Edgar Filing: FIRST RELIANCE BANCSHARES INC

Unassociated Document

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.

FORM 10-Q

(Mark One)

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

For the Quarterly Period Ended June 30, 2010

o	TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period from _________to_________

Commission File Number 000-49757

FIRST RELIANCE BANCSHARES, INC.

(Exact name of small business issuer as specified in its charter)

South Carolina	80-0030931
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

2170 West Palmetto Street

Florence, South Carolina 29501

(Address of principal executive offices, including zip code)

(843) 656-5000

(Issuer’s telephone number, including area code)

State the number of shares outstanding of each of the issuer’s classes of common equity as of the latest practicable date:

4,109,968 shares of common stock, par value $0.01 per share, as of July 31, 2010

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

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

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

Large accelerated filer o

Accelerated filer o

Non-accelerated filer o

Smaller reporting company x

(Do not check if a 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 x

INDEX

	Page No.
PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Condensed Consolidated Balance Sheets - June 30, 2010 (Unaudited) and December 31, 2009		3

Condensed Consolidated Statements of Operations – Six and three months ended June 30, 2010 and 2009 (Unaudited)		4

Condensed Consolidated Statements of Shareholders’ Equity and Comprehensive Income (Loss) - Six months ended June 30, 2010 and 2009 (Unaudited)		5

Condensed Consolidated Statements of Cash Flows - Six months ended June 30, 2010 and 2009(Unaudited)		6

Notes to Condensed Consolidated Financial Statements		7-17

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		18-36

Item 3. Quantitative and Qualitative Disclosure About Market Risk		36

Item 4. Controls and Procedures		36

PART II. OTHER INFORMATION

Item 1. Legal Proceedings		37

Item 1A Risk Factors		37

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		38

Item 3. Defaults Upon Senior Securities		38

Item 6. Exhibits		38

FIRST RELIANCE BANCSHARES, INC

Condensed Consolidated Balance Sheets

	June 30, 2010			December 31, 2009
Assets	(Unaudited)
Cash and cash equivalents:
Cash and due from banks	$	2,196,978		$	2,942,295
Interest-bearing deposits with other banks		30,637,573			50,356,191
Total cash and cash equivalents		32,834,551			53,298,486

Time deposits in other banks		503,644			502,089
Securities available-for-sale		122,201,795			121,948,744
Nonmarketable equity securities		4,812,100			4,812,100
Total investment securities		127,013,895			126,760,844

Mortgage loans held for sale		579,266			5,100,609
Loans receivable		375,344,297			406,627,401
Less allowance for loan losses		(7,048,764	)		(9,800,746	)
Loans, net		368,295,533			396,826,655
Premises and equipment, net		26,190,857			26,469,436
Accrued interest receivable		2,537,500			2,661,030
Other real estate owned		12,268,366			8,954,214
Cash surrender value life insurance		11,618,284			11,409,937
Other assets		11,007,722			13,525,073
Total assets	$	592,849,618		$	645,508,373

Liabilities and Shareholders’ Equity
Liabilities
Deposits
Noninterest-bearing transaction accounts	$	43,696,640		$	44,298,626
Interest-bearing transaction accounts		36,764,075			47,733,229
Savings		108,369,143			103,604,793
Time deposits $100,000 and over		183,128,203			195,346,191
Other time deposits		130,963,221			161,780,140
Total deposits		502,921,282			552,762,979
Securities sold under agreement to repurchase		545,647			598,342
Advances from Federal Home Loan Bank		26,000,000			34,000,000
Junior subordinated debentures		10,310,000			10,310,000
Accrued interest payable		592,527			680,880
Other liabilities		2,195,047			1,932,345
Total liabilities		542,564,503			600,284,546
Shareholders’ Equity
Preferred stock, no par value, authorized 10,000,000 shares:
Series A cumulative perpetual preferred stock 15,349 issued
and outstanding at June 30, 2010 and December 31, 2009		14,632,649			14,536,176
Series B cumulative perpetual preferred stock 767 shares issue
and outstanding at June 30, 2010 and December 31, 2009		827,775			835,960
Series C cumulative mandatory convertible preferred stock
2,293 shares issue and outstanding at June 30, 2010		2,293,000			-
Common stock, $0.01 par value; 20,000,000 shares authorized,
4,109,968 and 3,582,691 shares issued and outstanding
at June 30, 2010 and December 31, 2009, respectively		41,100			35,827
Capital surplus		28,121,138			26,181,576
Treasury stock at cost at 12,090 and 11,535 shares at
June 30, 2010 and December 31, 2009, respectively		(168,266	)		(163,936	)
Nonvested restricted stock		(856,860	)		(206,004	)
Retained earnings		4,790,734			5,269,463
Accumulated other comprehensive income (loss)		603,845			(1,265,235	)
Total shareholders’ equity		50,285,115			45,223,827

Total liabilities and shareholders’ equity	$	592,849,618		$	645,508,373

See notes to condensed consolidated financial statements

-3-

FIRST RELIANCE BANCSHARES, INC

Condensed Consolidated Statements of Operations

(Unaudited)

	Six Months Ended June 30,						Three Months Ended June 30,
	2010			2009			2010			2009
Interest income:
Loans, including fees	$	12,066,213		$	13,838,054		$	5,853,126		$	6,870,317
Investment securities:
Taxable		1,193,184			1,002,970			583,191			471,654
Nontaxable		1,306,871			745,799			653,973			432,381
Federal funds sold		-			1,332			-			349
Other interest income		55,472			36,720			26,599			27,121
Total		14,621,740			15,624,875			7,116,889			7,801,822
Interest expense:
Time Deposits over $100,000		2,903,397			2,575,302			1,447,695			1,382,735
Other deposits		2,598,035			3,433,801			1,245,226			1,810,957
Other interest expense		781,052			1,576,970			392,253			722,421
Total		6,282,484			7,586,073			3,085,174			3,916,113
Net interest income		8,339,256			8,038,802			4,031,715			3,885,709
Provision for loan losses		2,065,899			4,855,822			1,879,810			3,555,442
Net interest income after provision for loan losses		6,273,357			3,182,980			2,151,905			330,267

Noninterest income:
Service charges on deposit accounts		911,690			935,094			443,469			474,486
Gain on sales of mortgage loans		380,463			1,214,537			170,421			554,038
Income from bank owned life insurance		208,347			208,155			103,690			103,005
Other charges, commissions and fees		323,995			267,903			171,011			140,904
Gain on sale of securities		1,602			1,029,459			-			1,029,459
Gain (loss) on sale of other real estate owned		482,681			(15,892	)		240,560			-
Gain on sale of fixed assets		-			86,810			-			-
Other non-interest income		175,000			280,768			70,221			11,825
Total		2,483,778			4,006,834			1,199,372			2,313,717
Noninterest expenses:
Salaries and employee benefits		4,663,675			5,322,773			2,267,609			2,595,624
Occupancy expense		777,915			710,032			378,381			354,175
Furniture and equipment expense		598,356			562,569			288,130			276,704
Other operating expenses		3,390,843			2,883,428			1,554,713			1,527,420
Total		9,430,789			9,478,802			4,488,833			4,753,923
Loss before income taxes		(673,654	)		(2,288,988	)		(1,137,556	)		(2,109,939	)

Income tax benefit		(724,635	)		(1,148,239	)		(658,403	)		(955,325	)
Net income (loss)		50,981			(1,140,749	)		(479,153	)		(1,154,614	)
Preferred stock dividends		454,801			268,132			250,227			208,547
Deemed dividends on preferred stock resulting from
net accretion of discount and amortization
of premium		88,288			57,072			44,388			44,388
Net loss available to common shareholders	$	(492,108	)	$	(1,465,953	)	$	(773,768	)	$	(1,407,549	)

Average common shares outstanding, basic		3,760,792			3,546,386			3,935,610			3,567,533
Average common shares outstanding, diluted		3,760,792			3,546,386			3,935,610			3,567,533

Basic loss per share	$	(0.13	)	$	(0.41	)	$	(0.20	)	$	(0.40	)
Diluted loss per share	$	(0.13	)	$	(0.41	)	$	(0.20	)	$	(0.40	)

See notes to condensed consolidated financial statements

-4-

FIRST RELIANCE BANCSHARES, INC

Condensed Consolidated Statements of Shareholders’ Equity and Comprehensive Income (Loss)

For the Six Months Ended June 30, 2010 and 2009

(Unaudited)

																	Accumulated
																	Other
											Nonvested						Comprehensive
	Preferred			Common		Capital		Treasury			Restricted			Retained			Income
	Stock			Stock		Surplus		Stock			Stock			Earnings			(Loss)			Total
Balance, December 31, 2008	$	-		$	35,250	$	26,120,460	$	(159,777	)	$	(207,653	)	$	11,839,005		$	(201,527	)	$	37,425,758

Issuance of Series A preferred stock, net of issuance cost of $116,786		14,375,740																			14,375,740

Issuance of Series B preferred stock, net of issuance cost of $6,902		849,572																			849,572

Net loss															(1,140,749	)					(1,140,749	)

Other comprehensive loss, net of tax benefit of $583,818																		(1,133,294	)		(1,133,294	)

Comprehensive loss																					(2,274,043	)

Preferred stock dividends															(160,325	)					(160,325	)

Accretion of Series A Preferred stock discount		62,363													(62,363	)					-

Amortization of Series B Preferred stock premium		(5,291	)												5,291						-

Issuance of stock to employee					2		998														1,000

Non-vested restricted stock					622		139,377					(62,139	)								77,860

Purchase of treasury stock									(4,130	)											(4,130	)
Balance, June 30, 2009	$	15,282,384		$	35,874	$	26,260,835	$	(163,907	)	$	(269,792	)	$	10,480,859		$	(1,334,821	)	$	50,291,432

Balance, December 31, 2009	$	15,372,136		$	35,827	$	26,181,576	$	(163,936	)	$	(206,004	)	$	5,269,463		$	(1,265,235	)	$	45,223,827

Issuance of Series C		2,293,000																			2,293,000

Issuance of common stock net of issuance cost of $329,390					3,401		1,197,861														1,201,262

Net income															50,981						50,981

Other comprehensive gain, net of tax expense of $953,641																		1,869,080			1,869,080
Other comprehensive income																					1,920,061

Preferred Stock Dividend															(441,422	)					(441,422	)

Accretion of Series A Preferred stock discount		96,473													(96,473	)					-

Amortization of Series B Preferred stock premium		(8,185	)												8,185						-

Issuance Restricted Stock					1,872		741,701					(650,856	)								92,717

Purchase of treasury stock									(4,330	)											(4,330	)
Balance, June 30, 2010	$	17,753,424		$	41,100	$	28,121,138	$	(168,266	)	$	(856,860	)	$	4,790,734		$	603,845		$	50,285,115

See notes to condensed consolidated financial statements

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FIRST RELIANCE BANCSHARES, INC

Condensed Consolidated Statements of Cash Flows

(Unaudited)

	Six Months Ended June 30,
	2010			2009
Cash flows from operating activities:
Net income (loss)	$	50,981		$	(1,140,749	)
Adjustments to reconcile net income (loss) to net cash
Provided (used) by operating activities:
Provision for loan losses		2,065,899			4,855,822
Depreciation and amortization expense		492,979			542,760
Gain on sale of premises		-			(86,810	)
Gain on sale of available-for-sale securities		(1,602	)		(1,029,459	)
Impairment loss on available-for sale securities		18,750			-
Loss (gain) on sale of other real estate owned		(482,681	)		15,892
Write down of other real estate owned		187,582			-
Discount accretion and premium amortization		139,438			38,766
Disbursements for loans held-for-sale		(15,693,549	)		(119,138,851	)
Proceeds from loans held-for-sale		20,216,509			113,572,405
Net increase (decrease) in valuation allowance for loans held-for-sale		(1,617	)		229,782
Decrease in interest receivable		123,530			321,610
Increase in cash surrender value of life insurance		(208,347	)		(208,155	)
Increase (decrease) in interest payable		(88,353	)		17,049
Amortization of deferred compensation on restricted stock		92,717			77,860
Increase (decrease) in other liabilities		(39,151	)		1,076,966
(Increase) decrease in other assets		1,813,998			(2,847,259	)
Net cash provided (used) by operating activities		8,687,083			(3,702,371	)
Cash flows from investing activities:
Increase in time deposits		(1,555	)		-
Net decrease in loans receivable		19,165,193			12,054,022
Purchases of securities available-for-sale		(2,888,381	)		(61,714,944	)
Proceeds on sales of securities available-for-sale		3,117,545			40,506,377
Maturities of securities available-for-sale		2,183,920			7,187,809
Purchase of nonmarketable equity securities		-			(237,400	)
Proceeds from sales of other real estate owned		4,430,093			6,608
Improvements to other real estate owned		(149,116	)		-
Proceeds from disposal of premises, furniture, and equipment		-			2,286,810
Purchases of premises and equipment		(162,835	)		(736,200	)
Net cash provided (used) by investing activities		25,694,864			(646,918	)
Cash flows from financing activities:
Net increase (decrease) in demand deposits, interest-bearing and savings accounts		(6,806,790	)		5,720,879
Net increase (decrease) in certificates of deposit and other time deposits		(43,034,907	)		108,409,294
Net decrease in securities sold under agreements to repurchase		(52,695	)		(7,072,086	)
Decrease in advances from the Federal Home Loan Bank		(8,000,000	)		(21,500,000	)
Repayment of note payable		-			(6,950,000	)
Net proceeds from issuance of preferred stock		2,293,000			15,225,312
Net proceeds from issuance of common stock		1,201,262			-
Issuance of shares to employee		-			1,000
Preferred stock dividends paid		(441,422	)		(160,325	)
Purchase of treasury stock		(4,330	)		(4,130	)
Net cash used by financing activities		(54,845,882	)		(93,669,944	)
Net increase (decrease) in cash and cash equivalents		(20,463,935	)		89,320,655

Cash and cash equivalents, beginning of period		53,298,486			5,708,607
Cash and cash equivalents, end of period	$	32,834,551		$	95,029,262

Cash paid during the period for
Income taxes	$	-		$	4,257
Interest	$	6,370,837		$	7,569,024

Supplemental noncash investing and financing activities
Foreclosures on loans	$	7,300,030		$	3,544,350

See notes to condensed consolidated financial statements

-6-

FIRST RELIANCE BANCSHARES, INC.

