10-K

U.S. SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF

 THE SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended December 31, 2011 File Number 000-51950

CORNERSTONE BANCORP

(Exact name of registrant as specified in its Charter)

South Carolina	57-1077978
(State or Other Jurisdiction of Incorporation or Organization)	(IRS Employer Identification Number)

1670 East Main Street, Easley, South Carolina 29640

(Address of Principal Executive Office, Zip Code)

Registrant’s Telephone Number, Including Area Code: (864) 306-1444

Securities Registered Pursuant to Section 12(b) of the Act: None

Securities Registered Pursuant to Section 12(g) of the Act:  Common Stock, no par value

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

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

Yes   [  ]  No  [X] 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the 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.  Yes   [X]  No  [  ]

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

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

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

Large accelerated filer      [  ]                                                                                          Accelerated filer                    [  ]

Non-accelerated filer        [  ]                                                                                        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   [  ]  No  [X]

The aggregate market value of the voting Common Stock held by non-affiliates computed by reference to the average of the most recent trade prices of the Common Stock reported on the OTC Bulletin Board as of June 30, 2011, the last day of the registrant’s most recently completed second fiscal quarter, was approximately $1,906,692. The issuer has no non-voting common equity outstanding.  For purposes of the foregoing calculation only, all directors and executive officers of the registrant have been deemed affiliates.

As of March 14, 2012, there were 2,210,769 shares of the registrant’s Common Stock, no par value, outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

(1)   Portions of the Registrant’s 2011 Annual Report to Shareholders are incorporated by reference into Part II of this Form 10-K.

(2)   Portions of the Registrant’s 2012 Proxy Statement are incorporated by reference into Part III of this Form 10-K.

10-K CROSS REFERENCE INDEX

	PART I	Page
Item 1.	Business	3
Item 1A.	Risk Factors	12
Item 1B.	Unresolved Staff Comments	16
Item 2.	Properties	16
Item 3.	Legal Proceedings	16
Item 4.	Mine Safety Disclosures	17
	PART II
Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	17
Item 6.	Selected Financial Data	17
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	17
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	17
Item 8.	Financial Statements and Supplementary Data	17
Item 9.	Changes In and Disagreements with Accountants on Accounting and Financial Disclosure	17
Item 9A.	Controls and Procedures	17
Item 9B.	Other Information	18
	PART III
Item 10.	Directors, Executive Officers and  Corporate Governance	18
Item 11.	Executive Compensation	19
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	19
Item 13.	Certain Relationships and Related Transactions, and Director Independence	19
Item 14.	Principal Accountant Fees and Services	19
Item 15.	Exhibits, Financial Statement Schedules	20

CAUTIONARY NOTICE WITH RESPECT TO FORWARD LOOKING STATEMENTS

Statements included in this report which are not historical in nature are intended to be, and are hereby identified as “forward looking statements” for purposes of the safe harbor provided by Section 21E of the Securities Exchange Act of 1934, as amended. Words such as “estimate,” “project,” “intend,” “expect,” “believe,” “anticipate,” “plan,” “may,” “will,” “should,” “could,” “would,” “assume,” “indicate,” “contemplate,” “seek,” “target,” “potential,” and similar expressions identify forward-looking statements. The Company cautions readers that forward looking statements, including without limitation, those relating to the Company’s new offices, future business prospects, revenues, working capital, adequacy of the allowance for loan losses, liquidity, capital needs, interest costs, income, and the economy, are subject to certain risks and uncertainties that could cause actual results to differ from those indicated in the forward looking statements, due to several important factors identified in this report, among others, and other risks and factors identified from time to time in the Company’s other reports filed with the Securities and Exchange Commission.

These forward-looking statements are based on our current expectations, estimates and projections about our industry, management’s beliefs, and assumptions made by management. Such information includes, without limitation, discussions as to estimates, expectations, beliefs, plans, strategies, and objectives concerning the Company’s future financial and operating performance. These statements are not guarantees of future performance and are subject to risks, uncertainties and assumptions that are difficult to predict, particularly in light of the fact that the Company is a relatively new company with limited operating history. Therefore, actual results may differ materially from those expressed or forecasted in such forward-looking statements. The risks and uncertainties include, but are not limited to:

·   future economic and business conditions;

·   the Company’s growth and ability to maintain growth;

·   governmental monetary and fiscal policies;

·   legislative and regulatory changes;

·   the effect of interest rate changes on our level, costs and composition of deposits, loan demand, and the values of our loan collateral, securities, and interest sensitive assets and liabilities;

·   the effects of competition from a wide variety of local, regional, national and other providers of financial, investment and insurance services, as well as competitors that offer banking products and services by mail, telephone, computer, and/or the Internet;

·   credit risks;

·   higher than anticipated levels of defaults on loans;

·   perceptions by depositors about the safety of deposits;

·   failure of our customers to repay loans;

·   failure of assumptions underlying the establishment of the allowance for loan losses, including the value of collateral securing loans;

·   the risks of opening new offices, including, without limitation, the related costs and time of building customer relationships and integrating operations, and the risk of failure to achieve expected gains, revenue growth and/or expense savings;

·   the effect of agreements with regulatory authorities, which restrict various activities and impose additional administrative requirements without commensurate benefits;

·   changes in requirements of regulatory authorities;

·   changes in accounting policies, rules, and practices;

·   cost and difficulty of implementing changes in technology or products;

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

·   ability to weather the current economic downturn;

·   loss of consumer or investor confidence; and

·   other factors and information described in this report and in any of the other reports we file with the Securities and Exchange Commission under the Securities Act of 1934.

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All forward-looking statements are expressly qualified in their entirety by this cautionary notice. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. In light of these risks, uncertainties, and assumptions, the forward-looking events discussed in this report might not occur.

WEBSITE REFERENCES

References to our Bank’s website included in, or incorporated by reference into, this report are for information purposes only, and are not intended to incorporate our website by reference into this report.

PART I

Item 1.    Business.

General

Cornerstone Bancorp (the “Company”) is a South Carolina corporation incorporated in 1999. The Company is a bank holding company with no operations other than those carried on by its wholly owned subsidiary, Cornerstone National Bank (the “Bank”).  The Bank was organized in 1999 and conducts a general banking business under a national bank charter granted by the Office of the Comptroller of the Currency of the United States (the “OCC”) pursuant to the National Bank Act.  The Bank conducts its activities from its main office in the City of Easley in Pickens County, South Carolina, which opened in September, 1999, and from a branch office located in the Berea area of Greenville County, South Carolina, which opened in August, 2002, and from a branch office in the Powdersville/Piedmont area of Anderson County, South Carolina, which opened in July 2005. In 2004, our bank established a wholly owned subsidiary, Crescent Financial Services, Inc. (“Crescent”), which is an insurance agency that has not yet engaged in any significant operations.

The Bank’s primary market areas are the city of Easley, South Carolina and the immediately surrounding areas of Pickens County, the Berea area of Greenville County, and the Powdersville and Piedmont areas of Anderson County, and contiguous areas. Pickens County is included in the Greenville, South Carolina Metropolitan Statistical Area (the “Greenville MSA”). Anderson County is part of the Anderson, South Carolina MSA.

The Bank’s business primarily consists of accepting deposits and making loans. The Bank seeks deposit accounts from households and businesses in its primary market areas by offering a full range of savings accounts, retirement accounts, checking accounts, money market accounts, and time certificates of deposit. It also makes commercial, real estate and installment loans, primarily on a secured basis, to borrowers in the Upstate area of South Carolina and makes other authorized investments. The Bank offers both in-house and, when market conditions reasonably allow, brokered conventional residential mortgage loans. Brokered loans are funded by a third party investor.  The Bank stopped making brokered residential mortgage loans in November 2009 because of difficulties created by current market conditions in brokering such loans to third party investors.  The Bank plans to reevaluate offering conventional 30- and 15-year mortgage loans when the housing and mortgage lending markets stabilize.  The Bank does not hold any mortgage loans for sale.

As of December 31, 2011, the Bank employed 35  people.

Competition

South Carolina law permits statewide branching by banks and savings and loan associations.  Consequently, many financial institutions have branches located in several communities.  According to the FDIC Summary of Deposits at June 30, 2011, in addition to the Bank, 11 commercial banks and one savings institution operate branches in Pickens County. In addition to the Bank, 29 commercial banks and four savings institutions operate branches in Greenville County. In addition to the Bank, 20 commercial banks operate branches in Anderson County. The principal areas and methods of competition in the banking industry are the services offered, pricing of those services, the convenience and availability of the services, and the degree of expertise and personal manner with which those services are offered.

The Bank encounters strong competition from most of the financial institutions in its extended market area.  In the conduct of certain areas of its business, the Bank also competes with credit unions, insurance companies, money market mutual funds and other financial institutions, some of which are not subject to the same degree of regulation and restrictions as the Bank.  Most of these competitors have substantially greater resources and lending abilities than the Bank and offer certain services, such as international banking, investment banking, and trust services, which the Bank does not presently provide.

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SERVICES OF THE BANK

Deposits

The Bank offers the full range of deposit services typically available in most banks and savings and loan associations, including checking accounts, NOW accounts, retirement accounts (including Individual Retirement Accounts), and savings and other time deposits of various types, ranging from daily money market accounts to longer-term certificates of deposit. The transaction accounts and time certificates are tailored to the principal market area at rates competitive with those offered by other institutions in the area. All deposit accounts are insured by the Federal Deposit Insurance Corporation (“FDIC”) up to the maximum amount permitted by law. The Bank solicits these accounts from individuals, businesses, associations and organizations, and government authorities.

