UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(MARK ONE)

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

For the Quarterly Period ended March 31, 2012

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]

For the Transition Period from _________to_________

Commission File No. 000-28333

COASTAL BANKING COMPANY, INC.

(Exact name of registrant as specified in its charter)

South Carolina		58-2455445
(State or other jurisdiction		(I.R.S. Employer
of incorporation)		Identification No.)

36 Sea Island Parkway

Beaufort, SC 29907

(Address of principal executive

offices, including zip code)

(843) 522-1228

(Registrant's telephone number, including area code)

________________________________________________

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

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

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

Large accelerated filer

Accelerated filer

Non-accelerated filer

Smaller reporting company

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

State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date: 2,597,207 shares of common stock, $.01 par value, were issued and outstanding on May 10, 2012.

Index

		Page No.
PART I. FINANCIAL INFORMATION

Item 1.	Financial Statements

	Consolidated Balance Sheets – March 31, 2012 and December 31, 2011		3

	Consolidated Statements of Operations– Three Months Ended March 31, 2012 and 2011		4

	Consolidated Statements of Comprehensive Income (Loss) – Three Months Ended March 31, 2012 and 2011		5

	Consolidated Statements of Cash Flows - Three Months Ended March 31, 2012 and 2011		6

	Notes to Consolidated Financial Statements		7

Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations		25

Item 3.	Quantitative and Qualitative Disclosure About Market Risk		39

Item 4.	Controls and Procedures		39

PART II. OTHER INFORMATION

Item 1.	Legal Proceedings		40

Item 1A.	Risk Factors		40

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		40

Item 3.	Defaults Upon Senior Securities		40

Item 4.	Removed and Reserved		40

Item 5.	Other Information		40

Item 6.	Exhibits		41

PART 1. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

Coastal Banking Company

Consolidated Balance Sheets

March 31, 2012 and December 31, 2011

	March 31,			December 31,
	2012			2011
	(unaudited)			(audited)
Assets
Cash and due from banks	$	6,346,319		$	3,611,404
Interest-bearing deposits in banks		5,433,099			478,763
Federal funds sold		137,688			243,046
Securities available for sale, at fair value		18,476,408			22,505,649
Restricted equity securities, at cost		5,141,550			5,136,250
Loans held for sale, at fair value		46,773,200			36,122,381

Loans, net of unearned income		249,074,531			254,667,452
Less allowance for loan losses		5,813,232			5,221,736
Loans, net		243,261,299			249,445,716

Premises and equipment, net		7,346,976			7,309,083
Cash surrender value of life insurance		1,994,077			1,974,210
Intangible assets		17,365			22,651
Other real estate owned		18,313,315			15,423,903
Loan sales receivable		75,046,674			126,592,128
Other assets		9,946,800			8,734,053
Total assets	$	438,234,770		$	477,599,237
Liabilities and Shareholders’ Equity
Deposits:
Noninterest-bearing	$	22,656,969		$	20,476,198
Interest-bearing		340,013,865			334,195,148
Total deposits		362,670,834			354,671,346

Securities sold under agreements to repurchase		––			8,766,000
Other borrowings		28,000,000			68,447,000
Junior subordinated debentures		7,217,000			7,217,000
Other liabilities		7,116,517			5,336,341
Total liabilities		405,004,351			444,437,687

Commitments and contingencies

Shareholders’ Equity:
Preferred stock, par value $.01; 10,000,000 shares authorized; 9,950 shares issued and outstanding at March 31, 2012 and December 31, 2011		9,669,758			9,651,627
Common stock, par value $.01; 10,000,000 shares authorized; 2,595,207 shares issued and outstanding at March 31, 2012 and December 31, 2011		25,952			25,952
Additional paid-in capital		41,418,869			41,395,811
Accumulated deficit		(18,353,563	)		(18,510,653	)
Accumulated other comprehensive income		469,403			598,813
Total shareholders’ equity		33,230,419			33,161,550
Total liabilities and shareholders’ equity	$	438,234,770		$	477,599,237

See accompanying notes to unaudited consolidated financial statements.

Coastal Banking Company

Consolidated Statements of Operations

For the Three Months Ended March 31, 2012 and 2011

(Unaudited)

	2012			2011
Interest income:
Interest and fees on loans	$	4,327,947	$	3,963,074
Interest on taxable securities		212,865		343,385
Interest on nontaxable securities		2,018		50,908
Interest on deposits in other banks		2,072		6,546
Interest on federal funds sold		334		433
Total interest income		4,545,236		4,364,346

Interest expense:
Interest on deposits		868,222		1,031,478
Interest on junior subordinated debentures		54,642		97,624
Interest on other borrowings		226,912		310,345
Total interest expense		1,149,776		1,439,447

Net interest income		3,395,460		2,924,899
Provision for loan losses		1,017,000		515,000
Net interest income after provision for loan losses		2,378,460		2,409,899

Noninterest income:
Service charges on deposit accounts		77,902		110,738
Other service charges, commissions and fees		75,202		72,777
SBA loan income		941,771		849,854
Mortgage banking income		9,293,780		1,368,494
Gain on sale of securities available for sale		141,019		––
Income from investment in life insurance contracts		19,867		20,194
Other income		67,656		28,266
Total other income		10,617,197		2,450,323

Noninterest expenses:
Salaries and employee benefits		7,285,191		2,164,968
Occupancy and equipment expense		573,363		339,315
Advertising fees		1,406,559		49,660
Amortization of intangible assets		5,286		11,505
Audit fees		129,897		99,647
Data processing fees		322,718		251,031
Director fees		35,550		51,700
FDIC insurance expense		161,491		215,569
Legal and other professional fees		271,843		244,825
OCC examination fees		48,460		43,758
Other real estate expenses		787,475		657,485
Other operating		1,458,169		674,396
Total other expenses		12,486,002		4,803,859

Income before income taxes		509,655		56,363
Income tax expense		210,060		41,131
Net income	$	299,595	$	15,232

Preferred stock dividends		142,505		141,473
Net income (loss) available to common shareholders	$	157,090	$	(126,241	)
Basic and diluted earnings (loss) per share available to common shareholders	$	.06	$	(.05	)

See accompanying notes to unaudited consolidated financial statements.

Coastal Banking Company

Consolidated Statements of Comprehensive Income (Loss)

For the Three Months Ended March 31, 2012 and 2011

(Unaudited)

	2012			2011
Net income	$	299,595		$	15,232
Other comprehensive loss, net of tax:
Net unrealized holding losses arising during period, net of tax benefit of $18,719 and $63,646		(36,337	)		(123,548	)
Reclassification adjustment for gains included in net income, net of tax of $47,946		(93,073	)		––
Total other comprehensive loss		(129,410	)		(123,548	)
Comprehensive income (loss)	$	170,185		$	(108,316	)

See accompanying notes to unaudited consolidated financial statements.

Coastal Banking Company

Consolidated Statements of Cash Flows

For the Three Months Ended March 31, 2012 and 2011

(Unaudited)

	2012			2011
Cash flows from operating activities:
Net income	$	299,595		$	15,232
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation, amortization and accretion		176,513			178,772
Amortization of intangible assets		5,286			11,505
Stock-based compensation expense		23,058			36,301
Provision for loan losses		1,017,000			515,000
Gain on sale of securities available for sale		(141,019	)		—
Net decrease in loan sales receivable		51,545,454			10,698,601
Write downs and losses on sale of other real estate owned		661,350			496,940
Proceeds from sales of other real estate owned		1,365,809			2,335,450
Increase in cash value of life insurance		(19,867	)		(20,194	)
Originations of mortgage loans held for sale		(435,337,953	)		(173,347,037	)
Proceeds from sales of mortgage loans held for sale		433,980,914			204,707,727
Net decrease in interest receivable		68,736			26,227
Net increase in interest payable		88,922			134,572
SBA loan income		(941,771	)		(849,854	)
Mortgage banking income		(9,293,780	)		(1,368,494	)
Net other operating activities		1,293,833			2,103,798
Net cash provided by operating activities		44,792,080			45,674,546

Cash flows from investing activities:
Net increase in interest-bearing deposits in banks		(4,954,336	)		(16,336,346	)
Net (increase) decrease in federal funds sold		105,358			(183,293	)
Proceeds from maturities of securities available for sale		2,349,741			3,712,454
Proceeds from sale of securities available for sale		1,554,287			—
Net change in restricted equity securities		(5,300	)		15,000
Net decrease in loans		250,846			915,089
Purchase of premises and equipment		(144,249	)		(87,669	)
Net cash used in investing activities		(843,653	)		(11,964,765	)

Cash flows from financing activities:
Net increase (decrease) in deposits		7,999,488			(21,989,509	)
Net decrease in securities sold under agreements to repurchase		(8,766,000	)		—
Proceeds from other borrowings		7,000,000			—
Repayment of other borrowings		(47,447,000	)		(8,500,000	)
Net cash used in financing activities		(41,213,512	)		(30,489,509	)

Net increase in cash and due from banks		2,734,915			3,220,272
Cash and due from banks at beginning of period		3,611,404			1,823,132
Cash and due from banks at end of period	$	6,346,319		$	5,043,404

Supplemental disclosures of cash flow information:
Cash paid during the year for interest	$	1,060,854		$	1,304,875
Cash paid during the year for income taxes	$	14,062		$	106,000

Noncash Transactions:
Principal balances of loans transferred to other real estate owned	$	4,916,571		$	2,682,586

See accompanying notes to unaudited consolidated financial statements.

Notes to Consolidated Financial Statements – March 31, 2012 and 2011 (Unaudited) and December 31, 2011

Note 1 - Basis of Presentation

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 did 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, and the South Carolina branches replaced their local trade name during the first quarter of 2012. 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 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. The mortgage banking division operates thirteen retail residential loan production offices in California, Connecticut, Florida, Georgia, Kansas, Maryland, New Jersey, New York, and Ohio.

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 consolidated financial statements include the accounts of the Company and the Bank. All intercompany accounts and transactions have been eliminated in consolidation.