Notes to Condensed Consolidated Financial Statements

Note 1 - Basis of Presentation

The accompanying condensed consolidated financial statements have been prepared in accordance with the requirements for interim financial statements and, accordingly, they are condensed and omit certain disclosures, which would appear in audited annual consolidated financial statements. The consolidated financial statements as of June 30, 2010 and for the interim periods ended June 30, 2010 and 2009 are unaudited and, in the opinion of management, include all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation. The consolidated financial information as of December 31, 2009 has been derived from the audited consolidated financial statements as of that date. For further information, refer to the consolidated financial statements and the notes included in First Reliance Bancshares, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2009.

Note 2 - Recently Issued Accounting Pronouncements

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

Income Tax guidance was amended in April 2010 to reflect an SEC Staff Announcement after the President signed the Health Care and Education Reconciliation Act of 2010 on March 30, 2010, which amended the Patient Protection and Affordable Care Act signed on March 23, 2010. According to the announcement, although the bills were signed on separate dates, regulatory bodies would not object if the two Acts were considered together for accounting purposes. This view is based on the SEC staff's understanding that the two Acts together represent the current health care reforms as passed by Congress and signed by the President. The amendment had no impact on the financial statements.

In July 2010, the FASB issued Accounting Standard Codification Update No. 2010-20 concerning disclosures about the credit quality of financing receivables and the allowance for credit losses. Update No. 2010-20 is intended to provide additional information to assist financial statement users in assessing an entity’s credit risk exposures and evaluating the adequacy of its allowance for credit losses. Update No. 2010-20 requires companies to (1) provide enhanced disclosures around the nature of credit risk inherent in the entity’s portfolio of financing receivables; (2) explain how that risk is analyzed and assessed in arriving at the allowance for credit losses; and (3) explain the changes and reasons for changes in the allowance for credit losses. The provisions of Update No. 2010-20 concerning disclosures for the end of a period are effective for interim and annual periods ending on or after December 15, 2010, or December 31, 2010 for the Company. The provisions of Update No. 2010-20 concerning disclosures about activity that occurs during a reporting period are applicable to the Company for interim and annual periods beginning on or after December 15, 2010, the interim period ending on March 31, 2011. The adoption of Update No. 2010-20 is expected to provide the reader of the Company’s financial statements with expanded and enhanced disclosure surrounding the allowance for credit losses.

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s financial position, results of operations or cash flows.

-7-

FIRST RELIANCE BANCSHARES, INC.

Notes to Condensed Consolidated Financial Statements

Note 3 - Reclassifications

Certain captions and amounts in the financial statements in the Company’s Form 10-Q for the quarter ended June 30, 2009 were reclassified to conform to the June 30, 2010 presentation.

Note 4 - Comprehensive Income

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

The components of other comprehensive income and related tax effects are as follows:

	Pre-tax Amount			Tax (Expense) Benefit			Net-of-tax Amount
For the Six Months Ended June 30, 2010:
Unrealized gains on securities available-for-sale	$	2,824,323		$	(954,186	)	$	1,870,137
Reclassification adjustment for gains (losses) in net income		1,602			(545	)		1,057

	$	2,822,721		$	(953,641	)	$	1,869,080

For the Six Months Ended June 30, 2009:
Unrealized gains on securities available-for-sale	$	(687,653	)	$	233,802		$	(453,851	)
Reclassification adjustment for gains (losses) in net income		1,029,459			(350,016	)		679,443

	$	(1,717,112	)	$	583,818		$	(1,133,294	)

For the Three Months Ended June 30, 2010:
Unrealized gains on securities available-for-sale	$	1,955,376		$	(658,744	)	$	1,296,632
Reclassification adjustment for gains (losses) realized in net income		-			-			-

	$	1,955,376		$	(658,744	)	$	1,296,632

For the Three Months Ended June 30, 2009:
Unrealized gains on securities available-for-sale	$	(1,084,399	)	$	368,696		$	(715,703	)
Reclassification adjustment for gains (losses) realized in net income		1,029,459			(350,016	)		679,443

	$	(2,113,858	)	$	718,712		$	(1,395,146	)

Note 5 – Investment Securities

The amortized cost and estimated fair values of securities available-for-sale were:

	Amortized		Gross Unrealized				Estimated
	Cost		Gains		Losses		Fair Value
June 30, 2010
U.S. Government agencies	$	2,733,345	$	52,341	$	-	$	2,785,686
Mortgage-backed securities		57,330,574		1,173,526		-		58,504,100
Municipals		61,032,177		607,944		762,112		60,878,009
Other		200,000		-		166,000		34,000
	$	121,296,096	$	1,833,811	$	928,112	$	122,201,795

-8-

FIRST RELIANCE BANCSHARES, INC.

Notes to Condensed Consolidated Financial Statements

Note 5 – Investment Securities – (continued)

	Amortized		Gross Unrealized				Estimated
	Cost		Gains		Losses		Fair Value
December 31, 2009
U.S. Government agencies	$	3,021,782	$	751	$	11,167	$	3,011,366
Mortgage-backed securities		59,324,978		-		1,192,307		58,132,671
Municipals		61,300,256		460,262		1,023,326		60,737,192
Other		218,750		-		151,235		67,515
	$	123,865,766	$	461,013	$	2,378,035	$	121,948,744

The following is a summary of maturities of securities available-for-sale as of June 30, 2010. The amortized cost and estimated fair values are based on the contractual maturity dates. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalty.

	Securities Available-For-Sale
	Amortized Cost		Estimated Fair Value
Due after one year but within five years	$	4,509,267	$	4,451,490
Due after five years but within ten years		28,385,805		28,264,267
Due after ten years		30,870,450		30,947,938
		63,765,522		63,663,695
Mortgage-backed securities		57,330,574		58,504,100
Other		200,000		34,000
Total	$	121,296,096	$	122,201,795

The following table shows gross unrealized losses and fair value, aggregated by investment category, and length of time that individual securities have been in a continuous unrealized loss position, at June 30, 2010 and December 31, 2009.

	June 30, 2010				December 31, 2009
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Less Than 12 Months
U.S. government agencies and corporations	$	-	$	-	$	2,995,629	$	11,167
Mortgage-backed securities		-		-		58,132,671		1,192,307
Municipals		22,054,362		441,050		27,850,269		688,885
		22,054,362		441,050		88,978,569		1,892,359
12 Months or More
Municipals		4,323,550		321,062		4,314,797		334,441
Other		34,000		166,000		67,515		151,235
		4,357,550		487,062		4,382,312		485,676

Total securities available-for-sale	$	26,411,912	$	928,112	$	93,360,881	$	2,378,035

At June 30, 2010, securities classified as available-for-sale are recorded at fair market value. Approximately 52.48% of the unrealized losses, or nine individual securities, consisted of securities in a continuous loss position for twelve months or more. The Company believes that the deterioration in value is attributable to changes in market interest rates and not in credit quality and considers these losses temporary. The Company does not intend to sell these securities and it is more likely than not that the Company will not be required to sell these securities before recovery of their amortized costs. Management evaluates investment securities in a loss position based on length of impairment, severity of impairment and other factors.

An impairment loss of $18,750 was recognized during the second quarter of 2010. Management determined that the Company’s investment in Beach First National Bancshares, Inc. was worthless, since practically all of the assets of Beach First National were taken into receivership by the Federal Deposit Insurance Corporation.

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FIRST RELIANCE BANCSHARES, INC.

Notes to Condensed Consolidated Financial Statements

Note 5 – Investment Securities – (continued)

During the first six months of 2010 and 2009, gross proceeds from the sale of available-for-sale securities were $3,117,545 and $40,506,377, respectively. Gains on available-for-sale securities totaled $1,602 and $1,029,459 for the first six months of 2010 and 2009, respectively.

Note 6 – Shareholders’ Equity

On April 9, 2010, the Company issued 340,145 shares of its common stock at $4.50 per share and 2,293 shares of its newly created Series C Preferred Stock at $1,000. The gross proceeds from the issuance and sale of these securities was $3,823,653. Of the shares issued, 119,179 shares of common stock and 335 shares of Series C Preferred Stock were issued to related parties.

Common Stock – The following is a summary of the changes in common shares outstanding for the six months ended June 30, 2010 and 2009.

	Six Months Ended June 30,
	2010			2009
Common shares outstanding at beginning of the period		3,582,691			3,525,004
Issuance of common stock		340,145			-
Issuance of non-vested restricted shares		187,765			62,222
Forfeiture of non-vested restricted shares		(633	)		-
Issuance of stock to employee		-			200

Common shares outstanding at end of the period		4,109,968			3,587,426

Preferred Stock - On February 24, 2009, the Company’s Articles of Incorporation were amended to authorize the issuance of a class of 10,000,000 shares of preferred stock, having no par value. Subject to certain conditions, the amendment authorizes the Company’s Board of Directors to issue preferred stock without shareholders’ approval. Under this amendment, the Board is authorized to determine the terms of one or more series of preferred stock, including the preferences, rights, and limitations of each series.

On March 6, 2009, the Company completed a transaction with the United States Treasury (“Treasury”) under the Troubled Asset Relief Program Capital Purchase Program (“TARP CPP”), which was amended by the enactment of the American Recovery and Reinvestment Act of 2009 on February 17, 2009. Under the TARP CPP, the Company sold 15,349 shares of its Series A Cumulative Perpetual Preferred Stock. In addition, the Treasury received a warrant to purchase 767 shares of the Company’s Series B Cumulative Perpetual Preferred Stock, which was immediately exercised by the Treasury for a nominal exercise price. The preferred shares issued to the Treasury qualify as tier 1 capital for regulatory purposes.

The Series A Preferred Stock is a senior cumulative perpetual preferred stock that has a liquidation preference of $1,000 per share, pays cumulative dividends at a rate of 5% per year for the first five years and thereafter at a rate of 9% per year. Dividends are payable quarterly. At any time, the Company may, at its option and with regulatory approval, redeem the Series A Preferred Stock at par value plus accrued and unpaid dividends. The Series A Preferred Stock is generally non-voting. Prior to March 6, 2012, unless the Company has redeemed the Series A Preferred Stock or the Treasury has transferred the Series A Preferred Stock to a third party, the consent of the Treasury will be required for the Company to increase its common stock dividend or repurchase its common stock or other equity or capital securities, other than in connection with benefit plans consistent with past practices and certain other circumstances. A consequence of the Series A Preferred Stock purchase includes certain restrictions on executive compensation that could limit the tax deductibility of compensation the Company pays to executive management.

The Series B Preferred Stock is a cumulative perpetual preferred stock that has the same rights, preferences, privileges, voting rights and other terms as the Series A Preferred Stock, except that dividends will be paid at the rate of 9% per year and may not be redeemed until all the Series A Preferred Stock has been redeemed.

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FIRST RELIANCE BANCSHARES, INC.

Notes to Condensed Consolidated Financial Statements

Note 6 – Shareholders’ Equity – (continued)

The Series C Preferred Stock consists of 7% cumulative mandatory convertible preferred stock, which will be convertible into common shares for up to three years at the lesser of $6.50 per share or tangible common equity per share as of the calendar quarter ending on or before the conversion date and will mandatorily and automatically convert on July 31, 2013 under the same terms. Dividends are payable quarterly on March 1, June 1, September 1, and December 1 of each year. The Series C Preferred Stock ranks on par with the Company’s Series A and Series B Preferred Stock and senior to the common stock with respect to the payment of dividends and distributions and amounts payable upon liquidation, dissolution, and winding up of the Company. The Series C Preferred Stock is non-voting, except as required by law.

The proceeds from the issuance of the Series A and Series B were allocated based on the relative fair value of each series based on a discounted cash flow model. As a result of the valuations, $14,492,526 and $856,474 was allocated to the Series A Preferred Stock and Series B Preferred Stock, respectively. This resulted in a discount of $973,260 for the Series A stock and a premium of $82,572 for the Series B stock. The discount and premium will be accreted and amortized, respectively, through retained earnings over a five-year estimated life using the effective interest method.

The following is a summary of the accretion of the Series A discount and the amortization of the Series B premium for the six months and three months ended June 30, 2010 and 2009.

	Six Months Ended June 30,						Three Months Ended June 30,
	2010			2009			2010			2009

Accretion of Series A preferred stock discount	$	96,473		$	62,363		$	48,503		$	48,503
Amortization of Series B preferred stock premium		(8,185	)		(5,291	)		(4,115	)		(4,115	)

Accretion net of amortization	$	88,288		$	57,072		$	44,388		$	44,388

The net amount of the accretion and amortization was treated as a deemed dividend to preferred shareholders in the computation of earnings per share.

Note 7 - Earnings (Loss) Per Share

Net income (loss) available to common shareholders represents net income (loss) adjusted for preferred dividends including dividends declared, accretions of discounts and amortization of premiums on preferred stock issuances and cumulative dividends related to the current dividend period that have not been declared as of period end.

