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~~

For fiscal year ended December 31, 2011

¨ 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 ¨o Accelerated filer ¨o Non-accelerated filer ¨o Smaller reporting company þ (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~~2011, the last business day of the registrant’s most recently completed second fiscal quarter, was $85,~~848~~950,~~753~~925 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~~595,~~707~~207 shares of common stock were outstanding as of March 1716, ~~2011~~2012.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s Proxy Statement for the ~~2011~~2012 Annual Meeting of Shareholders, to be held on May 2523, ~~2011~~2012, are incorporated by reference into Part III.

~~TABLE~~Table OFof ~~CONTENTS~~Contents

		Page
PART I.
PART 1.
ITEM 1.	Business		3
Item 1.	Business		1
ITEM 1A.	Risk Factors		21
Item 1A.	Risk Factors		19
ITEM 1B.	Unresolved Staff Comments		30
Item 1B.	Unresolved Staff Comments		28
ITEM 2.	Properties		31
Item 2.	Properties		29
ITEM 3.	Legal Proceedings		31
Item 3.	Legal Proceedings		29
ITEM 4.	Reserved		31
Item 4.	Reserved		29
PART II.
ITEM 5.	Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities		32
Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities		30
ITEM 6.	Selected Financial Data		32
Item 6.	Selected Financial Data		30
ITEM 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operation		33
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operation		31
ITEM 7A.	Quantitative and Qualitative Disclosures About Market Risks		59
Item 7A.	Quantitative and Qualitative Disclosures About Market Risks		57
ITEM 8.	Financial Statements and Supplementary Data		60
Item 8.	Financial Statements and Supplementary Data		57
ITEM 9.	Changes In and Disagreements With Accountants on Accounting and Financial Disclosure		101
Item 9.	Changes In and Disagreements With Accountants on Accounting and Financial Disclosure		107
ITEM 9A.	Controls and Procedures		101
Item 9A.	Controls and Procedures		107
ITEM 9B.	Other Information		101
Item 9B.	Other Information		108
PART III.
ITEM 10.	Directors, Executive Officers, and Corporate Governance		102
Item 10.	Directors, Executive Officers, and Corporate Governance		109
ITEM 11.	Executive Compensation		102
Item 11.	Executive Compensation		109
ITEM 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters		102
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters		109
ITEM 13.	Certain Relationships and Related Transactions, and Director Independence		103
Item 13.	Certain Relationships and Related Transactions, and Director Independence		110
ITEM 14.	Principal Accountant Fees and Services		103
Item 14.	Principal Accountant Fees and Services		110
ITEM 15.	Exhibits		103
Item 15.	Exhibits		110

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 (“First Capital”) 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~~did ~~to do~~ business under the trade names “Lowcountry National Bank,” “First National Bank of Nassau County,” and “The Georgia Bank” in their respective markets. During 2011, the Florida and Georgia Bank branches replaced their local market trade names with CBC National Bank, while the South Carolina branches continued to operation under the Lowcountry National Bank trade name. 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”).

The Bank also has loan production offices in Savannah, Georgia and Jacksonville, Florida, as well as a residential mortgage banking division headquartered in Atlanta, Georgia. During the second and third quarters of 2011, the mortgage banking division opened fourteen additional retail residential loan production offices in California, Connecticut, Florida, Kansas, Maryland, Michigan, New York, and Ohio.

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~~the ~~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~~Troubled Asset Relief Program’s Capital Purchase Program (“TARP 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.1

3On 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, declaring or paying cash dividends, including dividends on its TARP preferred stock, or 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~~Lady’s 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, and customers in California, Connecticut, Florida, Kansas, Maryland, Michigan, New York, and Ohio through residential mortgage loan offices.

Lending Activities

General: We ~~emphasize~~offer 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 value any collateral and to establish athe borrower’s or guarantor’s ~~credit worthiness~~creditworthiness, level of financial reserves, and capacity to repay the loan ~~and the value of any collateral~~. ~~Credit~~Creditworthiness ~~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~~we 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~~the effects 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, and periodic inspection reports by qualified engineering firms, and ~~site~~account ~~visits~~officers byperform ~~account~~site ~~officers~~visits 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.2

4Our 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, 2011. 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.3

5These 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, loan-to-value 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~~no 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 residential 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~~the ~~National~~ Bank’s capitalization of $3840,~~526~~044,000 as of December 31, ~~2010~~2011, the Bank has a self-imposed loan limit of $5,000,000, which represents 8480% of our regulatory legal lending limit of $56,~~957~~279,000. 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 9593% 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~~entering ~~the~~into ~~interest~~forward ~~rate~~sale ~~for~~commitments ~~each~~with ~~loan~~secondary inmarket ainvestors ~~forward~~to ~~sale~~lock ~~commitment~~in ~~with~~ the ~~secondary~~price ~~market~~at ~~investor~~which a loan is sold, 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.

6We 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.

WeResidential ~~attempt~~Real toEstate ~~reduce~~Loans: ~~risk~~Residential byreal ~~obtaining~~estate ~~personal~~loans ~~guarantees~~generally ~~where~~have ~~possible,~~longer terms of up to 30 years. We offer fixed and byadjustable ~~keeping~~rate ~~the~~mortgages in conforming loan~~-to-value~~ ~~ratio~~amounts. We have a limited amount of ~~the~~interest-only ~~completed~~loans, ~~project~~but ~~below~~we ~~specified percentages~~do not offer negative amortization loans. We ~~may also~~have ~~reduce~~limited credit risk byon ~~selling~~these ~~participations~~loans inas ~~larger~~most ~~loans~~are sold to ~~other~~third ~~institutions~~parties ~~when~~soon ~~possible~~after closing.

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 aloans ~~temporary~~approved ~~basis~~between February 2009 and December 2010.

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.5

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, internet deposit listing services, 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 and regulation affecting our industry and how that legislation and regulation 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 (the “Bank Holding Company Act”), 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.6

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 Bank of Richmond. Generally, the Memorandum requires the Company to obtain prior approval of the Federal Reserve Bank of Richmond before incurring additional debt, purchasing or redeeming its capital stock, declaring or paying cash dividends to shareholders, including dividends on its TARP preferred stock, or paying 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.

8Under 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.

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 Office of the Comptroller of the Currency (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.8

~~Prompt Corrective Action~~Branching. National ~~The~~banks ~~Federal~~are ~~Deposit~~required ~~Insurance~~by ~~Corporation~~the ~~Improvement~~National Bank Act ofto ~~1991~~adhere ~~establishes~~to abranching ~~system~~laws ofapplicable ~~prompt~~to ~~corrective~~state ~~action~~banks toin ~~resolve~~ the ~~problems~~states ofin ~~undercapitalized~~which ~~financial~~they ~~institutions.~~are located. Under ~~this~~South ~~system~~Carolina, Georgia, and Florida law, the ~~federal~~Bank ~~banking~~may ~~regulators~~open ~~have~~branch ~~established~~offices ~~five~~throughout ~~capital~~each ~~categories:~~state with the prior approval of the OCC. ~~Well~~In ~~Capitalized~~addition, ~~Adequately~~with ~~Capitalized,~~prior ~~Undercapitalized~~regulatory approval, ~~Significantly~~the ~~Undercapitalized~~Bank may acquire branches of existing banks located in South Carolina, Georgia, and ~~Critically~~Florida. Prior ~~Undercapitalized~~to the enactment of the Dodd-Frank Act, the Bank and any other national- or state-chartered banks were generally permitted to branch across state lines by merging with banks in ~~which~~other ~~all~~states ~~institutions~~if ~~are~~allowed ~~placed~~by the applicable states’ laws. However, ~~The~~interstate ~~federal~~branching ~~banking~~is ~~agencies~~now ~~have~~permitted ~~also~~for ~~specified~~all national- and state-chartered banks as a result of the Dodd-Frank Act, provided that a state bank chartered by ~~regulation~~the state in which the ~~relevant~~branch ~~capital~~is ~~levels~~to ~~for~~be ~~each~~located ~~category~~would also be permitted to establish a branch.

AsPrompt aCorrective ~~bank’s~~Action. The ~~capital~~Federal ~~position~~Deposit ~~deteriorates,~~Insurance ~~federal~~Corporation ~~banking~~Improvement ~~regulators~~Act ~~are~~of ~~required~~1991 toestablishes ~~take~~a ~~various~~system ~~mandatory~~of ~~supervisory~~prompt ~~actions~~corrective ~~and~~action ~~are authorized~~ to ~~take~~resolve ~~other~~the ~~discretionary~~problems ~~actions~~of ~~with~~undercapitalized ~~respect~~financial to institutions ~~in the three undercapitalized categories~~. Under ~~The~~this ~~severity~~system, of the ~~action~~federal ~~depends~~banking ~~upon~~regulators ~~the~~have ~~capital~~established ~~category~~five incapital ~~which~~categories: well ~~the~~capitalized, ~~institution~~adequately iscapitalized, ~~placed. Generally~~undercapitalized, ~~subject~~significantly toundercapitalized, aand ~~narrow~~critically ~~exception~~undercapitalized, ~~the~~in ~~banking~~which ~~regulator~~all ~~must~~institutions ~~appoint~~are aplaced. The ~~receiver~~federal orbanking ~~conservator~~agencies ~~for~~have analso ~~institution~~specified ~~that~~by isregulation ~~critically undercapitalized. As of December 31, 2010,~~ the ~~Bank~~relevant ~~was~~capital ~~considered~~levels ~~well~~for ~~capitalized~~each category.

AAs ~~“well-capitalized”~~a bank’s iscapital ~~one~~position ~~that~~deteriorates, isfederal ~~not~~banking regulators are required to ~~meet~~take ~~and~~various ~~maintain~~mandatory asupervisory ~~specific~~actions ~~capital~~and ~~level~~are ~~for~~authorized ~~any capital measure, pursuant~~ to ~~any~~take ~~written agreement, order, capital directive, or~~ other ~~remediation,~~discretionary ~~and~~actions ~~significantly~~with ~~exceeds~~respect ~~all~~to ofinstitutions ~~its~~in ~~capital~~the ~~requirements,~~three ~~which~~undercapitalized ~~include~~categories. The ~~maintaining~~severity ~~a total risk-based capital ratio~~ of atthe ~~least~~action ~~10%,~~depends aupon ~~Tier~~the ~~1 risk-based~~ capital ~~ratio~~category ofin atwhich ~~least~~the ~~6%,~~institution ~~and~~is ~~a Tier 1 leverage ratio of at least 5%~~placed. Generally, asubject ~~classification~~to ~~as well capitalized will place~~ a ~~bank~~narrow ~~outside~~exception, of the ~~regulatory~~banking ~~zone~~regulator ~~for~~must ~~purposes~~appoint ~~of prompt corrective action. However,~~ a ~~well-capitalized~~receiver ~~bank~~or ~~may~~conservator befor ~~reclassified~~an asinstitution ~~“adequately capitalized” based on criteria other than capital, if the federal regulator determines~~ that ~~a bank~~ is incritically anundercapitalized. As ~~unsafe~~of ~~or unsound condition~~December 31, ~~or is engaged in unsafe or unsound practices~~2011, ~~which~~the ~~requires~~Bank ~~certain~~was ~~remedial~~considered ~~action~~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 prompt corrective action directive, and has 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; and

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

~~● prohibit any material changes in accounting methods.~~9

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, at the discretion of the bank’s primary federal regulator, also 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,~~interest ~~including~~rates apaid ~~requirement~~on ~~that the bank reduce its total assets~~deposits;

●· further restrict orgrowth, ~~prohibit~~including ~~all~~a ~~activities~~requirement that ~~are~~the ~~determined~~bank toreduce ~~pose~~its antotal ~~excessive risk to the bank~~assets;

●· ~~require~~restrict ~~the~~or ~~bank~~prohibit toall ~~elect~~activities ~~new~~that ~~directors,~~are ~~dismiss~~determined ~~directors~~to orpose ~~senior~~an ~~executive~~excessive ~~officers,~~risk ~~or employ qualified senior executive officers~~ to ~~improve~~the ~~management~~bank;

●· ~~prohibit~~require the ~~acceptance~~bank ofto ~~deposits~~elect ~~from~~new ~~correspondent~~directors, ~~banks~~dismiss directors or senior executive officers, ~~including~~or ~~renewals~~employ ~~and~~qualified ~~rollovers~~senior ofexecutive ~~prior~~officers ~~deposits~~to improve management;

●· ~~require~~prohibit ~~prior~~the ~~approval~~acceptance of ~~capital~~deposits ~~distributions~~from bycorrespondent ~~holding~~banks, ~~companies~~including renewals and rollovers of prior deposits;

●· require ~~holding~~prior ~~company~~approval ~~divestiture~~ of ~~the~~capital ~~financial~~distributions ~~institution,~~by ~~bank divestiture of subsidiaries and/or~~ holding ~~company divestiture of other affiliates~~companies; ~~and~~

●· require ~~the~~holding ~~bank~~company todivestiture ~~take~~of ~~any~~the ~~other~~financial ~~action~~institution, ~~the~~bank ~~federal~~divestiture ~~regulator~~of ~~determines~~subsidiaries ~~will~~and/or ~~“better~~holding ~~achieve”~~company ~~prompt~~divestiture ~~corrective~~of ~~action~~other ~~objectives.~~affiliates; and

11· 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~~ratio 1of ~~leverage~~tangible ~~ratio~~equity to total assets 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~~a ~~debt~~“scorecard” ~~issuer~~calculation ~~ratings~~ for large institutions. The ~~that~~FDIC ~~have~~adopted ~~such~~new ~~ratings~~rules, effective April 1, 2011, redefining the assessment base and adjusting the assessment rates. ~~For~~Under the old rules, the assessment base was domestic deposits; the new rule uses an assessment base of average consolidated total assets minus tangible equity, which is defined as Tier 1 Capital. Under the new rules, institutions assigned to the lowest risk category, ~~the~~must pay an annual assessment rate ~~ranges~~now ranging between 72.5 and 169 cents per $100 of ~~domestic~~the ~~deposits.~~assessment base. For institutions assigned to higher risk categories, assessment rates now range from 179 to ~~77.5~~45 cents per $100 of ~~domestic~~the ~~deposits~~assessment base. 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, possible upward adjustments for brokered deposits.

12The 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 (1) increase or decrease the total rates from one quarter to the next by more than two basis points, or (2) 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% but is less than 2%, base assessment rates would range from 1.5 to 40 basis points; if the DIF reserve ratio meets or exceeds 2% but is less than 2.5%, 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.

On ~~September~~November 2912, 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 previously 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.11

The ~~new rules retain the~~ FDIC ~~Board’s~~also ~~flexibility~~collects ~~to,~~a ~~without further notice~~deposit-~~and-comment~~based ~~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~~insured ~~quarter~~financial toinstitutions ~~the~~on ~~next~~behalf byof ~~more~~The ~~than~~Financing ~~two~~Corporation ~~basis points, or~~ (ii“FICO”) ~~deviate by more than two basis points from the stated base assessment rates~~. ~~Although~~The ~~the~~funds ~~Dodd-Frank~~from ~~Act~~these ~~requires~~assessments ~~that~~are ~~the~~used ~~FDIC eliminate its requirement~~ to ~~pay~~service ~~dividends~~debt toissued ~~depository~~by ~~institutions~~FICO ~~when~~in ~~the~~its ~~reserve~~capacity ~~ratio~~as ~~exceeds~~ a ~~certain~~financial ~~threshold,~~vehicle ~~the~~for ~~FDIC’s new rule establishes a decreasing schedule of assessment rates that would take effect when~~ the ~~DIF~~Federal ~~reserve~~Savings ~~ratio~~& ~~first~~Loan ~~meets~~Insurance ~~or exceeds 1~~Corporation.~~15%.~~ IfThe ~~the~~FICO ~~DIF~~assessment ~~reserve~~rate ~~ratio~~is ~~meets~~set orquarterly ~~exceeds~~and ~~1.15%,~~in ~~base~~2011 ~~assessment~~ranged ~~rates would range~~ from 10.568 tocents ~~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~~1.~~5%,~~00 ~~base~~cents ~~assessment~~per ~~rates~~$100 ~~would~~of ~~range~~assessable ~~from 0~~deposits.~~5 to 35 basis points.~~ ~~All~~These ~~base~~assessments ~~assessment~~will ~~rates would~~ continue tountil bethe ~~subject~~debt tomatures ~~adjustments~~between ~~for~~2017 ~~unsecured debt~~ and ~~brokered deposits~~2019.

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~~Allowance ~~Temporary~~for ~~Liquidity~~Loan ~~Guarantee~~and ~~Program~~Lease Losses. The OnAllowance ~~October 14,~~for ~~2008,~~Loan ~~the~~and ~~FDIC~~Lease ~~announced~~Losses ~~that~~(the ~~its~~“Allowance”) ~~Board~~represents one of ~~Directors,~~the ~~under~~most significant estimates in the ~~authority~~Bank’s tofinancial ~~prevent~~statements ~~“systemic~~and ~~risk”~~regulatory inreports. Because of its significance, the ~~U.S.~~Bank ~~banking~~has developed a system by which it develops, ~~approved~~maintains, ~~the~~and ~~Temporary~~documents ~~Liquidity~~a ~~Guarantee~~comprehensive, ~~Program~~systematic, ~~(“TLGP”).~~and ~~The~~consistently ~~purpose~~applied process for determining the amounts of the ~~TLGP~~Allowance isand tothe ~~strengthen~~provision ~~confidence~~for loan and ~~encourage~~lease ~~liquidity~~losses. “The inInteragency Policy Statement on the ~~banking~~Allowance ~~system.~~for ~~The~~Loan ~~TLGP~~and isLease ~~composed~~Losses,” ofissued ~~two~~on ~~components~~December 13, 2006, encourages all banks to ensure controls are in place to consistently determine the ~~Debt~~Allowance ~~Guarantee~~in ~~Program~~accordance ~~and~~with GAAP, the ~~Transaction~~Bank’s ~~Account~~stated ~~Guarantee~~policies ~~Program~~and procedures, management’s best judgment, and ~~institutions~~relevant ~~had~~supervisory guidance. Consistent with supervisory guidance, the ~~opportunity~~Bank maintains a prudent and conservative, but not excessive, Allowance, that is at a level that is appropriate to ~~opt-out~~cover estimated credit losses on individually evaluated loans determined to be impaired as well as estimated credit losses inherent in the remainder of ~~either~~the orloan ~~both~~and ~~components~~lease portfolio. The Bank’s estimate of credit losses reflects consideration of all significant factors that affect the ~~TLGP~~collectability of the portfolio as of the evaluation date. See “Management’s Discussion and Analysis – Critical Accounting Policies.”

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.

14As of December 31, 2011, the Bank’s total loans for construction, land development and other land represented 128% of total capital, slightly above the 100% regulatory threshold for significant CRE risk, however this CRE concentration ratio has been reduced significantly over the last several years from a level of 207% at September 30, 2008. Further, total commercial real estate loans represented 253% of total capital at December 31, 2011, which was below the 300% regulatory threshold for significant CRE risk, and it continues to trend downward from a level of 347% at September 30, 2008.