Lending Activities

The Bank offers a range of lending services, including commercial loans, consumer loans, and real estate mortgage loans. To address the risks inherent in making loans, management maintains an allowance for loan losses based on, among other things, an evaluation of the Bank’s loan loss experience, management’s experience at other financial institutions in the market area, peer data, the amount of and trends in past due and nonperforming loans, current economic conditions and the values of loan collateral. Based upon such factors, management makes various assumptions and judgments about the ultimate collectibility of the loan portfolio and provides an allowance for loan losses based upon a percentage of the outstanding balances and specific loans. However, because there are certain risks that cannot be precisely quantified, management’s judgment of the allowance is necessarily approximate and imprecise. The adequacy and methodology of the allowance for loan losses is also subject to regulatory examination. Refer to Management’s Discussion and Analysis of Financial Condition and Results of Operations-Loan Portfolio for additional information.

Real Estate Loans

One of the primary components of the Bank’s loan portfolio is loans secured by first or second mortgages on residential and commercial real estate. These loans generally consist of short to mid-term commercial real estate loans, construction and development loans and residential real estate loans (including home equity and second mortgage loans).  Interest rates may be fixed or adjustable and the Bank frequently charges an origination fee. The Bank seeks to manage credit risk in the commercial real estate portfolio by emphasizing loans on owner-occupied office and retail buildings where the loan-to-value ratio at origination, established by independent appraisals, does not exceed 80%. In addition, the Bank generally requires personal guarantees of the principal owners of the borrower. The loan-to-value ratio at origination for first and second mortgage loans generally does not exceed 80%, and for construction loans, generally does not exceed 75% of cost. The Bank employs a reappraisal policy to routinely monitor real estate collateral values on real estate loans where the repayment is dependent on sale of the collateral. In addition, in an effort to control interest rate risk, long term residential mortgages are not originated for the Bank’s portfolio.

The principal economic risk associated with all loans, including real estate loans, is the creditworthiness of the borrowers. The ability of a borrower to repay a real estate loan depends upon a number of economic factors, including employment levels and fluctuations in the value of real estate. In the case of a real estate construction loan, there is generally no income from the underlying property during the construction period, and the developer’s personal obligations under the loan are typically limited. In addition, construction loans also face the risks associated with inaccuracies in construction estimates, risk of over funding prior to completion of the related work, and other project-related risks. Speculative construction loans face the additional risk of over supply of homes in the market, and relatively few resources for accurately measuring inventory levels. (The Bank does not routinely originate construction and development loans with interest reserves, which are common in the industry, but elevate risk to the lender.) In the case of a real estate purchase loan that is not fully amortized, the borrower may be unable to repay the loan at the end of the loan term and thus may be forced to refinance the loan at a higher interest rate, or, in certain cases, the borrower may default as a result of the inability to refinance the loan. Each of these factors increases the risk of nonpayment by the borrower.

In 2007, the Company increased real estate construction loans approximately 60%. Some of the loans in this segment of the portfolio came under pressure when potential buyers faced a lack of available financing and unemployment levels increased significantly. As a result of the real estate crisis, which became evident in the Bank’s markets in 2009, the Bank tightened underwriting standards related to all of its loan segments. The Bank’s loan policy now contains specific minimum net worth requirements for borrowers, minimum debt coverage ratios, and for loans to construct single family residential properties, written contracts with the end purchaser that contain significant consequences to the purchaser for terminating the contract. The construction segment of the Bank’s business is managed in specific ways in order to minimize the risks normally associated with construction lending. Management requires lending personnel to visit job sites, maintain frequent contact with borrowers and arrange for third-party inspections of completed work prior to issuing additional construction loan draws. Speculative construction loans are not generally offered by the Bank unless extenuating circumstances exist.

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The Bank faces additional credit risks to the extent that it engages in making adjustable rate mortgage loans (“ARMs”). In the case of an ARM, as interest rates increase, the borrower’s required payments increase, thus increasing the potential for default. The marketability of all real estate loans, including ARMs, is also generally affected by the prevailing level of interest rates.

Commercial Loans

The Bank makes loans for commercial purposes in various lines of business. Commercial loans include both secured and unsecured loans for working capital (including inventory and receivables), loans for business expansion (including acquisition of real estate and improvements), and loans for purchases of equipment and machinery. Equipment loans are typically made for a term of five years or less at either fixed or variable rates, with the loan fully amortized over the term and secured by the financed equipment. Working capital loans typically have terms not exceeding one year and are usually secured by accounts receivable, inventory or personal guarantees of the principals of the business. Commercial loans vary greatly depending upon the circumstances and loan terms are structured on a case-by-case basis to better serve customer needs.

The risks associated with commercial loans vary with many economic factors, including the economy in the Bank’s market areas. The well-established banks in the Bank’s market areas make proportionately more loans to medium- to large-sized businesses than the Bank makes. Many of the Bank’s commercial loans are made to small- to medium-sized businesses, which typically are not only smaller, but also have shorter operating histories and less sophisticated record keeping systems than larger entities. As a result, these smaller entities may be less able to withstand adverse competitive, economic and financial conditions than larger borrowers. In addition, because payments on loans secured by commercial property generally depend to a large degree on the results of operations and management of the properties, repayment of such loans may be subject, to a greater extent than other loans, to adverse conditions in the real estate market or the economy.

Consumer Loans

The Bank makes a variety of loans to individuals for personal and household purposes, including secured and unsecured installment and term loans, home equity loans and lines of credit and unsecured revolving lines of credit.  The secured installment and term loans to consumers generally consist of loans to purchase automobiles, boats, recreational vehicles, mobile homes and household furnishings, with the collateral for each loan being the purchased property.  The underwriting criteria for home equity loans and lines of credit are generally the same as applied by the Bank when making a first mortgage loan, as described above, and home equity lines of credit typically expire 15 years or less after origination, unless renewed or extended.

Consumer loans generally involve more credit risks than other loans because of the type and nature of the underlying collateral or because of the absence of any collateral. Consumer loan repayments are dependent on the borrower’s continuing financial stability and are likely to be adversely affected by job loss, divorce and illness. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans in the case of default. In most cases, any repossessed collateral will not provide an adequate source of repayment of the outstanding loan balance. Although the underwriting process for consumer loans includes a comparison of the value of the security, if any, to the proposed loan amount, the Bank cannot predict the extent to which the borrower’s ability to pay, and the value of the security, will be affected by prevailing economic and other conditions.

Other Services

The Bank participates in a network of automated teller machines that may be used by Bank customers throughout the United States and the world.  The Bank offers both VISA and MasterCard brands of credit and debit cards together with related lines of credit. The lines of credit may be used for overdraft protection as well as pre-authorized credit for personal purchases and expenses. Credit cards are underwritten and funded by a third party provider. The Bank also provides stored value cards, direct deposit of payroll and social security checks, and automatic drafts for various accounts, but does not currently provide international or trust banking services, other than foreign currency exchange through a correspondent bank. The Bank offers an Internet banking product accessible via the Bank’s custom website at www.cornerstonenatlbank.com.  The interactive banking product includes an electronic bill payment service that allows customers to make scheduled and/or recurring bill payments electronically. The Bank also offers remote check deposit services to commercial and small business customers. The Bank also offers merchant and other business related services to its commercial customers.

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Until November 2009, the Bank had a residential mortgage loan department with a highly experienced staff qualified to make many types of residential mortgage loans. In an effort to control interest rate risk, long term residential mortgages were underwritten and funded by, and closed in the name of, third party lenders. Since the third quarter of 2007, some of the third party lenders that offer long term residential mortgages to the Bank’s customers no longer offered certain lending programs, or tightened credit standards in response to the crisis in the sub-prime segment of the mortgage lending market. As a result, there was a significant decrease in the volume of residential mortgages processed by the Bank’s mortgage lending staff. In November 30, 2009 the Bank determined that the volume of mortgage loans had decreased so much that it would be prudent to discontinue offering longer term mortgage loans. When the market for long term mortgages appears to have stabilized, management plans to reevaluate the possibility of offering long term residential mortgages.

Asset and Liability Management

The Bank’s primary earning assets consist of the loan portfolio and investment portfolio.  Management generally makes efforts to match maturities and rates of loans and the investment portfolio with those of deposits, although exact matching is not possible.  The majority of the Bank’s securities investments are in marketable obligations of government sponsored enterprises and state and municipal governments, generally with varied maturities.

Long-term loans are priced primarily to be interest-rate sensitive with only a portion of the Bank’s portfolio of long-term loans at fixed rates. Such fixed-rate loans generally do not have maturities longer than fifteen years, except in exceptional cases.

Deposit accounts represent the majority of the Bank’s liabilities. These include transaction accounts, savings and money market accounts and certificates of deposit. The maturities or repricing horizons of the majority of interest-sensitive accounts are 12 months or less.

Additional Information

For additional information about the business of the Company and the Bank, see Item 7- “Management’s Discussion and Analysis or Plan of Operation.”

Offices

The Company’s and Bank’s main office is located at 1670 East Main Street in Easley, South Carolina. The Bank also maintains full-service branch locations at 45 Farrs Bridge Road in the Berea area of Greenville, South Carolina and at 11000 Anderson Highway in the Powdersville area of Piedmont, South Carolina. An operations center is located at 1664 East Main Street in Easley, South Carolina. The Company owns all of these properties and believes they are well-suited to the banking business.

SUPERVISION AND REGULATION

Bank holding companies and banks are extensively regulated under federal and state law.  To the extent that the following information describes statutory and regulatory provisions, it is qualified in its entirety by reference to such statutes and regulations. Any change in applicable law or regulation may have a material effect on the business of the Company and the Bank.

General

The Company and the Bank operate in a highly regulated environment, and their business activities are governed by statute, regulation, and administrative policies, and supervised by a number of federal regulatory agencies, including the Board of Governors of the Federal Reserve System (the “Federal Reserve”), the OCC, and the FDIC.  The Company is also subject to limited regulation by the South Carolina State Board of Financial Institutions.  The following discussion summarizes some of the relevant aspects of the laws and regulations that affect the Company and the Bank.  It is important to note that these laws and regulations are intended primarily for the benefit and protection of the Bank’s depositors and the Deposit Insurance Fund, and not for the protection of the Company’s shareholders or creditors.   Proposals to change the laws and regulations that govern the banking industry are frequently raised in Congress, state legislatures, and various bank regulatory agencies, and such proposals have significantly increased in the wake of the recent financial crisis.