The following is a summary of the earnings (loss) per share calculations for the six months and three months ended June 30, 2010 and 2009.

	Six Months Ended June 30,						Three Months Ended June 30,
	2010			2009			2010			2009
Earnings (loss) available to common shareholders
Net income (loss)	$	50,981		$	(1,140,749	)	$	(479,153	)	$	(1,154,614	)
Preferred stock dividends		454,801			268,132			250,227			208,547
Deemed dividends on preferred stock resulting from
net accretion of discount and amortization
of premium		88,288			57,072			44,388			44,388
Net loss available to common shareholders	$	(492,108	)	$	(1,465,953	)	$	(773,768	)	$	(1,407,549	)
Basic earnings (loss) per share:
Net loss available to common shareholders	$	(492,108	)	$	(1,465,953	)	$	(773,768	)	$	(1,407,549	)
Average common shares outstanding - basic		3,760,792			3,546,386			3,935,610			3,567,533

Basic loss per share	$	(0.13	)	$	(0.41	)	$	(0.20	)	$	(0.40	)

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FIRST RELIANCE BANCSHARES, INC.

Notes to Condensed Consolidated Financial Statements

Note 7 - Earnings Per Share – (continued)

Diluted earnings per share:

	Six Months Ended June 30,						Three Months Ended June 30,
	2010			2009			2010			2009
Net loss available to common shareholders	$	(492,108	)	$	(1,465,953	)	$	(773,768	)	$	(1,407,549	)
Average common shares outstanding - basic		3,760,792			3,546,386			3,935,610			3,567,533

Dilutive potential common shares		-			-			-			-

Average common shares outstanding - diluted		3,760,792			3,546,386			3,935,610			3,567,533

Diluted earnings (loss) per share	$	(0.13	)	$	(0.41	)	$	(0.20	)	$	(0.40	)

Note 8 - Equity Incentive Plan

On January 19, 2006, the Company adopted the 2006 Equity Incentive Plan, which provides for the granting of dividend equivalent rights options, performance unit awards, phantom shares, stock appreciation rights and stock awards, each of which shall be subject to such conditions based upon continued employment, passage of time or satisfaction of performance criteria or other criteria as permitted by the plan. The plan, as amended on June 17, 2010, allows granting up to 950,000 shares of stock, to officers, employees, and directors, consultants and service providers of the Company or its affiliates. Awards may be granted for a term of up to ten years from the effective date of grant. Under this Plan, our Board of Directors has sole discretion as to the exercise date of any awards granted. The per-share exercise price of incentive stock awards may not be less than the market value of a share of common stock on the date the award is granted. Any awards that expire unexercised or are canceled become available for re-issuance.

The Company can issue the restricted shares as of the grant date either by the issuance of share certificate(s) evidencing restricted shares or by documenting the issuance in uncertificated or book entry form on the Company's stock records. Except as provided by the Plan, the employee does not have the right to make or permit to exist any transfer or hypothecation of any restricted shares. When restricted shares vest the employee must either pay the Company within two business days the amount of all tax withholding obligations imposed on the Company or make an election pursuant to Section 83(b) of the Internal Revenue Code to pay taxes at grant date.

Restricted shares may be subject to one or more objective employment, performance or other forfeiture conditions as established by the Plan Committee at the time of grant. Any shares of restricted stock that are forfeited will again become available for issuance under the Plan. An employee or director has the right to vote the shares of restricted stock after grant until they are forfeited or vested. Compensation cost for restricted stock is equal to the market value of the shares at the date of the award and is amortized to compensation expense over the vesting period. Dividends, if any, will be paid on awarded but unvested stock.

During the six months ended June 30, 2010 and 2009 the Company issued 187,765 and 62,222, respectively, of restricted stock pursuant to the 2006 Equity Incentive Plan. The shares cliff vest in three years and are fully vested in 2012 and 2011, respectively. The weighted-average fair value of restricted stock issued during the six months ended June 30, 2010 and 2009 was $4.00 and $2.25 per share, respectively. Compensation cost associated with the issuance for 2010 and 2009 was $751,091 and $139,999, respectively. There were 633 shares of restricted stock that were forfeited during the first six months of 2010 at a weighted-average fair value of $11.88 per share. There were no forfeitures during 2009. Deferred compensation expense of $92,717 and $77,860, relating to restricted stock, was amortized to income during six months ended June 30, 2010 and 2009, respectively.

The 2006 Equity Incentive Plan allows for the issuance of Stock Appreciation Rights ("SARs"). The SARs entitle the participant to receive the excess of (1) the market value of a specified or determinable number of shares of the stock at the exercise date over the fair value at grant date or (2) a specified or determinable price which may not in any event be less than the fair market value of the stock at the time of the award. Upon exercise, the Company can elect to settle the awards using either Company stock or cash. The shares start vesting after five years and vest at 20% per year until fully vested. Compensation cost for SARs is amortized to compensation expense over the vesting period.

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FIRST RELIANCE BANCSHARES, INC.

Notes to Condensed Consolidated Financial Statements

Note 8 - Equity Incentive Plan – (continued)

The SARs compensation expense for both the six months ended June 30, 2010 and 2009 was $36,917.

A summary of the status of the Company’s SARs as of June 30, 2010 and 2009 and changes during the period then ended is presented below.

	2010					2009
	Shares			Weighted- Average Exercise Price		Shares		Weighted- Average Exercise Price
Outstanding at beginning of year		89,293		$	14.95		93,981	$	14.95
Forfeited		(794	)		15.00		-		-
Outstanding at end of period		88,499		$	14.95		93,981	$	14.95

Note 9 – Stock-Based Compensation

The Company terminated its 2003 Employee Stock Option Plan and replaced it with the 2006 Equity Incentive Plan. No stock options have been granted since 2005 and none were exercised during 2010 or 2009. The 206,547 options outstanding at December 31, 2009 were forfeited during the six months ended June 30, 2010.

Note 10 – Fair Value Measurements

The current accounting literature requires the disclosure of fair value information for financial instruments, whether or not they are recognized in the consolidated balance sheets, when it is practical to estimate the fair value. The guidance defines a financial instrument as cash, evidence of an ownership interest in an entity or contractual obligations, which require the exchange of cash, or other financial instruments. Certain items are specifically excluded from the disclosure requirements, including the Company’s common stock, premises and equipment, accrued interest receivable and payable, and other assets and liabilities.

The fair value of a financial instrument is the amount at which the asset or obligation could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. Fair value estimates are made at a specific point in time based on relevant market information and information about the financial instruments. Because no market value exists for a significant portion of the financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors.

The Company has used management’s best estimate of fair value based on the above assumptions. Thus, the fair values presented may not be the amounts, which could be realized, in an immediate sale or settlement of the instrument. In addition, any income taxes or other expenses, which would be incurred in an actual sale or settlement, are not taken into consideration in the fair values presented.

The following methods and assumptions were used to estimate the fair value of significant financial instruments:

Cash and Due from Banks and Interest-bearing Deposits with Other Banks - The carrying amount is a reasonable estimate of fair value.

Federal Funds Sold and Purchased - Federal funds sold and purchased are for a term of one day and the carrying amount approximates the fair value.

Time Deposits in other Banks - The carrying amount is a reasonable estimate of fair value.

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FIRST RELIANCE BANCSHARES, INC.

Notes to Condensed Consolidated Financial Statements

Note 10 – Fair Value Measurements – (continued)

Securities Available-for-Sale - Investment securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage-backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. Securities classified as Level 3 include asset-backed securities in less liquid markets.

Nonmarketable Equity Securities - The carrying amount of nonmarketable equity securities is a reasonable estimate of fair value since no ready market exists for these securities.

Loans Held-for-Sale - The carrying amount of loans held for sale is a reasonable estimate of fair value.

Loans Receivable - The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At June 30, 2010, substantially all of the total impaired loans were evaluated based on the fair value of the collateral. Impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3.

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

Deposits - The fair value of demand deposits, savings, and money market accounts is the amount payable on demand at the reporting date. The fair values of certificates of deposit are estimated using a discounted cash flow calculation that applies current interest rates to a schedule of aggregated expected maturities.

Securities Sold Under Agreements to Repurchase - The carrying amount is a reasonable estimate of fair value because these instruments typically have terms of one day.

Advances From Federal Home Loan Bank - The fair values of fixed rate borrowings are estimated using a discounted cash flow calculation that applies the Company’s current borrowing rate from the Federal Home Loan Bank. The carrying amounts of variable rate borrowings are reasonable estimates of fair value because they can be repriced frequently.

Junior Subordinated Debentures - The carrying value of the junior subordinated debentures and note payable approximates their fair value since they were issued at a floating rate.

Accrued Interest Receivable and Payable - The carrying value of these instruments is a reasonable estimate of fair value.

Off-Balance Sheet Financial Instruments - Fair values of off-balance sheet lending commitments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties' credit standing.

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FIRST RELIANCE BANCSHARES, INC.

Notes to Condensed Consolidated Financial Statements

Note 10 – Fair Value Measurements – (continued)

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

	June 30,				December 31,
	2010				2009
	Carrying Amount		Estimated Fair Value		Carrying Amount		Estimated Fair Value
Financial Assets:
Cash and due from banks	$	2,196,978	$	2,196,978	$	2,942,295	$	2,942,295
Interest-bearing deposits with other banks		30,637,573		30,637,573		50,356,191		50,356,191
Time deposits in other banks		503,644		503,644		502,089		502,089
Securities available-for-sale		122,201,795		122,201,795		121,948,744		121,948,744
Nonmarketable equity securities		4,812,100		4,812,100		4,812,100		4,812,100
Loans, including loans held for sale		375,923,563		374,857,000		411,728,010		410,265,000
Accrued interest receivable		2,537,500		2,537,500		2,661,030		2,661,030

Financial Liabilities:
Demand deposit, interest-bearing
transaction, and savings accounts	$	188,829,858	$	188,829,858	$	195,636,648	$	195,636,648
Certificates of deposit		314,091,424		318,643,000		357,126,331		352,318,000
Securities sold under agreements
to repurchase		545,647		545,647		598,342		598,342
Advances from Federal Home Loan Bank		26,000,000		26,334,000		34,000,000		33,992,000
Junior subordinated debentures		10,310,000		10,310,000		10,310,000		10,310,000
Accrued interest payable		592,527		592,527		680,880		680,880

	Notional Amount		Estimated Fair Value		Notional Amount		Estimated Fair Value
Off-Balance Sheet Financial Instruments:
Commitments to extend credit	$	37,679,207	$	-	$	39,873,440	$	-
Standby letters of credit		2,102,497		-		2,583,466		-

In determining appropriate levels, the Company performs a detailed analysis of the assets and liabilities that are subject to fair value disclosures. At each reporting period, all assets and liabilities for which the fair value measurement is based on significant unobservable inputs are classified as Level 3.

Assets and liabilities that are carried at fair value are classified in one of the following three categories based on a hierarchy for ranking the quality and reliability of the information used to determine fair value:

Level 1 —		Quoted prices in active markets for identical assets or liabilities.
Level 2 —		Observable market based inputs or unobservable inputs that are corroborated by market data.
Level 3 —		Unobservable inputs that are not corroborated by market data.

The table below presents the balances of assets measured at fair value on a recurring basis as of June 30, 2010 and December 31, 2009, aggregated by the level in the fair value hierarchy within which those measurements fall.

-15-

FIRST RELIANCE BANCSHARES, INC.

Notes to Condensed Consolidated Financial Statements

Note 10 – Fair Value Measurements – (continued)

	Total		Level 1		Level 2		Level 3
June 30, 2010
Available for-sale-securities:
U.S. Government agencies	$	2,785,686	$	-	$	2,785,686	$	-
Mortgage-backed securities		58,504,100		-		58,504,100		-
Municipals		60,878,009		-		60,878,009		-
Other		34,000		-		34,000		-
		122,201,795		-		122,201,795		-
Mortgage loans held for sale (1)		579,266		-		579,266		-

	$	122,781,061	$	-	$	122,781,061	$	-

December 31, 2009
Available for-sale-securities:
U.S. Government agencies	$	3,011,366	$	-	$	3,011,366	$	-
Mortgage-backed securities		58,132,671		-		58,132,671		-
Municipals		60,737,192		-		60,737,192		-
Other		67,515		-		67,515		-
		121,948,744		-		121,948,744		-
Mortgage loans held for sale (1)		5,100,609		-		5,100,609		-
	$	127,049,353	$	-	$	127,049,353	$	-

(1) Carried at the lower of cost or market.

There were no liabilities carried at fair value at June 30, 2010 and December 31, 2009 on a recurring basis.

Certain assets and liabilities are measured at fair value on a nonrecurring basis; that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). The following table presents the assets and liabilities carried on the balance sheet by caption and by level within the valuation hierarchy (as described above) as of June 30, 2010 and 2009, for which a nonrecurring change in fair value has been recorded during the three months and the year ended June 30, 2010 and December 31, 2009, respectively.

June 30, 2010	Total		Level 1		Level 2		Level 3
Impaired loans receivable	$	18,837,598	$	-	$	18,837,598	$	-
Other real estate owned		12,268,366		-		12,268,366		-

Total assets at fair value	$	31,105,964	$	-	$	31,105,964	$	-

December 31, 2009
Impaired loans receivable	$	44,937,157	$	-	$	44,937,157	$	-
Other real estate owned		8,954,214		-		8,954,214		-

Total assets at fair value	$	53,891,371	$	-	$	53,891,371	$	-

The Company has no liabilities carried at fair value or measured at fair value on a nonrecurring basis at June 30, 2010 and December 31, 2009.

-16-

FIRST RELIANCE BANCSHARES, INC.