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;

15· 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;

●· ~~Talent~~Bank ~~Amendment~~Secrecy inAct, as amended by the ~~2007~~Uniting ~~Defense~~and ~~Authorization~~Strengthening ~~Act,~~America ~~establishing~~by aProviding ~~36%~~Appropriate ~~annual~~Tools ~~percentage~~Required ~~rate~~to ~~ceiling,~~Intercept ~~which~~and ~~includes~~Obstruct aTerrorism ~~variety~~Act of ~~charges~~2001 ~~including~~(the ~~late~~“USA ~~fees~~PATRIOT Act”), ~~for~~imposing ~~certain~~requirements ~~types~~and oflimitations ~~consumer~~on ~~loans~~specific financial transactions and account relationships, intended to ~~military~~guard ~~service~~against ~~members~~money laundering and ~~their~~terrorism ~~dependents~~financing;

●· ~~Bank~~sections ~~Secrecy~~22(g) ~~Act,~~and as22(h) ~~amended~~of by the ~~Uniting~~Federal ~~and~~Reserve ~~Strengthening~~Act ~~America~~which byset ~~Providing~~lending ~~Appropriate~~restrictions ~~Tools~~and ~~Required~~limitations toregarding ~~Intercept~~loans and ~~Obstruct~~other ~~Terrorism~~extensions ~~Act~~ of ~~2001~~credit ~~(the~~made ~~“USA~~to ~~PATRIOT~~executive ~~Act”)~~officers, ~~imposing requirements and limitations on specific financial transactions and account relationships~~directors, ~~intended~~principal toshareholders ~~guard against money laundering~~ and ~~terrorism~~other ~~financing~~insiders; and

●· ~~sections~~rules ~~22(g)~~ and ~~22(h)~~regulations of the ~~Federal~~various ~~Reserve~~federal ~~Act~~agencies ~~which~~charged ~~set~~with ~~lending~~the ~~restrictions~~responsibility ~~and limitations regarding loans and other extensions~~ of ~~credit~~implementing ~~made~~these tofederal ~~executive officers, directors, principal shareholders and other insiders; and~~laws.

~~● rules and regulations of the various federal agencies charged with the responsibility of implementing these federal laws.~~13

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.

1614

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. As Atof December 31, ~~2010~~2011, the Bank’s ratio of total capital to risk-weighted assets was 1416.5034% and the Bank’s ratio of Tier 1 capital to risk-weighted assets was 1315.2408%.

In addition, the Federal Reserve Board has established minimum leverage ratio guidelines for bank holding companies, which are intended to further address capital adequacy. The OCC has adopted substantially similar requirements for banks. 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~~institutions ~~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~~institutions ~~holding companies~~ generally are required to maintain a leverage ratio of at least 4%. As Atof December 31, ~~2010~~2011, the Bank’s leverage ratio was 8.5739%. The guidelines also provide that ~~bank~~institutions ~~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~~banking ~~Reserve~~regulators ~~Board~~consider ~~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~~“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.

1715

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~~Bank of Richmond, the Company is prohibited from declaring and paying cash dividends on ~~common~~its 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 (i1) all dividends for the securities purchased under the TARP CPP be paid before other dividends can be paid and (ii2) the Treasury must approve any increases in common dividends for three years following the Treasury’s investment. In addition, pursuant to the ~~MOU~~Memorandum, 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.

1816

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 (1) the transaction is on market terms and, (2) 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 has approved the transaction.

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~~undermine 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 (1) its incentive compensation arrangement or related risk management, control, or governance processes pose a risk to the safety and soundness of the organization and (2) 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~~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~~incentive compensation arrangements should be compatible with effective controls and risk management; and

●· ~~Incentive~~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~~CPP, it is subject to additional executive compensation limitations. For example, the Company must ~~meet the following standards~~:

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

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

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

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

1917

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~~The ~~of the requirements called for in the~~ Dodd-Frank Act ~~will~~has behad ~~implemented~~a ~~over~~broad ~~time~~impact ~~and~~on ~~most~~the ~~will~~financial beservices ~~subject~~industry, toincluding ~~implementing~~significant ~~regulations~~regulatory ~~over~~and ~~the~~compliance ~~course~~changes ofpreviously ~~several~~discussed ~~years. Given~~and ~~the~~including, ~~uncertainty~~among ~~associated~~other ~~with~~things, ~~the~~(1) enhanced ~~manner~~resolution inauthority ~~which the provisions~~ of ~~the~~troubled ~~Dodd-Frank~~and ~~Act~~failing ~~will~~banks beand ~~implemented~~their byholding ~~the~~companies; ~~various~~(2) increased regulatory ~~agencies~~examination fees; and ~~through~~(3) numerous ~~regulations,~~other ~~the~~provisions ~~full~~designed ~~extent~~to ofimprove ~~the~~supervision ~~impact~~and ~~such~~oversight ~~requirements~~of, ~~will~~and ~~have~~strengthening onsafety ~~financial~~and ~~institutions’~~soundness ~~operations~~for, isthe ~~unclear~~financial services sector. ~~The~~Additionally, ~~changes resulting from~~ the Dodd-Frank Act ~~may~~establishes ~~impact~~a ~~the~~new ~~profitability~~framework offor ~~our~~systemic ~~business~~risk ~~activities,~~oversight ~~require~~within ~~changes~~the tofinancial ~~certain~~system ofto ~~our~~be ~~business~~distributed ~~practices,~~among ~~impose~~new ~~upon~~and usexisting ~~more~~federal ~~stringent~~regulatory ~~capital~~agencies, ~~liquidity~~including ~~and~~the ~~leverage~~Financial ~~ratio~~Stability ~~requirements~~Oversight orCouncil, ~~otherwise~~the ~~adversely~~Federal ~~affect~~Reserve ~~our~~Board, ~~business. These~~the ~~changes~~OCC, ~~may also require us to invest significant management attention~~ and ~~resources~~the ~~to evaluate and make necessary changes in order to comply with new statutory and regulatory requirements~~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~~2011, we had ~~124~~325 full-time employees and 1831 part-time employees.

2018

ITEM 1A. RISK FACTORS

We ~~entered~~are ~~into~~subject ato ~~formal~~regulatory ~~agreement~~actions ~~(the~~by ~~“Agreement”)~~our ~~with~~primary ~~the~~regulatory authorities ~~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 we entered into aan ~~Memorandum~~Agreement ~~of Understanding (MOU)~~ with the ~~Federal~~OCC ~~Reserve~~to ~~Bank~~address ofasset ~~Richmond~~quality onand ~~November~~related ~~17, 2010~~issues. Under ~~The~~the terms of the ~~MOU~~Agreement, ~~are~~the ~~substantially~~Bank ~~similar~~has toprepared ~~the~~and ~~terms~~provided ofwritten ~~the~~plans ~~resolution~~and/or reports to the ~~Board~~regulators ofthat ~~Directors~~address ofthe ~~Coastal~~following ~~Banking~~items: ~~Company,~~reducing ~~Inc.~~the ~~adopted~~high onlevel ~~January~~of ~~27,~~risk ~~2010~~in the Bank, ~~pursuant~~taking toimmediate aand ~~request~~continuing byaction ~~the~~to ~~Federal~~protect ~~Reserve~~its ~~Board. Generally,~~interest ~~the~~in ~~MOU~~criticized ~~requires~~assets, ensuring the ~~Company~~Bank’s adherence to ~~obtain~~its ~~prior~~written ~~approval~~profit ofplan ~~the~~to ~~Federal~~improve ~~Reserve~~and ~~Bank~~sustain ~~before~~earnings, ~~incurring~~limiting ~~additional~~brokered ~~debt~~deposits, ~~purchasing~~excluding orreciprocal ~~redeeming its capital stock~~CDARS, orthat ~~declaring~~would orcause ~~paying~~the ~~cash~~Bank’s ~~dividends,~~level ~~including~~of ~~dividends~~brokered ~~related~~deposits to ~~its~~be ~~common~~in ~~stock~~excess ~~and~~of ~~TARP~~ten ~~preferred~~percent ~~stock~~of total deposits, and ~~interest~~establishing ona ~~its~~Compliance ~~trust~~Committee ~~preferred~~to ~~securities.~~monitor ~~Additionally,~~ the ~~MOU~~Bank’s ~~requires~~adherence to the ~~Company~~Agreement. Although management continues to ~~comply~~address ~~with~~the ~~banking~~regulatory ~~regulations~~concerns ~~that~~cited ~~prohibit~~in ~~certain~~the ~~indemnification~~Agreement, ~~and~~there ~~severance~~is ~~payments~~no ~~and~~assurance ~~require~~that ~~prior~~we ~~approval~~will ofbe ~~any~~able ~~appointment~~to ofmaintain ~~new~~compliance ~~directors~~with orthe Agreement in the ~~hiring~~future. If orwe ~~change~~are inunable ~~position~~to ofcomply, ~~any~~we ~~senior~~could ~~executive~~be ~~officers~~subject ofto ~~the~~other ~~Company. The~~regulatory ~~MOU~~sanctions ~~also~~that ~~requires~~could ~~the~~ultimately ~~submission~~result ofin ~~quarterly~~more ~~progress~~severe ~~reports~~penalties.

~~Compliance~~Additionally, we entered into the Memorandum with the ~~terms~~Federal Reserve Bank of ~~the~~Richmond ~~formal~~on ~~agreement~~November 17, ~~including~~2010. The terms of the ~~adoption~~Memorandum ~~and~~are ~~implementation~~substantially similar to the terms of the ~~plans~~resolution ~~and~~the ~~policies~~Board ~~discussed~~of ~~above,~~Directors ~~and~~of the ~~MOU~~Company ~~will~~adopted ~~require~~on ~~significant~~January ~~time~~27, ~~and~~2010 ~~attention~~pursuant ~~from~~to ~~our~~a ~~management~~request ~~team,~~by ~~which~~the ~~may~~Federal ~~increase~~Reserve ~~our~~Bank ~~costs~~of Richmond. Generally, ~~impede~~the Memorandum requires the ~~efficiency~~Company to obtain prior approval of ~~our~~the ~~internal~~Federal ~~business~~Reserve ~~processes~~Bank ~~and~~of ~~adversely~~Richmond ~~affect~~before ~~our~~incurring ~~profitability~~additional indebt, ~~the~~purchasing ~~near-term.~~or Ifredeeming weits ~~are~~capital ~~unable~~stock, declaring or paying cash dividends, including dividends related to ~~implement~~its ~~our~~common ~~plans~~stock inand aTARP ~~timely~~preferred ~~manner~~stock, or ~~otherwise~~paying ~~comply~~interest ~~with~~on ~~our~~its ~~commitments~~trust ~~outlined~~preferred ~~above~~securities. Additionally, orthe ifMemorandum werequires ~~fail~~the Company to ~~adequately~~comply ~~resolve~~with ~~any~~banking ~~other~~regulations ~~matters~~that ~~any~~prohibit ofcertain ~~our~~indemnification ~~regulators~~and ~~may~~severance ~~require~~payments usand torequire ~~address~~prior inapproval ~~the~~of ~~future,~~any weappointment ~~could~~of ~~become~~new ~~subject~~directors toor ~~more~~the ~~stringent~~hiring ~~supervisory~~or ~~actions.~~change ~~The~~in ~~terms~~position of any ~~such~~senior ~~supervisory~~executive ~~action~~officers ~~could~~of ~~have~~the aCompany. The ~~material~~Memorandum ~~negative~~also ~~effect~~requires onthe ~~our~~submission ~~business,~~of ~~operating~~quarterly ~~flexibility,~~progress ~~or financial condition~~reports.

WeCompliance ~~have~~with ~~incurred~~the ~~operating~~terms ~~losses~~of the Agreement, including the adoption and ~~cannot~~implementation ~~assure~~of ~~you~~the ~~that~~plans weand policies discussed above, and the Memorandum will berequire ~~profitable~~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.

~~Excluding~~We ~~the~~cannot ~~charges~~assure ofyou ~~$1.8~~that 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~~profitability ~~exposure~~is 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 operationssustainable.

21While we had net income of $357,000, or a loss of $0.08 per share after preferred stock dividends, for the year ended December 31, 2011, we incurred operating losses in the three previous years. Excluding the charges of $1.8 million for deferred tax asset valuation allowance, we incurred a net operating loss of $2.0 million, or $0.99 per share, for the year ended December 31, 2010, due primarily to credit losses and associated costs, including a significant provision for loan losses and elevated losses on other real estate owned. In 2011, the increased level of noninterest income was the primary driver to our improved profitability, as credit losses and associated costs were virtually unchanged from 2010. Although we have taken steps to reduce credit losses and associated costs, we will likely continue to experience a higher than normal level of asset quality related expenses in 2012. We cannot provide an assurance that the increased levels of noninterest income observed in 2011 will be sustained or sufficient to support continued profitability in 2012 and beyond.

~~We may experience increased delinquencies and credit losses, which could have a material adverse effect on our capital, financial condition and results of operations.~~19

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~~weakness continuing in ~~2011~~2012. 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~~weak 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~~2011, approximately 9593% of our loans receivable were secured by real estate. If we continue to experience ~~increased~~elevated 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.

2220

The overall ~~deterioration~~weakness in economic conditions may subject us to increased regulatory scrutiny in the current environment. In addition, further ~~deterioration~~weakness in national and local economic conditions in our markets could drive losses beyond ~~that~~the ~~which~~levels 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.

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

A portion of our commercial development and marketing strategy targets the banking and financial services needs of small and medium-sized businesses. These businesses generally have fewer financial resources in terms of capital or borrowing capacity than larger entities. If general economic conditions negatively impact this major economic sector in the markets in which we operate, our results of operations and financial condition may be adversely affected.

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 by creating discrepancies in value between the original appraisal and the value at time of sale, and by 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 a 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.21

We ~~offer~~make ~~land acquisition~~ and ~~development,~~hold ~~and~~in ~~construction~~our ~~loans~~portfolio ~~for~~a ~~builders~~significant ~~and~~number ~~developers. As~~ of ~~December 31,~~commercial ~~2010,~~real weestate ~~had $35 million~~loans, orincluding ~~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~~which ~~considered~~pose more ~~risky~~credit risk than other types of loans. ~~The~~typically ~~primary~~made 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~~financial ~~projects~~institutions. 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.

23We offer commercial real estate loans to our customers. These loans include land acquisition and development, and construction loans for builders and developers. As of December 31, 2011, we had $27 million, or 11%, 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 or leasing of the completed projects to end users. They include affordability risk, which means the risk that purchasers cannot obtain affordable financing, product design risk, and risks posed by competing projects. In addition, we offer other commercial real estate loans secured by completed projects. Excluding loans secured by owner-occupied properties, these loans represent an additional $50 million, or 20%, of our total loan portfolio. Loans secured by commercial properties that are not owner-occupied are subject to a variety of risks, including decreases in collateral values, changes in capitalization rates, increased vacancy rates, and decreasing rents.

~~The~~There ~~losses~~can 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~~no toassurance ~~take~~that ~~greater~~ losses ~~or retain more non-performing assets. In addition,~~ in ~~general~~our commercial real estate, ~~or CRE~~portfolio, isincluding ~~cyclical~~land acquisition and ~~poses~~development ~~risks of possible loss due to concentration levels~~ and ~~similar~~construction ~~risks~~loans, ofwill ~~the~~not ~~asset~~exceed ~~class.~~our ~~As of December 31~~reserves, ~~2010,~~which ~~approximately~~could ~~39%~~adversely ofimpact our ~~loan portfolio consisted of CRE loans~~earnings. ~~The~~Given ~~Agreement with~~ the ~~OCC~~current ~~requires~~economic ~~that~~environment, ~~we continue to adhere to a written program to reduce~~ the ~~high~~non-performing ~~level~~loans ofin ~~credit~~our ~~risk~~commercial atreal ~~the~~estate ~~Bank,~~portfolio ~~including~~are ~~instituting~~not ~~procedures~~likely to ~~strengthen~~improve ~~credit underwriting~~ in ~~our~~2012, ~~CRE portfolio~~ and, ifthese ~~excessive,~~non-performing ~~plans~~loans ~~to limit growth of our CRE concentration. We~~ could ~~also~~result bein ~~required to further increase our allowance for possible loan losses and capital levels as~~ a ~~result~~material level of ~~CRE lending exposures~~charge-offs, which ~~could~~will ~~have~~negatively ~~an adverse~~ impact on our ~~results~~capital ~~of operations~~ and ~~financial condition~~earnings.

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.

AtAs of December 31, ~~2009~~2010, we had a total of $1814.25 million of OREO, and atas of December 31, ~~2010~~2011, we had a total of $1415.54 million of OREO, reflecting a $~~3.7~~972,000, ~~million~~ or 207%, ~~decrease~~increase from year-end ~~2009~~2010 to year-end ~~2010~~2011. It ~~Although we experienced a decrease in the balance of OREO during 2010, it~~ is possible that the balance of OREO could increase in ~~2011~~2012 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. In addition, we are required to reflect the fair market value of our OREO in our financial statements. If the OREO declines in value, we are required to recognize a loss in connection with continuing to hold the property. As a result, declines in the value of our OREO have a negative effect on our results of operations and financial condition.

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. In addition, we rely on appraisals to establish the value of our OREO and to determine certain loan impairments. If appraisals are inaccurate, our financial statements may not reflect the correct value of OREO, and our Allowance may not reflect accurate loan impairments. The valuation of the property may negatively impact the continuing value of such loan or OREO and could adversely affect our ~~operating~~ results of operations and financial condition.

2422

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~~maintained our allowance for loan losses, as a percentage of our outstanding loan portfolio ~~from 1.59% at December 31~~, ~~2008~~between to 2.2005% ~~at December 31, 2009~~ and 2.25% as of December 31, 2009, 2010, and 2011. It may be necessary to further increase our allowance during ~~2011~~2012. 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~~continually ~~consistently~~review ~~adjusting~~ our ~~loan~~allowance ~~portfolio~~methodology ~~and underwriting standards~~ to reflect current market conditions, and 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.

2523

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~~Memorandum 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~~2011, we had approximately $1823.29 million in brokered deposits, excluding CDARS reciprocal deposits, which represented approximately 57% 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~~the ~~formal agreement~~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.

26Analysis 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 ~~agreement~~ and ~~MOU~~Memorandum, is costly and restricts certain of our activities, including the declaration and payment of cash dividends to common or preferred 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.

2725

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~~Memorandum 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.

WeBecause 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~~Memorandum, 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~~The ~~ability~~Treasury, toas ~~attract~~a ~~and~~holder ~~retain~~of ~~the~~our ~~best~~preferred ~~key~~stock, ~~employees~~has ~~may~~rights ~~be limited by the restrictions~~ that weare ~~must~~senior ~~place~~to onthose ~~the compensation~~ of ~~those employees due to~~ our ~~participation~~common ~~in the United States Department of the Treasury’s Troubled Assets Relief Program Capital Purchase Program (“TARP CPP”)~~stockholders.

