

From a historical perspective, prior to 2008, while the level of loans on nonaccrual was relatively stable, the allowance for loan losses was maintained in the range of 1.2% to 1.3% of the balance of gross loans. As we moved into 2008 and experienced an increase in loans on nonaccrual, it was determined that an increase to the allowance level was appropriate given the projected increased risk of loss, and so the allowance was increased to a range of 1.4% to 1.6% during 2008. The weakening of the loan portfolio performance continued into 2009 with actual loss levels that exceeded projections from earlier in 2008, resulting in the decision to increase the allowance level further, to the range of 1.6% to 1.8% in early 2009. With nonaccrual loans reaching a peak in mid-2009, further analysis and projections of potential loan losses in the Bank’s existing portfolio supported a further increase in the allowance level to a range of 2.0% to 2.3% of gross loans outstanding, which has been sustained over the last seven fiscal quarters.

Management continues to carefully monitor past due and nonaccrual loans. Management acknowledges that future asset quality results may vary from our estimates and expectations, resulting in negative asset quality metrics, which could have a material adverse effect on our results of operations and financial condition.

Other Real Estate Owned

Other real estate owned represents collateral property taken back from borrowers in partial or full satisfaction of their defaulted debt obligation to the Company. We track our historical experience of loans that ultimately convert to other real estate owned by major loan category and by geographic exposure as shown on the following tables:

	December 31, 2010
(In thousands)	Florida		Georgia		South Carolina		Total
Real estate – construction, commercial	$	1,001	$	272	$	1,557	$	2,830
Real estate – construction, residential		1,134		984		1,254		3,372
Real estate – mortgage, commercial		3,422		2,744		825		6,991
Real estate – mortgage, residential		1,009		––		250		1,259
	$	6,566	$	4,000	$	3,886	$	14,452

	December 31, 2009
(In thousands)	Florida		Georgia		South Carolina		Total
Real estate – construction, commercial	$	997	$	––	$	208	$	1,205
Real estate – construction, residential		7,266		5,370		1,492		14,128
Real estate – mortgage, commercial		567		––		808		1,375
Real estate – mortgage, residential		305		391		772		1,468
	$	9,135	$	5,761	$	3,280	$	18,176

	December 31, 2008
(In thousands)	Florida		Georgia		South Carolina		Total
Real estate – construction, commercial	$	1,308	$	1,482	$	922	$	3,712
Real estate – construction, residential		55		––		––		55
Real estate – mortgage, commercial		––		––		422		422
Real estate – mortgage, residential		––		––		1,562		1,562
	$	1,363	$	1,482	$	2,906	$	5,751

During the year ended December 31, 2010 we sold a total of 40 other real estate owned properties with a total book value of $9,777,000. The net proceeds from these sales were $8,301,000, which resulted in a net recovery of approximately 58.9% of the original loan amounts and 84.9% of the book value of the other real estate sold. During the year ended December 31, 2009 we sold a total of 31 other real estate owned properties with a total book value of $6,872,000. The net proceeds from these sales were $6,675,000, which resulted in a net recovery of approximately 73.4% of the original loan amounts and 97.1% of the book value of the other real estate sold.

The Bank’s special asset group is charged with the administration and liquidation of other real estate owned. Our approach has been to manage each property individually in such a way as to maximize our net proceeds upon sale. Management continues to evaluate other methods to liquidate these properties more quickly, but such methods typically result in a much lower recovery relative to the original loan amount. Management attempts to balance the desire to aggressively drive down the level of nonperforming assets with the objective to maximize recovery levels from liquidation of these assets. As shown above, the book value of assets disposed in 2010 was 42% higher than the book value of assets disposed in 2009, but as expected, the recovery value in 2010 diminished from levels obtained in 2009 as a result of more aggressive disposition activities.

Investment Securities

Investment securities decreased to $39,720,000 at December 31, 2010 from $62,515,000 at December 31, 2009.

The following table presents the investments by category:

	December 31,
	2010				2009				2008
(In thousands)	Amortized Cost		Estimated Fair Value		Amortized Cost		Estimated Fair Value		Amortized Cost		Estimated Fair Value
Available for sale
Government sponsored enterprises	$	—	$	—	$	—	$	—	$	500	$	502
State and municipal securities		7,132		6,977		10,185		10,370		16,956		16,573
Mortgage-backed securities		29,862		30,743		48,558		50,145		63,494		64,363
	$	36,994	$	37,720	$	58,743	$	60,515	$	80,950	$	81,438
Held to Maturity
Corporate debt securities	$	2,000	$	2,057	$	2,000	$	2,095	$	3,023	$	3,024
	$	2,000	$	2,057	$	2,000	$	2,095	$	3,023	$	3,024

The following table presents the maturities of investment securities at carrying value and the weighted average yields for each range of maturities presented. Yields are based on amortized cost of securities.