Notes to Condensed Consolidated Financial Statements

Note 11- Subsequent Events

In preparing these financial statements, subsequent events were evaluated through the time the financial statements were issued. Financial statements are considered issued when they are widely distributed to all shareholders and other financial statement users, or filed with the SEC.

Following an examination of the Bank by the FDIC during the first quarter of 2010, the Bank’s Board of Directors has agreed to enter into a Memorandum of Understanding (the “Memorandum”) with the FDIC and South Carolina Commissioner of Banks, the effective date of which will be late August 2010. Among other things, the Memorandum provides for the Bank to (i) review and formulate objectives relative to liquidity and growth, including a reduction in reliance on volatile liabilities, (ii) formulate plans for the reduction and improvement in adversely classified assets, (iii) maintain a Tier 1 Leverage Capital Ratio of 8% and continue to be “well capitalized” for regulatory purposes, (iv) continue to maintain an adequate allowance for loan and lease losses, (v) not pay any dividend without the approval of the regulators, (vi) review officer performance and consider additional staffing needs, and (vii) provide progress reports and submit various other information to the regulators.

In conjunction with applicable accounting standards, there were no other subsequent material events which should have been either recognized in the financial statements or disclosed in the notes to the financial statements.

-17-

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

The following discussion reviews our results of operations and assesses our financial condition. You should read the following discussion and analysis in conjunction with the accompanying consolidated financial statements. The commentary should be read in conjunction with the discussion of forward-looking statements, the financial statements and the related notes and the other statistical information included in this report.

Advisory Note Regarding Forward-Looking Statements

The statements contained in this report on Form 10-Q that are not historical facts are forward-looking statements subject to the safe harbor created by the Private Securities Litigation Reform Act of 1995. We caution readers of this report that such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of us to be materially different from those expressed or implied by such forward-looking statements. Although we believe that our expectations of future performance are based on reasonable assumptions within the bounds of our knowledge of our business and operations, there can be no assurance that actual results will not differ materially from our expectations.

Factors which could cause actual results to differ from expectations include, among other things:

·	the challenges, costs and complications associated with the continued development of our branches;

·	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 the control of us;

·	our dependence on senior management;

·	competition from existing financial institutions operating in our market areas as well as the entry into such areas of new competitors with greater resources, broader branch networks and more comprehensive services;

·	adverse conditions in the stock market, the public debt market, and other capital markets (including changes in interest rate conditions);

·	changes in deposit rates, the net interest margin, and funding sources;

·	inflation, interest rate, market, and monetary fluctuations;

·	risks inherent in making loans including repayment risks and value of collateral;

·	the strength of the United States economy in general and the strength of the local economies in which we conduct operations may be different than expected resulting in, among other things, a deterioration in credit quality or a reduced demand for credit, including the resultant effect on our loan portfolio and allowance for loan losses;

·	fluctuations in consumer spending and saving habits;

·	the demand for our products and services;

·	technological changes;

·	the challenges and uncertainties in the implementation of our expansion and development strategies;

·	the ability to increase market share;

·	the adequacy of expense projections and estimates of impairment loss;

·	the impact of changes in accounting policies by the SEC;

·	unanticipated regulatory or judicial proceedings;

·	the potential negative effects of future legislation affecting financial institutions (including without limitation laws concerning taxes, banking, securities, and insurance);

·	the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System;

·	the timely development and acceptance of products and services, including products and services offered through alternative delivery channels such as the Internet;

·	the impact on our business, as well as on the risks set forth above, of various domestic or international military or terrorist activities or conflicts;

·	other factors described in this report and in other reports we have filed with the SEC; and

·	our success at managing the risks involved in the foregoing.

Forward-looking statements speak only as of the date on which they are made. We undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made to reflect the occurrence of unanticipated events.

-18-

Overview

The following discussion describes our results of operation for the six months and quarter ended June 30, 2010 as compared to the six months and quarter ended June 30, 2009 and also analyzes our financial condition as of June 30, 2010 as compared to December 31, 2009.

Like most community bank holding companies, we derive the majority of our income from interest received 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 and borrowings. 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, which is called our net interest spread.

There are risks inherent in all loans, so we maintain an allowance for loan losses to absorb probable losses on existing loans that may become uncollectible. We maintain this allowance by charging a provision for loan losses against our operating earnings for each period. We have included a detailed discussion of this process, as well as several tables describing our allowance for loan losses.

In addition to earning interest on our loans and investments, we earn income through fees and other charges to our customers. We have also included a discussion of the various components of this non-interest income, as well as of our non-interest expense.

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

Critical Accounting Policies

We have adopted various accounting policies, which govern the application of accounting principles generally accepted in the United States in the preparation of our financial statements. Our significant accounting policies are described in the notes to the consolidated financial statements at December 31, 2009 as filed on our annual report on Form 10-K. Certain accounting policies involve significant judgments and assumptions by us, which have a material impact on the carrying value of certain assets and liabilities. We consider these accounting policies to be critical accounting policies. The judgments and assumptions we use are based on the 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 major impact on our carrying values of assets and liabilities and our results of operations.

We believe the allowance for loan losses is a critical accounting policy that requires the most significant judgments and estimates used in preparation of our consolidated financial statements. Refer to the portion of this discussion that addresses our allowance for loan losses for description of our processes and methodology for determining our allowance for loan losses.

Regulatory Matters

In response to the Memorandum, the Bank has already moved in good faith to take various actions designed to improve the Bank’s lending procedures and other conditions related to its operations. Over the past six months, the Bank has formed a Loss Mitigation and Recovery Division staffed with experienced bankers who specifically handle non-performing and deteriorating assets, which are largely localized to coastal South Carolina. The Bank has also moved, under the supervision of the Board’s Special Risk Committee, to strengthen the Bank’s already solid credit review process, aggressive risk review methodology, and conservative lending policies as part of a company-wide risk management assessment.

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In addition to these efforts, during the second quarter of 2010, we completed a private offering of shares of our common stock and Series C Preferred Stock, with gross proceeds of roughly $3.82 million. In addition, the Bank has moved to reduce its inventory of adversely classified assets during the first six months of 2010, and, in combination with the earlier capital raise, the Bank currently maintains a Tier 1 Leverage Ratio of 8.39%, a Tier 1 Risk Based Capital Ratio of 11.58%, and a Total Risk Based Capital Ratio of 12.83%, ratios which are in full compliance with the requirements of the Memorandum. Further, the Bank has taken strong steps to maintain its strong liquidity position into the future. Earlier in 2010, the Bank set a strategic goal of reducing wholesale funding by $30 million during 2010; during the first six months of 2010, the Bank had achieved a $20 million reduction in wholesale funding, and expects to achieve a further reduction of $10 million over the balance of the year.

We believe that the successful completion of these initiatives will result in full compliance with the Memorandum and position us well for short-term stability and long-term growth.

The Dodd-Frank Wall Street Reform and Consumer Protection Act.

On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”) which, among other things, alters the oversight and supervision of financial institutions by federal and state regulators, introduces minimum capital requirements, creates a new federal agency to supervise consumer financial products and services, and implements changes to corporate governance and compensation practices. Although the Act is particularly focused on large bank holding companies with consolidated assets of $50 billion or more, it does contain a number of provisions that may affect us, including:

Minimum Leverage and Risk-Based Capital Requirements. Under the Act, the appropriate Federal banking agencies are required to establish minimum leverage and risk-based capital requirements on a consolidated basis for all insured depository institutions and bank holding companies, which can be no less than the currently applicable leverage and risk-based capital requirements for depository institutions.

·	Deposit Insurance Modifications. The Act modifies the FDIC’s assessment base upon which deposit insurance premiums are calculated. The new assessment base will equal our average total consolidated assets minus the sum of our average tangible equity during the assessment period. The Act also makes permanent the increase in maximum federal deposit insurance limits from $100,000 to $250,000.

·	Creation of New Consumer Protection Bureau. The Act creates a new Bureau of Consumer Financial Protection within the Federal Reserve with broad powers to supervise and enforce consumer protection laws. The Bureau of Consumer Financial Protection will have broad rule-making authority for a wide range of consumer protection laws that apply to all insured depository institutions. The Bureau of Consumer Financial Protection has examination and enforcement authority over all depository institutions with more than $10 billion in assets. Depository institutions with $10 billion or less in assets, such as the Bank, will be examined by their applicable bank regulators.

·	Executive Compensation and Corporate Governance Requirements. The Act includes provisions that may impact our corporate governance, including a grant of authority to the SEC to issue rules that allow shareholders to nominate directors by using the company’s proxy solicitation materials. The Act further requires the SEC to adopt rules that prohibit the listing of any equity security of a company that does not have an independent compensation committee and require all exchange-traded companies to adopt clawback policies for incentive compensation paid to executive officers in the event of accounting restatements based on material non-compliance with financial reporting requirements.

Many provisions of the Act will require our regulators to adopt additional rules in order to implement the mandates included in the Act. In addition, the Act requires multiple studies which could result in additional legislative action. Governmental intervention and new regulations under these programs could materially and adversely affect our business, financial condition and results of operations.

Effect of Economic Trends

Economic conditions, competition and federal monetary and fiscal policies also affect financial institutions. Lending activities are also influenced by regional and local economic factors, such as housing supply and demand, competition among lenders, customer preferences and levels of personal income and savings in our primary market area.

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Results of Operations

For the quarter ended June 30, 2010, we incurred a net loss available to common shareholders of $773,768 compared to a net loss available to common shareholders of $1,407,549 for the quarter ended June 30, 2009. Basic and diluted loss per share was $0.20, compared to $0.40 reported in the prior year.

We realized a net loss available to common shareholders of $492,108 and $1,465,953 for the six months ended June 30, 2010 and 2009, respectively. This resulted in basic and diluted loss per share of $0.13 for the six months ended June 30, 2010, compared to $0.41 for the same period of 2009.

Our operating results for the six months ended June 30, 2010 were favorably impacted by the stabilization of the credit quality of our loan portfolio, which resulted in a provision for loan losses of $2,065,899 and $1,879,810 for the six and three months ended June 30, 2010, respectively, compared to $4,855,822 and $3,555,442 for the same periods of 2009, respectively. We believe this stabilization is attributed to the implementation of a loss mitigation and recovery division staffed with experienced bankers who specifically handle nonperforming and deteriorating assets. Additionally, we have strengthened our credit review process by being proactive in making conservative lending decisions.

Income Statement Review

Net Interest Income

The largest component of our net income (loss) is net interest income, which is the difference between the income earned on assets and interest paid on deposits and on the borrowings used to support such assets. Net interest income is determined by the yields earned on our interest-earning assets and the rates paid on interest-bearing liabilities, the relative amounts of interest-earning assets and interest-bearing liabilities, and the degree of mismatch and the maturity and repricing characteristics of our interest-earning assets and interest-bearing liabilities. Total interest-earning assets yield less total interest-bearing liabilities rate represents our net interest rate spread.

Net interest income increased $146,006, or 3.76%, to $4,031,715 for the quarter ended June 30, 2010, from $3,885,709 for the comparable period in 2009. Our net interest income for the six months ended June 30, 2010 and 2009 was $8,339,256 and $8,038,802, respectively. This represents an increase of $300,454 or 3.74%. We were able to improve our net interest income for both periods by lowering the cost of our interest-bearing liabilities, while improving the annualized yield on our average earning assets. See “Rate/Volume Analysis” below for a more detailed discussion.

For the second quarter of 2010, average earning assets totaled $543,619,700 with an annualized average yield of 5.42% compared to $620,495,434 and 5.14%, respectively, for the second quarter of 2009. Average interest-bearing liabilities totaled $506,075,351 with an annualized average cost of 2.45% for second quarter of 2010 compared to $561,243,480 and 2.80%, respectively, for the second quarter of 2009.

Average earning assets for the six months ended June 30, 2010 and 2009 were $554,734,315 and $604,254,596, respectively, with an annualized average yield of 5.48% and 5.30%, respectively. Average interest-bearing liabilities totaled $516,850,505 and $549,105,744 with an annualized average cost of 2.45% and 2.79% for the six months ended June 30, 2010 and 2009, respectively.

Our net interest margin and net interest spread were 3.14% and 2.97%, respectively, for the second quarter of 2010 compared to 2.61% and 2.34%, respectively, for the second quarter of 2009. For the six months ended June 30, 2010, our net interest margin and net interest spread were 3.19% and 3.03%, respectively compared to 2.77% and 2.51%, respectively for the comparable period of 2009.

Because loans often provide a higher yield than other types of earning assets, one of our goals is to maintain our loan portfolio as the largest component of total earning assets. Loans comprised 70.93% and 70.61% of average earning assets for the six months and three months ended June 30, 2010, respectively compared to 80.03% and 77.26%, respectively for the comparable period of 2009. Loan interest income for the six and three months ended June 30, 2010 was $12,066,213 and $5,853,126, respectively compared to $13,838,054 and $6,870,317 for the comparable periods of 2009. The annualized average yield on loans was 6.18% and 6.12%, respectively for the six and three months ended June 30, 2010 compared to 5.77% and 5.75%, respectively for the comparable 2009 periods. Compared to the six and three months ended June 30,2009, the average balances of our loans decreased by $90,103,724, or 18.63%, and $95,502,231, or 19.92%, for the six and three months ended June 30, 2010. Our loan income for the 2010 reporting periods was significantly impacted by the current downturn in our local real estate market, the significant increase in charged off loans, and the average volume of nonperforming loans. The decrease in the average volume of loans also had a significant impact on our net interest income. The economic downturn in our markets caused the volume of new loan customers to decrease, so we began shifting our asset mix toward securities during the second quarter of 2009.