~~Participants~~We inhave ~~the~~supported ~~TARP~~our ~~CPP~~capital ~~must~~operations ~~set~~by ~~specified~~issuing ~~limits~~a onclass ~~the~~of ~~compensation~~preferred stock to ~~certain~~the ~~senior~~Treasury ~~executive~~under ~~officers~~the TARP CPP. ~~The~~On ~~limitations~~December 5, ~~which~~2008, ~~include~~we aissued ~~prohibition~~preferred onstock ~~any~~to ~~“golden~~the ~~parachute”~~Treasury ~~payments~~under ~~and~~the aTARP ~~“clawback”~~CPP oftotaling ~~any~~$9.95 million. ~~bonus~~The preferred stock has dividend rights that ~~was~~are ~~based~~senior to our common stock; therefore, we must pay dividends on ~~materially~~the ~~inaccurate~~preferred ~~financial~~stock ~~data~~before orwe ~~other~~can ~~performance~~pay ~~metric,~~any ~~could~~dividends ~~limit~~on our ~~ability~~common tostock. ~~attract~~In ~~and~~the ~~retain~~event ~~the~~of ~~best~~our ~~executive~~bankruptcy, ~~officers~~dissolution, ~~because~~or ~~other~~liquidation, ~~competing~~the ~~employers~~holders ~~may~~of ~~not~~our preferred stock must be ~~subject~~satisfied before we can make any distributions to ~~these~~our ~~limitations~~common stockholders.

~~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.~~26

WeOur ~~have~~continued ~~supported~~participation ~~our~~in ~~capital operations by issuing a class of preferred stock to~~ the ~~United States Department of the Treasury under the~~ TARP CPP. Onmay ~~December 5,~~act ~~2008, we issued preferred stock~~ to ~~the~~depress ~~Treasury under~~ the ~~TARP~~market ~~CPP~~value ~~totaling~~of ~~$9.95 million. The preferred stock has dividend rights that are senior to~~ our common stock; ~~therefore,~~and wehinder ~~must pay dividends on the preferred stock before we can pay any dividends on~~ our ~~common~~ability ~~stock.~~to Inretain ~~the~~and ~~event~~attract ofwell-qualified ~~our bankruptcy, dissolution, or liquidation, the holders of our preferred stock must be satisfied before we can make any distributions to our common stockholders~~executives.

28Pursuant to the terms of the securities purchase agreement between us and the Treasury, the ability to declare or pay dividends on our common stock is limited. In addition, we are not permitted to declare or pay dividends on our common stock if we are in arrears on the payment of dividends on the TARP Preferred Stock. In addition, our ability to repurchase outstanding common stock is restricted. The restriction on our ability to pay dividends may depress the market price of our common stock.

~~Our~~As ~~agreement~~a participant under the TARP CPP, we must comply with the ~~United~~executive ~~States~~compensation ~~Department~~and ofcorporate governance standards imposed by statute and the TARP compensation standards for as long as the Treasury holds any securities acquired from us under ~~the~~this ~~TARP~~program. ~~CPP~~The isrestrictions ~~subject~~on our ability to ~~unilateral~~compensate ~~change~~senior byexecutives ~~the~~in ~~Treasury,~~relation ~~which~~to ~~could~~executive ~~adversely~~compensation ~~affect~~at companies that are not recipients of TARP funds may limit our ~~business,~~ability ~~financial~~to ~~condition,~~retain and ~~results~~recruit ofsenior ~~operations~~executives.

Effective February 15, 2014, the dividend payable on the TARP Preferred Stock will increase to 9.0% per year. If we are unable to redeem our TARP Preferred Stock prior to that date, the increase in the TARP dividend rate would decrease the amount of earnings available for distribution to common shareholders.

Our agreement with 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:

●· 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.

3028

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~~Savannah, ~~Florida~~Georgia and ~~Savannah~~Jacksonville, ~~Georgia~~Florida, as well as a residential mortgage ~~office~~banking division headquartered in Atlanta, Georgia. All of these properties are leased, with the Atlanta lease expiring in 2012,. The ~~and the~~ Savannah ~~lease~~and ~~expiring in 2011. The~~ Jacksonville ~~location~~locations isare not under a lease contract, and may be canceled at any time with three months notice.

The mortgage banking division opened fourteen additional retail residential loan production offices during 2011 in California, Connecticut, Florida, Kansas, Maryland, Michigan, New York, and Ohio. The Bank has operating leases for rental space for each of the retail residential mortgage loan production offices. Each of these leases is cancelable at any time, or transferable upon disassociation with the Bank.

ITEM 3.

LEGAL PROCEEDINGS

None.

ITEM 4.

RESERVED

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PART II.

ITEM 5.

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

	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

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, 2011. 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.

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.

	Years Ended December 31,
	2011				2010
	High		Low		High		Low
First quarter	$	2.40	$	1.65	$	3.60	$	2.67
Second quarter	$	2.25	$	1.70	$	3.64	$	3.01
Third quarter	$	2.40	$	1.80	$	3.33	$	2.00
Fourth quarter	$	2.25	$	1.76	$	2.50	$	1.80

The Company ~~did~~has never declared or paid a cash dividend and does not ~~sell~~expect ~~any~~to ~~unregistered~~do so in the foreseeable future. The ability of the Company 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 the Company by the Bank. Further, pursuant to our issuance of 9,950 shares ~~nor~~of ~~did~~the itCompany’s ~~repurchase~~Fixed ~~any~~Rate Cumulative Perpetual Preferred Stock, Series A, to the Treasury under the TARP 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 ~~its~~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 ~~during~~and our preferred stock issued pursuant to our participation in the ~~fourth~~TARP ~~quarter~~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 ~~2010~~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 2011.

ITEM 6.

SELECTED FINANCIAL DATA

Not applicable.

3230

ITEM 7.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

General

~~Coastal~~The ~~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~~the ~~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~~did ~~to do~~ business under the trade names “Lowcountry National Bank,” “First National Bank of Nassau County,” and “The Georgia Bank” in their respective markets. During 2011, the Florida and Georgia Bank branches replaced their local market trade names with CBC National Bank while the South Carolina branches continued to operation under the Lowcountry National Bank trade name. 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~~2011 as compared to ~~2009~~2010 and also analyzes our financial condition as of December 31, ~~2010~~2011 as compared to December 31, ~~2009~~2010. 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~~2011 and ~~2009~~2010 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.

3331

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 (GAAP) 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~~2011 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.

34Income 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, 2011, management determined that there was a low probability that the Company would realize the full deferred tax asset over the next three to five years through future operating income. Therefore, a deferred tax valuation allowance of $1,826,000 and $1,746,000 was recorded as of December 31, 2010 and 2011, respectively, as the amount of the existing deferred tax asset that is not likely to be realized over the next three to five 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.

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.32

Results of Operations

Overview

Net ~~loss~~income for ~~2010~~2011 was $3357,~~807,~~000, or ~~$1.70~~a ~~per basic common share compared to net~~ loss of $~~14,536,000 or $5~~0.8808 per basic common share inafter ~~2009.~~adjusting ~~The previously noted nonrecurring charge~~ for ~~goodwill~~preferred ~~impairment~~stock ~~represented $10~~dividends,~~412,000~~ ofcompared ~~the~~to 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 $13,~~981~~807,000, or $01.9970 per ~~share,~~basic ~~for~~common ~~the~~share ~~year~~in ~~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 $1112,~~946~~647,000 for the year ended December 31, ~~2010~~2011 compared to net interest income of $1011,~~944~~946,000 for the year ended December 31, ~~2009~~2010.

The provision for loan losses in ~~2010~~2011 was $2,~~696~~865,000 compared to $72,~~771~~696,000 in ~~2009~~2010. ~~Although~~The ~~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~~865,000 provision expense for ~~2010~~2011, 3249% ~~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, 4849% was related to collateral properties in South Carolina, and 72% was related to collateral properties in Georgia.

35Noninterest income for the year ended December 31, 2011 totaled $20,662,000, representing a $9,869,000 increase from December 31, 2010. This increase was associated with an increase in mortgage banking income of $8,033,000 and an increase in SBA loan income of $2,705,000, partially offset by a decrease in gain on sale of securities of $906,000. In addition, we recorded an other-than-temporary impairment loss on investment securities of $42,000 during 2011.

Noninterest ~~income~~expenses ~~for~~in ~~the~~2011 ~~year~~were ~~ended December 31~~$30,137,000, ~~2010~~which ~~totaled~~represents a $107,~~793~~835,000 increase compared to the 2010 amounts. The largest contributor to this increase was salaries and benefits, ~~representing~~which aincreased by $34,~~140~~906,000 ~~increase~~due to staffing additions at the national retail mortgage banking branches as well as increased commission and incentive costs from ~~December 31,~~residential ~~2009~~mortgage banking and SBA lending activity. Also ~~This~~contributing to the increase was ~~associated with~~ an increase in ~~mortgage~~advertising ~~banking~~expense ~~income~~ of $12,~~547~~329,000, anrelated ~~increase~~to inmarketing ~~SBA~~costs for new loan ~~income~~leads ofpurchased ~~$600,000,~~for ~~and~~the annew ~~increase~~retail inmortgage ~~gain~~offices onopened ~~sale~~in of2011. Occupancy ~~securities~~expense ofincreased $~~839~~432,000 during 2011, also related to the national retail mortgage expansion. These increases were partially offset by a decrease of $636,000 in ~~income~~costs ~~from~~associated ~~life~~with ~~insurance~~other ~~contracts~~real ofestate ~~$207~~owned. The Company’s efficiency ratio,~~000,~~ ~~and~~which is a ~~decrease~~measure inof ~~service~~total ~~charges~~noninterest onexpenses ~~deposits~~as ~~and~~a percentage ~~other~~of ~~service~~net ~~charges,~~interest ~~commissions~~income and ~~fees~~noninterest ~~of $136~~income,~~000~~ decreased to 90. In47% ~~addition,~~in we2011 ~~recorded~~from a98.08% ~~nonrecurring~~in ~~loss~~2010 ondue ~~Silverton~~in ~~Financial~~large ~~Services~~part ~~stock~~to ofthe ~~$507,000~~previously ~~during~~described ~~2009~~increases in noninterest income.

~~Noninterest~~In ~~expenses~~2011, inwe ~~2010~~recognized ~~were~~income ~~$22,301,000,~~tax ~~which~~benefit ~~represents~~of a $549,~~285,~~000 ~~decrease~~ compared to ~~the~~income ~~2009~~tax ~~amounts. This~~expense ~~decrease is primarily due to the Goodwill impairment charge~~ of $101,~~412~~548,000 ~~recognized~~ in ~~2009,~~2010. ~~offset~~Our byeffective antax ~~increase~~rate inwas ~~the~~(16.0%) ~~costs associated with the wholesale mortgage division~~ in ~~Atlanta,~~2011 ~~Georgia,~~ and an(68.5%) ~~increase of $2,820,000~~ in ~~costs associated with other real estate owned~~2010. The ~~Company’s~~fluctuation ~~efficiency~~in ~~ratio,~~effective ~~which~~tax isrates areflects ~~measure~~the impact of ~~total~~permanent ~~noninterest~~book-to-tax ~~expenses~~differences asfrom ~~a percentage~~income ofon ~~net~~bank ~~interest~~owned ~~income~~life insurance and ~~noninterest~~municipal ~~income~~securities, ~~decreased~~as towell ~~98.08%~~as innon-tax ~~2010~~deductible ~~from 148~~losses.~~33%~~ In inaddition, ~~2009~~we ~~due~~recorded ina ~~large~~valuation ~~part~~allowance toof ~~the~~$1,826,000 ~~previously~~in ~~described~~2010 ~~decreases~~against inour ~~noninterest~~deferred ~~expenses~~tax asset.

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.33

Net Interest Income

For the year ended December 31, ~~2010~~2011, net interest income totaled $1112,~~946~~647,000, as compared to $1011,~~944~~946,000 for the same period in ~~2009~~2010, an improvement of $1701,~~002,~~000 or 95.29% on a year over year basis. Interest income from loans, including fees, decreased $~~931~~722,000 to $1716,~~261~~539,000 for the year ended December 31, ~~2010~~2011. The average balance of loans was $~~344~~345,~~622~~025,000 in ~~2010~~2011 compared to $~~359~~344,~~541~~622,000 in ~~2009~~2010. The weighted average rate earned on loans was 54.0179% for ~~2010~~2011 compared to 5.0601% in ~~2009~~2010. Interest income from securities decreased $1816,~~608,~~000 on a tax equivalent basis. The average balance of investments was $5336,~~896~~379,000 in ~~2010~~2011 compared to $7953,~~742~~896,000 in ~~2009~~2010. The weighted average rate earned on investments was 43.1590% for ~~2010~~2011 compared to 4.8215% in ~~2009~~2010. This decrease in interest income was offset by decreased interest expense, which totaled $75,~~446~~233,000 for the year ended December 31, ~~2010~~2011, compared to $107,~~812~~446,000 in ~~2009~~2010. The net interest margin realized on earning assets and the interest rate spread were 23.9830% and 23.8420%, respectively, for the year ended December 31, ~~2010~~2011. For the year ended December 31, ~~2009~~2010, the net interest margin was 2.5398% and the interest rate spread was 2.3384%. Yields on interest earning assets decreased during the year by 1516 basis points compared to a decrease in rates on interest bearing liabilities of 6851 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~~2011, ~~2009~~2010 and ~~2008~~2009, 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,	~~For the Years Ended December 31,~~
		2010												2009												2008
	2011											2010											2009
(In thousands)	Average Balance	~~Average Balance~~			Interest	~~Interest~~			Yield/ Rate	~~Yield/ Rate~~		Average Balance		~~Average Balance~~		Interest		~~Interest~~		Yield/ Rate		~~Yield/ Rate~~	Average Balance			~~Average Balance~~	Interest			~~Interest~~	Yield/ Rate		~~Yield/ Rate~~
Assets:
Interest-earning assets:
Loans (including loan fees)	$	$345,025	~~344,622~~		$	$16,539	~~17,261~~		4.79	%	~~5.01~~	%$	344,622	$	~~359,541~~	$	17,261	$	~~18,192~~	5.01	%		~~5.06~~$	%359,541		$	~~325,098~~$	18,192		$	~~20,318~~5.06	%		~~6.25~~	%
Taxable investments		32,069	~~47,870~~			1,155	~~1,882~~		3.60	%	~~3.93~~	%	47,870		~~65,326~~		1,882		~~3,006~~	3.93	%		~~4.60~~	%65,326			~~65,702~~	3,006			~~3,328~~4.60	%		~~5.07~~	%
Tax-free investments		4,310	~~6,026~~			262	~~352~~		6.08	%	~~5.84~~	%	6,026		~~14,416~~		352		~~836~~	5.84	%		~~5.80~~	%14,416			~~16,699~~	836			~~988~~5.80	%		~~5.92~~	%
Interest-bearing deposits in other banks		4,019	~~818~~			13	3		0.32	%	~~0.37~~	%	4,624		~~1,827~~		13		2	0.28	%		~~0.11~~	%1,827			~~678~~	2			220.11	%		~~3.24~~	%
Federal funds sold		232	~~5,815~~			<1	14		0.17	%	~~0.24~~	%	2,009		~~2,137~~		4		4	0.20	%		~~0.19~~	%2,137			~~4,674~~	4			~~116~~0.19	%		~~2.48~~	%
Total interest-earning assets		385,655	~~405,151~~			17,969	~~19,512~~		4.66	%	~~4.82~~	%	405,151		~~443,247~~		19,512		~~22,040~~	4.82	%		~~4.97~~	%443,247			~~412,851~~	22,040			~~24,772~~4.97	%		~~6.00~~	%
Other noninterest earning assets		29,697	~~31,723~~										31,723		~~37,335~~									37,335			~~30,782~~
Total assets	$	$415,352	~~436,874~~									$	436,874	$	~~480,582~~								$	480,582		$	~~443,633~~
Liabilities and shareholders’ equity:
Interest-bearing liabilities:
Deposits:
Interest-bearing demand and savings deposits	$	$120,555	~~121,426~~		$	$976	~~1,332~~		0.81	%	~~1.10~~	%$	121,426	$	~~106,662~~	$	1,332	$	~~1,573~~	1.10	%		~~1.47~~$	%106,662		$	~~101,895~~$	1,573		$	~~2,442~~1.47	%		~~2.40~~	%
Time deposits		192,285	~~216,298~~			2,827	~~4,441~~		1.47	%	~~2.05~~	%	216,298		~~248,386~~		4,441		~~7,467~~	2.05	%		~~3.01~~	%248,386			~~228,355~~	7,467			~~10,117~~3.01	%		~~4.43~~	%
Other borrowings		46,425	~~39,583~~			1,430	~~1,673~~		3.08	%	~~4.23~~	%	39,583		~~53,420~~		1,673		~~1,772~~	4.23	%		~~3.32~~	%53,420			~~40,671~~	1,772			~~1,829~~3.32	%		~~4.50~~	%
Total interest-bearing liabilities		359,265	~~377,307~~			5,233	~~7,446~~		1.46	%	~~1.97~~	%	377,307		~~408,468~~		7,446		~~10,812~~	1.97	%		~~2.65~~	%408,468			~~370,921~~	10,812			~~14,388~~2.65	%		~~3.88~~	%
Other noninterest bearing liabilities		23,003	~~24,098~~										24,098		~~27,160~~									27,160			~~27,055~~
Shareholders’ equity		33,084	~~35,469~~										35,469		~~44,954~~									44,954			~~45,657~~
Total liabilities and shareholders’ equity	$	$415,352	~~436,874~~									$	436,874	$	~~480,582~~								$	480,582		$	~~443,633~~
Excess of interest-earning assets over interest bearing liabilities	$	$26,390	~~27,844~~									$	27,844	$	~~34,779~~								$	34,779		$	~~41,930~~
Ratio of interest-earning assets to interest-bearing liabilities		107	~~107~~%	%									107	%	~~109~~	%								109	%		~~111~~	%
Tax equivalent adjustment						(89	~~(120~~)	)									(120	)	~~(284~~	)								(284	)		~~(336~~	)
Net interest income					$	$12,647	~~11,946~~									$	11,946	$	~~10,944~~								$	10,944		$	~~10,048~~
Net interest spread									3.20	%	~~2.84~~	%								2.84	%		~~2.33~~	%							2.33	%		~~2.12~~	%
Net interest margin									3.30	%	~~2.98~~	%								2.98	%		~~2.53~~	%							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.

3734

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
	2011 Compared to 2010 Increase (decrease) due to changes in									2010 Compared to 2009 Increase (decrease) due to changes in
(In thousands)	Volume			Rate			Net Change			Volume			Rate			Net Change
Interest income on:
Loans (including loan fees)	$	~~(748~~20	)	$	(~~183~~742	)	$	(~~931~~722	)	$	~~2,006~~(748	)	$	(~~4,132~~183	)	$	(~~2,126~~931	)
Taxable investments		(~~728~~580	)		(~~396~~147	)		(~~1,124~~727	)		(19728	)		(~~303~~396	)		(~~322~~1,124	)
Non-taxable investments		(~~490~~104	)		614			(~~484~~90	)		(~~133~~490	)		~~(19~~6	)		(~~152~~484	)
Interest bearing deposits in other banks		(2	)		32			1—			145			~~(34~~6	)		~~(20~~11	)
Federal funds sold		9(3	)		(1	)		10(4	)		~~(41~~—	)		~~(71~~—	)		~~(112~~—	)
Total interest income (tax equivalent basis)		(~~1,959~~669	)		(~~569~~874	)		(21,~~528~~543	)		(1,~~827~~961	)		(~~4,559~~567	)		(2,~~732~~528	)
Interest expense on:
Interest-bearing demand and savings deposits		~~198~~(9	)		(~~439~~347	)		(~~241~~356	)		~~109~~198			(~~978~~439	)		(~~869~~241	)
Time deposits		(~~876~~454	)		(21,~~150~~160	)		(31,~~026~~614	)		~~827~~(876	)		(32,~~477~~150	)		(23,~~650~~026	)
Other borrowings		~~(520~~259	)		~~421~~(502	)		(99243	)		~~491~~(520	)		~~(548~~421	)		(5799	)
Total interest expense		(~~1,198~~204	)		(2,~~168~~009	)		(32,~~366~~213	)		(1,~~427~~198	)		(52,~~003~~168	)		(3,~~576~~366	)
Net interest income (tax equivalent basis)	$	(~~761~~465	)	$	1,~~599~~135		$	~~838~~670		$	~~400~~(763	)	$	~~444~~1,601		$	~~844~~838

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~~under ~~the~~various ~~expected~~ interest rate ~~environment~~scenarios 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 (receivable or 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~~for ~~the~~a ~~following~~given ~~twelve~~time ~~months~~period. This projected Gap exposure is expressed as a ratio of interest sensitive assets to interest sensitive liabilities in 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 the projected Gap exposure will be 1.0 or higher, indicating that more of its interest sensitive assets are expected to reprice ~~within twelve months~~ than its interest sensitive liabilities over the same period. By example, a projected Gap ratio of 1.20 indicates that $1.20 of interest sensitive assets are expected to reprice for every $1.00 of interest sensitive liabilities expected to reprice over a given time 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~~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 and liabilities 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.