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Furthermore, financial institutions are being subjected to increased scrutiny and enforcement activity by state and federal banking agencies, the United States Department of Justice, the Securities and Exchange Commission, and other state and federal regulatory agencies.  This increased scrutiny and enforcement activity entails significant potential increases in compliance requirements and associated costs.  The banking regulators periodically examine the Company and the Bank to assess compliance with applicable requirements and the level of risk existing with respect to the Company’s  and the Bank’s capital, asset quality, management, earnings, liquidity and sensitivity to market risk.  When the results of examinations are less than satisfactory, the regulators are authorized to require the Company and the Bank to take appropriate corrective actions through the mechanisms of agreements with the Company or the Bank, or enforcement orders.  The regulators also have the power to enforce compliance with laws, regulations, regulatory policies and agreements as well as regulatory orders by the imposition of civil money penalties.

Regulation of the Company by the Federal Reserve

The Company is regulated by the Federal Reserve under the Bank Holding Company Act (the “BHCA”).  Under the BHCA, the Company’s activities and those of its subsidiaries are limited to banking, managing or controlling banks, furnishing services to or performing services for its subsidiaries or engaging in any other activity which the Federal Reserve determines to be so closely related to banking or managing or controlling banks as to be a proper incident thereto.  The Company may engage in a broader range of activities if it becomes a “financial holding company” pursuant to the Gramm-Leach-Bliley Act, which is described below under the caption “Gramm-Leach-Bliley Act.”  The BHCA prohibits the Company from acquiring direct or indirect control of more than 5% of the outstanding voting stock or substantially all of the assets of any bank or from merging or consolidating with another bank holding company without prior approval of the Federal Reserve. Additionally, the BHCA prohibits the Company from engaging in or from acquiring ownership or control of more than 5% of the outstanding voting stock of any company engaged in a non-banking business unless such business is determined by the Federal Reserve to be so closely related to banking as to be properly incident thereto.  The BHCA generally does not place territorial restrictions on the activities of such non-banking related activities.

Obligations of the Company to its Subsidiary Bank

A number of obligations and restrictions are imposed on bank holding companies and their depository institution subsidiaries by Federal law and regulatory policy that are designed to reduce potential loss exposure to the depositors of such depository institutions and to the Deposit Insurance Fund in the event the depository institution is in danger of becoming insolvent or is insolvent.  For example, under the Federal Deposit Insurance Act, as amended (“FDIA”), and the policy of the Federal Reserve, a bank holding company is required to serve as a source of financial strength to its subsidiary depository institutions and to commit resources to support such institutions in circumstances where it might not do so absent such requirement.  In addition, the “cross-guarantee” provisions of the FDIA, require insured depository institutions under common control to reimburse the FDIC for any loss suffered or reasonably anticipated by the Deposit Insurance Fund of the FDIC as a result of the default of a commonly controlled insured depository institution or for any assistance provided by the FDIC to a commonly controlled insured depository institution in danger of default.  The FDIC may decline to enforce the cross-guarantee provisions if it determines that a waiver is in the best interest of the Deposit Insurance Fund.  The FDIC’s claim for damages is superior to claims of shareholders of the insured depository institution or its holding company but is subordinate to claims of depositors, secured creditors and holders of subordinated debt (other than affiliates) of the commonly controlled insured depository institutions.

The FDIA also provides that amounts received from the liquidation or other resolution of any insured depository institution by any receiver must be distributed (after payment of secured claims) to pay the deposit liabilities of the institution prior to payment of any other general or unsecured senior liability, subordinated liability, general creditor or shareholder.  This provision gives depositors a preference over general and subordinated creditors and shareholders in the event a receiver is appointed to distribute the assets of the Bank.

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Any capital loans by a bank holding company to any of its subsidiary banks are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary bank.  In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to a priority of payment.

Under the National Bank Act, if the capital stock of a national bank is impaired by losses or otherwise, the OCC is authorized to require payment of the deficiency by assessment upon the bank’s shareholders, pro rata, and to the extent necessary, if any such assessment is not paid by any shareholder after three months notice, to sell the stock of such shareholder to make good the deficiency.

Capital Adequacy Guidelines for Bank Holding Companies and National Banks

The various federal bank regulators, including the Federal Reserve and the OCC have adopted risk-based and leverage capital adequacy guidelines for assessing bank holding company and bank capital adequacy.  These standards define what qualifies as capital and establish minimum capital standards in relation to assets and off-balance sheet exposures, as adjusted for credit risks.  In addition, the OCC may establish individual minimum capital requirements for a national bank that are different from the general requirements, and the OCC has established such individual minimum capital requirements for the Bank.

Failure to meet capital requirements could subject the Bank to a variety of enforcement remedies, ranging from, for example, prohibition of the taking of brokered deposits to the termination of deposit insurance by the FDIC or the appointment of a receiver.

The risk-based capital standards of both the Federal Reserve and the OCC explicitly identify concentrations of credit risk and the risk arising from non-traditional activities, as well as an institution’s ability to manage these risks, as important factors to be taken into account by the agencies in assessing an institution’s overall capital adequacy. The capital guidelines also provide that an institution’s exposure to a decline in the economic value of its capital due to changes in interest rates should be considered by the agencies as a factor in evaluating a bank’s capital adequacy.  The Federal Reserve also has issued additional capital guidelines for bank holding companies that engage in certain trading activities.

The Bank exceeded all applicable capital requirements at December 31, 2011. The Company is also subject to capital requirements established by the Federal Reserve, which establish minimum ratios for capital adequacy as they apply to the Company. For 2011, the Company also met its capital ratios.  Additional information about regulatory capital requirements is set forth in Note 20 to the Company’s Financial Statements, which are included in the 2011 Annual Report to Shareholders filed as Exhibit 13 to this Form 10-K (the “2011 Annual Report”).

Payment of Dividends

The Company is a legal entity separate and distinct from its bank subsidiary. Most of the revenues of the Company are expected to result from dividends paid to the Company by the Bank. There are statutory and regulatory requirements applicable to the payment of dividends by the Bank to the Company as well as by the Company to its shareholders.  The ability of the Bank to pay dividends is currently limited by a Formal Agreement with the OCC, and, under a Memorandum of Understanding with the Federal Reserve, the Company is required to seek permission of the Federal Reserve prior to paying dividends.  See Item 7 – “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Regulatory Actions.”

Certain Transactions by the Company with its Affiliates

Federal law regulates transactions among the Company and its affiliates, including the amount of bank loans to or investments in nonbank affiliates and the amount of advances to third parties collateralized by securities of an affiliate.  Further, a bank holding company and its affiliates are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of services.

FDIC Insurance Assessments

The FDIC maintains the Deposit Insurance Fund (“DIF”) by assessing depository institutions insurance premiums.  During the first quarter of 2009, the FDIC announced a special one-time emergency assessment.  The Bank paid $80,894 in September, 2009 for the one-time emergency assessment.  On November 12, 2009, the FDIC Board of Directors adopted a final rule requiring insured depository institutions to prepay their quarterly risk-based deposit insurance assessment for all of 2010, 2011 and 2012. On December 30, 2009, the Bank paid $934,150 related to the prepayment of these quarterly premiums for the years 2010, 2011 and 2012. For 2010 and the following two years, on a quarterly basis, the FDIC  continued, and will continue, to calculate the assessment amount with then current financial information, and will deduct the quarterly assessment amount from the prepaid balance. The Bank expenses the current portion as calculated by the FDIC.  The amount expensed for 2011 was approximately $283,000. The FDIC also voted to adopt a uniform three-basis point increase in assessment rates effective January 1, 2011. 

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In November 2010, the FDIC approved a regulation, which was effective April 1, 2011, that implements a provision in the Dodd-Frank Act that changes the assessment base from one based on domestic deposits (as it has been since 1935) to one based on assets.  The regulation changes the assessment base from adjusted domestic deposits to average consolidated total assets minus average tangible equity.  Since the new base would be much larger than the current base, the FDIC will lower assessment rates, which achieves the FDIC’s goal of not significantly altering the total amount of revenue collected from the industry.  In December 2010, the FDIC voted to increase the required amount of reserves for the designated reserve ratio to 2.0%.  The ratio is higher than the 1.35% set by the Dodd-Frank Act in July 2010 and is an integral part of the FDIC’s comprehensive, long-range management plan for the DIF.

On December 29, 2010 the Dodd-Frank Act was amended to include full FDIC insurance on Interest on Lawyers Trust Accounts (“IOLTAs”).  IOLTAs will receive unlimited insurance coverage as non-interest bearing transaction accounts for two years ending December 31, 2012.

Regulation of the Bank

The Bank is subject to the National Bank Act and the regulations of the OCC, as well as to supervision by the OCC, the Consumer Financial Protection Bureau, and, to a limited extent, the FDIC.  The Bank is also subject to various other state and federal laws and regulations, including state usury laws, laws relating to fiduciaries, consumer credit laws and laws relating to branch banking.  The Bank’s loan operations are subject to certain federal consumer credit laws and regulations promulgated thereunder, including, but not limited to: the federal Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers; the Home Mortgage Disclosure Act, requiring financial institutions to provide certain information concerning their mortgage lending; the Equal Credit Opportunity Act and the Fair Housing Act, prohibiting discrimination on the basis of certain prohibited factors in extending credit; the Fair Credit Reporting Act, governing the use and provision of information to credit reporting agencies; the Bank Secrecy Act, dealing with, among other things, the reporting of certain currency transactions; the Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies; and the USA Patriot Act, dealing with, among other things, requiring the establishment of anti-money laundering programs including standards for verifying customer information at account opening.  The deposit operations of the Bank are subject to the Truth in Savings Act, requiring certain disclosures about rates paid on savings accounts; the Expedited Funds Availability Act, which deals with disclosure of the availability of funds deposited in accounts and the collection and return of checks by banks; the Right to Financial Privacy Act, which imposes a duty to maintain certain confidentiality of consumer financial records, and the Electronic Funds Transfer Act and regulations promulgated thereunder, which govern automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services.