The accompanying financial statements have been prepared in accordance with the requirements for interim financial statements and, accordingly, they omit disclosures which would substantially duplicate those contained in the Annual Report on Form 10-K for the year ended December 31, 2011. The financial statements as of March 31, 2012 and for the interim periods ended March 31, 2012 and 2011 are unaudited and, in the opinion of management, include all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation. The results of operations for the three months ended March 31, 2012 are not necessarily indicative of the results that may be expected for the year ending December 31, 2012. The financial information as of December 31, 2011 has been derived from the audited financial statements as of that date. For further information, refer to the financial statements and the notes included in the Company’s 2011 annual report to shareholders on Form 10-K as filed with the Securities and Exchange Commission.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates that affect the amounts of assets and liabilities and changes therein. Actual results could differ from those estimates.

Accounting Policies Recently Adopted

ASC Topic 310 “Receivables.” New authoritative accounting guidance under ASC Topic 310, “Receivables,” amended prior guidance to provide a greater level of disaggregated information about the credit quality of loans and leases and the Allowance for Loan and Lease Losses (the “Allowance”). The new authoritative guidance also requires additional disclosures related to credit quality indicators, past due information, and information related to loans modified in a troubled debt restructuring. The new authoritative guidance amends only the disclosure requirements for loans and leases and the allowance. The Company adopted the period end disclosures provisions of the new authoritative guidance under ASC Topic 310 in the reporting period ending December 31, 2010. Adoption of the new guidance did not have an impact on the Company’s statements of income and financial condition. The Company adopted the disclosures provisions of the new authoritative guidance about activity that occurs during a reporting period on January 1, 2011; the adoption did not have an impact on the Company’s statements of income and financial condition. The Company adopted the disclosures provisions related to loans modified in a troubled debt restructuring on July 1, 2011; the adoption did not have an impact on the Company’s statements of income and financial condition.

ASC Topic 310 “Receivables,” Subtopic 310-40 “Troubled Debt Restructurings by Creditors.” New authoritative accounting guidance under Subtopic 310-40, “Receivables — Troubled Debt Restructurings by Creditors” amended prior guidance to provide assistance in determining whether a modification of the terms of a receivable meets the definition of a troubled debt restructuring. The new authoritative guidance provides clarification for evaluating whether a concession has been granted and whether a debtor is experiencing financial difficulties. The new authoritative guidance was effective for the reporting periods beginning after June 15, 2011 and was applied retrospectively to restructurings occurring on or after the beginning of the fiscal year of adoption. The Company adopted this new guidance on July 1, 2011 and it did not have an impact on the Company’s statements of income and financial condition.

ASC Topic 820 “Fair Value Measurement.” New authoritative accounting guidance under ASC Topic 820, “Fair Value Measurement” amended prior guidance to achieve common fair value measurement and disclosure requirements in U.S. GAAP and International Financial Reporting Standards. The new authoritative guidance clarifies the highest and best use and valuation premise, measuring the fair value of an instrument classified in a reporting entity’s shareholders’ equity, measuring the fair value of financial instruments that are managed within a portfolio, and the application of premiums and discounts in a fair value measurement. The new authoritative guidance also requires additional disclosures about fair value measurements. The Company adopted this new guidance on January 1, 2012 and it did not have an impact on the Company’s statements of income and financial condition.

ASC Topic 220 “Comprehensive Income.” New authoritative accounting guidance under ASC Topic 220, “Comprehensive Income” amended prior guidance to increase the prominence of items reported in other comprehensive income. The new guidance requires that all changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The new guidance does not change the items that must be reported in other comprehensive income. The Company adopted this new guidance on January 1, 2012 and it did not have an impact on the Company’s statements of income and financial condition.

Note 2 -Regulatory Oversight, Capital Adequacy, Operating Results, Liquidity and Management’s Plans

Regulatory Oversight

The Bank entered into a formal agreement with the OCC on August 26, 2009 (the “Agreement”) that imposes certain operational and financial directives on the Bank. The specific directives of the Agreement address the credit risk in the Bank’s loan portfolio, action required to protect the Bank’s interest in criticized assets, adherence to the Bank’s written profit plan to improve and sustain earnings, limitations on the maximum allowable level of brokered deposits, excluding reciprocal CDARS deposits, and the establishment of a board level Compliance Committee to monitor the Bank’s adherence to the Agreement.

Additionally, in response to a request by the Federal Reserve Bank of Richmond, the Board of Directors of Coastal Banking Company, Inc. adopted a resolution on January 27, 2010. This resolution required that the Company 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. The resolution also required that the Company provide the Federal Reserve Bank with prior notification before using its cash assets for purposes other than investments in obligations or equity of the Bank, investments in short-term, liquid assets, or payment of normal and customary expenses, including regularly scheduled interest payments on existing debt.

On November 17, 2010 the Company entered into a Memorandum of Understanding (“MOU”), an informal enforcement action, with the Federal Reserve Bank of Richmond in lieu of the board resolution described above. The terms of the MOU are substantially similar to the terms of the Board Resolution. Generally, the MOU requires the Company to obtain prior approval of the Federal Reserve Bank before incurring additional debt, purchasing or redeeming its capital stock, or declaring or paying cash dividends on its securities, including dividends on its common stock and TARP preferred stock, and interest on its trust preferred securities. Additionally, the MOU requires the Company to comply with banking regulations that prohibit certain indemnification and severance payments and that require prior approval of any appointment of any 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.

As a result of the Agreement, and the MOU, the Bank and the Company are now operating under heightened regulatory scrutiny and monitoring. Management has taken aggressive steps to address the components of the Agreement and has frequent contact with the OCC as we work to improve our financial condition and comply with all regulatory directives. Monitoring of our progress by our regulators is much more frequent and includes interim on-site visits as well as ongoing telephone consultations. Management recognizes that failure to adequately address the Agreement and the MOU could result in additional actions by the banking regulators with the potential for more severe operating restrictions and oversight requirements, including, but not limited to, the issuance of a consent order and civil money penalties.

Capital Adequacy

As of March 31, 2012, the Bank exceeded all of the regulatory capital ratio levels to be categorized as “well capitalized.” 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. The Bank exceeded these internal capital ratios as well.

Key to our efforts to maintain existing capital adequacy was the need for the Bank to return to profitability through a continued focus on increasing core earnings and decreasing the levels of adversely classified and nonperforming assets. Management has pursued a number of strategic alternatives to improve the core earnings of the Bank and to reduce the level of classified assets. Current market conditions for banking institutions, the overall uncertainty in financial markets and the Bank’s high level of nonperforming assets are potential barriers to the success of these strategies. If current adverse market factors continue for a prolonged period of time, new adverse market factors emerge, and/or the Bank is unable to successfully execute its plans or adequately address regulatory concerns in a sufficient and timely manner, it could have a material adverse effect on the Bank’s business, results of operations and financial position.

Operating Results

The Company recorded net income of $300,000 for the three months ended March 31, 2012 compared to net income of $15,000 for the three months ended March 31, 2011. The increase in current year net income is a result of higher mortgage banking income, partially offset by higher direct mortgage costs, including salaries and benefits and advertising costs. During both periods, we experienced excessive levels of nonperforming assets, which caused the Company to record increased carrying costs on foreclosed properties and losses on the sale of foreclosed properties. Carrying costs on foreclosed assets are expected to remain elevated throughout 2012 as the Company continues to liquidate these nonperforming assets.

Management has implemented a number of actions in an effort to improve earnings, including continued emphasis on non-interest income from mortgage banking and small business lending activity, significant reductions to the cost of interest bearing liabilities and strict controls over other operating expenses. These actions have been effective in improving core earnings in 2011 and 2012; however, asset quality charges throughout the period continued to negatively impact earnings. Management will continue to focus on asset quality levels as concerns remain that the existing negative economic conditions may worsen, resulting in continued losses that will hinder our ability to return to profitability and further erode capital levels.

Liquidity

Management monitors liquidity on a daily basis and forecasts liquidity needs over a 90 day horizon in order to anticipate and provide for future needs. We also utilize a comprehensive contingency funding policy that uses several key liquidity ratios or metrics to define different stages of the Company’s overall liquidity position. This policy defines actions or strategies that are employed based on the liquidity position of the Company to reduce the risk of a future liquidity shortfall.

The primary sources of liquidity are cash and cash equivalents, deposits, scheduled repayments of loans, unpledged investment securities, available borrowing facilities and proceeds from loan sales receivable. Within deposits we utilize retail deposits from our branch locations, a modest level of brokered deposits, CDARS reciprocal deposits and deposits from other insured depository institutions. The Agreement requires that our brokered deposits, excluding reciprocal CDARs, not exceed 10% of our total deposits, which is consistent with our existing internal liquidity policy. As a result of our existing internal liquidity policy, we have been and anticipate continuing to be in compliance with the brokered deposit limitation provision of the Agreement. Although the FDIC Call Report defines CDARS reciprocal deposits as brokered deposits, CDARS reciprocal deposits are excluded from the brokered deposit limitation provision in the Agreement. At March 31, 2012 we have the capacity to raise up to an additional $10,064,000 in brokered deposits, if needed, and continue to remain in compliance with the 10% limitation in the Agreement. Our borrowing facilities include collateralized repurchase agreements and unsecured federal funds lines with correspondent banks, as well as borrowing agreements with the Federal Home Loan Bank of Atlanta and the Federal Reserve Bank collateralized by pledged loans and securities.

As of March 31, 2012, the Company had $172.3 million in total borrowing capacity, of which we had utilized $56.3 million or 32.7%, leaving remaining available liquidity of $116 million. Additionally, loans available for sale are considered by management as a key source of liquidity as a result of the speed with which these loans are sold and settled for cash. Management expects that, on average, loans originated for sale will be sold and converted to cash within 18 to 20 business days after the loan is originated. The balance of loans available for sale averaged just over $133 million during the first three months of 2012. Accordingly, in the event of a liquidity crisis, we anticipate having the ability to slow or stop loan origination activity to allow the loans available for sale to convert into cash. Based on current and expected liquidity needs and sources, management expects the Company to be able to meet all obligations as they become due.

Note 3 – Earnings (losses) Per Share

The following table sets forth the computation of basic and diluted earnings (losses) per share for the three months ended March 31.