3835

The following table summarizes the amounts of interest-earning assets and interest-bearing liabilities outstanding at December 31, ~~2010~~2011, 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~~2011

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~~243		$	—		$	—		$	—		$	~~185~~243
Deposits in other banks		~~407~~230			—249			—			—			~~407~~479
Investment securities		72,~~199~~698			45,~~079~~152			2316,~~194~~690			93,~~721~~102			4427,~~193~~642
Loans held for sale		55,336			—			—			—			55,336
Loans held for sale and loan sales receivable		162,714			—			—			—			162,714
Loans		~~122~~126,~~524~~590			4428,~~033~~395			7576,~~038~~745			2622,~~005~~937			~~267~~254,~~600~~667
Total interest-earning assets		~~185~~292,~~651~~475			4833,~~112~~796			9893,~~232~~435			3526,~~726~~039			~~367~~445,~~721~~745
Interest-bearing liabilities:
Deposits:
Savings and demand deposits		—3,232			509,~~298~~962			7053,~~500~~483			152,~~778~~812			~~122~~119,~~576~~489
Time deposits		5039,~~220~~988			~~104~~108,~~236~~795			5065,~~045~~923			251			~~204~~214,~~526~~707
FHLB advances		12,000			7,500			17,500			—			37,000
Securities sold under agreements to repurchase		8,766			—			—			—			8,766
Junior subordinated debentures		3,093			4,124			—			—			7,217
FHLB advances		50,947			2,500			15,000			—			68,447
Total interest-bearing liabilities		65,313			166,158			138,045			1,803			371,319
Junior subordinated debentures		7,217			—			—			—			7,217
Interest sensitive difference per period	$	120,338		$	(118,046	)	$	(39,813	)	$	33,923		$	4,865
Total interest-bearing liabilities		110,150			121,257			134,406			52,813			418,626
Cumulative interest sensitivity difference	$	120,338		$	2,292		$	(37,521	)	$	(3,598	)
Interest sensitive difference per period	$	182,325		$	(87,461	)	$	(40,971	)	$	(26,774	)	$	27,119
Cumulative difference to total interest-earning assets		32.7	%		0.6	%		(10.2	)%		(1.0)	%
Cumulative interest sensitivity difference	$	182,325		$	94,864		$	53,893		$	27,119
Cumulative difference to total interest-earning assets		40.9	%		21.3	%		12.1	%		6.1	%

At December 31, ~~2010~~2011, the Company, ~~had~~as ~~$120,338,000~~measured ~~more~~by ~~assets~~Gap, ~~than~~and ~~liabilities~~adjusted ~~repricing~~for orits ~~maturing~~expectations ~~within~~of ~~three~~changes ~~months,~~in ~~which~~interest ~~indicates~~bearing categories that ~~the~~might ~~Company~~not move completely in tandem with changing interest rates, is asset sensitive ~~over~~with ~~this~~a ~~time~~cumulative ~~horizon~~projected Gap ratio of 2.66 ~~When~~over ~~extended~~a ~~out~~three tomonth period and a cumulative projected Gap ratio of 1.41 over a one year period. At December 31, 2011, the Company had $2182,~~292~~325,000 more assets than liabilities repricing or maturing within three months, ~~indicating~~and ~~the~~$94,864,000 ~~Company~~more isassets ~~asset~~than ~~sensitive~~liabilities repricing over a one-year time period. 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.

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.

3936

Impaired Loans

A loan is considered ~~to be~~ impaired ~~when~~, in ~~management’s~~accordance ~~judgment~~with the impairment accounting guidance (FASB ASC 310-10-35-16), when, based on current information and events, it is probable that the ~~loan’s~~Company ~~principal~~will orbe ~~interest~~unable isto ~~not~~collect ~~collectible~~all amounts due from the borrower in accordance with the contractual terms of the ~~original~~ loan ~~agreement~~. Additionally, ~~Impaired~~recent ~~loans,~~FASB ~~when~~guidance ~~not~~requires ~~material,~~that ~~will~~by bedefinition, ~~carried~~all inloans ~~the~~classified ~~balance~~as ~~sheet~~troubled atdebt arestructurings ~~value~~(“TDRs”) ~~not~~must toalso ~~exceed~~be ~~their~~classified ~~observable~~as ~~market~~impaired. In ~~price~~cases orwhere ~~the~~management ~~fair~~believes ~~value~~a ofrestructured ~~the~~loan ~~collateral~~will ifreturn ~~the~~all ~~repayment~~amounts ofdue under the restructured loan isterms, ~~expected~~and tothose beterms ~~provided~~do ~~solely~~not byinclude the ~~underlying~~loss ~~collateral. The carrying values~~ of any ~~materially~~portion ~~impaired~~of ~~loans are measured based on~~ the ~~present~~original ~~value~~principal ofbalance, ~~expected~~restructured ~~future~~loans ~~cash~~are ~~flows~~not ~~discounted~~internally ~~at the loan’s effective interest rate~~classified, ~~which~~monitored isor ~~the~~managed ~~contractual~~as ~~interest~~impaired ~~rate~~loans. Accordingly, ~~adjusted~~GAAP ~~for~~reporting ~~any~~requirements ~~deferred~~result ~~loan~~in ~~fees~~a orhigher ~~costs,~~level ~~premium~~of orloans ~~discount~~classified ~~existing~~as atimpaired ~~the~~than ~~inception~~are orconsidered ~~acquisition~~as ofimpaired ~~the~~by ~~loan~~management.

~~Loans~~As ~~which~~of ~~management~~December ~~identifies~~31, as2011 ~~impaired~~there ~~generally~~are ~~will~~nine berestructured ~~non-performing~~ loans. ~~Non-performing~~with ~~loans~~a ~~include~~recorded ~~non-accrual~~investment ~~loans~~of or$4,160,000 ~~loans~~that ~~which~~ are 90included ~~days~~as orimpaired ~~more~~loans, ~~delinquent~~ as torequired ~~principal~~by orGAAP, ~~interest~~that ~~payments.~~management Inhas ~~some~~not ~~cases~~internally weclassified ~~continue~~as toimpaired ~~receive~~because ~~loan~~they ~~payments~~are performing in accordance with ~~loan~~their restructured terms ~~from~~such ~~loans~~ that ~~are~~we ~~considered~~expect ~~impaired because the underlying collateral value is insufficient~~ to ~~fully~~recover ~~satisfy~~all ~~the~~loan ~~debt. In~~principal; ~~these cases~~however, ~~the~~these ~~entire~~loans ~~loan~~meet ~~payment is applied to~~ the ~~unpaid~~GAAP ~~principal~~definition ~~balance~~ of ~~the~~a ~~loan~~TDR. ~~At December 31~~ Accordingly, ~~2010,~~while ~~the~~these ~~Company had $18,954,000 of~~ loans ~~that~~meet ~~were~~the ~~impaired~~technical ~~and~~definition ~~non-performing,~~ of ~~which~~a ~~$3,823,000~~restructured ~~continue to receive current payments in accordance with the~~ loan ~~terms.~~and Atmust ~~December 31,~~therefore ~~2009,~~be ~~the~~classified ~~Company~~as ~~had $8,215,000 of~~ impaired ~~and~~under ~~non-performing loans~~GAAP, ofmanagement ~~which~~evaluates ~~$268,000~~these ~~continue~~loans toas ~~receive current payments in accordance with the loan terms. A loan that is on nonaccrual status may not necessarily be considered~~ non-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. AtAs of December 31, ~~2010~~2011, the Company had $2922,~~054~~600,000 of potential problem loans. Potential problem loans atas of December 31, ~~2009~~2010 were $3929,~~055~~054,000.

4037

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~~865,000 for the year ended December 31, ~~2010~~2011 as compared to $72,~~771~~696,000 for the year ended December 31, ~~2009~~2010. On a year -over -year basis, the provision expense ~~decreased~~increased by 656% or $5169,~~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 $2212,~~059~~933,000 during the year ended December 31, ~~2010~~2011 as compared to a decrease of $1422,~~760~~059,000 in ~~2009~~2010. The allowance for loan losses was 2.2505% of gross loans at December 31, ~~2010~~2011 as compared to 2.2025% at December 31, ~~2009~~2010. 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 then 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.

4138

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
	2011					2010					2009					2008					2007
(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~~644		46	%	$	~~346~~543		4	%	$	~~252~~346		34	%	$	~~284~~252		43	%	$	~~107~~284		4	%
Real Estate—Construction		~~358~~1,231		2320			~~741~~358		2423			~~764~~741		3224			~~1,048~~764		4632			1,~~864~~048		4746
Real Estate—Mortgage		43,~~042~~041		7273			4,~~241~~042		7172			24,~~566~~241		6371			12,~~999~~566		4863			1,~~350~~999		4748
Consumer		~~326~~26		1			~~351~~326		1			~~264~~351		21			~~239~~264		2			62239		2
Unallocated		~~739~~280		—			~~707~~739		—			~~987~~707		—			83987		—			9283		—
Total	$	65,~~008~~222		100	%	$	6,~~386~~008		100	%	$	46,~~833~~386		100	%	$	34,~~653~~833		100	%	$	3,~~475~~653		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~~adjusted wefor ~~have~~the ~~sufficient~~impact of 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~~2011			~~2009~~2010			~~2008~~2009			~~2007~~2008			~~2006~~2007
Loans outstanding, end of year	$	~~267~~254,~~600~~667		$	~~289~~267,~~659~~600		$	~~304~~289,~~419~~659		$	~~281~~304,~~291~~419		$	~~291~~281,~~820~~291
Average loans outstanding	$	~~280~~259,~~223~~910		$	~~301~~280,~~931~~223		$	~~302~~301,~~461~~931		$	~~282~~302,~~182~~461		$	~~271~~282,~~414~~182
Allowance, beginning of year		6,~~386~~008			46,~~833~~386			34,~~653~~833			3,~~475~~653			23,~~863~~475
Charge-offs:
Commercial, financial and agricultural		~~237~~649			~~599~~237			~~249~~599			73249			9573
Real estate—construction		1,~~515~~888			31,~~831~~515			53,~~346~~831			15,346			—1
Real estate—mortgage		1,~~904~~788			1,~~828~~904			1,~~002~~828			541,002			—54
Consumer		71—			671			666			2566			2725
Total charge-offs		34,~~727~~325			63,~~264~~727			6,~~663~~264			~~153~~6,663			~~122~~153
Recoveries:
Commercial, financial and agricultural		130			21			162			1916			—19
Real estate—construction		~~263~~250			10263			—10			—			—
Real estate—mortgage		~~377~~387			19377			—19			—			—
Consumer		127			1512			415			24			72
Total recoveries		~~653~~674			46653			2046			2120			721
Net charge-offs		3,~~074~~651			63,~~218~~074			6,~~643~~218			~~132~~6,643			~~115~~132
Additions charged to operations		2,~~696~~865			72,~~771~~696			7,~~823~~771			~~310~~7,823			~~727~~310
Allowance, end of year	$	65,~~008~~222		$	6,~~386~~008		$	46,~~833~~386		$	34,~~653~~833		$	3,~~475~~653
Ratio of net charge-offs during the period to average loans outstanding during the period		1.1040	%		21.0610	%		2.2006	%		02.0520	%		0.0405	%
Allowance for loan losses to loans, end of year		2.2505	%		2.2025	%		12.5920	%		1.3059	%		1.1930	%

4239

	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 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, 2011, 2010, 2009, 2008, and 2007.

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)	2011		2010		2009		2008		2007
Other real estate and repossessions	$	15,424	$	14,452	$	18,176	$	5,756	$	340
Accruing loans 90 days or more past due		—		—		105		801		69
Non-accrual loans		15,937		22,302		13,754		18,213		2,018
Interest income recognized on non-accrual loans		143		283		157		60		4
Interest on non-accrual loans which would have been reported		797		936		727		602		104

	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		—		—		—

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, 2011, 2010, 2009, 2008, and 2007. 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)	2011		2010		2009		2008		2007
Restructured loans which are current and performing as agreed	$	2,435	$	5,911	$	16,052	$	—	$	—
Restructured loans 30-89 days past due		53		373		—		—		—
Restructured loans 90 days or more past due		—		—		—		—		—
Non-accrual restructured loans		9,260		10,073		3,690		—		—
Total restructured loans	$	11,748	$	16,357	$	19,742	$	—	$	—
Interest income recognized on restructured loans		302		607		654		—		—
Interest on non-accrual restructured loans which would have been reported		339		329		85		—		—

Noninterest Income

Noninterest income was $1020,~~793~~662,000 for the year ended December 31, ~~2010~~2011, which was an increase of $39,~~140~~869,000, or 4191%, from $710,~~653~~793,000 earned during the year ended December 31, ~~2009~~2010. The largest factor in this year -over -year improvement occurred in mortgage banking income, which was $816,~~230~~263,000 for the year ended December 31, ~~2010~~2011 compared to $68,~~683~~230,000 for the year ended December 31, ~~2009~~2010. This increase to mortgage banking income was driven almost entirely by the results of the mortgage origination business headquartered in Atlanta, which is discussed in further detail below.

~~Service~~In ~~charges~~addition onto ~~deposit~~improved ~~accounts~~mortgage ~~decreased~~banking income, SBA loan income increased by 18354% or $~~104~~2,705,000 to ~~a level of~~ $~~462~~3,469,000 for ~~the~~2011 ~~year~~compared ~~ended~~to ~~December 31~~$763,000 during 2010. ~~Income~~Service charges on ~~life~~deposit ~~insurance~~accounts ~~contracts~~ decreased by 7213% or $~~206~~59,000 to a level of $82403,000 for ~~2010~~the year ended December 31, 2011. ~~SBA~~ ~~loan~~Other ~~income~~service charges increased by ~~366~~11% or $~~599~~29,000 to ~~$763,000~~a ~~for~~level ~~2010~~of ~~compared to~~ $~~164~~303,000 ~~during~~for ~~2009~~2011. ~~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~~2011, we recorded net gains of $~~939~~33,000 on sales of securities available for sale, compared to net gains of $1939,000 during ~~2009~~2010. ~~During~~In ~~2009~~addition, we recorded aan ~~loss~~other onthan ~~our~~temporary ~~investment~~impairment inloss ~~Silverton~~on ~~Financial~~investment ~~Services~~securities ~~common stock~~ of $~~507~~42,000 ~~and~~during ~~a gain of $99,000 on the early tender of one of our investment securities held to maturity~~2011.

Noninterest Expense

Total noninterest expense for the year ended December 31, ~~2010~~2011 was $2230,~~301~~136,000 as compared to $2722,~~586~~301,000 for ~~2009~~2010. ~~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 $57,~~127~~835,000 is due largely to increased costs associated with higher mortgage lending volume and anthe ~~increase~~expansion of fourteen new retail residential loan production offices during 2011 in ~~other~~California, ~~real~~Connecticut, ~~estate~~Florida, ~~expenses~~Kansas, Maryland, Michigan, New York, and Ohio. Mortgage ~~loan~~division ~~expense~~expenses, excluding mortgage division salaries and benefits, increased ~~144~~171%, or $~~679~~3,743,000, to $15,~~150~~929,000 during ~~2010~~2011 compared to $~~471~~2,186,000 during ~~2009~~2010. Other real estate expenses ~~increased~~decreased ~~147~~13%, or $2636,~~820,~~000, to $4,~~739~~103,000 during ~~2010~~2011 compared to $14,~~919~~739,000 during ~~2009~~2010.

43Salaries and benefits totaled $14,418,000 for the year ended December 31, 2011, compared to $9,512,000 for the same period a year ago, for an increase of $4,906,000, reflecting staffing increases and higher commissions in mortgage banking and SBA lending. Excluding the mortgage banking division, the Company experienced an increase in salaries and benefits of $1,087,000 during 2011 compared to 2010.

~~Salaries~~Advertising ~~and~~expense ~~benefits~~increased ~~totaled~~significantly in 2011 at $92,~~512~~469,000, ~~for~~representing ~~the~~a ~~year~~near ~~ended~~18 ~~December 31,~~fold ~~2010,~~increase ~~compared~~from tothe $8140,~~002,~~000 ~~for~~expensed ~~the~~in ~~same~~2010. This ~~period~~$2,329,000 a year-over-year ~~ago~~increase ~~for~~was andue ~~increase~~solely ofto ~~$1,510,000.~~the ~~Excluding~~addition of the retail mortgage ~~banking~~production ~~division~~offices, ~~the~~and ~~community~~reflects ~~banking~~expenses ~~division~~related ~~experienced~~to angenerating ~~increase~~residential inreal ~~salaries~~estate ~~and~~loan ~~benefits~~application ofleads ~~$253~~through various media such as print advertising,~~000~~ ~~during~~mass ~~2010~~mailings, ~~compared~~internet toreferrals, ~~2009~~and telemarketing efforts.

Occupancy and equipment expense increased $~~194~~432,000 to $1,~~404~~836,000 for ~~2010~~2011 compared to $1,~~210~~404,000 during ~~2009~~2010. This increase was due to expansion in the mortgage banking division, inincluding ~~Atlanta. This~~fourteen ~~increase~~new ~~was~~retail ~~partially~~residential ~~offset~~loan byproduction aoffices ~~decrease~~opened induring ~~FDIC~~2011 ~~insurance~~in ~~expense~~California, ofConnecticut, ~~$181~~Florida,~~000~~ ~~during~~Kansas, ~~2010~~Maryland, ~~compared~~Michigan, toNew ~~the~~York, ~~same~~and ~~period in 2009~~Ohio.