Maturities at December 31, 2010 (In thousands)	State and Municipal Securities		Weighted Average Yields			Mortgage- Backed Securities		Weighted Average Yields			Corporate Debt Securities		Weighted Average Yields
Within 1 year	$	—		—		$	9,278		4.72	%	$	2,000		6.05	%
After 1 through 5 years		1,303		3.47	%		17,418		3.39	%		—		—
After 5 through 10 years		2,573		3.96	%		2,254		2.87	%		—		—
After 10 years		3,101		4.17	%		1,793		5.05	%		—		—
Totals	$	6,977		3.96	%	$	30,743		3.85	%	$	2,000		6.05	%

Mortgage-backed securities are included in the maturities categories in which they are anticipated to be repaid based on scheduled maturities.

Deposits

Total deposits decreased by $22,831,000, or 6%, to a total of $346,050,000 at December 31, 2010 from $368,881,000 at December 31, 2009. Noninterest-bearing demand deposits increased $1,172,000, or 7%, while interest-bearing deposits decreased $24,003,000, or 7%. The Company has continued its use of a modest level of brokered deposits, which carry substantially lower interest rates than comparable term core retail deposits. Brokered deposits are issued in individual’s names and in the names of trustees with balances participated out to others. Core retail deposits are deposits which are gathered in the normal course of business, without the use of a broker. Core reciprocal deposits are gathered in the same manner as core retail deposits, but the funds are participated out to other banks through use of the CDARS reciprocal transactions program. The CDARS program allows depositors to obtain FDIC insurance for deposits up to $50 million by exchanging the portions of their deposits in excess of FDIC insurance limitations with other financial institutions participating in the CDARS program. In return, we receive an equal amount of deposits back from other CDARS participating financial institutions, such that there is no net change in the level of total deposits on our balance sheet. Pursuant to the formal agreement entered into with the OCC, the Bank is required to limit its level of brokered deposits to no more than ten percent of total deposits, such requirement does not include reciprocal CDARS.

Balances and percentages within the major deposit categories are as follows:

	December 31, 2010
(In thousands)	Core Retail Deposits		Core Reciprocal Deposits		Brokered Deposits		Total Deposits
Noninterest-bearing demand deposits	$	18,948	$	––	$	––	$	18,948
Interest-bearing demand deposits		118,812		––		––		118,812
Savings deposits		3,764		––		––		3,764
Certificates of deposit $100,000 and over		90,272		27,633		––		117,905
Other time deposits		66,978		1,426		18,217		86,621
	$	298,774	$	29,059	$	18,217	$	346,050

	December 31, 2009
(In thousands)	Core Retail Deposits		Core Reciprocal Deposits		Brokered Deposits		Total Deposits
Noninterest-bearing demand deposits	$	17,776	$	––	$	––	$	17,776
Interest-bearing demand deposits		105,734		––		––		105,734
Savings deposits		2,959		––		––		2,959
Certificates of deposit $100,000 and over		118,684		12,763		––		131,447
Other time deposits		88,029		858		22,078		110,965
	$	333,182	$	13,621	$	22,078	$	368,881

	December 31, 2008
(In thousands)	Core Retail Deposits		Core Reciprocal Deposits		Brokered Deposits		Total Deposits
Noninterest-bearing demand deposits	$	18,639	$	––	$	––	$	18,639
Interest-bearing demand deposits		95,687		––		––		95,687
Savings deposits		3,027		––		––		3,027
Certificates of deposit $100,000 and over		130,837		––		––		130,837
Other time deposits		85,455		––		29,011		114,466
	$	333,645	$	––	$	29,011	$	362,656

The average balance of deposits and the average rates paid on such deposits are summarized as follows:

	December 31,
	2010					2009					2008
(In thousands)	Amount		Rate			Amount		Rate			Amount		Rate
Noninterest-bearing demand	$	20,187		—	%	$	19,216		—	%	$	23,134		—	%
Interest-bearing demand		117,991		1.11	%		103,640		1.50	%		98,889		2.49	%
Savings		3,435		0.49	%		3,022		0.50	%		3,006		0.52	%
Time		216,298		2.05	%		248,386		3.01	%		228,355		4.43	%
Total	$	357,911				$	374,264				$	353,384

Maturities of time certificates of deposit of $100,000 or more outstanding at December 31, 2010 are summarized as follows:

(In thousands)
Within 3 months	$	25,441
After 3 through 12 months	64,926
1 through 3 years	22,414
After 3 years	5,124
Total	$	117,905

COASTAL BANKING CO INC 10-K