	For the three months ended March 31,
	2012			2011
Net income	$	299,595		$	15,232
Preferred stock dividends		(142,505	)		(141,473	)
Net income (loss) available to common shareholders	$	157,090		$	(126,241	)

Weighted average common shares		2,583,885			2,571,735
Effect of dilutive securities		360			––
Diluted average common shares		2,584,245			2,571,735

Earnings (losses) per common share	$	0.06		$	(0.05	)
Diluted earnings (losses) per common share	$	0.06		$	(0.05	)

Note 4 – Investment Securities

Investment securities are as follows:

	March 31, 2012
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Available for sale
State and municipal securities	$	70,547	$	5,404	$	—		$	75,951
Mortgage-backed securities		17,694,644		712,534		(6,721	)		18,400,457
	$	17,765,191	$	717,938	$	(6,721	)	$	18,476,408

	December 31, 2011
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Available for sale
State and municipal securities	$	1,800,628	$	119,336	$	—		$	1,919,964
Mortgage-backed securities		19,797,729		797,364		(9,408	)		20,585,685
	$	21,598,357	$	916,700	$	(9,408	)	$	22,505,649

The following table shows gross unrealized losses and fair value of securities, aggregated by category and length of time that the securities have been in a continuous unrealized loss position, at March 31, 2012.

Investment securities available for sale:

	Less than 12 Months				12 Months or More					Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
Mortgage-backed securities	$	—	$	—	$	1,276,266	$	(6,721	)	$	1,276,266	$	(6,721	)
Total	$	—	$	—	$	1,276,266	$	(6,721	)	$	1,276,266	$	(6,721	)

As of March 31, 2012, two individual securities available for sale were in a continuous loss position for twelve months or more. The Company has reviewed these investment securities in accordance with its accounting policy for other than temporary impairment and believes, based on industry analyst reports and credit ratings, that the deterioration in value, as of March 31, 2012, was attributable to changes in market interest rates, and not due to the specific credit quality of the issuer. The unrealized loss is considered temporary because the security issuer carries an acceptable credit profile and the repayment sources of principal and interest are backed by the full faith and credit of the U.S. Government. The Company has the ability and intent to hold this security until such time as the value recovers or the security matures.

Investment securities available for sale:

	Less than 12 Months					12 Months or More					Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
Mortgage-backed securities	$	901,726	$	(3,870	)	$	1,214,800	$	(5,538	)	$	2,116,526	$	(9,408	)
Total	$	901,726	$	(3,870	)	$	1,214,800	$	(5,538	)	$	2,116,526	$	(9,408	)

As of December 31, 2011, one individual security available for sale was in a continuous loss position for twelve months or more. The Company has reviewed this investment security in accordance with its accounting policy for other than temporary impairment and believes, based on industry analyst reports and credit ratings, that the deterioration in value, as of December 31, 2011, was attributable to changes in market interest rates, and not due to the specific credit quality of the issuer. The unrealized loss is considered temporary because the security issuer carries an acceptable credit profile and the repayment sources of principal and interest are backed by the full faith and credit of the U.S. Government. The Company has the ability and intent to hold this security until such time as the value recovers or the security matures.

In addition, as of December 31, 2011 we recorded an other-than-temporary impairment loss on one municipal security that was in a continuous loss position for over twelve months. The deterioration was due to the specific credit quality of the issuer, and management sold the security during the first quarter of 2012. Because the security’s amortized cost was reduced to equal its fair value at December 31, 2011, it was not included in the unrealized loss table above.

The amortized cost and estimated fair value of investment securities at March 31, 2012, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers have the right to call or prepay obligations with or without call or prepayment penalties.

	Amortized Cost		Fair Value
Available for sale
Due from five to ten years	$	51,383	$	55,865
Due after ten years		19,164		20,086
Mortgage-backed securities		17,694,644		18,400,457
	$	17,765,191	$	18,476,408

Securities were pledged to secure public deposits and Federal Home Loan Bank borrowings with an amortized cost and fair value of $9,313,000 and $9,889,000, respectively, as of March 31, 2012 and $9,147,000 and $9,722,000, respectively, as of December 31, 2011. Pledged securities may not be sold without first pledging replacement securities and obtaining consent of the party to whom the securities are pledged.

Securities were sold under agreement to repurchase with an amortized cost and fair value of $9,433,000 and $9,640,000, respectively, as of December 31, 2011. No securities were sold under agreement to repurchase as of March 31, 2012.

Gains and losses on sales of securities available for sale consist of the following:

	For the Three Months Ended March 31,
	2012			2011
Gross gains on sales of securities	$	147,342		$	—
Gross losses on sales of securities		(6,323	)		—
Net realized gains on sales of securities available for sale	$	141,019		$	—

Note 5 — Loans and allowance for loan losses

The composition of loans is summarized as follows:

	March 31, 2012		December 31, 2011
Commercial and financial	$	11,353,979	$	15,039,027
Real estate – construction, commercial		35,139,169		39,760,844
Real estate – construction, residential		10,088,746		11,602,247
Real estate – mortgage, commercial		93,900,823		86,646,154
Real estate – mortgage, residential		96,952,817		99,918,177
Consumer installment loans		1,533,997		1,543,003
Other		105,000		158,000
Gross loans		249,074,531		254,667,452
Less: Allowance for loan losses		5,813,232		5,221,736
Net loans	$	243,261,299	$	249,445,716

The Bank grants loans and extensions of credit to individuals and a variety of businesses and corporations located in its general trade areas of Beaufort County, South Carolina, Nassau County, Florida and Thomas County, Georgia. Although the Bank has a diversified loan portfolio, a substantial portion of the loan portfolio is collateralized by improved and unimproved real estate and is dependent upon the real estate market.

A loan is considered impaired, in accordance with the impairment accounting guidance (FASB ASC 310-10-35-16), when, based on current information and events, it is probable that the Company will be unable to collect all amounts due from the borrower in accordance with the contractual terms of the loan. Additionally, recent FASB guidance requires that by definition, all loans classified as troubled debt restructurings must also be classified as impaired. In cases where management believes a restructured loan will return all amounts due under the restructured loan terms, and those terms do not include the loss of any portion of the original principal balance, restructured loans are not internally classified, monitored or managed as impaired loans. Accordingly, GAAP reporting requirements result in a higher level of loans classified as impaired than are considered as impaired by management. Impaired loans as defined by GAAP are summarized as follows:

	March 31, 2012
(In thousands)	Recorded Investment		Unpaid Principal Balance		Recorded Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial, financial & agricultural	$	231	$	231	$	—	$	244	$	1
Real estate - construction		3,381		4,174		—		3,403		—
Real estate - mortgage		5,178		5,519		—		5,186		46
With an allowance recorded:
Commercial, financial & agricultural		670		670		192		673		5
Real estate - construction		2,931		2,980		480		2,931		13
Real estate - mortgage		3,760		3,840		1,318		3,791		17
Total impaired loans:
Commercial, financial & agricultural	$	901	$	901	$	192	$	917	$	6
Real estate - construction	$	6,312	$	7,154	$	480	$	6,334	$	13
Real estate - mortgage	$	8,938	$	9,359	$	1,318	$	8,977	$	63

	December 31, 2011
(In thousands)	Recorded Investment		Unpaid Principal Balance		Recorded Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial, financial & agricultural	$	343	$	343	$	—	$	274	$	13
Real estate - construction		5,218		6,801		—		5,385		113
Real estate - mortgage		5,652		6,032		—		6,042		158
With an allowance recorded:
Commercial, financial & agricultural		510		510		98		1,375		54
Real estate - construction		2,838		2,870		213		2,809		94
Real estate - mortgage		4,461		4,721		826		4,393		92
Total impaired loans:
Commercial, financial & agricultural	$	853	$	853	$	98	$	1,649	$	67
Real estate - construction	$	8,056	$	9,671	$	213	$	8,194	$	207
Real estate - mortgage	$	10,113	$	10,753	$	826	$	10,435	$	250

As of March 31, 2012, there are four restructured loans with a recorded investment of $2,451,000 included in the impaired loans table above, as required by GAAP, that management has not internally classified as impaired. These loans are performing in accordance with their restructured terms such that we expect to recover all loan principal and interest, however, these loans meet the GAAP definition of a TDR. While these loans meet the technical definition of a TDR and must therefore be classified as impaired under GAAP, management evaluates these loans as non-impaired.

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 following is a summary of current, past due and nonaccrual loans:

	March 31, 2012
(In thousands)	30-59 Days Past Due		60-89 Days Past Due		Greater than 90 Days Past Due & Accruing		Nonaccrual		Total Past Due & Nonaccrual		Current Loans		Total Loans
Commercial and financial	$	21	$	––	$	––	$	161	$	182	$	11,172	$	11,354
Real estate – construction, commercial		––		––		––		6,967		6,967		28,172		35,139
Real estate – construction, residential		––		––		––		104		104		9,985		10,089
Real estate – mortgage, commercial		––		––		––		4,669		4,669		89,232		93,901
Real estate – mortgage, residential		1,215		––		––		1,624		2,839		94,114		96,953
Consumer installment loans		1		––		––		2		3		1,531		1,534
Other		––		––		––		––		––		105		105
	$	1,237	$	––	$	––	$	13,527	$	14,764	$	234,311	$	249,075

	December 31, 2011
(In thousands)	30-59 Days Past Due		60-89 Days Past Due		Greater than 90 Days Past Due & Accruing		Nonaccrual		Total Past Due & Nonaccrual		Current Loans		Total Loans
Commercial and financial	$	22	$	28	$	––	$	179	$	229	$	14,810	$	15,039
Real estate – construction, commercial		444		––		––		8,705		9,149		30,612		39,761
Real estate – construction, residential		––		53		––		73		126		11,476		11,602
Real estate – mortgage, commercial		––		––		––		5,035		5,035		81,611		86,646
Real estate – mortgage, residential		676		––		––		1,922		2,598		97,320		99,918
Consumer installment loans		––		––		––		23		23		1,520		1,543
Other		––		3		––		––		3		155		158
	$	1,142	$	84	$	––	$	15,937	$	17,163	$	237,504	$	254,667

Management evaluates all loan relationships periodically in order to assess the financial strength of the borrower and the value of any underlying collateral. Based on the results of these evaluations, management will assign internal loan classifications to designate the relative strength of the credit. The internal grades used are Pass, Special Mention, and Substandard. Within the Pass classification, there are sub grades that range from High to Acceptable, all of which indicate that the loan is expected to continue to perform in accordance with its terms. Loans with potential weaknesses that deserve management’s close attention are classified as Special Mention. If the potential weakness in a Special Mention loan was to go uncorrected, it could result in deteriorating prospects for continued loan performance at some future date; however, the loan is not currently adversely classified. The Substandard classification is assigned to loans that are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. These loans have a well-defined weakness that jeopardizes the payment of the debt or the liquidation of the collateral securing the debt, and are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. Loans classified as Special Mention or Substandard are 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, or potential weakness, identified.