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The following table sets forth, for the period indicated, certain information related to our average balance sheet and our average yields on assets and average costs of liabilities. Such yields are derived by dividing income or expense by the average balance of the corresponding assets or liabilities. Average balances have been derived from the daily balances throughout the periods indicated.

	Average Balances, Income and Expenses, and Rates
Three Months Ended June 30,	2010							2009							2008
(Dollars in thousands)(1)	Average Balance		Income/ Expense		Yield/ Rate			Average Balance		Income/ Expense		Yield/ Rate			Average Balance		Income/ Expense		Yield / Rate
Assets
Earning assets:
Loans (2)	$	383,866	$	5,853		6.12	%	$	479,368	$	6,870		5.75	%	$	489,482	$	8,561		7.03	%
Securities, taxable		60,929		583		3.84			41,464		472		4.56			26,064		330		5.09
Securities, nontaxable (3)		60,841		876		5.78			37,326		579		6.23			31,139		439		5.67
Federal funds sold		-		-		-			800		-		0.18			2,889		10		1.38
Other earning assets		37,984		27		0.28			61,537		28		0.18			4,372		62		5.77
Total earning assets		543,620		7,339		5.42			620,495		7,949		5.14			553,946		9,402		6.83

Non earning assets		59,094							40,293							41,541

Total assets	$	602,714						$	660,788						$	595,487
Liabilities and Shareholders' Equity
Interest-bearing deposits:
Transaction accounts	$	37,260	$	45		0.48	%	$	37,750	$	54		0.57	%	$	27,388	$	36		0.53	%
Savings and money
market accounts		106,910		343		1.29			97,473		481		1.98			87,611		470		2.16
Time deposits		324,730		2,305		2.85			349,665		2,659		3.05			294,230		2,993		4.09
Total interest-bearing deposits		468,900		2,693		2.30			484,888		3,194		2.64			409,229		3,499		3.44
Other interest-bearing liabilities:
Securities sold under agreement
to repurchase		788		-		0.00			1,260		-		-			7,997		32		1.58
Federal funds purchased		-		-		0.00			-		-		-			4,515		55		4.91
Federal Home Loan
Bank borrowing		26,077		238		3.66			64,785		568		3.52			73,445		693		3.80
Junior subordinated debentures		10,310		154		6.01			10,310		154		6.01			10,310		154		6.01
Note payable		-		-		-			-		-		-			3,000		31		4.14
Total other interest-bearing
liabilities		37,175		392		4.23			76,355		722		3.79			99,267		965		3.91
Total interest-bearing liabilities		506,075		3,085		2.45			561,243		3,916		2.80			508,496		4,464		3.53
Noninterest-bearing deposits		44,076							44,433							44,905
Other liabilities		5,154							2,580							3,696
Shareholders' equity		47,409							52,532							38,390

Total liabilities and equity	$	602,714						$	660,788						$	595,487
Net interest income/interest spread			$	4,254		2.97	%			$	4,033		2.34	%			$	4,938		3.30	%
Net yield on earning assets						3.14	%						2.61	%						3.59	%

(1)	Prior year percentages based on actual dollar amounts

(2)	Includes mortgage loans held for sale and nonaccruing loans

(3)	Fully tax-equivalent basis at 34% tax rate for nontaxable securities

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	Average Balances, Income and Expenses, and Rates
Six Months Ended June 30,	2010							2009							2008
	Average		Income/		Yield/			Average		Income/		Yield/			Average		Income/		Yield /
(Dollars in thousands)(1)	Balance		Expense		Rate			Balance		Expense		Rate			Balance		Expense		Rate
Assets
Earning assets:
Loans (2)	$	393,496	$	12,066		6.18	%	$	483,600	$	13,838		5.77	%	$	487,755	$	17,660		7.28	%
Securities, taxable		61,031		1,193		3.94			44,006		1,003		4.60			26,639		676		5.10
Securities, nontaxable(3)		60,685		1,751		5.82			33,219		999		6.07			31,046		878		5.69
Federal funds sold		-		-		-			1,033		1		0.26			1,787		12		1.33
Other earning assets		39,522		56		0.28			42,397		37		0.17			4,253		114		5.39
Total earning assets		554,734		15,066		5.48			604,255		15,878		5.30			551,480		19,340		7.05
Non earning assets		56,346							39,472							40,734
Total assets	$	611,080						$	643,727						$	592,214
Liabilities and Shareholders' Equity
Interest-bearing deposits:
Transaction accounts	$	39,295	$	88		0.45	%	$	35,929	$	103		0.58	%	$	29,458	$	95		0.65	%
Savings and money
market accounts		104,040		680		1.32			98,329		851		1.74			88,620		1,103		2.50
Time deposits		335,501		4,733		2.85			324,662		5,055		3.14			287,447		6,240		4.37
Total interest-bearing deposits		478,836		5,501		2.32			458,920		6,009		2.64			405,525		7,438		3.69

Other interest-bearing liabilities:
Securities sold under agreement
to repurchase		779		-		-			3,472		1		0.07			7,998		79		1.99
Federal funds purchased		1		-		-			41		-		0.82			6,734		113		3.37
Federal Home Loan
Bank borrowing		26,924		474		3.55			73,368		1,234		3.39			73,119		1,314		3.61
Junior subordinated debentures		10,310		307		6.01			10,310		307		6.00			10,310		309		6.03
Note payable		-		-		-			2,995		35		2.35			3,000		69		4.62
Total other interest-bearing
liabilities		38,014		781		4.14			90,186		1,577		3.53			101,161		1,884		3.75

Total interest-bearing liabilities		516,850		6,282		2.45			549,106		7,586		2.79			506,686		9,322		3.70

Noninterest-bearing deposits		43,724							45,996							44,285
Other liabilities		3,983							2,373							3,226
Shareholders' equity		46,523							46,252							38,017

Total liabilities and equity	$	611,080						$	643,727						$	592,214

Net interest income/interest spread				8,784		3.03	%			$	8,292		2.51	%			$	10,018		3.35	%
Net yield on earning assets						3.19	%						2.77	%						3.65	%

(1)	Prior year percentages based on actual dollar amounts

(2)	Includes mortgage loans held for sale and nonaccruing loans

(3)	Fully tax-equivalent basis at 34% tax rate for nontaxable securities

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

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Three Months Ended June 30,	2010 Compared to 2009									2009 Compared to 2008
	Due to increase (decrease) in									Due to increase (decrease) in
(Dollars in thousands)	Volume			Rate			Total			Volume			Rate			Total

Interest income:
Loans	$	(1,438	)	$	420		$	(1,018	)	$	(173	)	$	(1,518	)	$	(1,691	)
Securities, taxable		195			(83	)		112			179			(37	)		142
Securities, tax exempt		342			(45	)		297			94			46			140
Federal funds sold		-			-			-			(4	)		(5	)		(9	)
Other earning assets		(13	)		12			(1	)		20			(56	)		(36	)
Total interest income		(914	)		304			(610	)		116			(1,570	)		(1,454	)
Interest expense:
Interest-bearing deposits
Interest-bearing transaction accounts		(1	)		(8	)		(9	)		14			3			17
Savings and money market accounts		43			(181	)		(138	)		52			(41	)		11
Time deposits		(184	)		(170	)		(354	)		507			(841	)		(334	)
Total interest-bearing deposits		(142	)		(359	)		(501	)		573			(879	)		(306	)
Other interest-bearing liabilities
Securities sold under agreement
to repurchase		-			-			-			(14	)		(17	)		(31	)
Federal funds purchased		-			-			-			(28	)		(28	)		(56	)
Federal Home Loan Bank borrowings		(352	)		22			(330	)		(77	)		(48	)		(125	)
Junior subordinated debentures		-			-			-			-			-			-
Note payable		-			-			-			(15	)		(15	)		(30	)
Total other interest-bearing liabilities		(352	)		22			(330	)		(134	)		(108	)		(242	)

Total interest expense		(494	)		(337	)		(831	)		439			(987	)		(548	)

Net interest income	$	(420	)	$	641		$	221		$	(323	)	$	(583	)	$	(906	)

Six Months Ended June 30,	2010 Compared to 2009									2009 Compared to 2008
	Due to increase (decrease) in									Due to increase (decrease) in
(Dollars in thousands)	Volume			Rate			Total			Volume			Rate			Total

Interest income:
Loans	$	(2,706	)	$	934		$	(1,772	)	$	(3,672	)	$	(151	)	$	(3,823	)
Securities, taxable		348			(158	)		190			(72	)		399			327
Securities, tax exempt		795			(43	)		752			59			62			121
Federal funds sold		(1	)		-			(1	)		(7	)		(3	)		(10	)
Other earning assets		(2	)		21			19			(115	)		38			(77	)
Total interest income		(1,566	)		754			(812	)		(3,807	)		345			(3,462	)
Interest expense:
Interest-bearing deposits
Interest-bearing transaction accounts		9			(24	)		(15	)		(11	)		19			8
Savings and money market accounts		46			(217	)		(171	)		(362	)		110			(252	)
Time deposits		163			(485	)		(322	)		(1,917	)		732			(1,185	)
Total interest-bearing deposits		218			(726	)		(508	)		(2,290	)		861			(1,429	)
Other interest-bearing liabilities
Securities sold under agreement
to repurchase		(1	)		(1	)		(2	)		(49	)		(29	)		(78	)
Federal funds purchased		-			-			-			(49	)		(64	)		(113	)
Federal Home Loan Bank borrowings		(816	)		56			(760	)		(84	)		4			(80	)
Junior subordinated debentures		-			-			-			(2	)		-			(2	)
Note payable		(17	)		(17	)		(34	)		(34	)		-			(34	)
Total other interest-bearing liabilities		(834	)		38			(796	)		(218	)		(89	)		(307	)

Total interest expense		(616	)		(688	)		(1,304	)		(2,508	)		772			(1,736	)

Net interest income	$	(950	)	$	1,442		$	(492	)	$	(1,299	)	$	(427	)	$	(1,726	)

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Provision and Allowance for Loan Losses

We have developed policies and procedures for evaluating the overall quality of our credit portfolio and the timely identification of potential problem credits. On a quarterly basis, our Board of Directors reviews and approves the appropriate level for the allowance for loan losses based upon management’s recommendations, the results of our internal monitoring and reporting system, and an analysis of economic conditions in our market. The objective of management has been to fund the allowance for loan losses at a level greater than or equal to our internal risk measurement system for loan risk.

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

The allowance represents an amount which management believes will be adequate to absorb inherent losses on existing loans that may become uncollectible. Our judgment as to the adequacy of the allowance for loan losses is based on a number of assumptions about future events, which we believe to be reasonable, but which may or may not prove to be accurate. Our determination of the allowance for loan losses is based on regular 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, 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 and national economy, changes in volume or type of credits, changes in the volume or severity of problem loans, quality of loan review and board of director oversight, concentrations of credit, and peer group comparisons.

More specifically, in determining our allowance for loan loss, we regularly review loans for specific and impaired reserves based on the appropriate impairment assessment methodology. Pooled reserves are determined using historical loss trends measured over an eight quarter rolling average applied to risk rated loans grouped by Federal Financial Examination Council (“FFIEC”) call code and segmented by impairment status. The pooled reserves are calculated by applying the appropriate historical loss ratio to the loan categories. Impaired loans greater than a minimum threshold established by management are excluded from this analysis. The sum of all such amounts determines our pooled reserves.

We track our portfolio and analyze loans grouped by FFIEC call code categories. The first step in this process is to risk grade each and every loan in the portfolio based on one common set of parameters. These parameters include items like debt-to-worth ratio, liquidity of the borrower, net worth, experience in a particular field and other factors such as underwriting exceptions. Weight is also given to the relative strength of any guarantors on the loan.

After risk grading each loan, we then segment the portfolio by FFIEC call code groupings, separating out substandard or impaired loans. The remaining loans are grouped into “performing loan pools.” The loss history for each performing loan pool is measured over an eight quarter rolling average to create a loss factor. The loss factor is then applied to the pool balance and the reserve per pool calculated. Loans deemed to be substandard but not impaired are segregated and a loss factor is applied to this pool as well. Finally, impaired loans are segmented based upon size; smaller impaired loans are pooled and a loss factor applied, while larger impaired loans are assessed individually using the appropriate impairment measuring methodology. Finally, five qualitative factors are utilized to assess economic and other trends not currently reflected in the loss history. These factors include concentration of credit across the portfolio, the experience level of management and staff, effects of changes in risk selection and underwriting practice, industry conditions and the current economic and business environment. A quantitative value is assigned to each of the five factors, which is then applied to the performing loan pools. Negative trends in the loan portfolio increase the quantitative values assigned to each of the qualitative factors and, therefore, increase the reserve. For example, as general economic and business conditions decline, this qualitative factor’s quantitative value will increase, which will increase reserve requirement for this factor. Similarly, positive trends in the loan portfolio, such as improvement in general economic and business conditions, will decrease the quantitative value assigned to this qualitative factor, thereby decreasing the reserve requirement for this factor. These factors are reviewed and updated by our risk management committee on a regular basis to arrive at a consensus for our qualitative adjustments.

Periodically, we adjust the amount of the allowance based on changing circumstances. We recognize loan losses to the allowance and add subsequent recoveries back to the allowance for loan losses. In addition, on a quarterly basis we informally compare our allowance for loan losses to various peer institutions; however, we recognize that allowances will vary as financial institutions are unique in the make-up of their loan portfolios and customers, which necessarily creates different risk profiles for the institutions. We would only consider further adjustments to our allowance for loan losses based on this peer review if our allowance was significantly different from our peer group. To date, we have not made any such adjustment. There can be no assurance that charge-offs of loans in future periods will not exceed the allowance for loan losses as estimated at any point in time or that provisions for loan losses will not be significant to a particular accounting period, especially considering the overall weakness in the economic environment in our market areas.