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. In 2011, we expanded this division by opening fourteen new retail residential loan production offices in California, Connecticut, Florida, Kansas, Maryland, Michigan, New York, and Ohio. 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.41

44Outstanding 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 $816,~~230~~263,000 for ~~2010~~2011 compared to $68,~~683~~230,000 during ~~2009~~2010. Attractive mortgage rates caused a surge in mortgage loan refinancing during the ~~first~~last half of ~~2009~~2010, leading to above average volume at the mortgage banking division, and thus, above average gains on sales. During ~~the third quarter of 2010~~2011, mortgage rates ~~experienced~~remained ~~another~~at ~~low~~historical ~~period~~lows, which ~~led~~sustained tothe above average funding volumes and gains on sale during ~~the~~much ~~last half~~ of ~~2010~~2011. The direct noninterest expenses incurred by the division were $614,~~478~~040,000 during ~~2010~~2011, an increase of $27,~~289~~562,000 over the ~~2009~~2010 expenses of $46,~~189~~478,000. The largest contributor to this increase was in salaries and benefits, which were $48,~~292~~111,000 during ~~2010~~2011, compared to $34,~~035~~292,000 during ~~2009~~2010, and largely reflect the higher commissions and incentive compensation paid as a result of a combination of staffing additions and increased volume of loan originations in ~~2010~~2011 as compared to ~~2009~~2010.

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 $6485,~~400~~116,000 during ~~2010~~2011 and $5764,~~610~~400,000 during ~~2009~~2010. The interest income earned on these loans available for sale was $3,~~005~~676,000 and $23,~~937~~005,000 during the years ended December 31, ~~2010~~2011 and ~~2009~~2010, respectively.

Income Taxes

During ~~2010~~2011, we recognized an income tax ~~expense~~benefit of $149,~~548,~~000 compared to an income tax ~~benefit~~expense of ($21,~~223~~548,000) during ~~2009~~2010. Our effective tax rate was (6916%) in ~~2010~~2011 and 13(69%) in ~~2009~~2010. 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 during 2010 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, and during 2011, we retained a valuation allowance of $1,746,000 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.42

45Deferred 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~~After ~~the~~nine ~~last~~consecutive ~~year,~~quarterly ~~core~~losses ~~earnings~~through ~~have~~December ~~increased~~31, to2010, ~~levels~~the ~~last~~Company’s ~~attained~~banking ~~in 2006~~subsidiary, ~~and~~CBC soNational ~~management~~Bank, ishas ~~cautiously~~been ~~optimistic~~profitable ~~that~~for ~~more~~each ~~likely~~of ~~than not over~~ the ~~next~~four ~~two~~consecutive tofiscal ~~five~~quarters ~~years~~ending ~~taxable~~December ~~income~~31, ~~will return to levels approaching those prior to 2008~~2011.

●· ~~Management~~The ~~recommended~~recent ~~and~~profitability generated at the ~~Board~~Company’s ofbanking ~~Directors~~subsidiary ~~authorized~~was ~~early~~from ~~redemptions~~ongoing ofcore ~~the~~earning ~~majority~~sources ofwhich ~~our~~appear ~~bank~~to ~~owned~~be ~~life~~on ~~insurance~~a ~~policies~~stable ~~during~~to ~~2010~~improving trend. ~~Liquidating~~Core ~~these~~earning ~~policies~~sources ~~generated~~include ~~taxable~~net interest income ~~which~~and ~~was~~noninterest ~~utilized~~income tofrom ~~offset~~residential amortgage ~~portion~~banking ofand ~~our~~small ~~net~~business ~~operating~~lending ~~loss~~activity. ~~carry~~Management’s ~~forward~~forecasts ~~and~~indicate ~~decrease~~that ~~the~~this ~~related~~stable ~~deferred~~to ~~tax~~improving ~~asset~~trend in ~~the~~core ~~process.~~earnings ~~The~~appears ~~proceeds~~sustainable ~~from~~over ~~liquidating~~the ~~these~~next ~~policies~~few ~~will~~years, beand ~~available~~as tosuch ~~fund~~the ~~other~~expectation ~~earning~~is ~~assets,~~that ~~shifting~~there ~~approximately~~will ~~$210,000~~be offuture ~~annual~~earnings ~~tax~~available ~~exempt~~to ~~earnings~~realize tothe adeferred ~~like~~tax ~~amount~~asset ofin ~~taxable~~future ~~earnings~~periods.

●. ~~The~~Over ~~existing~~the ~~portfolio~~last ofyear, ~~marketable~~core ~~securities~~earnings ~~had~~have anincreased ~~unrealized mark~~ to ~~market~~levels ~~gain~~last asattained ofin ~~December 31~~2006, ~~2010~~and ofso ~~$727,000,~~management ~~which~~is ~~could~~cautiously ~~consume~~optimistic upthat tomore ~~$247,000~~likely ofthan ~~the~~not ~~deferred~~over ~~tax asset if~~ the ~~decision~~next ~~was~~three ~~made~~ to ~~sell~~five ~~securities~~years ~~from~~income ~~this~~will ~~portfolio~~return ~~and~~to ~~replace~~levels ~~them~~approaching ~~with~~those ~~current~~prior ~~market~~to ~~rate securities~~2008.

●· ~~During~~Management ~~2010~~recommended weand ~~sold~~the ~~approximately~~Board ~~$4.8~~of ~~million~~Directors authorized early redemptions of ~~tax~~the ~~exempt~~majority ~~municipal~~of ~~bonds,~~our ~~generating~~bank aowned ~~taxable~~life ~~gain~~insurance ofpolicies ~~$167,000,~~during 2010. Liquidating these policies generated taxable income which ~~allowed~~was usutilized to ~~reinvest~~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 ~~sale~~annual ~~into~~tax ~~securities~~exempt ~~that~~earnings ~~generate~~to a like amount of taxable ~~income~~earnings.

●· ~~During~~The ~~2010~~existing weportfolio ~~sold~~of ~~approximately~~marketable ~~$16.4~~securities ~~million~~had ofan ~~mortgage~~unrealized ~~backed~~mark ~~securities,~~to ~~generating~~market again ~~taxable~~as ~~gain~~of December 31, 2011 of $~~772~~917,000, ~~and~~which ~~reducing~~could consume up to $312,000 of the deferred tax asset byif ~~$262,000~~the decision was made to sell securities from this portfolio and replace them with current market rate securities.

~~Based~~· onDuring ~~the~~2010 ~~above~~we ~~analysis,~~sold ~~management~~approximately ~~believes~~$4.8 ~~that~~million ~~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~~exempt asmunicipal ~~described above. Therefore~~bonds, generating a ~~deferred~~taxable ~~tax~~gain ~~valuation allowance~~ of $1167,~~826,~~000 ~~has been recorded as of December 31~~, ~~2010~~which asallowed ~~the~~us ~~amount of the existing deferred tax asset that is not likely~~ to bereinvest ~~realized over~~ the ~~next~~proceeds ~~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~~sale ~~realization~~into ofsecurities ~~the~~that ~~deferred~~generate ~~tax~~taxable ~~asset~~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 and our projections for the next three to five years, management continues to believe that there is a low probability that the Company would realize the full deferred tax asset over the next three to five years through future operating income and implementation of tax strategies as described above. During 2011, we recorded a reduction of $80,457 to the deferred tax valuation allowance of $1,826,000 that was recorded in the year ended December 31, 2010. 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~~increased from $~~463~~427,~~097~~077,000 at December 31, ~~2009~~2010 to $~~427~~477,~~077~~599,000 at December 31, ~~2010~~2011. The primary source of the ~~decrease~~increase in assets was in ~~our~~loan ~~investment~~sales ~~portfolio~~receivable, which ~~decreased~~increased $2295,~~795~~086,000 during ~~2010~~2011, as a result of ~~several~~increased ~~security~~mortgage ~~sales,~~loan ~~calls, and maturities~~production. ~~Portfolio~~This ~~loans~~increase ~~decreased~~was ~~$22,059,000,~~partially oroffset ~~7.62%~~by ~~during~~decreases ~~2010.~~in ~~Cash~~loans ~~surrender~~held ~~value~~for ofsale, ~~bank~~portfolio ~~owned life insurance decreased $5~~loans,~~499,000~~ ~~during~~and ~~2010~~investment ~~as the Company made a decision to redeem several policies~~securities. ~~Other~~Loans ~~real~~held ~~estate~~for ~~owned~~sale decreased ~~20.49% to~~ $1419,~~452~~214,000, ator ~~December 31~~34.72%, ~~2010~~during 2011. ~~These~~Portfolio ~~decreases~~loans ~~were~~decreased ~~offset by an increase of~~ $1612,~~656~~933,000, or ~~112~~4.1783%, induring ~~loan~~2011. ~~sales~~Investment ~~receivable~~securities ~~and~~available anfor ~~increase~~sale ofdecreased 40.34% to $522,~~330~~506,000 inat ~~loans~~December ~~held~~31, ~~for sale~~2011. During ~~2010~~2011, total liabilities ~~decreased~~increased $3150,~~153~~396,000, or 712.3379%, when compared to December 31, ~~2009~~2010. During ~~2010~~2011, total deposits ~~decreased~~increased $228,~~830~~621,000, or 62.1949%, and other borrowings ~~decreased~~increased $831,~~237~~447,000, or 1884.2199%.

Interest-Earning Assets

Loans

Gross loans totaled $~~267~~254,~~600~~667,000 at December 31, ~~2010~~2011, a decrease of $2212,~~059~~933,000, or 74.6283%, since December 31, ~~2009~~2010. We continue to work to reduce our exposure to higher risk loans as evidenced by the $611,~~300~~512,000, or 1022.9445%, decline in the balance of ~~real~~Real estate - construction, commercial loans during ~~2010~~2011. We also experienced a decline in ~~real~~Real estate - mortgage, residential loans, which decreased $93,~~132~~934,000, or 83.0879%, to $~~103~~99,~~852~~918,000 at December 31, ~~2010~~2011, and a decrease in ~~real~~Real estate - mortgage, commercial loans, which decreased $31,~~568~~112,000, or 31.9127%, to $8786,~~758~~646,000 at December 31, ~~2010~~2011. Offsetting these decreases was an increase in Commercial and financial loans of $4,919,000, or 48.61%, to $15,039,000 at December 31, 2011. 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~~2011				~~2009~~2010				~~2008~~2009				~~2007~~2008				~~2006~~2007
Commercial and financial	$	1015,~~120~~039	46	%	$	10,~~956~~120	4	%	$	10,~~294~~956	34	%	$	10,~~235~~294	43	%	$	1310,~~053~~235	4	%
Agricultural		~~151~~—	—	%		~~319~~151	—	%		~~326~~319	—	%		~~519~~326	—	%		55519	—	%
Real estate – construction, commercial		5139,~~273~~761	1916	%		5751,~~573~~273	2019	%		8857,~~151~~573	2920	%		~~111~~88,~~988~~151	4029	%		~~121~~111,~~791~~988	4240	%
Real estate – construction, residential		1211,~~094~~602	4	%		1312,~~063~~094	4	%		1513,~~166~~063	54	%		1715,~~619~~166	65	%		1617,~~250~~619	6	%
Real estate – mortgage, farmland		—	—	%		—	—	%		~~199~~—	—	%		94199	—	%		1494	—	%
Real estate – mortgage, commercial		8786,~~758~~646	3334	%		9187,~~326~~758	3233	%		8191,~~360~~326	2732	%		6881,~~281~~360	2427	%		7268,~~001~~281	2524	%
Real estate – mortgage, residential		~~103~~99,~~852~~918	39	%		~~112~~103,~~984~~852	39	%		~~103~~112,~~588~~984	3439	%		68103,~~772~~588	2534	%		6468,~~334~~772	2225	%
Consumer installment loans		21,~~145~~543	1	%		32,~~293~~145	1	%		53,~~223~~293	21	%		25,~~626~~223	12	%		32,~~339~~626	1	%
Other		~~207~~158	—	%		~~145~~207	—	%		~~112~~145	—	%		~~1,157~~112	—	%		~~983~~1,157	—	%
	$	~~267~~254,~~600~~667			$	~~289~~267,~~659~~600			$	~~304~~289,~~419~~659			$	~~281~~304,~~291~~419			$	~~291~~281,~~820~~291

	Loans on Nonaccrual as of December 31,
(In thousands)	~~2010~~2011				~~2009~~2010				~~2008~~2009				~~2007~~2008				~~2006~~2007
Commercial and financial	$	5179	—1	%	$	405	—	%	$	340	—	%	$	—3	—	%	$	49—	57—	%
Agricultural		~~151~~—	1—	%		~~319~~151	21	%		~~326~~319	2	%		—326	—2	%		—	—	%
Real estate – construction, commercial		98,~~112~~705	4155	%		69,~~836~~112	5041	%		146,~~479~~836	8050	%		114,~~498~~479	7480	%		—1,498	—74	%
Real estate – construction, residential		7573	—	%		~~526~~75	4—	%		~~249~~526	14	%		—249	—1	%		—	—	%
Real estate – mortgage, farmland		—	—	%		—	—	%		—	—	%		—	—	%		—	—	%
Real estate – mortgage, commercial		45,~~284~~035	1932	%		24,~~831~~284	2119	%		2,~~424~~831	1321	%		~~502~~2,424	2513	%		—502	—25	%
Real estate – mortgage, residential		81,~~673~~922	3912	%		38,~~198~~673	2339	%		~~718~~3,198	423	%		—718	—4	%		—	—	%
Consumer installment loans		223	—	%		42	—	%		144	—	%		1814	1—	%		3718	431	%
Other		—	—	%		—	—	%		—	—	%		—	—	%		—	—	%
	$	2215,~~302~~937			$	1322,~~754~~302			$	1813,~~213~~754			$	218,~~018~~213			$	862,018

~~As of December 31, 2010, maturities of loans in the indicated classifications were as follows:~~44

(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, 2011, 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	$	25,267	$	16,658	$	8,760	$	5,597	$	56,282
1 to 5 years		19,228		32,487		16,744		9,197		77,656
Over 5 years		6,868		37,501		74,414		1,946		120,729
Totals	$	51,363	$	86,646	$	99,918	$	16,740	$	254,667

As of December 31, ~~2010~~2011, the interest terms of loans in the indicated classification for the indicated maturity ranges are as follows:

(In thousands)

Fixed Interest Rates

~~Fixed Interest Rates~~

Variable Interest Rates

~~Variable Interest Rates~~

Total

~~Total~~

Real estate – construction

Within 1 year

2220,~~095~~084

35,~~583~~183

25,~~678~~267

1 to 5 years

2016,~~009~~349

62,~~630~~879

2619,~~639~~228

Over 5 years

31,~~881~~756

75,~~169~~112

116,~~050~~868

Real estate – mortgage, commercial

Within 1 year

2114,~~143~~208

~~865~~2,450

2216,~~008~~658

1 to 5 years

3130,~~373~~359

32,~~481~~128

3432,~~854~~487

Over 5 years

5,~~598~~397

2532,~~298~~104

3037,~~896~~501

Real estate – mortgage, residential

Within 1 year

137,~~047~~983

~~1,528~~777

148,~~575~~760

1 to 5 years

1411,~~898~~971

34,~~242~~773

1816,~~140~~744

Over 5 years

2919,~~400~~302

4155,~~737~~112

7174,~~137~~414

All other loans

Within 1 year

5,~~263~~345

~~575~~252

5,~~838~~597

1 to 5 years

38,~~921~~095

~~340~~1,102

49,~~261~~197

Over 5 years

~~246~~490

21,~~278~~456

21,~~524~~946

~~170~~141,~~874~~339

96113,~~726~~328

~~267~~254,~~600~~667

Risk Elements in the Loan Portfolio

As addressed above, loans on nonaccrual status ~~increased~~decreased by $86,~~548~~365,000, or 6228.25%, from $1322,~~754~~302,000 at December 31, ~~2009~~2010 to $2215,~~302~~937,000 at December 31, ~~2010~~2011. 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~~2011				December 31, 2010			~~December 31, 2009~~
Commercial and financial	$	54,~~413~~827	10	%	9$	%5,413	9	$%	~~6,330~~	7	%
Real estate – construction, commercial		2214,~~407~~901	30	%	37	%22,407	37	%	~~30,230~~	35	%
Real estate – construction, residential		2,~~097~~691	5	%	4	%2,097	4	%	~~6,872~~	8	%
Real estate – mortgage, commercial		1110,~~026~~143	21	%	18	%11,026	18	%	~~15,899~~	19	%
Real estate – mortgage, residential		1916,~~136~~597	34	%	31	%19,136	31	%	~~24,481~~	29	%
Consumer installment loans		~~712~~128	––	%	1	%712	1	%	~~1,402~~	2	%
Other		~~156~~105	––	%	––	%156	––	%	~~145~~	––	%
	$	6049,~~947~~392			$	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, 2011
(In thousands)	Florida		Georgia		South Carolina		Other
Commercial and financial	$	5,760	$	1,329	$	7,790	$	160
Agricultural		––		––		––		––
Real estate – construction, commercial		12,400		6,157		19,276		1,928
Real estate – construction, residential		3,696		2,114		5,560		232
Real estate – mortgage, commercial		34,962		12,888		36,781		2,015
Real estate – mortgage, residential		37,042		23,059		30,989		8,828
Consumer installment loans		507		327		684		25
Other		––		155		3		––
	$	94,367	$	46,029	$	101,083	$	13,188

	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~~2011, the Company held $2321,~~418~~470,000 of loans secured by junior liens, which ~~represents~~represented approximately 8.84% of the total net ~~portfolio~~loan ~~of loans~~portfolio. ~~Historical~~Net ~~loss experience as measured by net~~ loan charge -offs was $~~414~~232,000 in the year ended December 31, ~~2010~~2011 for all loans secured by junior liens for an annualized loss rate of 1.81%. At December 31, ~~2009~~2010, the Company held $2223,~~588~~418,000 of loans secured by junior liens, which ~~represented~~represents approximately 78.8% of the total net ~~loan~~ portfolio of loans. ~~Net~~Historical loss experience as measured by net loan charge- offs was $~~561~~414,000 in the year ended December 31, ~~2009~~2010 for all loans secured by junior liens for an annualized loss rate of 21.58%.

High Loan -to-value ~~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~~renewal 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~~2011 the loan portfolio included 2939 loans with aan aggregate balance of $1012,~~855~~661,000, or 45.10% of the net loan portfolio, with LTV ratios in excess of 100%. At December 31, ~~2009~~2010 the loan portfolio included 2229 loans with aan aggregate balance of $10,~~244~~855,000, or 34.51% 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.46

~~The~~Restructured ~~first~~Loans ~~category~~– isHistorically, ~~identified~~the asCompany ~~performing~~has ~~restructured~~followed ~~loans,~~a ~~which~~conservative ~~includes~~approach ~~loans~~by ~~that~~classifying ~~are~~any onloan ~~accrual~~as ~~status~~restructured ~~because~~whenever ~~they~~the terms of a loan were ~~current~~adjusted orto ~~less~~the ~~than~~benefit 90of ~~days~~any ~~past~~borrower ~~due~~in financial distress, regardless of the status of the loan at the time of ~~restructure~~restructuring. In ~~many~~some cases ~~the~~we ~~borrower~~have ~~has~~restructured ~~never~~loans ~~been~~for borrowers who were not delinquent, but for various reasons isthese borrowers were experiencing financial distress that ~~raises~~raised a doubt about ~~the~~their ~~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~~the loan will avoid a future default. ~~For~~In ~~regulatory~~other ~~purposes,~~cases ~~these~~we ~~loans~~have ~~are~~restructured ~~only~~loans ~~reported~~for asborrowers ~~restructured~~who ~~during~~were ~~the~~in ~~fiscal~~default ~~year~~at inthe ~~which~~time the ~~restructure~~loan ~~occurred,~~terms ~~after~~were ~~which~~restructured. The ~~the~~expectation ~~designation~~is asthat aby ~~restructured~~adjusting ~~loan~~the isterms ~~removed~~of ~~provided~~such loans, the borrower ismay ~~paying~~begin into ~~accordance~~make ~~with~~payments again based on the ~~restructured~~improved loan terms.