A summary of loan credit quality is presented below:

(In thousands)	March 31, 2012
	Pass		Special Mention		Substandard		Total
Commercial and financial	$	10,216	$	456	$	682	$	11,354
Real estate – construction, commercial		24,497		520		10,122		35,139
Real estate – construction, residential		9,738		98		253		10,089
Real estate – mortgage, commercial		77,018		8,137		8,746		93,901
Real estate – mortgage, residential		90,697		2,661		3,595		96,953
Consumer installment loans		1,479		5		50		1,534
Other		105		––		––		105
	$	213,750	$	11,877	$	23,448	$	249,075

(In thousands)	December 31, 2011
	Pass		Special Mention		Substandard		Total
Commercial and financial	$	14,166	$	216	$	657	$	15,039
Real estate – construction, commercial		25,526		483		13,752		39,761
Real estate – construction, residential		11,331		53		218		11,602
Real estate – mortgage, commercial		69,713		7,065		9,868		86,646
Real estate – mortgage, residential		93,748		2,317		3,853		99,918
Consumer installment loans		1,491		12		40		1,543
Other		155		3		––		158
	$	216,130	$	10,149	$	28,388	$	254,667

Risk Elements in the Loan Portfolio

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

	Loans with Interest Only Payments
(In thousands)	March 31, 2012				December 31, 2011
Commercial and financial	$	4,916	10	%	$	4,827	10	%
Real estate – construction, commercial		14,080	30	%		14,901	30	%
Real estate – construction, residential		1,678	4	%		2,691	5	%
Real estate – mortgage, commercial		10,445	22	%		10,143	21	%
Real estate – mortgage, residential		16,304	34	%		16,597	34	%
Consumer installment loans		124	––	%		128	––	%
Other		105	––	%		105	––	%
	$	47,652			$	49,392

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
	March 31, 2012
(In thousands)	Florida		Georgia		South Carolina		Other
Commercial and financial	$	5,876	$	577	$	4,753	$	148
Real estate – construction, commercial		9,459		4,814		18,938		1,928
Real estate – construction, residential		3,497		871		5,494		227
Real estate – mortgage, commercial		36,394		16,219		39,287		2,001
Real estate – mortgage, residential		37,580		21,631		30,782		6,960
Consumer installment loans		449		343		663		79
Other		––		105		––		––
	$	93,255	$	44,560	$	99,917	$	11,343

	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
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

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 March 31, 2012 the Company held $20,901,000 of loans secured by junior liens, which represented approximately 8.4% of the total net loan portfolio. Net loan charge-offs was $143,000 in the quarter ended March 31, 2012 for all loans secured by junior liens for an annualized loss rate of 2.7%. At December 31, 2011 the Company held $21,470,000 of loans secured by junior liens which represented approximately 8.4% of the total net loan portfolio. Historical loss experience as measured by net loan charge offs was $232,000 in the year ended December 31, 2011 for all loans secured by junior liens for an annualized loss rate of 1.1%.

High Loan to Value Ratios – Typically the Company will not originate a new loan with a loan to value (LTV) ratio in excess of 100%. However, declines in collateral values can result in the case of an existing loan renewal with an LTV ratio in excess of 100% based on the current appraised value of the collateral. In such cases the borrower may be asked to pledge additional collateral or to renew the loan for a lesser amount. If the borrower lacks the ability to pay down the loan or provide additional collateral, but has the ability to continue to service the debt, the loan will be renewed with an LTV ratio in excess of 100%. At March 31, 2012 the loan portfolio included 44 loans with an aggregate balance of $17,882,000, or 7.2% of the net loan portfolio, with LTV ratios in excess of 100%. At December 31, 2011 the loan portfolio included 39 loans with an aggregate balance of $12,661,000, or 5.0% of the net loan portfolio, with LTV ratios in excess of 100%.

Restructured Loans – Historically, 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. In some cases we have restructured loans for borrowers who were not delinquent, but for various reasons these borrowers were experiencing financial distress that raised a doubt about their 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 the loan will avoid a future default. In other cases we have restructured loans for borrowers who were in default at the time the loan terms were restructured. The expectation is that by adjusting the terms of such loans, the borrower may begin to make payments again based on the improved loan terms.

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

●	Deferral of one or more scheduled loan payments to a future date

●	Temporary or permanent reduction of the loan interest 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 will 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.

	March 31, 2012						December 31, 2011
Troubled debt restructurings	Number of loans		Recorded Investment		Unpaid Principal Balance		Number of loans		Recorded Investment		Unpaid Principal Balance
Commercial, financial & agricultural		2	$	372,862	$	372,862		2	$	342,917	$	342,917
Real estate – construction		14		7,931,144		8,150,517		9		6,342,581		6,639,087
Real estate – mortgage		7		1,311,655		1,311,655		13		5,062,359		5,189,288
Total troubled debt restructurings		23	$	9,615,661	$	9,835,034		24	$	11,747,857	$	12,171,292

The following table provides the payment status as of March 31, 2012 and March 31, 2011 of all loans that were restructured in the twelve month periods ending on those respective dates.

	March 31, 2012				March 31, 2011
	Number of loans		Recorded Investment		Number of loans		Recorded Investment
Restructured loans less than 30 days past due
Commercial, financial & agricultural		1	$	87,878		1	$	141,380
Real estate – construction		––		––		2		1,173,839
Real estate – mortgage		2		621,531		––		––
Total restructured loans less than 30 days past due		3	$	709,409		3	$	1,315,219
Restructured loans 30 days or more past due
Real estate – mortgage		––		––		1		280,173
Total restructured loans 30 days or more past due		––	$	––		1	$	280,173
Restructured loans on nonaccrual
Real estate – construction		1		31,067		1		1,462,825
Real estate – mortgage		5		2,675,594		3		502,074
Total restructured loans on nonaccrual		6	$	2,706,661		4	$	1,964,899

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 March 31, 2012, the Company had $35,325,000 in loans that were internally classified as Special Mention or Substandard, of which $28,290,000, or 80%, were either current or less than 30 days past due. 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.

We have established an allowance for loan losses through a provision for loan losses charged to expense on our statement of earnings. Additions to the allowance for loan losses are made periodically to maintain the allowance at an appropriate level based on management’s analysis of the potential risk in the loan portfolio. The allowance for loan losses represents an amount, which we believe will be adequate to absorb probable losses on existing loans that may become uncollectible. Our judgment as to the adequacy of the allowance for loan losses is based upon a number of assumptions about future events, which we believe to be reasonable, but which may or may not prove to be accurate. To the extent that the recovery of loan balances has become collateral dependent, we obtain appraisals not less than annually, and then we reduce these appraised values by the amount estimated 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.

An analysis of the activity in the allowance for loan losses is presented below:

	For the Three Months Ended March 31,
	2012			2011
Balance, beginning of year	$	5,221,736		$	6,007,690
Provision for loan losses		1,017,000			515,000
Loans charged off		(697,713	)		(499,947	)
Recoveries of loans previously charged off		272,209			93,301
Balance, end of period	$	5,813,232		$	6,116,044

The following tables provide additional information concerning changes to the allowance for loan losses within major loan categories:

	For the Three Months Ended March 31, 2012
(In thousands)	Commercial, Financial & Agricultural			Real Estate - Construction			Real Estate - Mortgage			Consumer			Unallocated		Total
Allowance balance, beginning of year	$	644		$	1,231		$	3,041		$	26		$	280	$	5,222
Loans charged off		(28	)		(394	)		(250	)		(26	)		––		(698	)
Recoveries		3			220			46			3			––		272
Provision for loan losses		3			225			440			26			323		1,017
Allowance balance, end of period	$	622		$	1,282		$	3,277		$	29		$	603	$	5,813

	March 31, 2012
(In thousands)	Commercial, Financial & Agricultural		Real Estate - Construction		Real Estate - Mortgage		Consumer		Unallocated		Total

Allowance for loans individually evaluated for impairment	$	192	$	480	$	1,318	$	5	$	––	$	1,995
Allowance for loans collectively evaluated for impairment		430		802		1,959		24		603		3,818
Total allowance for loan losses		622		1,282		3,277		29		603		5,813
Loans individually evaluated for impairment		901		6,312		8,938		5		––		16,156
Loans collectively evaluated for impairment		10,453		38,916		181,916		1,634		––		232,919
Total loans	$	11,354	$	45,228	$	190,854	$	1,639	$	––	$	249,075

	For the Three Months Ended March 31, 2011
(In thousands)	Commercial, Financial & Agricultural			Real Estate - Construction			Real Estate - Mortgage			Consumer		Unallocated		Total
Allowance balance, beginning of year	$	543		$	358		$	4,042		$	326	$	739	$	6,008
Loans charged off		––			(3	)		(497	)		––		––		(500	)
Recoveries		13			––			79			1		––		93
Provision for loan losses		(290	)		20			608			6		171		515
Allowance balance, end of period	$	266		$	375		$	4,232		$	333	$	910	$	6,116

	December 31, 2011
(In thousands)	Commercial, Financial & Agricultural		Real Estate - Construction		Real Estate - Mortgage		Consumer		Unallocated		Total
Allowance for loans individually evaluated for impairment	$	98	$	213	$	826	$	––	$	––	$	1,137
Allowance for loans collectively evaluated for impairment		546		1,018		2,215		26		280		4,085
Total allowance for loan losses		644		1,231		3,041		26		280		5,222
Loans individually evaluated for impairment		853		8,056		10,113		––		––		19,022
Loans collectively evaluated for impairment		14,186		43,307		176,451		1,701		––		235,645
Total loans	$	15,039	$	51,363	$	186,564	$	1,701	$	––	$	254,667