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Various regulatory agencies review our allowance for loan losses through their periodic examinations, and they may require additions to the allowance for loan losses based on their judgment about information available to them at the time of their examinations. Our losses will undoubtedly vary from our estimates, and it is possible that charge-offs in future periods will exceed the allowance for loan losses as estimated at any point in time.

As of June 30, 2010 and 2009, the allowance for loan losses was $7,048,764 and $7,541,049 respectively, a decrease of $492,285, or 6.53%, from the 2009 allowance. As a percentage of total loans, the allowance for loan losses was 1.88% and 1.68% at June 30, 2010 and 2009, respectively. The decrease in the allowance for loan losses was driven by the significant reduction of our loan portfolio, while we continue to charge off loan losses once they are identified. At June 30, 2010 compared to June 30, 2009, our loan portfolio was $72,508,861 or 16.19% lower. See “Loans” below for additional information regarding our asset quality and loan portfolio.

For the second quarter of 2010 and 2009, the provision for loan losses was $1,879,810 and $3,555,442, respectively, a decrease of $1,675,632. The provision for loan losses was $2,065,899 and $4,855,822 for the six months ended June 30, 2010 and 2009, respectively. This represents a decrease of $2,789,923. The decrease in the provision for loan losses for both periods is primarily attributable to the stabilization of the credit quality of our loan portfolio during the second quarter of 2010 and to the reduction in the volume of our loans outstanding.

We believe the allowance for loan losses at June 30, 2010, is adequate to meet potential loan losses inherent in the loan portfolio, and, as described earlier, maintain the flexibly to adjust the allowance should our local economy and loan portfolio either improve or decline over the balance of 2010.

Noninterest Income

The following table sets forth information related to our noninterest income.

	Three months ended				Six months ended
	June 30,				June 30,
	2010		2009		2010		2009
Service charges on deposit accounts	$	443,469	$	474,486	$	911,690	$	935,094
Gain on sale of mortgage loans		170,421		554,038		380,463		1,214,537
Gain on sale of securities available-for-sale		-		1,029,459		1,602		1,029,459
Gain (loss) on sale of other real estate owned		240,560		-		482,681		(15,892	)
Other income		344,922		255,734		707,342		843,636
Total noninterest income	$	1,199,372	$	2,313,717	$	2,483,778	$	4,006,834

Noninterest income decreased $1,114,345, or 48.16%, to $1,199,372 for the second quarter of 2010 from $2,313,717 for the second quarter of 2009. For the six months ended June 30, 2010, noninterest income decreased $1,523,056, or 38.01% to $2,483,778 from $4,006,834 for the comparable 2009 period. The decrease in both periods is largely attributable to the gain on sale of securities available-for-sale that were sold during the second quarter of 2009 in accordance with our strategy to reposition the investment portfolio in order to maximize the yield on our investment securities. Additionally, the decrease in both periods was negatively impacted by the decline in the gain on the sale of mortgage loans, which decrease due to the weak demand for mortgage loans and the bottoming out of residential mortgages being refinanced because of low interest rates

Noninterest Expense

Total noninterest expense for the three months ended June 30, 2010, was $4,488,833, a decrease of $265,090, or 5.58% from the three months ended June 30, 2009. For the six months ended June 30, 2010 and 2009, noninterest expense totaled $9,430,789 and $9,478,802, respectively, a decrease of $48,013, or 0.51%.

For the three months ended June 30, 2010, compared to the quarter ended June 30, 2009, salaries and employee benefits decreased $328,015, or 12.64%, while all other major categories of noninterest expense increased $62,925, or 2.92%. For the six months ended June 30, 2010, compared to the six months ended June 30, 2009, salaries and employee benefits decreased $659,098, or 12.38%, while all other major categories of noninterest expense increased $611,085, or 14.70%. This increase is largely attributable to the increase in the expenses relating to our foreclosed properties, which were $635,896 higher for the first six months of 2010 compared to the first six months of 2009.

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Our income tax provision for the three and six months ended June 30, 2010, consists of a tax benefit of $658,403 and $724,635, respectively, compared to $955,325 and $1,148,239, respectively for the comparable 2009 periods. The decrease in the tax benefit for both periods is attributable to the reduction of the net operating loss incurred before our income tax provision and the significant increase in our nontaxable investment income.

Balance Sheet Review

General

At June 30, 2010, we had total assets of $592.8 million, consisting principally of $375.3 million in loans, $127.0 million in investments, and $32.8 million in cash and due from banks. Our liabilities at June 30, 2010 totaled $542.6 million, which consisted principally of $502.9 million in deposits, $26.0 million in FHLB advances, and $10.9 million in other borrowings. At June 30, 2010, our shareholders’ equity was $50.3 million.

At December 31, 2009, we had total assets of $645.5 million, consisting principally of $406.6 million in loans, $126.7 million in investments, and $53.3 million in cash and due from banks. Our liabilities at December 31, 2009 totaled $600.2 million, consisting principally of $552.7 million in deposits, $34.0 million in FHLB advances, and $10.9 million in other borrowings. At December 31, 2009, our shareholders' equity was $45.2 million.

Investments Securities

The investment securities portfolio, which is also a component of our total earning assets, consists of securities available-for-sale and nonmarketable equity securities.

At June 30, 2010 and December 31, 2009, we had investment securities totaling $127,013,895 and $126,760,844, respectively, which represented 21.42% and 19.63% of our total assets, respectively.

Nonmarketable equity securities consist of Federal Home Loan Bank stock, which is recorded at its original cost of $4,812,100 at June 30, 2010 and December 31, 2009

The amortized costs and the fair value of our securities available-for-sale at June 30, 2010 and December 31, 2009 are shown in the following table.

	June 30, 2010				December 31,2009
	Amortized				Amortized
	Cost		Estimated		Cost		Estimated
	(Book Value)		Fair Value		(Book Value)		Fair Value
Government sponsored enterprises		2,733,345		2,785,686		3,021,782		3,011,366
Mortgage-backed securities		57,330,574		58,504,100		59,324,978		58,132,671
Municipal securities		61,032,177		60,878,009		61,300,256		60,737,192
Other		200,000		34,000		218,750		67,515
	$	121,296,096	$	122,201,795	$	123,865,766	$	121,948,744

At June 30, 2010, securities classified as available-for-sale are recorded at fair market value. Approximately 52.48% of the unrealized losses, or nine individual securities, consisted of securities in a continuous loss position for twelve months or more. We believe that the deterioration in value is attributable to changes in market interest rates and not in credit quality and thus, we consider these losses temporary. We do not intend to sell these securities and it is more likely than not that we will not be required to sell these securities before recovery of their amortized costs. We evaluate investment securities in a loss position based on length of impairment, severity of impairment and other factors.

An impairment loss of $18,750 was recognized during the second quarter of 2010. We determined that our investment in Beach First National Bancshares, Inc, was worthless, since practically all of the assets of Beach First National were taken into receivership by the Federal Deposit Insurance Corporation.

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Securities Available-for-sale Maturity Distribution and Yields

Contractual maturities and yields on our available for sale securities at June 30, 2010 are shown in the following table. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

	After One But					After Five But
June 30, 2010	Within Five Years					Within Ten Years					After Ten Years					Total
(Dollars in thousands)	Amount		Yield			Amount		Yield			Amount		Yield			Amount		Yield
U.S. government agencies
and corporations	$	6		6.32	%	$	2,779		4.22	%	$	-		-	%	$	2,785		4.23	%
Municipals (1)		4,445		6.15			25,485		6.54			30,948		6.69			60,878		6.59
Total securities (2)	$	4,451		6.15	%	$	28,264		6.32	%	$	30,948		6.69	%	$	63,663		6.50	%

(1)	Yields are based on a tax equivalent basis of 34%.

(2)	Excludes mortgage-backed securities totaling $58,504,100 with a yield of 4.276% and other equity securities totaling $34,000.

Loans

Loans, including loans held for sale, are the largest category of earning assets and typically provide higher yields than the other types of earning assets. Associated with the higher loan yields are the inherent credit and liquidity risks which management attempts to control and counterbalance. For the six months ended June 30, 2010 and 2009, average loans, including mortgage loans held for sale, were $393,496,225 and $483,599,949, respectively, a decrease of $90,103,724, or 18.63%. At June 30, 2010, total loans were $375,923,563 compared to $411,728,010 at December 31, 2009, a decrease of $35,804,447, or 8.69%. Excluding loans held for sale, loans were $375,344,297 at June 30, 2010, compared to $406,627,401 at December 31, 2009, a decrease of $31,283,104, or 7.69%. This decrease is the result of the economic downturn in our markets that caused the volume of new loan customers to decrease.

The following table sets forth the composition of the loan portfolio, excluding loans held for sale, by category at the dates indicated and highlights the Company’s general emphasis on all types of lending.

The following table summarizes the composition of our loan portfolio at June 30, 2010 and December 31, 2009.

	June 30,		% of			December 31,		% of
	2010		Total			2009		Total
Mortgage loans on real estate
Residential 1-4 family	$	55,101,455		14.68	%	$	57,539,371		14.15	%
Multifamily		10,376,657		2.77			9,962,625		2.45
Commercial		158,010,250		42.10			169,933,348		41.79
Construction		66,816,984		17.80			77,566,504		19.08
Second mortgages		4,328,026		1.15			4,746,686		1.17
Equity lines of credit		29,609,681		7.89			31,596,471		7.77
Total mortgage loans		324,243,053		86.39			351,345,005		86.41
Commercial and industrial		43,820,664		11.67			45,887,237		11.28
Consumer		6,571,205		1.75			7,942,668		1.95
Other, net		709,375		0.19			1,452,491		0.36
Total loans	$	375,344,297		100.00	%	$	406,627,401		100.00	%

In the context of this discussion, a “real estate mortgage loan” is defined as any loan, other than a loan for construction purposes, secured by real estate, regardless of the purpose of the loan. It is common practice for financial institutions in our market area to obtain a mortgage on real estate whenever possible, in addition to any other available collateral. This collateral is taken to reinforce the likelihood of the ultimate repayment of the loan and tends to increase management’s willingness to make real estate loans and, to that extent, also tends to increase the magnitude of the real estate loan portfolio component.

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The largest component of our loan portfolio is real estate mortgage loans. At June 30, 2010, real estate mortgage loans totaled $257,426,069 and represented 68.58% of the total loan portfolio, compared to $273,778,501, or 67.33%, at December 31, 2009.

Residential mortgage loans totaled $99,415,820 at June 30, 2010, and represented 26.49% of the total loan portfolio, compared to $103,845,153 and 25.54%, respectively, at December 31, 2009. Residential real estate loans consist of first and second mortgages on single or multi-family residential dwellings. Nonresidential mortgage loans, which include commercial loans and other loans secured by multi-family properties and farmland, totaled $158,010,250 at June 30, 2010, compared to $169,933,348 at December 31, 2009. This represents a decrease of $11,923,698, or 7.01%, from the December 31, 2009 balance. Real estate construction loans were $66,816,984 and $77,566,504 at June 30, 2010 and December 31, 2009, respectively, and represented 17.80% and 19.08% of the total loan portfolio, respectively. Currently, the demand for all types of real estate mortgage loans in our market area is very weak.

Commercial and industrial loans decreased $2,066,573, or 4.50%, to $43,820,664 at June 30, 2010, from $45,887,237 at December 31, 2009. The decrease is mainly due to the economic downturn in our markets that caused the demand for these types of loans to decrease.

Our loan portfolio is also comprised of consumer loans. Consumer loans decreased $1,371,463, or 17.27%, to $6,571,205 at June 30, 2010, from $7,942,668 at December 31, 2009.

Our loan portfolio reflects the diversity of our markets. The economies of our markets contain elements of medium and light manufacturing, higher education, regional health care, and distribution facilities. We expect the area to remain stable; however due to the current depressed economies of our markets, we do not expect any material growth in the near future. We do not engage in foreign lending.

Maturities and Sensitivity of Loans to Changes in Interest Rates

The information in the following tables is based on the contractual maturities of individual loans, including loans which may be subject to renewal at their contractual maturity. Renewal of such loans is subject to review and credit approval, as well as modification of terms upon maturity. Actual repayments of loans may differ from the maturities reflected below because borrowers have the right to prepay obligations with or without prepayment penalties.

The following table summarizes the loan maturity distribution by type and related interest rate characteristics at June 30, 2010.

Loan Maturity Schedule and Sensitivity to Changes in Interest Rates

June 30, 2010 (Dollars in thousands)	One Year or Less		Over One Year Through Five Years		Over Five Years		Total
Commercial and industrial	$	152	$	40,006	$	3,663	$	43,821
Real estate		12,050		247,573		64,620		324,243
Consumer and other		679		5,117		1,484		7,280
	$	12,881	$	292,696	$	69,767	$	375,344
Loans maturing after one year with:
Fixed interest rates							$	183,320
Floating interest rates								178,332
							$	361,652

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Activity in the Allowance for Loan Losses

The following table summarizes the activity related to our allowance for loan losses for the six months ended June 30, 2010 and 2009.

	June 30,
	2010			2009
Balance, January 1	$	9,800,746		$	8,223,899
Provision for loan losses for the period		2,065,899			4,855,822
Net loans (charged-off) recovered for the period		(4,817,881	)		(5,538,672	)
Balance, end of period	$	7,048,764		$	7,541,049
Total loans outstanding, end of period	$	375,344,297		$	447,853,158
Allowance for loan losses to loans outstanding		1.88	%		1.68	%

Risk Elements in the Loan Portfolio

Nonperforming Assets - At June 30, 2010 and 2009, loans totaling $19,501,320 and $26,393,371, respectively, were in nonaccrual status, total loans of $2,260,431 and $1,419,207, respectively, were 90 days or more overdue and still accruing interest.