49The types of changes that are made for troubled borrowers to restructure their obligations include the following:

~~Although~~· ~~our~~Deferral 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~~or ~~due~~more ~~restructured~~scheduled loan ~~with~~payments ato ~~balance of $373,000, and 13 nonperforming restructured loans with~~ a ~~balance~~future 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.date

~~Criticized~~· orTemporary 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~~permanent ~~weakness~~reduction 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~~loan ~~had~~interest ~~$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.~~rate

·	Conversion from principal and interest payment term to an interest only payment term on a temporary basis, or until maturity

·	Forgiveness of accrued but uncollected interest

·	Extension of loan maturity date

·	Reduction in principal due under the loan agreement

The potential financial effects of restructuring troubled debts includes a reduction in the level of interest income collected, a complete loss of interest income, or a loss of some portion of the original loan principal. All troubled debt restructurings are tested for impairment. If a loan is considered to be collateral dependent, the measurement of impairment is based on the fair value of the collateral, net of estimated liquidation costs. If the loan is not considered to be collateral dependent, the present value of expected cash flows is used to determine any amount of impairment. Any impairment is then charged to the allowance for loan and lease losses or designated as a specific reserve, and as such will be considered as a component of the reserve calculation.

For regulatory purposes, in 2010 and prior years, restructured loans that were accruing interest (not on nonaccrual status) would be reported as performing restructured loans until the end of the fiscal year in which the restructure occurred. At the beginning of the following fiscal year, the “restructured” designation for these performing restructured loans was removed, provided the borrower was paying in accordance with the restructured loan terms and the loan had a market rate of interest.

Recent interpretations of the topic of restructured loans by the Company’s primary regulator effectively prohibit the practice of removing the “restructured” designation from any restructured loan during the life of the loan, beginning with the third quarter of 2011. For 2011 and later, all restructured loans will continue to be reported as restructured, even if (1) the underlying conditions that resulted in the borrower’s financial distress were cured, (2) the loan terms were modified back to current fair value levels, (3) the loan is current and accruing interest, and (4) the borrower has not missed a payment since the loan was restructured. As a result, expectations are that the level of restructured loans will continue to increase in the future.

The following table provides a summary of all loans that are currently designated as restructured for regulatory purposes.

	December 31, 2011						December 31, 2010
Troubled debt restructurings	Number of loans		Recorded Investment		Unpaid Principal Balance		Number of loans		Recorded Investment		Unpaid Principal Balance
Commercial, financial & agricultural		2	$	342,917	$	342,917		1	$	481,250	$	481,250
Real estate – construction		9		6,342,581		6,639,087		12		6,026,819		6,254,777
Real estate – mortgage		13		5,062,359		5,189,288		14		9,849,187		10,209,623
Total troubled debt restructurings		24	$	11,747,857	$	12,171,292		27	$	16,357,256	$	16,945,650

Of the 27 loans totaling $16,357,000 reported as restructured as of December 31, 2010, there were 7 loans with a total balance of $3,345,000 that were no longer reported as restructured effective January 1, 2011. The loans are no longer reported as restructured because they were accruing interest, they were in compliance with the restructured loan terms and they yielded a market rate of interest at the time of restructure.

The following table provides the payment status as of December 31, 2011 and December 31, 2010 of all loans that were restructured in the twelve month periods ending on those respective dates.

	December 31, 2011				December 31, 2010
	Number of loans		Recorded Investment		Number of loans		Recorded Investment
Restructured loans less than 30 days past due
Commercial, financial & agricultural		2	$	347,917		––	$	––
Real estate – construction		2		1,173,839		6		1,392,693
Real estate – mortgage		2		605,321		6		3,723,324
Total restructured loans less than 30 days past due		6	$	2,122,077		12	$	5,116,017
Restructured loans 30 days or more past due
Real estate – construction		1		53,118		––		––
Total restructured loans 30 days or more past due		1	$	53,118		––	$	––
Restructured loans on nonaccrual
Real estate – construction		––		––		2		1,816,869
Real estate – mortgage		6		3,576,390		4		990,820
Total restructured loans on nonaccrual		6	$	3,576,390		6	$	2,807,689

Loans classified as Special Mention or Substandard – 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 classified as special mention or substandard 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, 2011, the Company had $38,537,000 in loans that were internally classified as Special Mention or Substandard, of which $28,141,000, or 73%, were either current or less than 30 days past due. At December 31, 2010, the Company had $51,072,000 in loans that were internally classified as Special Mention or Substandard, of which $34,437,000, or 67%, 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~~2011		September 30, ~~2010~~2011		June 30, ~~2010~~2011		March 31, ~~2010~~2011		December 31, ~~2009~~2010		September 30, ~~2009~~2010		June 30, ~~2009~~2010		March 31, ~~2009~~2010
Portfolio loans, gross	$	~~267~~254,~~600~~667	$	~~277~~260,~~611~~789	$	~~284~~259,~~604~~561	$	~~285~~263,~~972~~596	$	~~289~~267,~~659~~600	$	~~299~~277,~~270~~611	$	~~305~~284,~~669~~604	$	~~305~~285,~~240~~972
Loans past due > 30 days and still accruing interest	$	21,~~135~~142	$	~~6,063~~844	$	41,~~884~~950	$	52,~~844~~063	$	2,~~032~~135	$	26,~~832~~063	$	34,~~345~~884	$	25,~~782~~844
Loans on nonaccrual	$	2215,~~302~~937	$	1922,~~998~~338	$	1625,~~666~~399	$	1220,~~992~~678	$	1322,~~754~~302	$	2319,~~903~~998	$	2516,~~925~~666	$	2412,~~336~~992
(as a % of loans, gross)		86.3326%		78.2057%		59.8379%		47.5484%		48.7533%		7.9920%		85.4883%		74.9754%
Net loan charge offs (recoveries)	$	~~535~~1,713	$	~~1,553~~846	$	~~863~~685	$	~~123~~407	$	~~2,072~~535	$	1,~~485~~553	$	~~473~~863	$	~~2,188~~123
(as a % of loans, gross)		0.2067%		0.5632%		0.3026%		0.0415%		0.7220%		0.5056%		0.1530%		0.7204%

50Loans 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 has been observed in the past 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 declined for four consecutive quarters to $844,000 at September 30, 2011, the lowest level reported in over four years, but increased to $1,142,000 at December 31, 2011. Despite the increase during the final quarter of 2011, this remains an encouraging metric. Management will continue to carefully monitor past due loans and work aggressively to manage loan delinquency levels. It is likely that the weakening loan quality that began in late 2008 will continue to be an area of concern in future periods.

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.48

~~Net~~Loans ~~loan~~on ~~charge~~nonaccrual ~~offs~~has orbeen ~~recoveries~~another ~~reflect~~leading ~~our~~indicator ~~practice~~ of ~~charging~~potential ~~recognized~~future losses tofrom ~~the~~loans. ~~allowance~~We ~~and~~typically ~~adding~~place ~~subsequent~~loans ~~recoveries~~on ~~back~~nonaccrual tostatus ~~the~~when ~~allowance~~they become 90 days past due. ~~During~~In addition to the ~~three~~interest ~~months~~lost ~~ended~~when ~~December~~a ~~31,~~loan ~~2010~~is placed on nonaccrual status, wethere ~~recorded~~is ~~charge~~an ~~offs~~increased ~~net~~probability of ~~recoveries~~a loan on nonaccrual moving into foreclosure with a potential loss outcome. Although it is not shown in the table above, the level of loans on nonaccrual peaked at $~~535~~25,925,000 at June 30, 2009. Over ~~This~~the ~~amount~~following ~~represented~~three aquarters, ~~decrease~~this ofmeasure declined by 50% to $112,~~018~~992,000 at the end of the first quarter of 2010. However, orsince ~~66%~~March ~~from~~31, 2010, we experienced three consecutive quarters of deterioration with the level of loans on nonaccrual increasing to $122,~~553~~302,000 inat ~~net~~December ~~charge~~31, ~~offs~~2010. The ~~recorded~~level ~~during~~of nonaccrual loans in 2011 declined in the ~~prior~~first quarter, ~~ended~~rose ~~September~~in ~~30,~~the ~~2010~~second quarter, and adeclined ~~decrease~~again in the third and fourth quarters, with the result that loans on nonaccrual at December 31, 2011 of $115,~~537~~937,000, orwere ~~74%~~lower ~~from~~than the level of loans on nonaccrual at the end of 2010 by $26,~~072~~365,000, ~~net~~or ~~charge~~29%. Changes ~~offs~~in this asset quality indicator during 2011 do not appear to indicate broad portfolio deterioration, but reflects the ~~same~~impact of two large relationships going into default during the second quarter of 2011. Regardless, management remains vigilant in ~~the~~its ~~prior~~loan ~~year~~monitoring and loss mitigation efforts.

~~Prior~~Net toloan ~~the fourth fiscal quarter of 2008, we had very little~~ charge ~~off~~offs ~~activity,~~or ~~and~~recoveries ~~therefore,~~reflect ~~have~~our ~~little~~practice ~~historical~~of ~~information~~charging ~~upon~~recognized ~~which~~losses to ~~base~~the ~~our~~allowance ~~current~~and ~~estimates.~~adding ~~Accordingly,~~subsequent werecoveries ~~continue~~back to ~~assess~~ the ~~implications of trends in recent charge off activity on potential future losses~~allowance. ~~The~~During ~~recent~~the ~~volatility~~three inmonths ~~the~~ended ~~level~~December of31, ~~quarterly~~2011, ~~net~~we ~~loan~~recorded charge offs ornet of recoveries ~~makes~~of it$1,713,000. ~~difficult~~This toamount ~~identify~~represented aan ~~specific~~increase ~~trend~~of $867,000, or ~~establish~~102%, ~~reliable~~from ~~future~~the ~~expectations. As a result~~$846,000 ~~there~~in ~~can~~net ~~be no assurance that~~ charge offs ofrecorded ~~loans~~during ~~in future periods will not increase or exceed~~ the ~~allowance~~prior ~~for~~quarter ~~loan~~ended ~~losses~~September as30, ~~estimated~~2011, atand ~~any~~an ~~point~~increase inof ~~time~~$1,178,000, or ~~that~~220% ~~provisions~~from ~~for~~the ~~loan losses will not be significant to a particular accounting period. Thus~~$535,000 ~~there~~net ischarge aoffs ~~risk~~during ~~that~~the ~~substantial~~same ~~additional~~quarter ~~increases~~ in the ~~allowance~~prior ~~for loan losses could be required, which would result in a decrease in our net income and possibly our capital~~year.

InPrior ~~addition~~ to ~~considering~~ the ~~metrics~~fourth ~~described~~fiscal ~~above~~quarter of 2008, we ~~evaluate~~had ~~the~~very ~~collectability~~little ofcharge ~~individual~~off ~~loans~~activity and therefore, ~~the~~had ~~balance~~limited ofhistorical ~~impaired~~information ~~loans,~~upon ~~economic~~which ~~conditions~~to ~~that~~base ~~may~~past ~~affect~~estimates. ~~the~~Accordingly, ~~borrower’s~~we ~~ability~~continue to ~~repay,~~assess the ~~amount~~implications ~~and~~of ~~quality~~trends ofin ~~collateral~~recent ~~securing~~charge ~~the~~off ~~loans~~activity ~~and~~on apotential ~~review~~future losses. The recent volatility in the level of quarterly net loan charge offs or recoveries makes it difficult to identify a specific ~~problem~~trend ~~loans~~or establish reliable future expectations. ~~Based~~As ona ~~this~~result, ~~process~~there ~~and~~can asbe ~~shown~~no ~~below,~~assurance ~~the~~that ~~provision~~charge ~~charged~~offs toof ~~expense~~loans ~~was~~in ~~$250,000~~future ~~for~~periods ~~the~~will ~~three~~not ~~months~~increase ~~ended~~or ~~December~~exceed ~~31,~~the ~~2010,~~allowance for loan losses as ~~compared~~estimated toat ~~$2,125,000~~any ~~for~~point ~~the~~in ~~three~~time ~~months~~or ~~ended~~that ~~December~~provisions ~~31,~~for ~~2009.~~loan Onlosses will not be significant to a ~~consecutive~~particular ~~quarter~~accounting ~~basis~~period. Thus, ~~this~~there ~~provision~~is ~~level~~a ~~was~~risk ~~$1,111,000,~~that orsubstantial ~~82%,~~additional ~~lower~~increases ~~than~~in the $1allowance for loan losses could be required,~~361,000~~ ~~provision~~which ~~charged~~would toresult ~~expense~~in ~~during~~a ~~the~~decrease ~~quarter~~in ~~ended~~our ~~September~~net ~~30,~~income ~~2010~~and possibly our capital.

(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%

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 $1,150,000 for the three months ended December 31, 2011, as compared to $250,000 for the three months ended December 31, 2010. On a consecutive quarter basis, this provision level was $447,000, or 64%, higher than the $703,000 provision charged to expense during the quarter ended September 30, 2011.

(In thousands)	December 31, 2011		September 30, 2011		June 30, 2011		March 31, 2011		December 31, 2010			September 30, 2010			June 30, 2010			March 31, 2010
Provision during quarter ended	$	1,150	$	703	$	497	$	515	$	250		$	1,361		$	685		$	400

Provision added in excess of net charge offs	$	(563)	$	(143)	$	(188)	$	108	$	(285	)	$	(192	)	$	(178	)	$	277

Allowance for loan losses	$	5,222	$	5,785	$	5,928	$	6,116	$	6,008		$	6,293		$	6,485		$	6,663
(as a % of loans, gross)		2.05%		2.22%		2.28%		2.32%		2.25%			2.27%			2.28%			2.33%

~~From~~The adifference ~~historical~~between ~~perspective, prior to 2008, while~~ the ~~level~~amount of ~~loans~~the onprovision ~~nonaccrual~~for ~~was~~loan ~~relatively~~losses ~~stable,~~and ~~the~~net ~~allowance for~~ loan ~~losses~~charge ~~was~~offs ~~maintained~~will result in ~~the~~expansion ~~range~~or ofshrinkage ~~1.2%~~ to ~~1.3%~~the level of the ~~balance~~allowance offor ~~gross~~loan ~~loans~~losses. As weshown ~~moved~~above, ~~into~~during ~~2008~~the ~~and~~three ~~experienced~~months anended ~~increase~~December ~~in loans on nonaccrual~~31, it2011 ~~was~~the ~~determined~~current ~~that~~provision anfor ~~increase~~loan tolosses ~~the~~of ~~allowance~~$1,150,000 ~~level~~ was ~~appropriate~~less ~~given~~than ~~the~~net ~~projected~~charge ~~increased~~offs ~~risk~~against ~~of loss, and so~~ the allowance ~~was increased to a range~~ of $1~~.4%~~,713,000 toby 1$563,000.6% The ~~during~~result ~~2008.~~was ~~The~~a ~~weakening~~decrease ofto the ~~loan~~allowance ~~portfolio~~for ~~performance~~loan ~~continued~~losses ~~into~~by ~~2009 with actual loss levels that exceeded projections from earlier in 2008~~$563,000 ~~resulting in the decision~~ to ~~increase~~a ~~the allowance~~ level ~~further, to the range~~ of ~~1.6%~~$5,222,000, toor 12.805% inof ~~early~~gross ~~2009. With nonaccrual~~ loans ~~reaching~~outstanding aat ~~peak~~December in31, ~~mid-2009~~2011, ~~further~~as ~~analysis~~compared ~~and projections of potential loan losses in the Bank’s existing portfolio supported a further increase in the allowance level~~ to a$6,008,000, ~~range~~or of 2.025% ~~to 2.3%~~ of gross loans outstanding, ~~which~~at ~~has~~December ~~been~~31, ~~sustained over the last seven fiscal quarters~~2010.

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, 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 two years. Management believes that the changes in the level of the allowance for loan losses is directionally consistent with the trends observed in the various asset quality metrics discussed above.

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~~collateral ~~loan~~type ~~category~~ and by geographic exposure as shown on the following tables:

	December 31, 2010
	Book Value of Other Real Estate at December 31, 2011
(In thousands)	Florida		Georgia		South Carolina		Total
Real estate – construction, commercial	$	1,001	$	272	$	1,557	$	2,830
Residential	$	1,524	$	559	$	3,063	$	5,146
Real estate – construction, residential		1,134		984		1,254		3,372
Commercial		868		473		3,619		4,960
Real estate – mortgage, commercial		3,422		2,744		825		6,991
Finished lots		950		––		1,612		2,562
Real estate – mortgage, residential		1,009		––		250		1,259
Raw land		2,013		526		217		2,756
	$	65,~~566~~355	$	41,~~000~~558	$	38,~~886~~511	$	1415,~~452~~424

	December 31, 2009
	Number of Parcels at December 31, 2011
(In thousands)	Florida		Georgia		South Carolina		Total
	Florida		Georgia		South Carolina		Total
Real estate – construction, commercial	$	997	$	––	$	208	$	1,205
Residential		11		3		35		49
Real estate – construction, residential		7,266		5,370		1,492		14,128
Commercial		5		1		16		22
Real estate – mortgage, commercial		567		––		808		1,375
Finished lots		17		––		89		106
Real estate – mortgage, residential		305		391		772		1,468
Raw land		6		2		3		11
	$	9,135	$	5,761	$	3,280	$	18,176
		39		6		143		188

	December 31, 2008
	Book Value of Other Real Estate at December 31, 2010
(In thousands)	Florida		Georgia		South Carolina		Total
Real estate – construction, commercial	$	1,308	$	1,482	$	922	$	3,712
Residential	$	1,893	$	1,897	$	898	$	4,688
Real estate – construction, residential		55		––		––		55
Commercial		1,646		984		1,608		4,238
Real estate – mortgage, commercial		––		––		422		422
Finished lots		1,360		315		1,300		2,975
Real estate – mortgage, residential		––		––		1,562		1,562
Raw land		1,166		1,185		200		2,551
	$	16,~~363~~065	$	14,~~482~~381	$	24,~~906~~006	$	514,~~751~~452

	Number of Parcels at December 31, 2010
	Florida		Georgia		South Carolina		Total
Residential		14		8		4		26
Commercial		5		1		5		11
Finished lots		19		18		13		50
Raw land		4		3		1		8
		42		30		23		95

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.

	Book Value of Other Real Estate at December 31, 2009
(In thousands)	Florida		Georgia		South Carolina		Total
Residential	$	5,612	$	4,671	$	839	$	11,122
Commercial		1,324		––		741		2,065
Finished lots		1,202		443		1,980		3,625
Raw land		1,124		––		240		1,364
	$	9,262	$	5,114	$	3,800	$	18,176

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.50

	Number of Parcels at December 31, 2009
	Florida		Georgia		South Carolina		Total
Residential		16		15		5		36
Commercial		2		––		2		4
Finished lots		14		18		15		47
Raw land		2		––		1		3
		34		33		23		90

During the year ended December 31, 2011 we sold a total of 55 other real estate owned properties with a total book value of $9,591,000. The net proceeds from these sales were $8,146,000, which resulted in a net recovery of approximately 55.2% of the original loan amounts and 84.9% of the book value of the other real estate sold. 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.