Note 6 — Other Real Estate Owned

A summary of other real estate owned is presented as follows:

	Three Months Ended March 31,
	2012			2011
Balance, beginning of year	$	15,423,903		$	14,452,043
Additions		4,916,571			2,682,586
Disposals		(1,365,809	)		(2,335,450	)
Valuation write downs and losses on sales		(661,350	)		(496,940	)
Balance, end of period	$	18,313,315		$	14,302,239

Expenses related to other real estate owned include the following:

	Three Months Ended March 31,
	2012		2011
Net loss on sales of real estate	$	482,493	$	246,995
Valuation write downs		178,857		249,945
Operating expenses		126,125		160,545
	$	787,475	$	657,485

Note 7 — Stock-Based Compensation

The Company adopted a Stock Incentive Plan in 2000 which currently authorizes 389,281 shares of the Company’s common stock for issuance under the Plan. The Plan provides for the total number of shares authorized for issuance under the Plan to be increased upon the issuance of new shares by the Company by an amount equal to the difference between 15% of the total outstanding shares after the issuance of the new shares and the number of shares authorized for issuance prior to the issuance of the new shares. The Plan is administered by the Board of Directors and provides for the granting of options to purchase shares of common stock to officers, directors, employees or consultants of the Company and Bank. The exercise price of each option granted under the Plan will not be less than the fair market value of the shares of common stock subject to the option on the date of grant as determined by the Board of Directors. Options are exercisable in whole or in part upon such terms as may be determined by the Board of Directors, and are exercisable no later than ten years after the date of grant. Options granted under the Plan generally vest over a five-year vesting period. Pursuant to the Plan, no Incentive Stock Option may be granted more than ten years after February 15, 2000, the effective date of the Plan. As of March 31, 2012, there were 111,916 shares available for grant under this Plan as non-qualified stock options.

Additionally, the Company assumed the outstanding options under the 1999 First Capital Bank Holding Corporation Stock Option Plan (the “First Capital Plan”) in connection with the merger of First Capital Bank Holding Company with and into the Company on October 1, 2005. As a result of the merger, each outstanding option under the First Capital Plan was converted into an option to purchase Coastal Banking Company, Inc. common stock. Coastal assumed and maintains the First Capital Plan solely to administer the options that were outstanding as of the effective time of the merger. As of the effective time of the merger, the Company elected to discontinue the issuance of options under the First Capital Plan.

On August 24, 2011, the Company granted a restricted stock award to Michael G. Sanchez, Chief Executive Officer, for 6,500 shares of the Company’s common stock. The restricted stock vests and becomes transferable on the later of the date when the Company has fully repaid all obligations under the TARP Capital Purchase Program or the two year anniversary date of the grant date of the restricted stock. The restricted stock was granted to Mr. Sanchez as compensation for his service to the Company. The ultimate cost to the Company from this grant will be $14,300, and will be expensed between August 24, 2011 and August 24, 2013.

On May 26, 2010, the Company granted a restricted stock award to Michael G. Sanchez, Chief Executive Officer, for 20,000 shares of the Company’s common stock. The restricted stock vests and becomes transferable on the later of the date when the Company has fully repaid all obligations under the TARP Capital Purchase Program or the two year anniversary date of the grant date of the restricted stock. The restricted stock was granted to Mr. Sanchez as compensation for his service to the Company. The ultimate cost to the Company from this grant will be $68,000, and will be expensed between May 26, 2010 and May 26, 2012.

On May 26, 2010, the Company granted non-qualified stock options to all full time employees for a total of 126,000 options. The options vest over a five year period beginning on May 26, 2010. The ultimate cost to the Company from this grant will be impacted by future option forfeitures, but in any case will not exceed $175,492, and will be expensed between May 26, 2010 and the last vesting date of May 26, 2015.

On August 15, 2008, the Board of Directors of Coastal Banking Company approved a reduction in the exercise price of 42,603 incentive stock options that were previously issued and outstanding. The options had been issued to 14 officers and employees of the Company with an average exercise price of $19.26 per share. The new exercise price was $7.50 per share, the market value of the Company's common stock on the day the lower exercise price was set by the Board action. The ultimate full cost to the Company will be impacted by future option forfeitures, but in any case will not exceed $63,075 over the period beginning on August 15, 2008 and ending on December 31, 2012.

On March 21, 2008, the Company granted a restricted stock award to Gary Horn, Regional President of Lowcountry National Bank, for 5,000 shares of the Company’s common stock. The restricted stock vests in five equal annual increments on the anniversary date of the grant date of the restricted stock. The restricted stock was granted to Mr. Horn as compensation for his service to the Bank. The ultimate cost to the Company from this grant will be $68,750, and will be expensed between March 21, 2008 and March 21, 2013.

Note 8 — Fair Value

Determination of Fair Value

The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. In accordance with the Fair Value Measurements and Disclosures topic (FASB ASC 820), the fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between willing market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.

The fair value guidance provides a consistent definition of fair value, which focuses on exit price in an orderly transaction (that is, not a forced liquidation or distressed sale) between willing market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.

Fair Value Hierarchy

In accordance with this guidance, the Company groups its financial assets and financial liabilities generally measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.

Level 1 - Valuation is based on quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. Level 1 assets and liabilities generally include debt and equity securities that are traded in an active exchange market. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.

Level 2 - Valuation is based on inputs other than quoted prices included within level 1 that are observable for the asset or liability, either directly or indirectly. The valuation may be based on quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset or liability.

Level 3 - Valuation is based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which determination of fair value requires significant management judgment or estimation.

A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

Assets and Liabilities Measured at Fair Value on a Recurring Basis

The following is a description of the valuation methodologies used for instruments measured at fair value on a recurring basis and recognized in the accompanying balance sheet, as well as the general classification of such instruments pursuant to the valuation hierarchy.

Where quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. Level 1 securities would include highly liquid government bonds and exchange traded equities. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics or discounted cash flows. Level 2 securities include U.S. agency securities, mortgage-backed agency securities, obligations of states and political subdivisions and certain corporate, asset backed and other securities. Also included in Level 2 are derivative asset and liability positions and loans held for sale. In certain cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy.

There have been no transfers of assets or liabilities between levels 1, 2, and 3 during the periods ended March 31, 2012 and March 31, 2011.

The table below presents the Company’s assets and liabilities measured at fair value on a recurring basis as of March 31, 2012, aggregated by the level in the fair value hierarchy within which those measurements fall.

	Carrying Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Investment securities available for sale	$	18,476,408	$	131,763	$	17,227,984	$	1,116,661
Loans held for sale		46,773,200		––		46,773,200		––
Derivative asset positions		932,621		––		932,621		––
Total fair value of assets measured on a recurring basis	$	66,182,229	$	131,763	$	64,933,805	$	1,116,661
Liabilities:
Derivative liability positions	$	788,552	$	––	$	788,552	$	––
Total fair value of liabilities measured on a recurring basis	$	788,552	$	––	$	788,552	$	––

The table below presents the Company’s assets and liabilities measured at fair value on a recurring basis as of December 31, 2011, aggregated by the level in the fair value hierarchy within which those measurements fall.

	Carrying Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Investment securities available for sale	$	22,505,649	$	199,805	$	21,200,948	$	1,104,896
Loans held for sale		36,122,381		––		36,122,381		––
Derivative asset positions		806,184		––		806,184		––
Total fair value of assets measured on a recurring basis	$	59,434,214	$	199,805	$	58,129,513	$	1,104,896
Liabilities:
Derivative liability positions	$	716,986	$	––	$	716,986	$	––
Total fair value of liabilities measured on a recurring basis	$	716,986	$	––	$	716,986	$	––

The table below presents a reconciliation of level 3 assets as of March 31, 2012 and 2011.

	2012		2011
Balance, beginning of year	$	1,104,896	$	1,049,954
Total gains included in net income		––		39,959
Issuances		––		3,510,848
Sales		––		(4,278,140	)
Unrealized holding gains included in other comprehensive income		11,765		––
Balance, end of period	$	1,116,661	$	322,621

Assets Measured at Fair Value on a Nonrecurring Basis

The following is a description of the valuation methodologies used for instruments measured at fair value on a nonrecurring basis and recognized in the accompanying balance sheet, as well as the general classification of such instruments pursuant to the valuation hierarchy.

Loan impairment is reported when full payment under the loan terms is not expected. Impaired loans are carried at the present value of estimated future cash flows using the loan's existing rate, or the fair value of collateral if the loan is collateral dependent. A portion of the allowance for loan losses is allocated to impaired loans if the value of such loans is deemed to be less than the unpaid balance. If these allocations cause the allowance for loan losses to require an increase, such increase is reported as a component of the provision for loan losses. Loan losses are charged against the allowance when management believes the uncollectability of a loan is confirmed. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the loan impairment as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the loan impairment as nonrecurring Level 3.

There have been no transfers of assets or liabilities between levels 1, 2, and 3 during the periods ended March 31, 2012 and March 31, 2011.

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

The table below presents the Company’s assets for which a nonrecurring change in fair value has been recorded during the three months ended March 31, 2012, aggregated by the level in the fair value hierarchy within which those measurements fall.

	Carrying Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total losses for the three months ended March 31, 2012
Assets:
Impaired loans	$	13,704,812	$	––	$	––	$	13,704,812	$	––
Other real estate owned		18,313,315		––		––		18,313,315		(661,350	)
Total fair value of assets measured on a nonrecurring basis	$	32,018,127	$	––	$	––	$	32,018,127	$	(661,350	)

The table below presents the Company’s assets for which a nonrecurring change in fair value has been recorded during the year ended December 31, 2011, aggregated by the level in the fair value hierarchy within which those measurements fall.

	Carrying Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total losses for the year ended December 31, 2011
Assets:
Impaired loans	$	14,861,500	$	––	$	––	$	14,861,500	$	––
Other real estate owned		15,423,903		––		––		15,423,903		(3,369,170	)
Total fair value of assets measured on a nonrecurring basis	$	30,285,403	$	––	$	––	$	30,285,403	$	(3,369,170	)

Fair Value of Financial Instruments

The fair value of a financial instrument is the current amount that would be exchanged between willing parties in an orderly transaction. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. Where quoted prices are not available, fair values are based on estimates using discounted cash flows and other valuation techniques. The use of discounted cash flows can be significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. The following disclosures should not be considered as representative of the liquidation value of the Bank, but rather represent a good-faith estimate of the increase or decrease in value of financial instruments held by the Bank since purchase, origination, or issuance.