The Bank is also subject to the requirements of the Community Reinvestment Act (the “CRA”).  The CRA imposes on financial institutions an affirmative and ongoing obligation to meet the credit needs of their local communities, including low- and moderate-income neighborhoods, consistent with the safe and sound operation of those institutions.  Each financial institution’s actual performance in meeting community credit needs is evaluated as part of the examination process, and also is considered in evaluating mergers, acquisitions and applications to open a branch or facility.

Other Safety and Soundness Regulations

Prompt Corrective Action.  The federal banking agencies have broad powers under current federal law to take prompt corrective action to resolve problems of insured depository institutions.  The extent of these powers depends upon whether the institutions in question are “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized.”

A bank that is “undercapitalized” becomes subject to provisions of the FDIA: restricting payment of capital distributions and management fees; requiring the FDIC to monitor the condition of the bank; requiring submission by the bank of a capital restoration plan; restricting the growth of  the bank’s assets and requiring prior approval of certain expansion proposals.  A bank that is “significantly undercapitalized” is also subject to restrictions on compensation paid to senior management of the bank.  A bank that is “critically undercapitalized” is further subject to restrictions on the activities of the bank and restrictions on payments of subordinated debt of the bank, as well as a requirement that the bank be placed in receivership within 90 days in most cases.  The purpose of these provisions is to require banks with less than adequate capital to act quickly to restore their capital and to have the FDIC move promptly to take over banks that are unwilling or unable to take such steps.

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Brokered Deposits.  Under current FDIC regulations, “well capitalized” banks may accept brokered deposits without restriction, “adequately capitalized” banks may accept brokered deposits with a waiver from the FDIC (subject to certain restrictions on payment of rates), while “undercapitalized” banks may not accept brokered deposits.

Pursuant to a formal agreement with the OCC, the Bank may not accept brokered deposits without obtaining a prior determination of no supervisory objection from the OCC.

Interstate Banking

Under federal law, the Company and any other adequately capitalized bank holding company located in South Carolina can acquire a bank located in any other state, and a bank holding company located outside South Carolina can acquire any South Carolina-based bank, in either case subject to certain deposit percentage and other restrictions.  The Dodd-Frank Act discussed below expanded the law relating to authority of banks to branch across state lines.  Under the Dodd-Frank Act, the authority of a bank to establish and operate branches within a state continues to be subject to applicable state branching laws, but interstate branching is permitted to the same extent it would be permitted under state law if the branching bank’s home office were located in the state in which the branch will be located.

Gramm-Leach-Bliley Act

The Gramm-Leach-Bliley Act expanded the activities in which a bank holding company and a bank can engage through affiliations created under a holding company structure or through a financial subsidiary if certain conditions are met.  Significantly, the permitted financial activities for financial holding companies include authority to engage in merchant banking and insurance activities, including insurance portfolio investing.  The Act also established a minimum federal standard of privacy to protect the confidentiality of a consumer’s personal financial information and gives the consumer the power to choose how personal financial information may be used by financial institutions.  The regulations adopted pursuant to the Act govern the consumer’s right to opt-out of further disclosure of nonpublic personal financial information and require the Bank to provide initial and annual privacy notices.  The Act and regulations also required the Bank to develop and maintain a comprehensive plan for the safeguarding of customer information  which  encompasses all aspects of the Bank’s  technological environment, business practices, and Bank facilities.

Although the Act and the regulations created new opportunities for the Company to offer expanded services to customers in the future, the Company has not determined what the nature of the expanded services might be or whether and when the Company might find it feasible to offer them.  The Act has increased competition from larger financial institutions that are currently more capable than the Company of taking advantage of the opportunity to provide a broader range of services.  However, the Company continues to believe that its commitment to providing high quality, personalized service to customers will permit it to remain competitive in its market area.

Governmental Response to the Financial Crisis that began in 2008

During the fourth quarter of 2008 and continuing throughout 2009 the FDIC, the Federal Reserve, the Department of the Treasury and Congress took a number of actions designed to alleviate or correct mounting problems in the financial services industry.  A number of these initiatives were directly applicable to community banks.

Congress enacted the Emergency Economic Stabilization Act of 2008 which, among other things, temporarily increased the maximum amount of FDIC deposit insurance from $100,000 to $250,000 (which increase was made permanent by the Dodd-Frank Act discussed below), and created a Troubled Assets Relief Program (“TARP”) administered by Treasury.  In October, 2008, Treasury announced a Capital Purchase Program (“CPP”) under TARP to increase the capital of healthy banks.  Under the CPP, Treasury would purchase preferred stock with warrants from qualified banks and bank holding companies in an amount up to 3% of the seller’s risk-weighed assets as of September 30, 2008.  Institutions wishing to participate in the CPP were required to file an application with their principal federal regulators.  The Company filed such an application and received preliminary approval to sell preferred stock to the Treasury, but ultimately elected not to participate in the CPP because of (i) the cost of the preferred stock, (ii) the open-ended administrative burdens associated with the preferred stock, including having to agree to allow Treasury to amend unilaterally the stock purchase agreement to comply with subsequent changes in applicable federal statutes, (iii) the fact that the Company and the Bank were already well capitalized under regulatory guidelines and expected to continue to be so, and (iv) management’s belief that other sources of capital were, and would continue to be, available should additional capital be needed.

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The FDIC also implemented in October, 2008 a Temporary Liquidity Guarantee Program consisting of a deposit insurance component pursuant to which it undertook to provide deposit insurance in an unlimited amount for non-interest bearing transaction accounts, and a debt guarantee component pursuant to which it undertook to fully guarantee senior, unsecured debt issued by banks or bank holding companies.  Coverage of both components was automatic until December 5, 2008, at which time covered institutions could opt out of one or both of the components.  Institutions not opting out would be charged fees for their participation in the components.  The Bank did not opt out of either component.

An unfortunate consequence of the difficulties that have beset the banking industry since the latter part of 2008 has been a large increase in bank failures, which has led to substantial claims being made against the FDIC’s Deposit Insurance Fund.  See “FDIC Insurance Assessments” above for additional information.

Dodd-Frank Wall Street Reform and Consumer Protection Act

On July 21, 2010, the President signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), which significantly changes the regulation of financial institutions and the financial services industry.  The Dodd-Frank Act has had, and will continue to have, extensive effects on all financial institutions, and includes provisions that will affect how community banks, thrifts, and small bank and thrift holding companies will be regulated in the future.  The Dodd-Frank Act includes changes to the financial regulatory systems, enhanced bank capital requirements, creates the Financial Stability Oversight Council, provides for mortgage reform provisions regarding a customer’s ability to repay, changes the assessment base for federal deposit insurance from the amount of insured deposits to consolidated assets less tangible capital, makes permanent the $250,000 limit for federal deposit insurance, provides for unlimited federal deposit insurance for noninterest-bearing transaction accounts until December 31, 2012, implements corporate governance requirements for public companies with regard to executive compensation including providing shareholders the right to vote on executive compensation, repeals the federal prohibitions on the payment of interest on demand deposits, and amends the Electronic Funds Transfer Act to give the Federal Reserve the authority to establish rules regarding interchange fees charged for electronic debit transactions, among other measures.  The Dodd-Frank Act also establishes the Bureau of Consumer Financial Protection as an independent entity within the Federal Reserve, which has been given the authority to promulgate consumer protection regulations applicable to all entities offering consumer financial services or products, including banks.  Additionally, the Dodd-Frank Act includes a series of provisions covering mortgage loan origination standards affecting originator compensation, minimum repayment standards, and pre-payments.

The Dodd-Frank Act requires regulatory agencies to implement new regulations that establish the parameters of the new regulatory framework and provide a clearer understanding of the legislation’s effect on banks.  We continue to evaluate proposed and final regulations related to the Dodd-Frank Act as they are implemented in order to determine the impact each will have on current and future operations.  The majority of the resulting regulations affecting us have been implemented, and we have experienced a moderate loss of income associated with debit transactions and moderate increased compliance costs associated with other provisions of the Dodd-Frank Act.

Legislative Proposals

Additional governmental efforts to ameliorate the problems afflicting the banking industry have been adopted or proposed, or are being considered by Congress, the General Assembly of South Carolina, and various governmental entities.  For example, numerous bills are pending in Congress and the South Carolina Legislature to provide various forms of relief to homeowners from foreclosure of mortgages as a result of publicity surrounding economic problems resulting from subprime mortgage lending and the economic adjustments in national real estate markets. Broader problems in the financial sector of the economy, which became apparent in 2008, have led to numerous calls for, and legislative and regulatory proposals for, restructuring of the regulation of financial institutions.  The Company is presently unable to predict the impact of any such changes, although it appears that they are likely to increase operating expenses in the near term without creating completely offsetting benefits.

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Fiscal and Monetary Policy

Banking is a business that depends largely on interest rate differentials.  In general, the difference between the interest paid by a bank on its deposits and its other borrowings, and the interest received by a bank on its loans and securities holdings, constitutes the major portion of a bank’s earnings.  Thus, the earnings and growth of the Company and the Bank are subject to the influence of economic conditions generally, both domestic and foreign, and also to the monetary and fiscal policies of the United States and its agencies, particularly the Federal Reserve. The Federal Reserve regulates the supply of money through various means, including open-market dealings in United States government securities, the discount rate at which banks may borrow from the Federal Reserve, and the reserve requirements on deposits.  The nature and timing of any changes in such policies and their impact on the Company and the Bank cannot be predicted.

Item 1A.    Risk Factors

Risks Related to Our Business

There can be no assurance that recent government actions will continue to stabilize the U.S.  financial system.