Investment Securities

Investment securities decreased to $3922,~~720~~506,000 at December 31, ~~2010~~2011 from $6239,~~515~~720,000 at December 31, ~~2009~~2010.

The following table presents the investments by category:

	December 31,
	2010				2009				2008
	2011				2010				2009
(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	$	1,800	$	1,920	$	7,132	$	6,977	$	10,185	$	10,370
State and municipal securities		7,132		6,977		10,185		10,370		16,956		16,573
Mortgage-backed securities		19,798		20,586		29,862		30,743		48,558		50,145
Mortgage-backed securities		29,862		30,743		48,558		50,145		63,494		64,363
	$	21,598	$	22,506	$	36,994	$	37,720	$	58,743	$	60,515
	$	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~~057	$	32,~~023~~000	$	32,~~024~~095
	$	~~2,000~~—	$	~~2,057~~—	$	2,000	$	2,~~095~~057	$	32,~~023~~000	$	32,~~024~~095

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
Maturities at December 31, 2011 (In thousands)	State and Municipal Securities		Weighted Average Yields			Mortgage- Backed Securities		Weighted Average Yields
Within 1 year	$	—275		—3.59	%	$	91,~~278~~034		43.7297	%	$	~~2,000~~		~~6.05~~	%
After 1 through 5 years		~~1,303~~—		~~3.47~~—	%		17,~~418~~394		3.3991	%		—		—
After 5 through 10 years		21,~~573~~110		34.9630	%		~~2,254~~—		~~2.87~~—	%		—		—
After 10 years		~~3,101~~535		4.1718	%		12,~~793~~158		54.0507	%		—		—
Totals	$	61,~~977~~920		34.9616	%	$	3020,~~743~~586		3.8593	%	$	~~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.

5351

Deposits

Total deposits ~~decreased~~increased by $228,~~831~~621,000, or 62%, to a total of $~~346~~354,~~050~~671,000 at December 31, ~~2010~~2011 from $~~368~~346,~~881~~050,000 at December 31, ~~2009~~2010. Noninterest-bearing demand deposits increased $1,~~172~~528,000, or 78%, while interest-bearing deposits ~~decreased~~increased $247,~~003~~093,000, or 72%. 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, 2011
(In thousands)	Core Retail Deposits		Core Reciprocal Deposits		Brokered Deposits		Total Deposits
Noninterest-bearing demand deposits	$	20,476	$	––	$	––	$	20,476
Interest-bearing demand deposits		114,919		––		––		114,919
Savings deposits		4,569		––		––		4,569
Certificates of deposit $100,000 and over		104,110		28,273		––		132,383
Other time deposits		57,195		1,252		23,877		82,324
	$	301,269	$	29,525	$	23,877	$	354,671

	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,	~~December 31,~~
		2010						2009						2008
	2011						2010						2009
(In thousands)	Amount	~~Amount~~		Rate			Amount	~~Amount~~		Rate			Amount	~~Amount~~		Rate
Noninterest-bearing demand		$	20,~~187~~595		—	%		$	1920,~~216~~187		—	%		$	2319,~~134~~216		—	%
Interest-bearing demand			~~117~~116,~~991~~280		10.1183	%			~~103~~117,~~640~~991		1.5011	%			98103,~~889~~640		21.4950	%
Savings			34,~~435~~276		0.4939	%			3,~~022~~435		0.5049	%			3,~~006~~022		0.5250	%
Time			~~216~~192,~~298~~284		21.0547	%			~~248~~216,~~386~~298		32.0105	%			~~228~~248,~~355~~386		43.4301	%
Total		$	~~357~~333,~~911~~435					$	~~374~~357,~~264~~911					$	~~353~~374,~~384~~264

Maturities of time certificates of deposit of $100,000 or more outstanding at December 31, ~~2010~~2011 are summarized as follows:

(In thousands)
Within 3 months	$	2522,~~441~~494
After 3 through 12 months	6467,~~926~~202
1 through 3 years	2236,~~414~~717
After 3 years	5,~~124~~970
Total	$	~~117~~132,~~905~~383

Other Borrowings

Other Borrowings of $3768,~~000~~447,000 at December 31, ~~2010~~2011 are composed of advances from the Federal Home Loan Bank of Atlanta (FHLB), and represent aan ~~decrease~~increase from $4537,~~237~~000,000 at December 31, ~~2009~~2010. At December 31, ~~2010~~2011 the Bank has pledged $98128,~~499~~017,000 of its portfolio loans and loans available for sale to the FHLB and can borrow up to $5393,~~666~~420,000 on such collateral. The Bank has also pledged $4836,~~390~~007,000 of its portfolio loans to the Federal Reserve Bank of Atlanta at December 31, ~~2010,~~2011 and can borrow up to $2824,~~267~~500,000 on such collateral at the Discount Window. At December 31, ~~2009~~2010 the Bank pledged $~~110~~98,~~223~~499,000 of its portfolio loans to FHLB and could borrow up to $6053,~~271~~666,000 on such collateral. The Bank had also pledged $5548,~~240~~390,000 of its portfolio loans to the Federal Reserve Bank of Atlanta at December 31, ~~2009,~~2010 and could borrow up to $28,~~256~~267,000 on such collateral at the Discount Window.

During the third quarter of 2011, the Bank requested and obtained a $2 million letter of credit from the FHLB to be issued in favor of Wells Fargo Bank, a major purchaser of the Bank’s mortgage loans available for sale. Consistent with the growth in residential mortgage banking origination levels, there was an increase in the level of mandatory forward loan sale commitments between the Bank and Wells Fargo Bank. As a result, Wells Fargo was exposed to an increasing level of credit risk in the event that the Bank failed to deliver loans for sale under these commitments, and so a letter of credit was required to mitigate that credit risk. While this letter of credit had no impact on the level of borrowings outstanding, it is collateralized by loans and securities pledged to the FHLB, and as such it has reduced the Bank’s borrowing capacity with the FHLB by $2 million.

Junior Subordinated Debentures

In May 2004, Coastal Banking Company Statutory Trust I issued $3.0 million of trust preferred securities with a maturity of July 23, 2034. The proceeds from the issuance of the trust preferred securities were used by the Trust to purchase $3,093,000 of the Company’s junior subordinated debentures, which pay interest at a floating rate equal to 3 month LIBOR plus 275 basis points. The Company used the proceeds from the sale of the junior subordinated debentures for general purposes, primarily to provide capital to the Bank. The debentures represent the sole asset of the Trust.

In June 2006, Coastal Banking Company Statutory Trust II issued $4.0 million of trust preferred securities with a maturity of September 30, 2036. The proceeds from the issuance of the trust preferred securities were used by the Trust to purchase $4,124,000 of the Company’s junior subordinated debentures, which pay interest at a ~~fixed~~floating rate ~~of 7.18% until September 30, 2011 and a variable rate thereafter~~ equal to 3 month LIBOR plus 160 basis points. The Company used the proceeds from the sale of the junior subordinated debentures for general purposes, primarily to provide capital to the Bank. The debentures represent the sole asset of the Trust.

Pursuant to the terms of the junior subordinated debentures held by Coastal Banking Company Statutory Trust I and Coastal Banking Company Statutory Trust II, the Company has the option to defer distributions on such securities at any time, and from time to time, for a period not to exceed twenty consecutive quarters. During the fourth quarter of 2010, the Company elected to defer the interest payments on its trust preferred securities. Furthermore, pursuant to the terms of the MOU, the Company is prohibited from paying interest on its trust preferred securities absent prior written approval from the Federal Reserve Bank of Richmond.53

55Pursuant to the terms of the junior subordinated debentures held by Coastal Banking Company Statutory Trust I and Coastal Banking Company Statutory Trust II, the Company has the option to defer distributions on such securities at any time, for a period not to exceed twenty consecutive quarters. During the fourth quarter of 2010, the Company elected to defer the interest payments on its trust preferred securities. Furthermore, pursuant to the terms of the MOU, the Company is prohibited from paying interest on its trust preferred securities absent prior written approval from the Federal Reserve Bank of Richmond.

Capital Resources

Total shareholders’ equity ~~decreased~~increased from $3733,~~902~~035,000 at December 31, ~~2009~~2010 to $33,~~035~~162,000 at December 31, ~~2010~~2011. Net ~~loss~~income for the period ~~reduced~~increased equity by $3357,~~807,~~000. InThis ~~addition,~~increase was offset by a decrease of $~~690~~497,000 ~~resulted~~ from the ~~decrease~~accrual inof ~~fair~~preferred ~~market~~stock ~~value~~dividends. In ofaddition, ~~investment~~stock ~~securities~~based ~~available~~compensation ~~for~~increased ~~sale~~equity ~~during~~by ~~2010~~$148,000, ~~net~~and ofother ~~tax~~comprehensive income increased equity by $119,000.

Bank holding companies, including the Company, and their banking subsidiaries are required by banking regulators to meet particular minimum levels of capital adequacy, which are expressed in the form of certain ratios. Capital is separated into Tier 1 capital (essentially common shareholders’ equity and a limited amount of trust preferred securities less intangible assets) and Tier 2 capital (essentially the allowance for loan losses limited to 1.25% of risk-weighted assets). The first two ratios, which are based on the degree of credit risk in our assets, provide the weighting of assets based on assigned risk factors and include off-balance sheet items such as loan commitments and stand-by letters of credit. The ratio of Tier 1 capital to risk-weighted assets must be at least 4.0% and the ratio of total capital (Tier 1 capital plus Tier 2 capital) to risk-weighted assets must be at least 8.0% to be adequately capitalized. The capital leverage ratio supplements the risk-based capital guidelines. Banks and bank holding companies are required to maintain a minimum ratio of Tier 1 capital to adjusted quarterly average total assets of 4.0% to be adequately capitalized.

The following table summarizes the Company’s capital ratios at December 31, ~~2010~~2011 and ~~2009~~2010, respectively:

	December 31, 2010			December 31, 2009
	December 31, 2011			December 31, 2010
Tier 1 capital (to risk-weighted assets)		1315.8621	%		1413.0386	%
Total capital (to risk-weighted assets)		1516.1347	%		15.2813	%
Tier 1 capital (to total average assets)		8.9646	%		98.3696	%

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.

See Note 1718 of the footnotes to the consolidated financial statements at December 31, ~~2010~~2011 included elsewhere in this annual report for a detail of the Bank’s and Company’s equity and capital positions.

Liquidity

The Bank must maintain, on a daily basis, sufficient funds to cover the withdrawals from depositors’ accounts and to supply new borrowers with funds. To meet these obligations, the Bank keeps cash on hand, maintains account balances with its correspondent banks, and purchases and sells federal funds and other short-term investments. Asset and liability maturities are monitored in an attempt to match the maturities to meet liquidity needs. It is the policy of the Bank to monitor its liquidity to meet regulatory requirements and local funding requirements.

The Bank maintains relationships with correspondent banks that can provide funds on short notice, if needed. Presently, the Bank has arrangements with commercial banks for short term unsecured advances of overnight borrowings of up to $1522,~~000~~400,000, in addition to up to $4,000,000 available for ~~day~~daylight ~~light~~ overdraft. The Bank also has reverse repurchase accommodations with a term of up to one month for a maximum advance of $5025 million, limited by the amount of eligible securities pledged, which was $288.8 million at December 31, ~~2010~~2011. The reverse repurchase agreements are committed borrowing facilities granted by other commercial banks and are secured by securities in the Bank’s investment portfolio.

The amount due from commercial banks on loan sales is another source of short term liquidity available to the Bank. When residential mortgage loans are shipped to other commercial banks for sale under the terms of forward sale commitments, the gain or loss on sale is immediately recognized under trade date accounting rules, and a loan sales receivable balance is established in other assets. At December 31, 2010, the balance of the loan sales receivable was $31.5 million, of which approximately 83% was received as cash payments within 31 calendar days. As such, these funds represent another source of quickly available liquidity to either fund new residential loan originations or repay borrowings.54

56The amount due from commercial banks on loan sales is another source of short term liquidity available to the Bank. When residential mortgage loans are shipped to other commercial banks for sale under the terms of forward sale commitments, the gain or loss on sale is immediately recognized under trade date accounting rules, and a loan sales receivable balance is established in other assets. At December 31, 2011, the balance of the loan sales receivable was $126.6 million, of which approximately 73% was received as cash payments within 31 calendar days. As such, these funds represent another source of quickly available liquidity to either fund new residential loan originations or repay borrowings.

Cash and due from banks as of December 31, ~~2010~~2011 totaled $13,~~823~~611,000, aan ~~decrease~~increase of $~~856~~1,788,000 from December 31, ~~2009~~2010. Cash used by operating activities totaled $959,~~223~~862,000 in ~~2010~~2011, while inflows from investing activities totaled $3912,~~447~~816,000. Investing inflows were attributable to sales, calls and maturities of investment securities totaling $3718,~~373~~296,000, ~~combined~~offset ~~with~~by a net ~~decrease~~increase in loans totaling $103,~~480~~205,000~~, and proceeds from redemption of bank owned life insurance policies totaling $5,581,000~~. ~~These inflows were offset by purchases of securities totaling $14,836,000.~~

During ~~2010~~2011, we had net cash ~~used~~provided of $3148,~~080~~834,000 infrom financing activities. Financing activities included net ~~decrease~~increase in deposits of $228,~~830~~621,000, combined with ~~repayments~~net ofincrease in borrowings of $831,~~250~~447,000.

Off -Balance Sheet Commitments

We are a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments consist of commitments to extend credit, standby letters of credit, and loans sold with representations and warranties. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Standby letters of credit are written conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. A commitment involves, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. Our exposure to credit loss in the event of non-performance by the other party to the instrument is represented by the contractual notional amount of the instrument.

Since certain commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. We use the same credit policies in making commitments to extend credit as we do for on-balance sheet instruments. Collateral held for commitments to extend credit varies but may include accounts receivable, inventory, property, plant, equipment, and income-producing commercial properties.

Loans on one-to-four family residential mortgages originated by us are sold to various other financial institutions with representations and warranties that are usual and customary for the industry. In addition to these representations and warranties, our loan sale contracts define a condition in which the borrower fails to make any one of the first four loan payments within 30 days of the due date as an Early Payment Default (“EPD”). In the event of an EPD occurrence, we are required to return the premium paid by the investor for the loan as well as pay certain administrative fees. 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~~a ~~whole~~ loan repurchase related to a make whole 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.

~~The~~From the September 2007 inception of the mortgage banking division through December 31, 2011, we have sold nearly 15,700 residential mortgage loans into the secondary market with a principal balance of just over $3.3 billion. From this population of sold loans, the Bank has received notification from purchasers of ~~three~~a total of fourteen EPD claims, three in 2008, seven ~~EPD claims~~ in 2009, ~~and~~ three ~~EPD~~in ~~claims~~2010, and one in ~~2010~~2011. Beyond the initial payment to the purchasers of $7173,~~900~~700 upon receipt of the EPD claims, the maximum remaining exposure under investor claims of a representation and warranty breach would be the difference between the total loan amount and the liquidated value of the underlying collateral. In the case of our 14 EPD claims received since the inception of mortgage banking operations, the ~~total~~aggregate loan ~~amount~~balance was $2,~~318~~360,000 and consisted of 1314 single family residences. Original loan -to -value ratios ranged from 7565% to 98%, and loans with a loan -to -value ratio over 80% have a mortgage insurance policy in place. If repurchase was required in the future, management believes that the potential amount of loss would not be material and that sufficient reserves exist to fully absorb any loss. Management does not anticipate any material credit risk related to potential EPD claims on loans that have been previously sold and are no longer on the Bank’s balance sheet. Because the risk of an EPD claim only exists during the first four payments after a loan is originated, we report the total of the most recent four months mortgage banking lending volume as our off-balance sheet credit risk from EPD claims.

As discussed above, the representations and warranties in our loan sale agreements provide that we repurchase loans or indemnify the investors for losses or costs on loans we sell under certain limited conditions. Some of these conditions include underwriting errors or omissions, fraud or material misstatements by the borrower in the loan application or invalid market value on the collateral property due to deficiencies in the appraisal. From the September 2007 inception of the mortgage banking division through December 31, 2010, we have sold residential mortgage loans into the secondary market with a principal balance of approximately $2.364 billion. From this population of sold loans, we have been required to settle four make whole claims totaling $324,000, and we have repurchased one loan totaling $225,000.55

57As discussed above, the representations and warranties in our loan sale agreements provide that we repurchase loans or indemnify the investors for losses or costs on loans we sell under certain limited conditions. Some of these conditions include underwriting errors or omissions, fraud or material misstatements by the borrower in the loan application, or invalid market value on the collateral property due to deficiencies in the appraisal. From the total population of sold loans, in four years of operations we have been required to settle eight make whole claims at a cost of $946,000, and we have repurchased three loans totaling $1,084,000. The three repurchased loans are current and performing in accordance with their loan terms.

Management has recognized the potential risk from costs related to EPD claims and breaches of representations and warranties made in connection with residential loan sales. Nationally the industry has seen a significant increase in the level of loan “put backs” to lenders on the basis of representation and warranty breaches. It is noteworthy that our loan sale activity began in late 2007 at a time when underwriting requirements had changed and limited documentation loans were no longer eligible for purchase in the secondary market. Accordingly, the population of loans we have sold was underwritten based on fully documented information. While this will not eliminate all risk of repurchase or indemnification costs, we believe it significantly mitigates that risk as evidenced by the relatively insignificant level of repurchase and indemnification costs incurred to date.

In recognition of risk from potential EPD claims and breaches of representations and warranties, an indemnification reserve has been established and maintained since mortgage banking loan sales began in late 2007 to cover potential costs. We have limited history of costs incurred, so additions to the reserve are made monthly based on a percentage of loan balances sold that month. This approach recognizes that the risk of indemnification costs will rise in relation to the level of loans sold. The balance in this indemnification reserve was $~~683~~800,000 at December 31, ~~2010~~2011 and based on the Company’s modest historical loss experience and the current level of indemnification claims under review, management believes this level of reserve is adequate for potential exposure in connection with loan sale indemnification or EPD claims. However, we can provide no assurance that our methodology will not change and that the balance of this indemnification reserve will prove sufficient to cover actual costs in the future.

The Bank’s exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit, standby letters of credit, and loans sold with representations and warranties is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance- sheet instruments. In most cases, the Bank requires collateral to support financial instruments with credit risk.

The following table summarizes our off-balance- sheet financial instruments whose contract amounts represent credit risk as of December 31, ~~2010~~2011:

Commitments to extend credit	$	1715,~~527~~980,000
Standby letters of credit	$	~~347~~57,000
Loans sold with representations and warranties	$	~~426~~448,~~202~~104,000

Management is not aware of any significant concentrations of loans to classes of borrowers or industries that would be affected similarly by economic conditions. Although the Bank’s loan portfolio is diversified, a substantial portion of our borrowers’ ability to honor the terms of their loans is dependent on the economic conditions in Beaufort County, South Carolina; Nassau County, Florida; and Fulton and Thomas Counties, Georgia as well as the surrounding areas. In addition, a substantial portion of our loan portfolio is collateralized by improved and unimproved real estate and is therefore dependent on the local real estate markets.

Contractual Obligations

Summarized below are our contractual obligations as of December 31, ~~2010~~2011.