The following methods and assumptions were used in this analysis in estimating the fair value of financial instruments:

●

Cash, due from banks, interest-bearing deposits in banks, federal funds sold, and securities sold under agreement to repurchase: The carrying amount of cash, due from banks, interest-bearing deposits in banks, federal funds sold, federal funds purchased, and securities sold under agreement to repurchase approximates fair value.

●

Securities: The fair values of securities available for sale are determined by an independent securities accounting service provider using quoted prices on nationally recognized securities exchanges or matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities. The carrying amount of equity securities with no readily determinable fair value approximates fair value.

●

Loans: The carrying amount of variable-rate loans that reprice frequently and have no significant change in credit risk approximates fair value. The fair value of fixed-rate loans is estimated based on discounted contractual cash flows, using interest rates currently being offered for loans with similar terms to borrowers with similar credit quality. The fair value of impaired loans is estimated based on discounted contractual cash flows or underlying collateral values, where applicable. Loans are classified as Level 2 assets.

●

Loans Held for Sale (LHFS): Residential mortgage loans are originated for sale as whole loans in the secondary market. These loans are carried at fair value, with changes in the fair value of these loans recognized in mortgage banking noninterest income. Direct loan origination costs and fees are deferred at origination, and then recognized in the gain or loss on loan sales when the loans are sold. Gains and losses on loan sales (sales proceeds minus the carrying value of the loan sold) are recorded as noninterest income.

●

Derivative asset and liability positions: The fair value of derivative asset and liability positions is based on available quoted market prices.

●

Deposits: The carrying amount of demand deposits, savings deposits and variable-rate certificates of deposits approximates fair value. The fair value of fixed-rate certificates of deposit is estimated based on discounted contractual cash flows using interest rates currently being offered for certificates of similar maturities. Deposits are classified as Level 2 liabilities.

●

Other Borrowings: The carrying amount of variable rate borrowings and federal funds purchased approximates fair value. The fair value of fixed rate other borrowings is estimated based on discounted contractual cash flows using the current incremental borrowing rates for similar type borrowing arrangements. Other borrowings are classified as Level 2 liabilities.

●

Junior Subordinated Debentures: The fair value of the Company’s trust preferred securities is based on discounted contractual cash flows using the current incremental borrowing rates for similar type borrowing arrangements. Junior subordinated debentures are classified as Level 2 liabilities.

●

Accrued Interest: The carrying amount of accrued interest approximates fair value.

●

Off-Balance-Sheet Instruments: The carrying amount of commitments to extend credit and standby letters of credit approximates fair value. The carrying amount of the off-balance-sheet financial instruments is based on fees charged to enter into such agreements.

The carrying amount and estimated fair value of the Company’s financial instruments are as follows:

	March 31, 2012				December 31, 2011
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Financial assets:
Cash, due from banks, and interest-bearing deposits in banks	$	11,779,418	$	11,779,418	$	4,090,167	$	4,090,167
Federal funds sold		137,688		137,688		243,046		243,046
Securities available for sale		18,476,408		18,476,408		22,505,649		22,505,649
Restricted equity securities		5,141,550		5,141,550		5,136,250		5,136,250
Loans held for sale		46,773,200		46,773,200		36,122,381		36,122,381
Loans, net		243,261,299		240,201,022		249,445,716		246,790,693
Derivative asset positions		932,621		932,621		806,184		806,184
Accrued interest receivable		886,061		886,061		954,797		954,797

Financial liabilities:
Deposits		362,670,834		364,341,596		354,671,346		356,151,418
Securities sold under agreements to repurchase		––		––		8,766,000		8,766,000
Other borrowings		28,000,000		30,349,197		68,447,000		70,724,008
Junior subordinated debentures		7,217,000		7,217,000		7,217,000		7,217,000
Derivative liability positions		788,552		788,552		716,986		716,986
Accrued interest payable		769,976		769,976		681,054		681,054

Note 9 – Derivative Financial Instruments

Mortgage banking derivatives used in the ordinary course of business consist of best efforts and mandatory forward sales contracts and interest rate lock commitments on residential mortgage loan applications. Forward sales contracts represent future commitments to deliver loans at a specified price and by a specified date and are used to manage interest rate risk on loan commitments and mortgage loans held for sale. Rate lock commitments represent commitments to fund loans at a specific rate and by a specified expiration date. These derivatives involve underlying items, such as interest rates, and are designed to mitigate risk. Substantially all of these instruments expire within 60 days from the date of issuance. Notional amounts are amounts on which calculations and payments are based, but which do not represent credit exposure, as credit exposure is limited to the amounts required to be received or paid.

The following tables include the notional amounts and realized gain (loss) for mortgage banking derivatives recognized in mortgage banking income for the periods end March 31, 2012 and December 31, 2011:

Derivatives not designated as hedging instruments (in thousands)	March 31, 2012			December 31, 2011
Mandatory forward sales contracts
Notional amount	$	109,389		$	97,395
Gain (loss) on change in market value of mandatory forward sales contracts	$	144		$	(259	)
Derivative asset balance included in other assets	$	354		$	196
Derivative liability balance included in other liabilities	$	210		$	456

Best efforts forward sales contracts
Notional amount	$	83,057		$	50,890
Gain (loss) on change in market value of best efforts forward sales contracts	$	309		$	(107	)
Derivative asset balance included in other assets	$	388		$	81
Derivative liability balance included in other liabilities	$	79		$	188

Rate lock loan commitments
Notional amount	$	172,614		$	141,330
Gain (loss) on change in market value of rate lock commitments	$	(309	)	$	456
Derivative asset balance included in other assets	$	191		$	529
Derivative liability balance included in other liabilities	$	500		$	73

Forward sales contracts also contain an element of risk in that the counterparties may be unable to meet the terms of such agreements. In the event the parties to delivery commitments are unable to fulfill their obligations, the Company could potentially incur significant additional costs by replacing the positions at then current market rates. The Company manages its risk of exposure by limiting counterparties to those banks and institutions deemed appropriate by management and the Board of Directors. The Company does not expect any counterparty to default on their obligations and therefore, the Company does not expect to incur any cost related to counterparty default.

The Company is exposed to interest rate risk on loans held for sale and loan rate lock commitments. As market interest rates increase or decrease, the fair value of mortgage loans held for sale and rate lock commitments will decline or increase accordingly. To offset this interest rate risk, the Company enters into derivatives such as forward contracts to sell loans. The fair value of these forward sales contracts will change as market interest rates change, and the change in the value of these instruments is expected to largely, though not entirely, offset the change in fair value of loans held for sale and rate lock commitments. The objective of this activity is to minimize the exposure to losses on rate lock commitments and loans held for sale due to market interest rate fluctuations. The net effect of derivatives on earnings will depend on risk management activities and a variety of other factors, including market interest rate volatility, the amount of rate lock commitments that close, the ability to fill the forward contracts before expiration, and the time period required to close and sell loans.

Note 10 - Supplemental Segment Information

The Bank has three reportable segments: community banking, SBA lending, and mortgage banking operations. The community banking segment provides traditional banking services offered through the Bank’s branch locations, including limited retail residential mortgage banking origination activity at selected branch locations.

The Small Business Administration lending division originates SBA loans throughout the southeastern United States by the Bank’s SBA business development officers. These officers serve markets in Jacksonville and Vero Beach, Florida; Atlanta, Georgia; Charlotte, North Carolina; and Beaufort, South Carolina. The majority of loans originated by the division are processed through the SBA 7(a) loan program. Participations in these loans are typically sold to secondary market investors within 30 days of the loan being funded. All loan funding, sales and servicing activity is centralized at the Bank’s operations center in Fernandina Beach, Florida.

The SBA lending division maintains an escrow reserve cash account with a balance of $1,428,000 at March 31, 2012. The account was established as a condition to the Bank’s inclusion in the Small Business Administration’s Preferred Lender Program which allows the Bank to sell participation interests in SBA loans in the secondary market without obtaining the prior approval of the SBA. As each participation interest in an SBA loan is sold, the Bank must make an additional deposit to this account of approximately 3% of the balance of the loan participation sold. The cash is reported in the balance of “Cash & due from banks” on the Consolidated Balance Sheet although it is restricted and not available to the Bank without prior release authorization from the SBA. In the event that the Small Business Administration makes a post-purchase reimbursement demand of the Bank, and the Bank fails to reimburse the SBA as requested, then the SBA could draw on the escrow reserve account to fund the reimbursement demand.

The mortgage banking operations segment originates residential mortgage loans submitted through four distinct delivery channels. These channels include (1.) a network of independent mortgage brokers, (2.) a national network of traditional retail mortgage lending branches, (3.) an internet leads based retail loan origination branch, and (4.) retail mortgage lending through the Bank’s deposit branch locations. Most of these loans are closed by the Bank and sold to various investors on the secondary market while a limited number of loans are retained in the Bank’s loan portfolio. Additionally, approximately 10% of the loan production is brokered away to other lenders and so are not closed by the Bank. All wholesale and internet retail mortgage banking activity is conducted in the Bank’s mortgage banking offices in Atlanta, Georgia, as is the national retail mortgage lending administration function. The national retail lending branches are located in California, Connecticut, Florida, Georgia, Kansas, Maryland, New Jersey, New York, and Ohio.

The accounting policies of the segments are the same as those described in the summary of significant accounting policies. The Company evaluates performance based on profit and loss from operations before income taxes not including nonrecurring gains and losses.

All direct costs and revenues generated by each segment are allocated to the segment; however, there is no allocation of indirect corporate overhead costs to the SBA lending or mortgage banking segments. The Company accounts for intersegment revenues and expenses as if the revenue/expense transactions were to third parties at current market prices.

The Company’s reportable segments are strategic business units that offer different products and services to a different customer base. They are managed separately because each segment has different types and levels of credit and interest rate risk.