In response to the financial crises affecting the banking system and financial markets and going concern threats to investment banks and other financial institutions, various branches and agencies of the U.S. government have put in place laws, regulations and programs to address capital and liquidity issues in the banking system.  There can be no assurance, however, as to the actual long-term impact that such laws, regulations and programs will have on the financial markets, including the extreme levels of volatility, liquidity and confidence issues, and limited credit availability experienced over the last several years.  The failure of such laws, regulations and programs to continue to help stabilize the financial markets and a continuation or worsening of current  financial market  conditions could materially and adversely affect our business, financial condition, results of operations, access to credit or the trading price of our common stock.

Recent levels of market volatility are unprecedented.

The volatility and disruption of financial and credit markets has reached unprecedented levels for recent times.  In some cases, the markets have produced downward pressure on stock prices and credit availability for certain issuers without regard to those issuers’ underlying financial strength.  If recent and current levels of market disruption and volatility continue or worsen, there can be no assurance that we will not experience an adverse effect, which may be material, on our ability to access capital and on our business, financial condition and results of operations.

The soundness of other financial institutions could adversely affect us.

Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships.  We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial services industry, including brokers, dealers, commercial banks,  investment  banks, and government  sponsored enterprises.  Many of these transactions expose us to credit risk in the event of default of our counterparty.  In addition, our credit risk may be exacerbated when the collateral we hold cannot be realized or is liquidated at prices not sufficient to recover the full amount of the loan or other obligation due us.  There is no assurance that any such losses would not materially and adversely affect our results of operations or earnings.

Our primary source of funding for our operations is deposits from customers in our local market.  Should other banks in or near our market areas fail, it could cause our deposit customers to lose confidence in banks and cause them to withdraw or substantially restrict their deposits with us.  If such activity reached a high enough level, it could substantially disrupt our business.  There is no assurance that such disruptions, were they to occur, would not materially and adversely affect our results of operations or earnings.

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Current market developments may adversely affect our industry, business and results of operations.

Dramatic declines in the housing market during the prior three years, with falling home prices and increasing foreclosures and  unemployment,  have resulted in significant write-downs of asset values by financial institutions, including government-sponsored entities and major commercial and investment banks.  These write-downs, initially of mortgage-backed securities but spreading to credit default swaps, other derivative securities, and mortgage loans have caused many financial institutions to seek additional capital, to merge with larger and stronger institutions and, in some cases, to fail.  Reflecting concern about the stability of the financial markets generally and the strength of counterparties, many lenders and institutional investors have reduced, and in some cases, ceased to provide funding to borrowers, including other financial institutions.  The resulting lack of available credit, lack of confidence in the financial sector, increased volatility in the financial markets and reduced business activity could materially and adversely, directly or indirectly, affect our business, financial condition and results of operations.

Our long-term growth strategy will require future increases in capital that we may not be able to accomplish.

We are required by banking regulators to maintain various ratios of capital to assets.  As our assets grow we expect our capital ratios to decline unless we can increase our earnings or raise sufficient new capital to keep pace with asset growth.  Our ability to raise additional capital, if needed, will depend, among other things, on conditions in the capital markets at that time, which are outside our control, and on our financial condition and performance.  If we are unable to limit a capital ratio decline by increasing our capital, we will have to restrict our asset growth as we approach the minimum required capital to asset ratios.

We may be unable to successfully manage our future growth.

Our future profitability will depend in part on our ability to manage growth successfully.  Our ability to manage growth successfully will depend on our ability to maintain cost controls and asset quality while attracting additional loans and deposits, as well as on factors beyond our control, such as economic conditions and interest rate trends.  If we grow too quickly and are not able to control costs and maintain asset quality, growth could materially adversely affect our financial performance.

We depend on the services of a number of key personnel, and a loss of any of those personnel could disrupt our operations and result in reduced revenues.

We are a relationship-driven organization.  Our growth and development to date have depended in large part on the efforts of our senior management team.  These senior officers have primary contact with our customers and are extremely important in maintaining personalized relationships with our customer base, which are key aspects of our business strategy, and in increasing our market presence.  The unexpected loss of services of one or more of these key employees could have a material adverse effect on our operations and possibly result in reduced revenues if we were unable to find suitable replacements promptly.

If our loan customers do not pay us as they have contracted to, we may experience losses.

Our principal revenue producing business is making loans.  If our customers do not repay the loans, we will suffer losses.  Even though we maintain an allowance for loan losses, the amount of the allowance may not be adequate to cover the losses we experience.  We attempt to mitigate this risk by a thorough review of the creditworthiness of loan customers.  Nevertheless, there is risk that our credit evaluations will prove to be inaccurate due to changed circumstances, unanticipated economic conditions, or otherwise.

Our assets include substantial amounts of real estate acquired through foreclosure or in settlement of loans, which we may not be able to sell without incurring additional losses.

    We have acquired, and expect to continue to acquire, substantial amounts of real estate through foreclosure or settlement of loans in default. When we acquire such real estate, it is written down to its estimated fair market value less the estimated costs of selling.  If we cannot sell the property for that amount we will incur additional loss which, for one or more properties, could materially reduce our earnings.

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Our business is concentrated in the Upstate area of South Carolina, and, as has been the case over the past three years, a continuing downturn in the economy of the area, a continuing decline in area real estate values or other events in our market area may adversely affect our business.

Substantially all of our business is located in the Upstate area of South Carolina.  As a result, our financial condition and results of operations are affected by changes in the Upstate economy.  Over the past three years, we have experienced the adverse effects of the economic recession in the form of increased nonpayment and delinquent payment of loans, and decreases in the value of collateral securing loans and of real estate acquired through foreclosures.  If the economic recession and general decline in Upstate area real estate values or other adverse economic conditions continue, we would expect continuing decreases in demand for our services, increases in nonpayment of loans and decreases in the value of collateral securing loans.  The existence of adverse economic conditions, declines in real estate values or the occurrence of other adverse economic conditions in the Upstate and South Carolina could have a material adverse effect on our business, future prospects, financial condition or results of operations.  The longer such adverse economic conditions persist, the greater the adverse impact on us will be.

We face strong competition from larger, more established competitors which may adversely affect our ability to operate profitably.

We encounter strong competition from financial institutions operating in the Upstate area of South Carolina.  In the conduct of our business, we also compete with credit unions, insurance companies, money market mutual funds and other financial institutions, some of which are not subject to the same degree of regulation as we are.  Many of these competitors have substantially greater resources and lending abilities than we have and offer services, such as investment banking, trust and international banking services that we do not provide.  We believe that we have been able to, and will continue to be able to, compete effectively with these institutions because of our experienced bankers and personalized service, as well as through loan participations and other strategies and techniques.  However, we cannot promise that we are correct in our belief.  If we are wrong, our ability to operate profitably may be negatively affected.

Technological changes affect our business, and we may have fewer resources than many of our competitors to invest in technological improvements.

The financial  services  industry  continues  to undergo  rapid technological changes with frequent introductions of new technology-driven products and services.  In addition to enabling financial institutions to serve customers better, the effective use of technology may increase efficiency and may enable financial institutions to reduce costs.  Our future success may depend, in part, upon our ability to use technology to provide products and services that provide convenience to customers and to create additional efficiencies in our operations.  We may need to make significant additional capital investments in technology in the future, and we may not be able to effectively implement new technology-driven products and services.   Many of our competitors  have substantially greater resources to invest in technological improvements.

Our profitability and liquidity are affected by changes in interest rates and economic conditions.

Our profitability depends upon our net interest income, which is the difference between interest earned on our interest earning assets, such as loans and investment securities, and interest expense on interest bearing liabilities, such as deposits and borrowings.  Our net interest income is adversely affected when market interest rates change such that the interest we pay on deposits and borrowings increases faster than the interest earned on loans and investments, or, conversely, when the interest earned on loans and investments decreases faster than the interest we pay on deposits and borrowings.  Interest rates, and consequently our results of operations, are affected by general economic conditions (domestic and foreign) and fiscal and monetary policies.  Monetary and fiscal policies may materially affect the level and direction of interest rates. Increases in interest rates generally decrease the market values of interest earning investments and loans held and therefore may adversely affect our liquidity and earnings.  Increased interest rates also generally affect the volume of mortgage loan originations, the resale value of mortgage loans originated for resale, and the ability of borrowers to perform under existing loans of all types.   In 2007 and 2008, the Federal Reserve decreased interest rates significantly, and has held rates to historically low levels throughout 2009, 2010 and 2011.  When the Federal Reserve begins to increase interest rates back to equilibrium rates, rapid increases in rates could expose the Bank to interest rate risk. Management plans for possible changes in interest rates and takes steps to capitalize on changes in rates to increase net interest income. However, the difficulty in predicting the timing and magnitude of changes in interest rates creates the risk that our plans are not properly suited to the actual changes in rates that occur.

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RISKS RELATED TO OUR COMMON STOCK

Our common stock has a limited trading market, which may make the prompt execution of sale transactions difficult.

Although our common stock may be traded from time to time on an individual basis, no active trading market has developed and none is likely to develop in the foreseeable future.  Our common stock is not traded on any exchange.  Accordingly, if you wish to sell shares you may experience a delay or have to sell them at a lower price in order to sell them promptly, if at all.

We may issue additional securities, which could affect the market price of our common stock and dilute your ownership.

 We may issue additional securities to raise additional capital, to support growth, or to make acquisitions.  Sales of a substantial number of shares of our common stock, or the perception by the market that those sales could occur, could cause the market price of our common stock to decline or could make it more difficult for us to raise capital through the sale of common stock or to use our common stock in future acquisitions.  The issuance of substantial amounts of additional securities could reduce shareholders’ proportionate ownership of the Company.

Our Preferred Stock has preferential rights over our common stock, and we could issue additional shares of preferred stock in the future.