The following table shows the nonperforming assets, percentages of net charge-offs, and the related percentage of allowance for loan losses for the three months ended June 30, 2010 and 2009.

(Dollars in thousands)	2010			2009
Loans over 90 days past due and still accruing	$	2,260		$	1,419
Loans on nonaccrual:
Real Estate Construction		13,587			18,541
Real Estate Mortgage		4,917			7,286
Commercial		988			494
Consumer		9			72
Total nonaccrual loans		19,501			26,393
Total of nonperforming loans		21,761			27,812
Other nonperforming assets		12,268			3,901
Total nonperforming assets	$	34,029		$	31,713

Percentage of nonperforming assets to total assets		5.74	%		4.56	%
Percentage of nonperforming loans to total loans		5.80	%		6.21	%
Allowance for loan losses as a percentage of non-performing loans		32.39	%		27.11	%

Generally, loans are placed on nonaccrual status if principal or interest payments become 90 days past due and/or we deem the collectability of the principal and/or interest to be doubtful. Once a loan is placed in nonaccrual status, all previously accrued and uncollected interest is reversed against interest income. Interest income on nonaccrual loans is recognized on a cash basis when the ultimate collectability is no longer considered doubtful. Loans are returned to accrual status when the principal and interest amounts contractually due are brought current and future payments are reasonably assured. All nonaccruing loans at June 30, 2010 and 2009 were included in our classification of impaired loans at those dates.

Impaired loans – We consider all loans in nonaccrual status to be impaired. At June 30, 2010, we had impaired loans totaling $19,501,320, as compared to $49,263,581 at June 30, 2009. The significant reduction in impaired loans is due mainly to the removal of approximately $30,000,000 of loans from the impaired loan classification. Historically, we considered all loans identified as “substandard” assets to be “impaired” assets. A regulatory external audit identified the need to separate these categories per the actual regulatory definition for each classification. A bank asset may meet the definition of “substandard” while not also meeting the definition of “impaired.” However, all assets meeting the definition of “impaired” are automatically “substandard.” Accordingly, we evaluated those loans identified as substandard and separated “substandard” assets from “substandard and impaired” assets. The evaluation revealed that approximately $30 million of assets considered substandard did not meet the requirements to be considered impaired. Additionally, during the first six months of 2010 we charged off approximately $4,800,000 in impaired loans. Included in the impaired loans at June 30, 2010, were 12 borrowers that accounted for approximately 72.23% of the total amount of the impaired loans at that date. These loans were primarily commercial real estate loans isolated to the coastal regions of South Carolina. Impaired loans, as a percentage of total loans, were 5.20% at June 30, 2010.

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During the first six months of 2010, the average investment in impaired loans was $23,241,454 as compared to $41,066,599 for the first six months of 2009. Impaired loans with a specific allocation of the allowance for loan losses totaled $13,041,855 and $25,970,639 at June 30, 2010 and 2009, respectively. The amount of the specific allocation at June 30, 2010 and 2009 was $663,722 and $4,880,786, respectively.

The recent downturn in the real estate market has resulted in an increase in loan delinquencies, defaults and foreclosures; however, we believe these trends are stabilizing. In some cases, this downturn has resulted in a significant impairment to the value of our collateral and ability to sell the collateral upon foreclosure at its appraised value. However, there is a risk that downward trends could continue at a higher pace. If real estate values further decline, it is also more likely that we would be required to increase our allowance for loan losses.

On a monthly basis, we analyze each loan that is classified as impaired to determine the potential for possible loan losses. This analysis is focused upon determining the then current estimated value of the collateral, local market condition, and estimated costs to foreclose, repair and resell the property. The net realizable value of the property is then computed and compared to the loan balance to determine the appropriate amount of specific reserve for each loan.

Deposits and Other Interest-Bearing Liabilities

Average interest-bearing liabilities decreased $32,255,239, or 5.87%, to $516,850,505 for the six months ended June 30, 2010, from $549,105,744 for the six months ended June 30, 2009.

Deposits

For the six months ended June 30, 2010 and 2009, average total deposits were $522,559,992 and $504,915,663, respectively, which is an increase of $17,644,329 or 3.49%. At June 30, 2010 and December 31, 2009, total deposits were $502,921,282 and $552,762,979, respectively, a decrease of $49,841,697 or 9.02%.

Average interest-bearing deposits increased $19,916,284, or 4.34%, to $478,836,380 for the six months ended June 30, 2010, from $458,920,096 for the six months ended June 30, 2009.

The average balance of non-interest bearing deposits decreased $2,271,956, or 4.94%, to $43,723,611 for the six months ended June 30, 2010, from $45,995,567 for the six months ended June 30, 2009.

The following table shows the average balance amounts and the average rates paid on deposits held by us for the six months ended June 30, 2010 and 2009.

	2010					2009
	Average		Average			Average		Average
	Amount		Rate			Amount		Rate
Noninterest bearing demand deposits	$	43,723,611		0.00	%	$	45,995,567		0.00	%
Interest bearing demand deposits		39,295,697		0.45			35,928,629		0.58
Savings accounts		104,039,903		1.32			98,328,994		1.74
Time deposits		335,500,781		2.85			324,662,473		3.14
	$	522,559,992		2.12	%	$	504,915,663		2.40	%

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Core deposits, which exclude time deposits of $100,000 or more, provide a relatively stable funding source for our loan portfolio and other earning assets. Our core deposits were $319,793,079 and $357,416,788 at June 30, 2010 and December 31, 2009, respectively. This equates to a decrease in core deposits of $37,623,709, or 10.53%. As our loan demand declined, we correspondently lowered our rates for time deposits, especially those under $100,000. This is the primary reason why our time deposits under $100,000 declined by $30,816,919 from December 31, 2009 to June 30, 2010 and is the primary reason for the decline in our total core deposits.

Included in time deposits $100,000 and over, at June 30, 2010 and December 31, 2009 are brokered time deposits of $111,929,000 and $124,468,000, respectively. In accordance with our asset/liability management strategy, we do not intend to renew or replace the outstanding brokered deposits at June 30, 2010, when they mature. In comparing June 30, 2010 with June 30, 2009, we have reduced our brokered time deposits by $45,571,000.

Deposits, and particularly core deposits, have been our primary source of funding and have enabled us to meet successfully both our short-term and long-term liquidity needs. We anticipate that such deposits will continue to be our primary source of funding in the future. Our loan-to-deposit ratio was 74.63% on June 30, 2010, and 73.56% at December 31, 2009.

All of our time deposits are certificates of deposits. The maturity distribution of our time deposits of $100,000 or more at June 30, 2010 was as follows:

	June 30,
	2010
Three months or less	$	28,172,728
Over three through twelve months		55,765,725
Over one year through three years		62,720,580
Over three years		36,469,170
Total	$	183,128,203

Borrowings

The following table outlines our various sources of borrowed funds during the three months ended June 30, 2010 and the year ended December 31, 2009, the amounts outstanding at the end of each period, at the maximum point for each component during the periods and on average for each period, and the average interest rate that we paid for each borrowing source. The maximum month-end balance represents the high indebtedness for each component of borrowed funds at any time during each of the periods shown.

	Maximum
	Outstanding		Weighted
(Dollars in thousands)	at any		Average		Average			Ending		Period
	Month End		Balance		Interest Rate			Balance		End Rate
At or for the six months
ended June 30, 2010
Securities sold under
agreement to repurchase	$	934	$	779		0.25	% $		546		0.25	%
Advances from Federal
Home Loan Bank		27,010		26,924		3.55			26,000		3.74
Federal funds purchased		1		1		0.91			-		-
Junior subordinated debentures		10,310		10,310		6.01			10,310		5.93

At or for the year ended
December 31, 2009
Securities sold under
agreement to repurchase	$	7,664	$	2,262		0.05	% $		598		0.25	%
Advances from Federal
Home Loan Bank		93,500		59,800		3.57			34,000		3.17
Federal funds purchased		11,482		21		0.82			-		-
Note payable		6,950		1,485		2.01			-		-
Junior subordinated debentures		10,310		10,310		5.95			10,310		5.93

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Capital Resources

Total shareholders' equity at June 30, 2010 and December 31, 2009 was $50,285,115 and $45,223,827, respectively. The $5,061,288 increase during the first six months of 2010 resulted primarily from the increase in accumulated other comprehensive income of $1,869,080, issuance of $2,293,000 of Series C Preferred Stock, and issuance of $1,201,262 of common stock.

The following table shows the return on average assets (net income divided by average total assets), return on average equity (net income divided by average equity), and equity to assets ratio (average equity divided by average total assets) for the three months ended June 30, 2010 and 2009. Since our inception, we have not paid cash dividends on our common stock.

	June 30,			June 30,
	2010			2009
Return on average assets		0.02	%		(0.36	)%
Return on average equity		0.22	%		(4.94	)%
Average equity to average assets ratio		7.61	%		7.23	%

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

Quantitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum ratios of Tier 1 and total capital as a percentage of assets and off-balance-sheet exposures, adjusted for risk weights ranging from 0% to 100%. Tier 1 capital of the Company consists of common shareholders’ equity, excluding the unrealized gain or loss on securities available-for-sale, minus certain intangible assets. The Company’s Tier 2 capital consists of the allowance for loan losses subject to certain limitations. Total capital for purposes of computing the capital ratios consists of the sum of Tier 1 and Tier 2 capital. The regulatory minimum requirements are 4% for Tier 1 capital and 8% for total risk-based capital; under the provisions of the Memorandum the Bank will be required to maintain a Tier 1 leverage ratio of 8% and a total risk-based capital ratio of 10%.

The Company and the Bank are also required to maintain capital at a minimum level based on quarterly average assets, which is known as the leverage ratio. Only the strongest banks are allowed to maintain capital at the minimum requirement of 3%. All others are subject to maintaining ratios 1% to 2% above the minimum.

The following table sets forth the holding company's and the bank's various capital ratios at June 30, 2010 and at December 31, 2009. For all periods, the bank was considered "well capitalized" and the holding company met or exceeded its applicable regulatory capital requirements.

	June 30, 2010						December 31, 2009
	Holding						Holding
	Company			Bank			Company			Bank
Tier 1 capital (to risk-weighted assets)		14.31	%		12.83	%		12.78	%		12.01	%
Total capital (to risk-weighted assets)		13.05	%		11.58	%		11.52	%		10.75	%
Leverage or Tier 1 capital (to total average assets)		9.59	%		8.39	%		8.25	%		7.69	%

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Effect of Inflation and Changing Prices

The effect of relative purchasing power over time due to inflation has not been taken into account in our consolidated financial statements. Rather, our financial statements have been prepared on an historical cost basis in accordance with generally accepted accounting principles.

Unlike most industrial companies, our assets and liabilities are primarily monetary in nature. Therefore, the effect of changes in interest rates will have a more significant impact on our performance than will the effect of changing prices and inflation in general. In addition, interest rates may generally increase as the rate of inflation increases, although not necessarily in the same magnitude. As discussed previously, we seek to manage the relationships between interest sensitive assets and liabilities in order to protect against wide rate fluctuations, including those resulting from inflation.

Off-Balance Sheet Risk

Through our operations, we have made contractual commitments to extend credit in the ordinary course of its business activities. These commitments are legally binding agreements to lend money to our customers at predetermined interest rates for a specified period of time. At June 30, 2010 we had issued commitments to extend credit of $37.7 million and standby letters of credit of $2.1 million through various types of commercial lending arrangements. Approximately $31.47 million of these commitments to extend credit had variable rates.

The following table sets forth the length of time until maturity for unused commitments to extend credit and standby letters of credit at June 30, 2010:

					After
			After One		Three
			Through		Through					Greater
	Within One		Three		Twelve		Within One			Than
	Month		Months		Months		Year			One Year		Total
(Dollars in thousands)
Unused commitments to
extend credit	$	5,633	$	206	$	11,272		$	17,111	$	20,568	$	37,679
Standby letters of credit		-		-		2,004			2,004		98		2,102

Totals	$	5,633	$	206	$	13,276		$	19,115	$	20,666	$	39,781

We evaluate each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by us upon extension of credit, is based on its credit evaluation of the borrower. Collateral varies but may include accounts receivable, inventory, property, plant and equipment, commercial and residential real estate.

Market Risk

Market risk is the risk of loss from adverse changes in market prices and rates and principally arises from interest rate risk inherent in our lending, investing, deposit gathering, and borrowing activities. Other types of market risks, such as foreign currency exchange rate risk and commodity price risk, do not generally arise in the normal course of our business. Our finance committee monitors and considers methods of managing exposure to interest rate risk. We have both an internal finance committee consisting of senior management that meets at various times during each quarter and a management finance committee that meets weekly as needed. The finance committees are responsible for maintaining the level of interest rate sensitivity of our interest sensitive assets and liabilities within board-approved limits.

We actively monitor and manage our interest rate risk exposure principally by measuring our interest sensitivity "gap," which is the positive or negative dollar difference between assets and liabilities that are subject to interest rate repricing within a given period of time. Interest rate sensitivity can be managed by repricing assets or liabilities, selling securities available for sale, replacing an asset or liability at maturity, or adjusting the interest rate during the life of an asset or liability. Managing the amount of assets and liabilities repricing in this same time interval helps to hedge the risk and minimize the impact on net interest income of rising or falling interest rates. We generally would benefit from increasing market rates of interest when we have an asset-sensitive gap position and generally would benefit from decreasing market rates of interest when we are liability-sensitive.