(In thousands)	Community Banking						SBA Lending Operations				Mortgage Banking Operations
Three months ended March 31,	2012			2011			2012		2011		2012		2011
Interest income	$	2,776		$	3,440		$	331	$	261	$	1,438	$	663
Interest expense		601			1,139			12		9		536		291
Net interest income		2,175			2,301			319		252		902		372
Provision for loan losses		992			483			23		11		2		21
Net interest income after provision		1,183			1,818			296		241		900		351
Non interest income		420			274			949		848		9,248		1,328
Non interest expense		3,504			3,400			381		262		8,601		1,142
Net income (loss) before tax expense (benefit)		(1,901	)		(1,308	)		864		827		1,547		537
Income tax expense (benefit)		(513	)		(368	)		259		248		464		161
Net income (loss)	$	(1,388	)	$	(940	)	$	605	$	579	$	1,083	$	376

Note 11 – Reclassifications

Certain amounts reported as of December 31, 2011, or the periods ended March 31, 2011, have been reclassified to conform with the presentation of March 31, 2012. These reclassifications had no effect on previously reported net loss or shareholders’ equity.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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

This report contains “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,” and “intend,” as well as other similar words and expressions of the future, are intended to identify forward-looking statements. Our actual results may differ materially from the results discussed in the forward-looking statements, and our operating performance each quarter is subject to various risks and uncertainties that are discussed in detail in our filings with the Securities and Exchange Commission, including, without limitation:

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

●	changes in the interest rate environment which could reduce anticipated or actual margins;

●	changes in political conditions or the legislative or regulatory environment;

●

general economic conditions, either nationally or regionally and especially in our primary service area, becoming less favorable than expected resulting in, among other things, a continued or increased deterioration in credit quality or a reduced demand for credit, including the resultant effect on our loan portfolio and allowance for loan losses;

●	the ability to increase market share;

●	changes occurring in business and monetary conditions and inflation;

●	changes in technology;

●	the potential that loan charge-offs may exceed the allowance for loan losses or that such allowance will be increased as a result of factors beyond our control;

●	fluctuations in consumer spending and saving habits;

●	adverse changes in the market value of real estate serving as the collateral underlying our loans;

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

●	the rates of loan growth;

●	unanticipated regulatory or judicial proceedings;

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

●	changes in monetary, accounting or tax policies;

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

●	adverse conditions in the securities markets, including the stock market, the public debt market and other capital markets; and

●	other risks and uncertainties detailed from time to time in our filings with the Securities and Exchange Commission.

Overview

The following discussion describes our results of operations for the quarter ended March 31, 2012 as compared to the quarter ended March 31, 2011 and also analyzes our financial condition as of March 31, 2012 as compared to December 31, 2011. Like most community banks, we derive most of our income from interest we receive on our loans and investments. Our primary source of funds for making these loans and investments is our deposits, on which we pay interest. Consequently, one of the key measures of our success is our amount of net interest income, or the difference between the income on our interest-earning assets, such as loans and investments, and the expense on our interest-bearing liabilities, such as deposits. Another key measure is the spread between the yield we earn on these interest-earning assets and the rate we pay on our interest-bearing liabilities.

Of course, there are risks inherent in all loans, so we maintain an allowance for loan losses to absorb 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, gain 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 non-interest income, as well as our non-interest 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.

Critical Accounting Policies

We have adopted various accounting policies which govern the application of accounting principles generally accepted in the United States of America in the preparation of our financial statements. Our significant accounting policies are described in the footnotes to the consolidated financial statements at December 31, 2011, as filed in our Annual Report on Form 10-K. Certain accounting policies involve significant judgments and assumptions by us which have a material impact on the carrying value of certain assets and liabilities. We consider these accounting policies to be critical accounting policies. The judgments and assumptions we use are based on historical experience and other factors, which we believe to be reasonable under the circumstances. Because of the nature of the judgments and assumptions we make, actual results could differ from these judgments and estimates, which could have a material impact on our carrying values of assets and liabilities and our results of operations.

We believe the allowance for loan losses is a critical accounting policy that requires the most significant judgments and estimates used in preparation of our consolidated financial statements. Some of the more critical judgments supporting the amount of our allowance for loan losses include judgments about the credit worthiness of borrowers, the estimated value of the underlying collateral, the assumptions about cash flow, determination of loss factors for estimating credit losses, the impact of current events, and conditions, and other factors impacting the level of probable inherent losses. Under different conditions or using different assumptions, the actual amount of credit losses incurred by us may be different from management’s estimates provided in our consolidated financial statements. Refer to the portion of this discussion that addresses our allowance for loan losses for a description of our processes and methodology for determining our allowance for loan losses.

Results of Operations

Net Interest Income

The Bank’s net interest income is determined by the level of our earning assets, primarily loans outstanding, and the management of our net interest margin. For the quarter ended March 31, 2012, net interest income totaled $3,395,000 as compared to $2,925,000 for the quarter ended March 31, 2011 for an increase of $470,000. On a consecutive quarter basis, net interest income was down by $237,000, or 7%, from the $3,632,000 earned during the quarter ended December 31, 2011.

Total interest income increased by $181,000, or 4%, to $4,545,000 for the three months ended March 31, 2012 compared to $4,364,000 for the three months ended March 31, 2011. On a consecutive quarter basis, total interest income decreased by $299,000, or 6%, from the $4,844,000 earned during the quarter ended December 31, 2011.

The impact of the interest rate environment is seen in the Prime interest rate, which has been set at a historical low rate of 3.25% since December 16, 2008. This historic low Prime interest rate has had an extremely negative impact on the yield earned by the Bank on that portion of the loan portfolio that carry rates based on the Prime interest rate index. At March 31, 2012 and March 31, 2011 the Bank held $103,815,000 and $113,469,000, respectively, in loans carrying rates based on the Prime interest rate index.

In addition to the negative impact of decreased interest rates, interest income was also negatively impacted by elevated nonperforming loans, offset by an increase in average interest earning assets. Average earning assets increased to an average balance of $407,631,000 during the quarter ended March 31, 2012, up by $29,519,000, or 8%, from the average balance during the quarter ended March 31, 2011. This increase was largely the result of increases in loans held for sale and loan sales receivable, offset by decreases in investment securities and portfolio loans. The overall impact of these factors was a decrease in interest income from investment securities of $179,000, or 45%, to $215,000 in the three months ended March 31, 2012 compared to $394,000 earned in the three months ended March 31, 2011. Interest and fees earned on loans increased by $365,000, or 9%, to $4,328,000 in the three months ended March 31, 2012 from $3,963,000 in the three months ended March 31, 2011. On a consecutive quarter basis, interest income from investments decreased by $33,000 from $248,000 earned during the quarter ended December 31, 2011. Interest and fees earned on loans decreased by $267,000, or 6%, from $4,595,000 during the quarter ended December 31, 2011.

Interest income not recognized on non-accruing loans during the quarter ended March 31, 2012 was $193,000, a decrease of $42,000 from the $235,000 of interest income not recognized during the same quarter in 2011. On a consecutive quarter basis, interest income not recognized on non-accruing loans decreased $34,000 from $227,000 during the quarter ended December 31, 2011.

Total interest expense decreased by $289,000, or 20%, to $1,150,000 for the three months ended March 31, 2012 compared to $1,439,000 for the same period in 2011. On a consecutive quarter basis, total interest expense decreased by $62,000, or 5%, from $1,212,000 expensed during the quarter ended December 31, 2011.

The net interest margin is a performance metric that reports how successful the Bank’s investment decisions have been relative to its funding choices. It is calculated by dividing the annualized net interest income by the balance of the average earning assets for the period. The net interest margin realized on earning assets increased by 21 basis points to 3.35% for the three months ended March 31, 2012 when compared to the 3.14% net interest margin earned during the same three months in 2011. On a consecutive quarter basis, the net interest margin decreased by 6 basis points from 3.41% during the quarter ended December 31, 2011.

The net interest rate spread is the difference between the average yield earned by the Bank on loans, investment securities and other earning assets, and the rate paid by the Bank on interest bearing deposits and other borrowings. The net interest rate spread improved by 26 basis points to 3.28% for the three months ended March 31, 2012 compared to the 3.02% net interest rate spread earned during the same three month period in 2011. On a consecutive quarter basis, the net interest rate spread decreased by 6 basis points from 3.34% during the quarter ended December 31, 2011.

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 under various interest rate 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 for a given time 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 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 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 March 31, 2012, 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 with a cumulative projected Gap ratio of 3.70 over a three month period, and a cumulative projected Gap ratio of 1.48 over a one year 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. For more information on asset-liability management, see the Annual Report on Form 10-K for the year ended December 31, 2011 filed with the Securities and Exchange Commission.

Provision and Allowance for Loan Losses

There are risks inherent in making all loans, including risks with respect to the period of time over which loans may be repaid, risks resulting from changes in economic and industry conditions, risks inherent in dealing with individual borrowers, and, in the case of a collateralized loan, risks resulting from uncertainties about the future value of the collateral. We establish and maintain an allowance for loan losses based on a number of qualitative factors including, among other things, historical experience, evaluation of economic conditions, regular reviews of delinquencies and loan portfolio quality and a number of assumptions about future events, which we believe to be reasonable, but which may not prove to be accurate. We believe that changes in economic and industry conditions capture the impact of general declines in the value of collateral property, and in this way our qualitative factors reflect general declines in collateral values.

To the extent that the recovery of loan balances has become collateral dependent, we obtain appraisals not less than annually, and then we reduce these appraised values for selling and holding costs to determine the liquidated value. Any shortfall between the liquidated value and the loan balance is charged against the allowance for loan losses in the month the related appraisal was received. In the ordinary course of managing and monitoring nonperforming loans, information may come to our attention that indicates the collateral value has declined further from the value established in the most recent appraisal. Such other information may include prices on recent comparable property sales or internet based property valuation estimates. In cases where this other information is deemed reliable, and the impact of a further reduction in collateral value would result in a further loss to the Company, we will record an increase to the allowance to reflect the additional estimated collateral shortfall.