We have issued shares of preferred stock that are entitled to payment of dividends before any dividends may be paid on our common stock, and, upon any liquidation of the Company, the preferred stock is entitled to be paid in full before any distribution may be made with respect to the common stock.  We may issue additional shares of preferred stock with similar preferences over our common stock in the future.  Such preferred stock may reduce the value of our common stock.

We do not plan to pay cash dividends in the foreseeable future.

We have paid a cash dividend only once, and do not plan to pay cash dividends again in the foreseeable future.  We plan to use the funds that might otherwise be available to pay dividends to increase our capital and expand our business.

Declaration and payment of dividends are within the discretion of our board of directors.  Our Bank will be our most likely source of funds with which to pay cash dividends.  Our Bank’s declaration and payment of future dividends to us are within the discretion of the Bank’s board of directors, and are dependent upon its earnings, financial condition, its need to retain earnings for use in the business and any other pertinent factors.  The Bank’s payment of dividends is also subject to various regulatory requirements and considerations.

Provisions in our articles of incorporation and South Carolina law may discourage or prevent takeover attempts, and these provisions may have the effect of reducing the market price for our stock.

Our articles of incorporation include several provisions that may have the effect of discouraging or preventing hostile takeover attempts, and therefore of making the removal of incumbent management difficult.  In addition, South Carolina law contains several provisions that may make it more difficult for a third party to acquire control of us without the approval of our board of directors, and may make it more difficult or expensive for a third party to acquire a majority of our outstanding common stock.  To the extent that these provisions are effective in discouraging or preventing takeover attempts, they may tend to reduce the market price for our stock.

Our common stock is not insured, so you could lose your total investment.

Our common stock is not a deposit or savings account, and is not insured by the Federal Deposit Insurance Corporation or any other government agency.  Should our business fail, you could lose your total investment.

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RISKS RELATED TO OUR INDUSTRY

We are subject to governmental regulation that could change and increase our cost of doing business or have an adverse affect on our business.

We operate in a highly regulated industry and are subject to examination, supervision and comprehensive regulation by various federal and state agencies.  Most of this regulation is designed to protect our depositors and other customers, and not our shareholders.  Our compliance with the requirements of these agencies is costly and may limit our growth and restrict certain of our activities, including payment of dividends, mergers and acquisitions, investments, loans and interest rates charged, and locations of offices.  We are also subject to capitalization guidelines established by federal authorities and our failure to meet those guidelines could result, in an extreme case, in our Bank’s being placed in receivership.  We are also subject to some of the extensive and expensive requirements imposed on public companies by the Sarbanes-Oxley Act of 2002 and related regulations.

Various laws, including the Federal Deposit Insurance Act, the Emergency Economic Stabilization Act of 2008 (“EESA”), and the Dodd-Frank Act, and related regulations are structured to spread the governmental costs of problems in the financial industry broadly over the financial industry in order to prevent the taxpayers from having to pay such costs.  As a result, assessments by the FDIC to pay for deposit insurance have increased, and will likely continue to increase, substantially, and the total our bank will be required to pay could increase enough to materially affect our income and our ability to operate profitably.  Additionally, EESA contains a provision for the financial industry to be required to absorb, in an as yet undetermined fashion, any losses suffered by the government on account of its acquiring troubled assets under the Troubled Assets Relief Program of EESA.  The Dodd-Frank Act also makes numerous changes in the way financial institutions are regulated, and creates a new agency to regulate consumer protection as well as expanding and modifying consumer protection laws.

The laws and regulations applicable to the banking industry could change at any time.  Because government regulation greatly affects the business and financial results of all commercial banks and bank holding companies, such regulation may not put us at a competitive disadvantage with respect to other similarly situated banks and holding companies, but our cost of compliance could adversely affect our ability to operate profitably.

We are susceptible to changes in monetary policy and other economic factors which may adversely affect our ability to operate profitably.

Changes in governmental, economic and monetary policies may affect the ability of our Bank to attract deposits and make loans.  The rates of interest payable on deposits and chargeable on loans are affected by governmental regulation and fiscal policy as well as by national, state and local economic conditions.  All of these matters are outside of our control and affect our ability to operate profitably.

Item 1B.  Unresolved Staff Comments.

Not applicable.

Item 2.    Properties.

The Company owns 1.83 acres of land at 1670 East Main Street in Easley, South Carolina where its main office and an operations center are located. The Company also owns 6.197 acres of land in the 40 block of Farrs Bridge Road in the Berea area of Greenville, South Carolina where a branch office is located and .95 acres of land in the Powdersville area of Piedmont, South Carolina where another branch is located.

Item 3.    Legal Proceedings.

The Company may from time to time be a party to various legal proceedings arising in the ordinary course of business, but management of the Company is not aware of any pending or threatened litigation or unasserted claims or assessments that are expected to result in losses, if any, that would be material to the Company’s business and operations.

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Item 4.    Mine Safety Disclosures.

Not applicable.

PART II

Item 5.    Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

The information set forth in the 2011 Annual Report to Shareholders (the “2011 Annual Report”) under the caption “Market for Common Equity and Related Stockholder Matters,” which is included in Exhibit 13 to this Annual Report on Form 10-K, is incorporated herein by reference.

The information required by Item 201(d) of Regulation S-K is set forth in Item 12 hereof.

The Company has not in the past year sold any securities that were not registered under the Securities Act of 1933.

Neither the Company nor any “affiliated purchaser” (as defined in 17 C.F.R. 240.10b-18(a)(3)) purchased any shares or units of any class of the Company’s equity securities that is registered pursuant to Section 12 of the Exchange Act during the fourth quarter of 2011.

Item 6.    Selected Financial Data.

Not applicable.

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

The information set forth in the 2011 Annual Report under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” which is included in Exhibit 13 to this Annual Report on Form 10-K, is incorporated herein by reference.

Item 7A.    Quantitative and Qualitative Disclosures About Market Risk.

Not applicable.

Item 8.    Financial Statements and Supplementary Data.

The Consolidated Financial Statements and notes thereto and Report of Independent Registered Public Accounting Firm set forth in the 2011 Annual Report, which are included in Exhibit 13 to this Annual Report on Form 10-K, are incorporated herein by reference.

Item 9.    Changes In and Disagreements With Accountants on Accounting and Financial Disclosure.

Not Applicable.

Item 9A Controls and Procedures.

Disclosure Controls and Procedures

Based on the evaluation required by 17 C.F.R. Section 240.13a-15(b) or 240.15d-15(b) of the Company’s disclosure controls and procedures (as defined in 17 C.F.R. Sections 240.13a-15(e) and 240.15d-15(e)), the Company’s chief executive officer and chief financial officer concluded that such controls and procedures, as of the end of the year covered by this annual report, were effective.

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Management’s Annual Report on Internal Control Over Financial Reporting

The report set forth under the caption “Management’s Annual Report on Internal Control Over Financial Reporting” set forth in the 2011 Annual Report is incorporated herein by reference to Exhibit 13 hereto.

Changes in Internal Control Over Financial Reporting

The Company is continuously seeking to improve the efficiency and effectiveness of its operations and of its internal controls. This results in modifications to its processes throughout the Company. However, there has been no change in its internal control over financial reporting that occurred during the Company’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

Item 9B.  Other Information

No information was required to be disclosed in a report on Form 8-K during the fourth quarter of 2011 that was not disclosed.

PART III

Item 10. Directors, Executive Officers and Corporate Governance.

The information set forth under the captions “Management of the Company” and “Section 16(a) Beneficial Ownership Reporting Compliance” in the Company’s Proxy Statement for the Annual Meeting of Shareholders to be held on May 15, 2012 (the “2012 Proxy Statement”) is incorporated herein by reference.

Code of Ethics

The Company has adopted a code of ethics (as defined by 17 C.F.R. 229.406) that applies to its principal executive officer and principal financial officer. The Company will provide a copy of the code of ethics, free of charge, to any person upon written request to Jennifer M. Champagne, Chief Financial Officer, Cornerstone Bancorp, 1670 East Main Street, Easley, South Carolina 29640.

Audit Committee

The Company has a separately-designated standing Audit Committee established in accordance with Section 3(a)(58)(A) of the Securities Exchange Act of 1934.  The Audit Committee is responsible for seeing that audits of the Company are conducted annually.  An independent registered public accounting firm is employed for that purpose by the Board of Directors upon recommendation of the Audit Committee. Reports on these audits are reviewed by the Committee upon receipt and a report thereon is made to the Board at its next meeting. The Audit Committee is comprised of Messrs. Gaston, Hooper, Hendricks and Wike, each of whom is independent as defined in the Nasdaq Stock Market Marketplace Rules.  Mr. Spearman, who served on the Audit Committee until his death in March 2012, was also independent under the NASDAQ Rules.   The Audit Committee operates pursuant to a written charter.

Audit Committee Financial Expert

The Company’s board of directors has determined that the Company does not have an “audit committee financial expert,” as that term is defined by Item 407(d)(5) of Regulation S-K promulgated by the Securities and Exchange Commission, serving on its audit committee. The Company’s audit committee is a committee of directors who are elected by the shareholders and who are independent of the Company and its management. After reviewing the experience and training of all of the Company’s independent directors, the board of directors has concluded that no independent director meets the SEC’s very demanding definition.  Therefore, it would be necessary to find a qualified individual willing to serve as both a director and member of the audit committee and have that person elected by the shareholders in order to have an “audit committee financial expert” serving on the Company’s audit committee. The Company’s audit committee is, however, authorized to use consultants to provide financial accounting expertise in any instance where members of the committee believe such assistance would be useful. Accordingly, the Company does not believe that it needs to have an “audit committee financial expert” on its audit committee.

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Item 11.   Executive Compensation.

The information set forth under the captions “Management Compensation” and “Compensation of Directors” in the 2012 Proxy Statement is incorporated herein by reference.

Item 12.   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

The information set forth under the caption “Security Ownership of Certain Beneficial Owners and Management” in the 2012 Proxy Statement is incorporated herein by reference.