(In thousands)	Total		Less than 1 year		1 to 3 years		3 to 5 years		More than 5 years
Other borrowings	$	37,000	$	16,000	$	4,000	$	15,000	$	2,000
Other borrowings and securities sold under agreements to repurchase	$	77,213	$	60,213	$	10,000	$	5,000	$	2,000
Operating lease obligations		~~337~~608		~~227~~389		~~110~~219		––		––
Junior subordinated debentures		7,217		––		––		––		7,217
	$	4485,~~554~~038	$	1660,~~227~~602	$	410,~~110~~219	$	155,000	$	9,217

Inflation

Inflation impacts the growth in total assets in the banking industry and causes a need to increase equity capital at higher than normal rates to meet capital adequacy requirements. We cope with the effects of inflation through the management of interest rate sensitivity, by periodically reviewing and adjusting our pricing of services to consider current costs.

Selected Ratios

The following table sets out certain ratios:

	For the Years Ended December 31,
	2010			2009			2008
	2011			2010			2009
Net income (loss) to:
Average tangible shareholders’ equity		~~(11~~3.0966	)%		(4211.2809	) %		(1342.8628	) %
Average tangible assets		(0.8931	)%		(30.1889	) %		(13.1218	) %
Dividends to net income		—	%		—	%		—	%
Average equity to average tangible assets		87.1096	%		78.5110	%		87.0651	%

ITEM 7A.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS

59Not applicable.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors

and Stockholders of

Coastal Banking Company

We have audited the accompanying balance sheets of Coastal Banking Company as of December 31, ~~2010~~2011 and ~~2009~~2010, and the related statements of operations, comprehensive loss, changes in shareholders’ equity and cash flows for each of the years in the two-year period ended December 31, ~~2010~~2011. Coastal Banking Company’s management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Coastal Banking Company as of December 31, ~~2010~~2011 and ~~2009~~2010, and the results of its operations and its cash flows for each of the years in the two-year period ended December 31, ~~2010~~2011 in conformity with accounting principles generally accepted in the United States of America.

/s/ Mauldin & Jenkins, LLC

Albany, Georgia

March 1716, ~~2011~~2012

6058

COASTAL BANKING COMPANY, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

	December 31,
	2010			2009
	2011			2010
Assets
Cash and due from banks	$	13,~~823~~611,~~132~~404		$	21,~~679~~823,~~003~~132
Interest-bearing deposits in banks		~~406~~478,~~700~~763			~~707~~406,~~593~~700
Federal funds sold		~~185~~243,~~258~~046			~~539~~185,~~326~~258
Securities available for sale, at fair value		3722,~~720~~505,~~495~~649			6037,~~515~~720,~~592~~495
Securities held to maturity, at cost		~~2,000,000~~—			2,000,000
Restricted equity securities, at cost		45,~~472~~136,~~500~~250			4,~~996~~472,~~250~~500
Loans held for sale		5536,~~336~~122,~~007~~381			5055,~~005~~336,~~901~~007
Loans, net of unearned income		~~267~~254,~~600~~667,~~402~~452			~~289~~267,~~658~~600,~~956~~402
Less allowance for loan losses		65,~~007~~221,~~690~~736			6,~~386~~007,~~409~~690
Loans, net		~~261~~249,~~592~~445,~~712~~716			~~283~~261,~~272~~592,~~547~~712
Premises and equipment, net		7,~~380~~309,~~238~~083			7,~~599~~380,~~170~~238
Cash surrender value of life insurance		1,~~894~~974,~~971~~210			71,~~394~~894,~~114~~971
Intangible assets		6222,~~452~~651			~~136~~62,~~480~~452
Other real estate owned		1415,~~452~~423,~~043~~903			1814,~~176~~452,~~169~~043
Loan sales receivable		31126,~~505~~592,~~783~~128			1431,~~849~~505,~~299~~783
Other assets		8,~~244~~734,~~448~~053			108,~~225~~244,~~954~~448
Total assets	$	~~427~~477,~~076~~599,~~739~~237		$	~~463~~427,~~097~~076,~~398~~739
Liabilities and Shareholders’ Equity
Deposits:
Noninterest-bearing	$	1820,~~948~~476,~~135~~198		$	1718,~~775~~948,~~762~~135
Interest-bearing		~~327~~334,~~102~~195,~~144~~148			~~351~~327,~~104~~102,~~768~~144
Total deposits		~~346~~354,~~050~~671,~~279~~346			~~368~~346,~~880~~050,~~530~~279
Other borrowings		37,000,000			45,237,158
Securities sold under agreements to repurchase		8,766,000			—
Other borrowings		68,447,000			37,000,000
Junior subordinated debentures		7,217,000			7,217,000
Other liabilities		35,~~774~~336,~~705~~341			3,~~860~~774,~~284~~705
Total liabilities		~~394~~444,~~041~~437,~~984~~687			~~425~~394,~~194~~041,~~972~~984
Commitments and contingencies (Note 15)
Commitments and contingencies (Note 16)
Shareholders’ Equity:
Preferred stock, par value $.01; 10,000,000 shares authorized; 9,950 shares issued and outstanding in 2010 and 2009		9,581,703			9,515,758
Preferred stock, par value $.01; 10,000,000 shares authorized; 9,950 shares issued and outstanding at December 31, 2011 and December 31, 2010		9,651,627			9,581,703
Common stock, par value $.01; 10,000,000 shares authorized; 2,588,707 and 2,568,707 shares issued and outstanding in 2010 and 2009, respectively		25,887			25,687
Common stock, par value $.01; 10,000,000 shares authorized; 2,595,207 shares issued and outstanding at December 31, 2011; 2,588,707 shares issued and outstanding at December 31, 2010		25,952			25,887
Additional paid-in capital		41,~~247~~395,~~995~~811			41,~~121~~247,~~636~~995
Accumulated deficit		(18,~~300~~510,~~457~~653	)		(1318,~~930~~300,~~443~~457	)
Accumulated other comprehensive income		~~479~~598,~~627~~813			1479,~~169,788~~627
Total shareholders’ equity		33,~~034~~161,~~755~~550			3733,~~902~~034,~~426~~755
Total liabilities and shareholders’ equity	$	~~427~~477,~~076~~599,~~739~~237		$	~~463~~427,~~097~~076,~~398~~739

See accompanying notes to consolidated financial statements.

6159

COASTAL BANKING COMPANY, INC. AND SUBSIDIARIES

Consolidated Statements of Operations

	For the years ended December 31,
	2010				2009
	2011				2010
Interest income:
Interest and fees on loans	$	1716,~~260~~539,~~374~~340		$	1817,~~191~~260,~~733~~374
Interest on taxable securities		1,~~882~~154,~~331~~762			31,~~006~~882,~~007~~331
Interest on nontaxable securities		~~232~~172,~~013~~972			~~551~~232,~~813~~013
Interest on deposits in other banks		313,~~100~~093			212,~~703~~573
Interest on federal funds sold		~~14,039~~399			34,~~990~~566
Total interest income		1917,~~391~~880,~~857~~566			2119,~~756~~391,~~246~~857
Interest expense:
Interest on deposits		53,~~772~~802,~~726~~813			95,~~039~~772,~~805~~726
Interest on junior subordinated debentures		~~397~~350,~~223~~534			~~417~~397,~~071~~223
Interest on other borrowings		1,~~275~~079,~~983~~724			1,~~354~~275,983
Total interest expense		75,~~445~~233,~~932~~071			107,~~811~~445,~~859~~932
Net interest income		1112,~~945~~647,~~925~~495			1011,~~944~~945,~~387~~925
Provision for loan losses		2,~~695~~865,~~930~~039			72,~~771~~695,~~000~~930
Net interest income after provision for loan losses		9,~~249~~782,~~995~~456			39,~~173~~249,~~387~~995
Noninterest income:
Service charges on deposit accounts		~~461~~402,~~738~~792			~~565~~461,~~858~~738
Other service charges, commissions and fees		~~273~~303,~~683~~279			~~306~~273,~~059~~683
SBA loan income		~~763~~3,~~369~~468,859			~~163~~763,~~792~~369
Mortgage banking income		816,~~230~~263,~~001~~183			68,~~682~~230,~~665~~001
Gain on sale of securities available for sale		~~939~~33,~~385~~484			1939,~~065~~385
Gain on tender of securities held to maturity		—			98,996
Other than temporary impairment loss on securities available for sale		(41,963	)		—
Loss on Silverton Financial Services stock		—			(507,366	)
Income from investment in life insurance contracts		79,239			82,152
Income from investment in life insurance contracts		82,152			288,714
Other income		153,203			42,594
Other income		42,594			53,445
Total other income		20,662,076			10,792,922
Total other income		10,792,922			7,653,228
Noninterest expenses:
Salaries and employee benefits		914,~~511~~417,~~877~~984			89,~~001~~511,~~701~~877
Occupancy and equipment expense		1,~~403~~835,~~786~~573			1,~~210~~403,~~033~~786
Advertising fees		~~139~~2,~~654~~468,684			~~140~~139,~~470~~654
Amortization of intangible assets		7439,~~028~~801			~~124~~74,~~161~~028
Audit fees		~~463~~426,~~480~~111			~~390~~463,~~531~~480
Data processing fees		1,~~006~~150,~~908~~479			~~921~~1,~~893~~006,908
Director fees		~~165~~134,~~150~~500			~~159~~165,~~200~~150
FDIC insurance expense		~~836~~642,~~245~~505			1836,~~017,378~~245
Goodwill impairment		—			10,411,914
Legal and other professional fees		962,244			686,641
Legal and other professional fees		686,641			728,450
Loan collection expense		585,458			310,648
Loan collection expense		310,648			777,315
Mortgage loan expense		1,429,727			1,150,240
Mortgage loan expense		1,150,240			470,771
OCC examination fees		171,443			179,526
OCC examination fees		179,526			124,492
Other real estate expenses		4,103,258			4,738,759
Other real estate expenses		4,738,759			1,918,990
Other operating		1,768,743			1,634,476
Other operating		1,634,476			1,189,064
Total other expenses		30,136,510			22,301,418
Total other expenses		22,301,418			27,586,363
Income (loss) before income taxes		308,022			(2,258,501	)
Loss before income taxes		(2,258,501	)		(16,759,748	)
Income tax expense (benefit)		(49,202	)		1,548,072
Income tax expense (benefit)		1,548,072			(2,223,360	)
Net income (loss)	$	357,224		$	(3,806,573	)
Net loss	$	(3,806,573	)	$	(14,536,388	)
Preferred stock dividends		567,420			563,441
Preferred stock dividends		563,441			559,685
Net loss available to common shareholders	$	(210,196	)	$	(4,370,014	)
Net loss available to common shareholders	$	(4,370,014	)	$	(15,096,073	)
Basic and diluted loss per share available to common shareholders	$	(.08	)	$	(1.70	)
Basic and diluted loss per share available to common shareholders	$	(1.70	)	$	(5.88	)

See accompanying notes to consolidated financial statements.

6260

COASTAL BANKING COMPANY, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income (Loss)

	For the years ended December 31,
	2010			2009
	2011			2010
Net loss	$	(3,806,573	)	$	(14,536,388	)
Net income (loss)	$	357,224		$	(3,806,573	)
Other comprehensive income (loss), net of tax (benefit):
Net unrealized holding gains (losses) arising during period, net of tax (benefit) of $36,147 and ($436,900)		(70,167	)		848,100
Net unrealized holding gains (losses) arising during period, net of tax (benefit) of $72,783 and ($36,147)		141,285			(70,167	)
Reclassification adjustment for gains included in net loss, net of tax of $319,391 and $362		(619,994	)		(703	)
Reclassification adjustment for gains included in net income (loss), net of tax of $11,385 and $319,391		(22,099	)		(619,994	)
Total other comprehensive income (loss)		~~(690~~119,~~161~~186	)		~~847~~(690,~~397~~161	)
Comprehensive loss	$	(4,496,734	)	$	(13,688,991	)
Comprehensive income (loss)	$	476,410		$	(4,496,734	)

See accompanying notes to consolidated financial statements.

6361

COASTAL BANKING COMPANY, INC. AND SUBSIDIARIES

Consolidated Statements of Changes in Shareholders’ Equity

For the Years Ended December 31, ~~2010~~2011 and ~~2009~~2010

	Preferred Stock				Common Stock				Additional Paid-in Capital			~~Retained~~Accumulated ~~Earnings~~Deficit			Accumulated Other Comprehensive Income			Total
	Shares		Amount		Shares		Amount		~~Capital~~			~~(Deficit)~~			~~Income~~			~~Total~~
Balance, December 31, 2008		9,950	$	9,453,569		2,568,707	$	25,687	$	41,037,403		$	1,165,630		$	322,391		$	52,004,680
Balance, December 31, 2009		9,950	$	9,515,758		2,568,707	$	25,687	$	41,121,636		$	(13,930,443	)	$	1,169,788		$	37,902,426
Net loss		—		—		—		—		––			(14,536,388	)		—			(14,536,388	)
Preferred stock dividend		—		62,189		—		—		––			(559,685	)		—			(497,496	)
Stock-based compensation expense		—		—		—		—		84,233			—			—			84,233
Other comprehensive income		—		—		—		—		—			—			847,397			847,397
Balance, December 31, 2009		9,950		9,515,758		2,568,707		25,687		41,121,636			(13,930,443	)		1,169,788			37,902,426
Net loss		—		—		—		—		––			(3,806,573	)		—			(3,806,573	)
Restricted stock grant		—		—		20,000		200		(200	)		—			—			—
Preferred stock dividend		—		65,945		—		—		––			(563,441	)		—			(497,496	)
Stock-based compensation expense		—		—		—		—		126,559			—			—			126,559
Other comprehensive loss		—		—		—		—		—			—			(690,161	)		(690,161	)
Balance, December 31, 2010		9,950	$	9,581,703		2,588,707	$	25,887	$	41,247,995		$	(18,300,457	)	$	479,627		$	33,034,755
Net income		—		—		—		—		––			357,224			—			357,224
Restricted stock grant		—		—		6,500		65		(65	)		—			—			—
Preferred stock dividend		—		69,924		—		—		––			(567,420	)		—			(497,496	)
Stock-based compensation expense		—		—		—		—		147,881			—			—			147,881
Other comprehensive income		—		—		—		—		—			—			119,186			119,186
Balance, December 31, 2011		9,950	$	9,651,627		2,595,207	$	25,952	$	41,395,811		$	(18,510,653	)	$	598,813		$	33,161,550

See accompanying notes to consolidated financial statements.

6462

COASTAL BANKING COMPANY, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

	For the years ended December 31,
	2010			2009
	2011			2010
Cash flows from operating activities:
Net loss	$	(3,806,573	)	$	(14,536,388	)
Net income (loss)	$	357,224		$	(3,806,573	)
Adjustments to reconcile net loss to net cash used by operating activities:
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Depreciation, amortization and accretion		~~713~~587,~~337~~371			~~462~~713,~~202~~337
Amortization of intangible assets		7439,~~028~~801			~~124~~74,~~161~~028
Goodwill impairment		—			10,411,914
Stock-based compensation expense		147,881			126,559
Stock-based compensation expense		126,559			84,233
Provision for loan losses		2,865,039			2,695,930
Provision for loan losses		2,695,930			7,771,000
Provision for deferred income taxes		439,111			198,424
Provision for deferred income taxes		198,424			(2,860,351	)
Gain on sale of securities available for sale		(33,484	)		(939,385	)
Gain on sale of securities available for sale		(939,385	)		(1,065	)
Other than temporary impairment on securities available for sale		41,963			—
Gain on tender of securities held to maturity		—			(98,996	)
Net increase in loan sales receivable		(95,086,345	)		(16,656,484	)
Loss on Silverton Financial Services stock		—			507,366
Write downs and losses on sale of other real estate owned		3,369,170			3,927,693
Net increase in loan sales receivable		(16,656,484	)		(2,548,139	)
Proceeds from sales of other real estate owned		8,146,338			8,300,582
Write downs and losses on sale of other real estate owned		3,927,693			1,054,759
Increase in cash value of life insurance		(79,239	)		(82,152	)
Proceeds from sales of other real estate owned		8,300,582			6,671,738
Originations of mortgage loans held for sale		(1,069,123,073	)		(1,013,249,195	)
Increase in cash value of life insurance		(82,152	)		(288,714	)
Proceeds from sales of mortgage loans held for sale		1,104,599,882			1,007,919,089
Originations of mortgage loans held for sale		(1,013,249,195	)		(946,928,854	)
Net decrease in interest receivable		175,763			314,142
Proceeds from sales of mortgage loans held for sale		1,007,919,089			928,327,943
Net increase in interest payable		256,400			18,590
Net decrease in interest receivable		314,142			267,809
SBA loan income		(3,468,859	)		(763,369	)
Net increase (decrease) in interest payable		18,590			(192,474	)
Mortgage banking income		(16,263,183	)		(8,230,001	)
SBA loan income		(763,369	)		(163,792	)
Net other operating activities		3,166,461			10,216,182
Mortgage banking income		(8,230,001	)		(6,682,665	)
Net cash used in operating activities		(59,861,779	)		(9,222,603	)
Net other operating activities		10,216,182			6,611,652
Net cash used by operating activities		(9,222,603	)		(12,006,661	)
Cash flows from investing activities:
Net (increase) decrease in interest-bearing deposits in banks		~~300~~(72,~~893~~063	)		~~(596~~300,~~845~~893	)
Net (increase) decrease in federal funds sold		~~354~~(57,~~068~~788	)		~~(74~~354,~~602~~068	)
Proceeds from maturities of securities available for sale		169,~~218~~888,~~827~~126			1416,~~373~~218,~~147~~827
Proceeds from sale of securities available for sale		216,~~154~~407,~~370~~595			921,~~906~~154,~~198~~370
Purchases of securities available for sale		(141,~~835~~094,~~580~~613	)		(214,~~107~~835,~~227~~580	)
Proceeds from maturities of securities held to maturity		—2,000,000			~~1,120,000~~—
Redemption of bank owned life insurance policies		~~5,581,295~~—			—5,581,295
Net change in restricted equity securities		~~523~~(663,750	)		~~(709~~523,~~700~~750	)
Net (increase) decrease in loans		10(3,~~479~~205,~~756~~411	)		~~(11~~10,~~610~~479,~~027~~756	)
Purchase of premises and equipment		(~~330~~386,~~396~~112	)		(~~160~~330,~~190~~396	)
Net cash provided by investing activities		3912,~~446~~815,~~983~~984			1039,~~140~~446,~~754~~983
Cash flows from financing activities:
Net increase (decrease) in deposits		~~(22~~8,~~830~~621,~~251~~067	)		6(22,~~224~~830,~~285~~251	)
Repayment of other borrowings		(8,250,000	)		(6,470,000	)
Net increase in securities sold under agreements to repurchase		8,766,000			—
Net cash used by financing activities		(31,080,251	)		(245,715	)
Proceeds from other borrowings		43,447,000			—
Net decrease in cash and due from banks		(855,871	)		(2,111,622	)
Repayment of other borrowings		(12,000,000	)		(8,250,000	)
Cash and due from banks at beginning of year		2,679,003			4,790,625
Net cash used provided by (used in) financing activities		48,834,067			(31,080,251	)
Cash and due from banks at end of year	$	1,823,132		$	2,679,003
Net increase (decrease) in cash and due from banks		1

Filing Compare · COASTAL BANKING CO INC