The provision for loan losses is the periodic charge to operating earnings that management believes is necessary to maintain the allowance for possible loan losses at an adequate level. The amount of these periodic charges is based on management’s analysis of the potential risk in the loan portfolio. This analysis includes, among other things, evaluation of the trends in key loan portfolio metrics as follows:

(In thousands)	March 31, 2012		December 31, 2011		September 30, 2011		June 30, 2011		March 31, 2011		December 31, 2010		September 30, 2010		June 30, 2010
Portfolio loans, gross	$	249,075	$	254,667	$	260,789	$	259,561	$	263,596	$	267,600	$	277,611	$	284,604

Loans past due > 30 days and still accruing interest	$	1,237	$	1,142	$	844	$	1,950	$	2,063	$	2,135	$	6,063	$	4,884

Loans on nonaccrual	$	13,527	$	15,937	$	22,338	$	25,399	$	20,678	$	22,302	$	19,998	$	16,666
(as a % of loans, gross)		5.43%		6.26%		8.57%		9.79%		7.84%		8.33%		7.20%		5.83%

Net loan charge offs (recoveries)	$	426	$	1,713	$	846	$	685	$	407	$	535	$	1,553	$	863
(as a % of loans, gross)		0.17%		0.67%		0.32%		0.26%		0.15%		0.20%		0.56%		0.30%

Portfolio loans, gross addresses the impact on the provision for loan losses from changes in the size and composition of our loan portfolio. In the past we applied various reserve factors to our portfolio based on the risk-rated categories of loans because we had relatively little charge off activity prior to the quarter ended December 31, 2008. As a result of increasing charge off activity over the past three years, we have begun to rely more on historical levels and trends to establish various reserve percentages based on the relative inherent risk for a particular loan type and grade. The inherent risk is established based on peer group data, information from regulatory agencies, the experience of the Bank’s lending officers, and recent trends in portfolio losses. These reserve factors are continuously evaluated and subject to change depending on trends in national and local economic conditions, the depth of experience of the Bank’s lenders, delinquency trends and other factors. As our portfolio size has decreased over the last two years, there has been a shift in composition from higher risk rated real estate construction loans to comparably lower risk rated owner occupied residential real estate loans.

Loans past due greater than 30 days and still accruing interest has proven to be a useful leading indicator of directional trends in future loan losses. As the level of this metric rises, expectations are for a comparable increase in loans moving into a nonaccrual status and ultimately foreclosure resulting in increased losses. This pattern 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 slightly in the most recent two quarters to $1,237,000 at March 31, 2012. Despite the recent increase, 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. Although it is not shown in the table above, the level of loans on nonaccrual peaked at $25,925,000 at June 30, 2009 and then declined by 50% over the following three quarters to $12,992,000 at March 31, 2010. From that March 31, 2010 low point, loans on nonaccrual gradually increased again to peak at $25,399,000 in mid-2011 which was very near the mid-2009 high point. Once again we’ve seen a downward trend over the most recent three quarters to a level of $13,527,000 at March 31, 2012 which is the lowest level of loans on nonaccrual in two years. Despite the recent improvement in this indicator, management remains vigilant in its loan monitoring and loss mitigation efforts.

Net loan charge offs or recoveries reflect our practice of charging recognized losses to the allowance and adding subsequent recoveries back to the allowance. During the three months ended March 31, 2012, we recorded charge offs net of recoveries of $426,000. This amount represented a decrease of $1,287,000, or 75%, from the $1,713,000 in net charge offs recorded during the prior quarter ended December 31, 2011, and an increase of $19,000, or 5% from the $407,000 net charge offs during the same quarter in the prior year.

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

In addition to considering the metrics described above, we evaluate the collectability of individual loans, the balance of impaired loans, economic conditions that may affect the borrower’s ability to repay, the amount and quality of collateral securing the loans and a review of specific problem loans. Based on this process and as shown below, the provision charged to expense was $1,017,000 for the three months ended March 31, 2012, as compared to $515,000 for the three months ended March 31, 2011. On a consecutive quarter basis, this provision level was $133,000, or 12%, lower than the $1,150,000 provision charged to expense during the quarter ended December 31, 2011.

(In thousands)	March 31, 2012		December 31, 2011		September 30, 2011		June 30, 2011		March 31, 2011		December 31, 2010			September 30, 2010			June 30, 2010
Provision during quarter ended	$	1,017	$	1,150	$	703	$	497	$	515	$	250		$	1,361		$	685

Provision added in excess of net charge offs	$	591	$	(563)	$	(143)	$	(188)	$	108	$	(285	)	$	(192	)	$	(178	)

Allowance for loan losses	$	5,813	$	5,222	$	5,785	$	5,928	$	6,116	$	6,008		$	6,293		$	6,485
(as a % of loans, gross)		2.33%		2.05%		2.22%		2.28%		2.32%		2.25%			2.27%			2.28%

The difference between the amount of the provision for loan losses and net loan charge offs will result in expansion or shrinkage to the level of the allowance for loan losses. As shown above, during the three months ended March 31, 2012 the current provision for loan losses of $1,017,000 was greater than net charge offs against the allowance of $426,000 by $591,000. The result was an increase to the allowance for loan losses by $591,000 to a level of $5,813,000, or 2.33% of gross loans outstanding at March 31, 2012, as compared to $5,222,000, or 2.05% of gross loans outstanding at December 31, 2011.

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.

Noninterest Income

Noninterest income for the three months ended March 31, 2012 totaled $10,617,000, as compared to $2,450,000 for the three months ended March 31, 2011. The largest factor in this year-over-year improvement occurred in mortgage banking income, which was $9,294,000 for the quarter ended March 31, 2012 compared to $1,368,000 for the same period during 2011. 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.

In addition to improved mortgage banking income, SBA loan income increased by 11% or $92,000 to $942,000 for the first quarter of 2012 compared to $850,000 during the first quarter of 2011. Service charges on deposit accounts decreased by 30% or $33,000 to a level of $78,000 for the first three months of 2012. During the first quarter of 2012, we recorded net gains of $141,000 on sales of securities available for sale.

Noninterest Expense

Total noninterest expense for the three months ended March 31, 2012 was $12,486,000 as compared to $4,804,000 for the same period in 2011. The year-over-year increase in noninterest operating expense of $7,682,000 is due largely to increased costs associated with higher mortgage lending volume and the expansion of retail residential loan production offices during the last three quarters of 2011 and first quarter of 2012 in California, Connecticut, Florida, Georgia, Kansas, Maryland, New Jersey, New York, and Ohio. Mortgage division expenses, excluding mortgage division salaries and benefits, increased 553%, or $2,535,000, to $2,993,000 during the first three months of 2012 compared to $458,000 during the same period in 2011. Other real estate expenses increased 20%, or $130,000, to $787,000 during the first quarter of 2012 compared to $657,000 during the first quarter of 2011.

Salaries and benefits totaled $7,285,000 for the three months ended March 31, 2012, compared to $2,165,000 for the same period a year ago, for an increase of $5,120,000, 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 $196,000 during the first quarter of 2012 compared to the first quarter of 2011.

Advertising expense increased significantly in 2012 at $1,407,000, representing a near 28 fold increase from the $50,000 expensed in the first quarter of 2011. This $1,357,000 year-over-year increase was due solely to the addition of the retail mortgage production offices, and reflects expenses related to generating residential real estate loan application leads through various media such as print advertising, mass mailings, internet referrals, and telemarketing efforts.

Occupancy and equipment expense increased $234,000 to $573,000 for the first three months of 2012 compared to $339,000 during the same period of 2011. This increase was due to expansion in the mortgage banking division, including thirteen retail residential loan production offices in California, Connecticut, Florida, Georgia, Kansas, Maryland, New Jersey, New York, and Ohio.

Mortgage Banking Activities

The primary source of direct income generated by this division is the gain on sale of mortgage loans which was $9,294,000 for the quarter ended March 31, 2012 compared to $1,368,000 for the quarter ended March 31, 2011. The increase in gain on sale is a result of increased volume caused by the new national retail mortgage offices. The direct noninterest expenses incurred by the division were $8,601,000 for the first quarter of 2012, an increase of $7,459,000 over the first quarter 2011 expenses of $1,142,000. The largest contributor to this increase was in salaries and benefits, which were $5,608,000 for first quarter 2012, compared to $684,000 for first quarter 2011, and largely reflect staffing additions at the national retail mortgage banking branches.

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 $133,184,000 for the three months ended March 31, 2012 and $58,615,000 for the three months ended March 31, 2011. The interest income earned on these loans available for sale was $1,336,000 and $646,000 during the three months ended March 31, 2012 and 2011, respectively.

The combination of the above factors resulted in net income at the mortgage banking division of $1,083,000 for the three months ended March 31, 2012, compared to net income for the three months ended March 31, 2011 of $376,000.

Income Taxes

For the three months ended March 31, 2012, we recognized income tax expense of $210,000 compared to income tax expense of $41,000 for the first quarter of 2011. Our effective tax rate was 41% in 2012 and 73% in 2011. The fluctuation in effective tax rates reflects the impact of permanent book-to-tax differences from tax exempt income on bank owned life insurance and municipal securities.

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

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

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

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

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

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

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

●	After nine consecutive quarterly losses through December 31, 2010, the Company’s banking subsidiary, CBC National Bank, has been profitable for each of the five consecutive fiscal quarters ending March 31, 2012.

●

The recent profitability generated at the Company’s banking subsidiary was from ongoing core earning sources which appear to be on a stable to improving trend. Core earning sources include net interest income and noninterest income from residential mortgage banking and small business lending activity. Management’s forecasts indicate that this stable to improving trend in core earnings appears sustainable over the next few years, and as such the expectation is that there will be future earnings available to realize the deferred tax asset in future periods.

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

●

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

●	The existing portfolio of marketable securities had an unrealized mark to market gain as of March 31, 2012 of $718,000, which could consume up to $244,000 of the deferred tax asset if the decision was made to sell securities from this portfolio and replace them with current market rate securities.

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 $80,000 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.

Net Income

The combination of the above factors resulted in net income of $300,000 for the three months ended March 31, 2012, compared to net income for the three months ended March 31, 2011 of $15,000. Although we recorded net income during the first quarters of 2012 and 2011, that income must be reduced by preferred stock dividends accrued during the period to arrive at a net loss available to common shareholders for the first quarter of 2011. Basic and diluted earnings per share available to common shareholders were $.06 for the three months ended March 31, 2012, compared to basic and diluted loss per share of ($.05) for the three month period ended March 31, 2011.

COASTAL BANKING CO INC 10-Q