Equity Compensation Plan Information

The following table sets forth information as of December 31, 2011 about all of the Company’s compensation plans (including individual compensation arrangements) under which equity securities of the Company are authorized for issuance.

Plan Category	Number of securities to be issued upon exercise of outstanding options, warrants and rights		Weighted-average exercise price of outstanding options, warrants and rights		Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
	(a)		(b)		(c)
Equity compensation plans approved by security holders		102,169	$	10.00		63,785
Equity compensation plans not approved by security holders		-		-		-
Total		102,169				63,785

The equity securities shown in the table under “Equity compensation plans approved by security holders” are stock options granted to employees and directors pursuant to the 2003 Stock Option Plan. Further information about these options is set forth in the 2012 Proxy Statement under the caption “Management Compensation – 2003 Stock Option Plan,” and in Note 18 to the Financial Statements included in Exhibit 13 to this Annual Report on Form 10-K.

Item 13.  Certain Relationships and Related Transactions, and Director Independence.

The information set forth under the captions “Certain Relationships and Related Transactions,” and “Governance Matters – Director Independence” in the 2012 Proxy Statement is incorporated herein by reference.  Each current member of the Audit Committee (and each person who served as a member of the Audit Committee during 2011) and the Human Resources (compensation) Committee is independent as defined by the Nasdaq Stock Market Marketplace Rules.  The entire Board of Directors serves as a nominating committee, and not all members of the Board are independent as defined by such rules.

Item 14.  Principal Accountant Fees and Services

The information set forth under the caption “Registered Public Accounting Firm” in the 2012 Proxy Statement is incorporated herein by reference.

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Item 15.                      Exhibits

(a)           Exhibits, Financial Statement Schedules.

Financial Statements

The following financial statements are filed with this report:

-   Report of Independent Registered Public Accounting Firm.

-   Consolidated Balance Sheets as of December 31, 2011 and 2010.

-   Consolidated  Statements of Income (Loss) for the years ended  December 31, 2011, 2010 and 2009.

-   Consolidated  Statements of Shareholders’  Equity and Comprehensive  Income (Loss) for the years ended December 31, 2011, 2010 and 2009.

-   Consolidated Statements of Cash Flows for the years ended December 31, 2011, 2010 and 2009.

-   Notes to Consolidated Financial Statements.

Exhibit No.	Description
3.1	Articles of Incorporation of Registrant (incorporated by reference to Report on Form 8-K filed July 19, 2010)
3.2	Bylaws of Registrant (incorporated by reference to Report on Form 8-K filed September 15, 2010)
10.1		Cornerstone Bancorp 2003 Stock Option Plan (incorporated by reference to Quarterly Report on Form 10-QSB for the quarter ended June 30, 2003)
10.2		Amended Change of Control Agreement between the Company and J. Roger Anthony (incorporated by reference to Report on Form 8-K filed December 6, 2007)
10.3		Form of Amended Change of Control Agreement between the Company and each of Jennifer M. Champagne and Susan S. Jolly (incorporated by reference to Report on Form 8-K filed December 6, 2007)
10.4		Form of Amendment to Endorsement Method Split Dollar Plan, dated as of December 5, 2007, between the Company’s wholly-owned subsidiary, Cornerstone National Bank, and each of J. Rodger Anthony, Jennifer M. Champagne and Susan S. Jolly (incorporated by reference to Report on Form 8-K filed December 6, 2007)
10.5		Agreement between Cornerstone National Bank and The Comptroller of the Currency, dated as of May 12, 2010 (incorporated by reference to Quarterly Report on Form 10-Q for the quarter ended June 30, 2010)
13		Portions of 2011 Annual Report to Shareholders incorporated by reference into this Form 10-K
21		Subsidiaries of Registrant
31-1		Rule 13a-14(a) Certifications
31-2		Rule 13a-14(a) Certifications
32		Section 1350 Certifications
101		Interactive Data File

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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.

		Cornerstone Bancorp
March 28, 2012	By:	s/J. Rodger Anthony
		J. Rodger Anthony
		President and Chief Executive Officer
	By:	s/Jennifer M. Champagne
		Jennifer M. Champagne
		Chief Financial Officer
		(Principal Financial and Principal Accounting Officer)

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Pursuant to the requirements of the Securities Exchange Act of 1934 this Report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated:

Signature	Title	Date
s/J. Rodger Anthony
J. Rodger Anthony	President, Chief Executive Officer, Director	March  28, 2012
s/Jennifer M. Champagne
Jennifer M. Champagne	Chief Financial Officer , Director	March 28, 2012
s/Janice E. Childress
Janice E. Childress	Director	March  19, 2012
s/J. Bruce Gaston
J. Bruce Gaston	Director	March  28, 2012
s/S. Ervin Hendricks, Jr.
S. Ervin Hendricks, Jr.	Director	March  28, 2012
s/Joe E. Hooper
Joe E. Hooper	Director	March  28, 2012
s/Susan S. Jolly
Susan S. Jolly	Director	March  28, 2012
s/John M. Warren, Jr., M.D.
John M. Warren, Jr., M.D.	Director	March  20, 2012
________________________
George I. Wike, Jr.	Director	March  __, 2012

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Exhibit Index

Exhibit No. Description

3.1	Articles of Incorporation of Registrant (incorporated by reference to Report on Form 8-K filed July 19, 2010)
3.2	Bylaws of Registrant (incorporated by reference to Report on Form 8-K filed September 15, 2010)
10.1		Cornerstone Bancorp 2003 Stock Option Plan (incorporated by reference to Quarterly Report on Form 10-QSB for the quarter ended June 30, 2003)
10.2		Amended Change of Control Agreement between the Company and J. Roger Anthony (incorporated by reference to Report on Form 8-K filed December 6, 2007)
10.3		Form of Amended Change of Control Agreement between the Company and each of Jennifer M. Champagne and Susan S. Jolly (incorporated by reference to Report on Form 8-K filed December 6, 2007)
10.4		Form of Amendment to Endorsement Method Split Dollar Plan, dated as of December 5, 2007, between the Company’s wholly-owned subsidiary, Cornerstone National Bank, and each of J. Rodger Anthony, Jennifer M. Champagne and Susan S. Jolly (incorporated by reference to Report on Form 8-K filed December 6, 2007)
10.5		Agreement between Cornerstone National Bank and The Comptroller of the Currency, dated as of May 12, 2010 (incorporated by reference to Quarterly Report on Form 10-Q for the quarter ended June 30, 2010)
13		Portions of 2011 Annual Report to Shareholders incorporated by reference into this Form 10-K
21		Subsidiaries of Registrant
31-1		Rule 13a-14(a) Certifications
31-2		Rule 13a-14(a) Certifications
32		Section 1350 Certifications
101		Interactive Data File

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EX-13

EXHIBIT 13

Portions of Cornerstone Bancorp

2011 Annual Report to Shareholders

Incorporated by Reference into 2011 Form 10-K

CONTENTS

Letter from Chief Executive Officer	1
Business of Company	3
Management’s Discussion and Analysis of Financial Condition and Results of Operations	5
Report of Independent Registered Public Accounting Firm	30
Consolidated Balance Sheets	31
Consolidated Statements of Income (Loss)	32
Consolidated Statements of Shareholders’ Equity and Comprehensive Income (Loss)	33
Consolidated Statements of Cash Flows	34
Notes to Consolidated Financial Statements	35
Board of Directors and Management of the Company	62
Management of the Bank and Advisory Boards	63
Shareholder and Investor Information	65

Dear Shareholders,

On behalf of the board of directors of Cornerstone Bancorp, I would like to share our results for 2011. This year has continued to be challenging for the local economy and for Cornerstone. Real estate values and market activity have trended lower and some borrowers have continued to struggle. Throughout the downturn, Cornerstone has attempted to work with borrowers and to protect our assets. In 2011, we continued to make progress toward resolving the issues raised by the economy, and we anticipate that the worst of the economic decline is behind us.

Cornerstone posted a loss of $.71 per share for the year. This can be attributed to the decline in real estate values and the lack of market activity as well as a valuation allowance we placed against our deferred tax asset. Costs of maintaining foreclosed properties were high in 2011. If sales activity in real estate increases in 2012, we expect to be able to lower foreclosure expenses in the future.

At the beginning of the economic downturn, Cornerstone was in a position of having capital levels well above the regulatory required minimums. The level of capital held by the Company has allowed us to weather this downturn well.  We continue to maintain higher capital levels than those mandated by our primary regulatory agency, and we are focused on maintaining high capital levels going forward.

Over the next year we plan to serve our local communities and continue to offer in-person service and local decision making. We are still lending to qualified borrowers and offering a wide range of financial products. Our market areas are blessed with an excellent business climate and positive population growth, which are both necessary to overall economic health and prosperity.

The competitive landscape for our industry is undergoing numerous changes. Legislative and regulatory changes as well as mergers in and around our markets will continue to bring new challenges and players to our business. However, one thing that will not change is our commitment to the customers and communities we serve. Cornerstone will continue to offer products that cater to the needs of individuals and small businesses.

As always, our continued success depends on the support of our shareholders, customers, and friends. We appreciate your confidence and thank you for recommending us to your family and associates. Please let us know how we can serve you and the communities of the Upstate of South Carolina.

Sincerely,

J. Rodger Anthony

Chief Executive Officer

March 15, 2012

CAUTIONARY NOTICE WITH RESPECT TO FORWARD LOOKING STATEMENTS

Statements included in this report which are not historical in nature are intended to be, and are hereby identified as “forward looking statements” for purposes of the safe harbor provided by Section 21E of the Securities Exchange Act of 1934, as amended. Words such as “estimate,” “project,” “intend,” “expect,” “believe,” “anticipate,” “plan,” “may,” “will,” “should,” “could,” “would,” “assume,” “indicate,” “contemplate,” “seek,” “target,” “potential,” and similar expressions identify forward-looking statements. The Company cautions readers that forward looking statements including without limitation, those relating to the Company’s new offices, future business prospects, revenues, working capital, adequacy of the allowance for loan losses, liquidity, capital needs, interest costs, future sales of repossessed collateral, income, and the economy, are subject to certain risks and uncertainties that could cause actual results to differ from those indicated in the forward looking statements, due to several important factors identified in this report, among others, and other risks and factors identified from time to time in the Company’s other reports filed with the Securities and Exchange Commission.