We were asset sensitive during most of the year ended December 31, 2009 and during the six months ended June 30, 2010. As of June 30, 2010, we expect to be liability sensitive for the next nine months because a majority of our deposits reprice over a 12-month period. Approximately 55% of our loans were variable rate loans at June 30, 2010. The ratio of cumulative gap to total earning assets after 12 months was (32.54%) because $173.8 million more assets will reprice in a 12 month period than liabilities. However, our gap analysis is not a precise indicator of our interest sensitivity position. The analysis presents only a static view of the timing of maturities and repricing opportunities, without taking into consideration that changes in interest rates do not affect all assets and liabilities equally. For example, rates paid on a substantial portion of core deposits may change contractually within a relatively short time frame, but those rates are viewed by us as significantly less interest-sensitive than market-based rates such as those paid on noncore deposits. Net interest income may be affected by other significant factors in a given interest rate environment, including changes in the volume and mix of interest-earning assets and interest-bearing liabilities.

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Liquidity and Interest Rate Sensitivity

Liquidity represents the ability of a company to convert assets into cash or cash equivalents without significant loss, and the ability to raise additional funds by increasing liabilities. Liquidity management involves monitoring our sources and uses of funds in order to meet our day-to-day cash flow requirements while maximizing profits. Liquidity management is made more complicated because different balance sheet components are subject to varying degrees of management control. For example, the timing of maturities of our investment portfolio is fairly predictable and subject to a high degree of control at the time investment decisions are made. However, net deposit inflows and outflows are far less predictable and are not subject to the same degree of control.

At June 30, 2010, our liquid assets, consisting of cash and cash equivalents due from banks amounted to $32.8 million, or 5.54% of total assets. Our investment securities, excluding nonmarketable securities, at June 30, 2010 amounted to $122.2 million, or 20.61% of total assets. Investment securities traditionally provide a secondary source of liquidity since they can be converted into cash in a timely manner. However, $121.2 million of these securities are pledged as collateral to secure public deposits and borrowings. At December 31, 2009, our liquid assets amounted to $53.3 million, or 8.26% of total assets. Our investment securities, excluding nonmarketable securities, at December 31, 2009 amounted to $121.9 million, or 18.89% of total assets. However, $115.3 million of these securities were pledged.

Our ability to maintain and expand our deposit base and borrowing capabilities serves as our primary source of liquidity. Over the past six months we have reduced wholesale funding by $20 million. It is our goal to reduce total wholesale funding by an additional $10 million by year-end 2010. We plan to meet our future cash needs through the liquidation of temporary investments, the generation of deposits, and from additional borrowings. In addition, we will receive cash upon the maturity and sale of loans and the maturity of investment securities. During most of 2009 and the first six months of 2010, as a result of historically low rates that were being earned on short-term liquidity investments, we maintained a lower than normal level of short-term liquidity securities. In addition, we maintain three federal funds purchased lines of credit with correspondent banks giving us credit availability totaling approximately $12.0 million for which there were no borrowings against the lines at June 30, 2010. Also, we are a member of the Federal Home Loan Bank of Atlanta, from which applications for borrowings can be made for leverage purposes. The FHLB requires that securities, qualifying mortgage loans, and stock of the FHLB owned by the bank be pledged to secure any advances from the FHLB. We have an available line to borrow funds from the Federal Home Loan Bank up to 30% of the Bank’s total assets, which provide additional available funds of $98.7 million at June 30, 2010. At June 30, 2010 the bank had $26 million outstanding in FHLB advances. Additionally, we have an available line of credit at the Federal Reserve of $50.6 million. At June 30, 2010, there were no borrowings against this line. We believe that sources described above will be sufficient to meet our future liquidity needs.

Asset/liability management is the process by which we monitor and control the mix and maturities of our assets and liabilities. The essential purposes of asset/liability management are to ensure adequate liquidity and to maintain an appropriate balance between interest sensitive assets and liabilities in order to minimize potentially adverse impacts on earnings from changes in market interest rates. We have both an internal finance committee consisting of senior management that meets at various times during each quarter and a management finance committee that meets weekly as needed. The finance committees are responsible for maintaining the level of interest rate sensitivity of our interest sensitive assets and liabilities within board-approved limits.

Interest Sensitivity Analysis

The following table sets forth information regarding our rate sensitivity as of June 30, 2010 for each of the time intervals indicated. The information in the table may not be indicative of our rate sensitivity position at other points in time. In addition, the maturity distribution indicated in the table may differ from the contractual maturities of the earning assets and interest-bearing liabilities presented due to consideration of prepayment speeds under various interest rate change scenarios in the application of the interest rate sensitivity methods described above.

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June 30, 2010

				After One			Three						Greater Than
				Through			Through						One Year or
	Within One			Three			Twelve			Within One			Non-
(Dollars in thousands)	Month			Months			Months			Year			Sensitive			Total
Assets
Interest-earning assets
Interest-bearing deposits in
other banks	$	30,638		$	-		$	-		$	30,638		$	-		$	30,638
Loans (1)		51,390			24,974			75,140			151,504			224,420			375,924
Securities, taxable		-			-			-			-			61,324			61,324
Securities, nontaxable		-			-			-			-			60,878			60,878
Nonmarketable securities		4,812			-			-			4,812			-			4,812
Time Deposits in other banks								504			504			-			504
Total earning assets		86,840			24,974			75,644			187,458			346,622			534,080

Liabilities
Interest-bearing liabilities
Interest-bearing deposits:
Demand deposits		36,764			-			-			36,764			-			36,764
Savings deposits		108,369			-			-			108,369			-			108,369
Time deposits		69,480			40,778			89,287			199,545			114,546			314,091
Total interest-bearing deposits		214,613			40,778			89,287			344,678			114,546			459,224
Federal Home Loan Bank Advances		-			-			16,000			16,000			10,000			26,000
Junior subordinated debentures		-			-			-			-			10,310			10,310
Repurchase agreements		546			-			-			546			-			546
Total interest-bearing liabilities		215,159			40,778			105,287			361,224			134,856			496,080

Period gap	$	(128,319	)	$	(15,804	)	$	(29,643	)	$	(173,766	)	$	211,766

Cumulative gap	$	(128,319	)	$	(144,123	)	$	(173,766	)	$	(173,766	)	$	38,000

Ratio of cumulative gaap to total earning assets		(24.03	)%		(26.99	)%		(32.54	)%		(32.54	)%		7.12	%

(1) Including mortgage loans held for sale.

Item 3 - Quantitative and Qualitative Disclosures About Market Risk

See "Market Risk" and "Liquidity and Interest Rate Sensitivity" in Item 2, Management Discussion and Analysis of Financial Condition and Results of Operations for quantitative and qualitative disclosures about market risk, which information is incorporated herein by reference.

Item 4. Controls and Procedures

As of the end of the period covered by this Quarterly Report on Form 10-Q, our chief executive officer and chief financial officer have evaluated the effectiveness of our “disclosure controls and procedures” (“Disclosure Controls”). Disclosure Controls, as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), are procedures that are designed with the objective of ensuring that information required to be disclosed in our reports filed under the Exchange Act, such as this quarterly Report on Form 10-Q, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure Controls are also designed with the objective of ensuring that such information is accumulated and communicated to our management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.

Our management, including the CEO and CFO, does not expect that our Disclosure Controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

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Based upon their controls evaluation, our CEO and CFO have concluded that our Disclosure Controls are effective at a reasonable assurance level.

There have been no changes in our internal controls over financial reporting during our second fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Part II - Other Information

Item 1. Legal Proceedings

There are no material, pending legal proceedings to which the Company or its subsidiary is a party or of which any of their property is the subject.

Item 1A. Risk Factors

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2009, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

The following risks supplement the risk factors previously identified in our Annual Report on Form 10-K for the year ended December 31, 2009. The risks discussed below also include forward-looking statements, and our actual results may differ substantially from those discussed in these forward-looking statements.

We will be subject to a Memorandum that could have a material negative effect on our business, operating flexibility, financial condition and the value of our common stock. In addition, addressing the Memorandum will require significant time and attention from our management team, which may increase our costs, impede the efficiency of our internal business processes and adversely affect our profitability in the near-term.

We anticipate that the Bank will enter into a Memorandum of Understanding with its primary regulators, the FDIC and the South Carolina Commissioner of Banks (the “Commissioner”), in late August 2010. Through the completion of the Memorandum, the Bank, the FDIC and the Commissioner will have agreed as to certain areas of the Bank’s operations that warrant improvement and a plan for making those improvements. The Memorandum will require the Bank to review and revise various policies and procedures, including those associated with concentration management, the allowance for loan and lease losses, liquidity management, criticized assets, credit administration and capital.

Should the Bank fail to comply with the provisions of the Memorandum, it could result in further enforcement actions by the FDIC and/or the Commissioner. While the Company intends to take such actions as may be necessary to enable the Bank to comply with the requirements of the Memorandum, there can be no assurance that the Bank will be able to comply fully with the provisions of the Memorandum, or that efforts to comply with the Memorandum will not have adverse effects on the operations and financial condition of the Company and the Bank.

The Dodd-Frank Act and related regulations may adversely affect our business, financial condition, liquidity or results of operations.

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 was enacted on July 21, 2010. The Dodd-Frank Act creates a new Consumer Financial Protection Bureau with power to promulgate and enforce consumer protection laws. Smaller depository institutions, including those with $10 billion or less in assets, will be subject to the Consumer Financial Protection Bureau’s rule-writing authority, and existing depository institution regulatory agencies will retain examination and enforcement authority for such institutions. The Dodd-Frank Act also establishes a Financial Stability Oversight Council chaired by the Secretary of the Treasury with authority to identify institutions and practices that might pose a systemic risk and, among other things, includes provisions affecting (1) corporate governance and executive compensation of all companies whose securities are registered with the SEC, (2) FDIC insurance assessments, (3) interchange fees for debit cards, which would be set by the Federal Reserve under a restrictive “reasonable and proportional cost” per transaction standard and (4) minimum capital levels for bank holding companies, subject to a grandfather clause for financial institutions with less than $15 billion in assets.

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At this time, it is difficult to predict the extent to which the Dodd-Frank Act or the resulting regulations may adversely impact us. However, compliance with these new laws and regulations may increase our costs, limit our ability to pursue attractive business opportunities, cause us to modify our strategies and business operations and increase our capital requirements and constraints, any of which may have a material adverse impact on our business, financial condition, liquidity or results of operations.

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

(a)

On June 17, 2010, the Board of Directors of the Company amended Section 2.2 of the Company’s 2006 Equity Incentive Plan (the “Plan”) to increase the maximum number of shares of the Company’s common stock reserved exclusively for issuance under the Plan from 350,000 shares to 950,000 shares (collectively, the “Plan Amendment”). However, due to an administrative error, 67,082 shares of restricted stock were issued (the “Grant”) under the Plan in April 2010, prior to the Plan Amendment that authorized issuance of an additional 600,000 shares of restricted stock under the Plan. As of the date of the Grant, insufficient shares to complete the Grant were authorized and issuable under the Plan.

A Form S-8 Registration Statement (No. 333-168236) registering the offer and sale of the additional 600,000 shares (with a maximum offering price of $3.75 per share) was filed with the SEC on July 21, 2010. On August 2, 2010 the Board of Directors became aware of the over-issuance under the 2006 Equity Incentive Plan, ratified the April 2010 issuance of 67,082 shares of restricted stock, and declared that the shares of restricted stock shall be deemed to have been issued under the 2006 Equity Incentive Plan, reducing by 67,082 the number of shares available for awards under the 2006 Equity Incentive Plan. At present, there are 578,352 shares currently available for awards under the 2006 Equity Incentive Plan.

The over-issuance of shares under the 2006 Equity Incentive Plan occurred on or about April 1, 2010. The shares were issued as compensation to six officers. The shares are subject to restrictions on resale. Exemption for the offer and sale of the 67,082 shares is claimed under section 4(2) of the Securities Act of 1933, a transaction by the issuer not involving any public offering.

(b)	Not applicable.

(c)	The following stock repurchases were made during the period covered by this report in connection with administration of the Company’s employee stock ownership plan.

					Total
					Number of		Maximum
					Shares		Number of
					Purchased as		Shares that
					Part of		May Yet Be
	Total		Average		Publicly		Purchased
	Number of		Price		Announced		Under the
	Shares		Paid per		Plans or		Plans or
Period	Purchased		Share		Programs		Programs
April 1, 2010 – April 30, 2010		-	$	-		-		-
May 1, 2010 – May 31, 2010		288	$	4.30		-		-
June 1, 2010 – June 30, 2010/a		164	$	4.30		-		-
		452	$	4.30		-		-

Item 3. Defaults Upon Senior Securities

Not applicable.

Item 6. Exhibits

Exhibit Number		Exhibit
3.1		Amended and Restated Articles of Incorporation, as amended, as of April 7, 2010.
31.1		Certification pursuant to Rule 13a-15 under the Securities Exchange Act of 1934, as amended.
31.2		Certification pursuant to Rule 13a-15 under the Securities Exchange Act of 1934, as amended.
32.1		Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2		Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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SIGNATURE

In accordance with the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	FIRST RELIANCE BANCSHARES, INC.

Date: August 12, 2010	By:	/s/ F. R. SAUNDERS, JR.
		F. R. Saunders, Jr.
		President & Chief Executive Officer



Date: August 12, 2010	By:	/s/ JEFFERY A. PAOLUCCI
		Jeffery A. Paolucci
		Senior Vice President and Chief Financial Officer

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