These forward-looking statements are based on our current expectations, estimates and projections about our industry, management's beliefs, and assumptions made by management. Such information includes, without limitation, discussions as to estimates, expectations, beliefs, plans, strategies, and objectives concerning the Company’s future financial and operating performance. These statements are not guarantees of future performance and are subject to risks, uncertainties and assumptions that are difficult to predict, particularly in light of the fact that the Company is a relatively new company with limited operating history. Therefore, actual results may differ materially from those expressed or forecasted in such forward-looking statements. The risks and uncertainties include, but are not limited to:

·   future economic and business conditions;

·   the Company’s growth and ability to maintain growth;

·   governmental monetary and fiscal policies;

·   legislative changes;

·   actions taken by regulatory authorities;

·   the effect of interest rate changes on our level, costs and composition of deposits, loan demand, and the values of our loan collateral, securities, and interest sensitive assets and liabilities;

·   the effects of competition from a wide variety of local, regional, national and other providers of financial, investment and insurance services, as well as competitors that offer banking products and services by mail, telephone, computer, and/or the Internet;

·   credit risks;

·   higher than anticipated levels of defaults on loans;

·   perceptions by depositors about the safety of deposits;

·   failure of our customers to repay loans;

·   failure of assumptions underlying the establishment of the allowance for loan losses, including the value of collateral securing loans;

·   the risks of opening new offices, including, without limitation, the related costs and time of building customer relationships and integrating operations, and the risk of failure to achieve expected gains, revenue growth and/or expense savings;

·   the effect of agreements with regulatory authorities, which restrict various activities and impose additional administrative requirements without commensurate benefits;

·   changes in requirements of regulatory authorities;

·   changes in accounting policies, rules, and practices;

·   sustainability of income tax filing positions taken by the Company and underlying assumptions;

·   cost and difficulty of implementing changes in technology or products;

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

·   ability to weather the current economic downturn;

·   loss of consumer or investor confidence; and

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·   other factors and information described in this report and in any of the other reports we file with the Securities and Exchange Commission under the Securities Act of 1934.

All forward-looking statements are expressly qualified in their entirety by this cautionary notice. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. In light of these risks, uncertainties, and assumptions, the forward-looking events discussed in this report might not occur.

WEBSITE REFERENCES

References to the Bank’s website included in, or incorporated by reference into, this report are for information purposes only, and are not intended to incorporate the website by reference into this report.

BUSINESS OF THE COMPANY

Cornerstone Bancorp (the “Company”) is a bank holding company and has no operations other than those carried on by its wholly owned subsidiary, Cornerstone National Bank (the “Bank”). The Bank commenced business in 1999, and conducts a general banking business from three offices in the Easley area of Pickens County, in the Berea area of Greenville County, and in the Powdersville area of Anderson County, South Carolina. In 2004, the Bank established a wholly owned subsidiary, Crescent Financial Services, Inc. (“Crescent”), which is an insurance agency that engages in limited operations.

Services of the Bank

Deposits

The Bank offers the full range of deposit services typically available in most banks and savings and loan associations, including checking accounts, NOW accounts, retirement accounts (including Individual Retirement Accounts), and savings and other time deposits of various types, ranging from daily money market accounts to longer-term certificates of deposit. The transaction accounts and time certificates are tailored to the principal market area at rates competitive with those offered by other institutions in the area. All deposit accounts are insured by the Federal Deposit Insurance Corporation (“FDIC”) up to the maximum amount permitted by law. The Bank solicits these accounts from individuals, businesses, associations and organizations, and government authorities.

Lending Activities

The Bank offers a range of lending services, including commercial loans, consumer loans, and real estate mortgage loans. To address the risks inherent in making loans, management maintains an allowance for loan losses based on, among other things, an evaluation of the Bank’s loan loss experience, management’s experience at other financial institutions in the market area, peer data, the amount of and trends in past due and nonperforming loans, current economic conditions and the values of loan collateral. Based upon such factors, management makes various assumptions and judgments about the ultimate collectibility of the loan portfolio and provides an allowance for loan losses based upon a percentage of the outstanding balances and specific loans. However, because there are certain risks that cannot be precisely quantified, management’s judgment of the allowance is necessarily approximate and imprecise. The adequacy and methodology of the allowance for loan losses is also subject to regulatory examination. Refer to Management’s Discussion and Analysis of Financial Condition and Results of Operations-Loan Portfolio for additional information.

Real Estate Loans

One of the primary components of the Bank’s loan portfolio is loans secured by first or second mortgages on residential and commercial real estate. These loans generally consist of short to mid-term commercial real estate loans, construction and development loans and residential real estate loans (including home equity and second mortgage loans).  Interest rates may be fixed or adjustable and the Bank frequently charges an origination fee. The Bank seeks to manage credit risk in the commercial real estate portfolio by emphasizing loans on owner-occupied office and retail buildings where the loan-to-value ratio at origination, established by independent appraisals, does not exceed 80%. In addition, the Bank generally requires personal guarantees of the principal owners of the property. The loan-to-value ratio at origination for first and second mortgage loans generally does not exceed 80%, and for construction loans generally does not exceed 75%, of cost. The Bank employs a reappraisal policy to routinely monitor real estate collateral values on real estate loans where the repayment is dependent on sale of the collateral. In addition, in an effort to control interest rate risk, long term residential mortgages are not originated for the Bank’s portfolio.

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The principal economic risk associated with all loans, including real estate loans, is the creditworthiness of the borrowers. The ability of a borrower to repay a real estate loan depends upon a number of economic factors, including employment levels and fluctuations in the value of real estate. In the case of a real estate construction loan, there is generally no income from the underlying property during the construction period, and the developer’s personal obligations under the loan are typically limited. In addition, construction loans also face the risks associated with inaccuracies in construction estimates, risk of over funding prior to completion of the related work, and other project-related risks. Speculative residential construction loans face the additional risk of over supply of homes in the market, and relatively few resources for accurately measuring inventory levels. (Cornerstone does not routinely originate construction and development loans with interest reserves, which are common in the industry, but elevate risk to the lender.) In the case of a real estate purchase loan that is not fully amortized, the borrower may be unable to repay the loan at the end of the loan term and thus may be forced to refinance the loan at a higher interest rate, or, in certain cases, the borrower may default as a result of the inability to refinance the loan. Each of these factors increases the risk of nonpayment by the borrower.

In 2007, the Company increased real estate construction loans approximately 60%. Some of the loans in this segment of the portfolio came under pressure when potential buyers faced a lack of available financing and unemployment levels increased significantly. As a result of the real estate crisis, which became evident in the Bank’s markets in 2009, the Bank tightened underwriting standards related to all of its loan segments. The Bank’s loan policy now contains specific minimum net worth requirements for borrowers, minimum debt coverage ratios, and for loans to construct single family residential properties, written contracts with the end purchaser that contain significant consequences to the purchaser for terminating the contract. The construction segment of the Bank’s business is managed in specific ways in order to minimize the risks normally associated with construction lending. Management requires lending personnel to visit job sites, maintain frequent contact with borrowers and arrange for third-party inspections of completed work prior to issuing additional construction loan draws. Speculative construction loans are not currently offered in general by the Bank, unless extenuating circumstances exist.

The Bank faces additional credit risks to the extent that it engages in making adjustable rate mortgage loans (“ARMs”). In the case of an ARM, as interest rates increase, the borrower’s required payments increase, thus increasing the potential for default. The marketability of all real estate loans, including ARMs, is also generally affected by the prevailing level of interest rates.

Commercial Loans

The Bank makes loans for commercial purposes in various lines of business. Commercial loans include both secured and unsecured loans for working capital (including inventory and receivables), loans for business expansion (including acquisition of real estate and improvements), and loans for purchases of equipment and machinery. Equipment loans are typically made for a term of five years or less at either fixed or variable rates, with the loan fully amortized over the term and secured by the financed equipment. Working capital loans typically have terms not exceeding one year and are usually secured by accounts receivable, inventory or personal guarantees of the principals of the business. Commercial loans vary greatly depending upon the circumstances and loan terms are structured on a case-by-case basis to better serve customer needs.

The risks associated with commercial loans vary with many economic factors, including the economy in the Bank’s market areas. The well-established banks in the Bank’s market areas make proportionately more loans to medium- to large-sized businesses than the Bank makes. Many of the Bank’s commercial loans are made to small- to medium-sized businesses, which typically are not only smaller, but also have shorter operating histories and less sophisticated record keeping systems than larger entities. As a result, these smaller entities may be less able to withstand adverse competitive, economic and financial conditions than larger borrowers. In addition, because payments on loans secured by commercial property generally depend to a large degree on the results of operations and management of the properties, repayment of such loans may be subject, to a greater extent than other loans, to adverse conditions in the real estate market or the economy.

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Consumer Loans

The Bank makes a variety of loans to individuals for personal and household purposes, including secured and unsecured installment and term loans, home equity loans and lines of credit and unsecured revolving lines of credit.  The secured installment and term loans to consumers generally consist of loans to purchase automobiles, boats, recreational vehicles, mobile homes and household furnishings, with the collateral for each loan being the purchased property.  The underwriting criteria for home equity loans and lines of credit are generally the same as applied by the Bank when making a first mortgage loan, as described above, and home equity lines of credit (“HELOCs”) typically expire 15 years or less after origination, unless renewed or extended.

Consumer loans generally involve more credit risks than other loans because of the type and nature of the underlying collateral or because of the absence of any collateral. Consumer loan repayments are dependent on the borrower’s continuing financial stability and are likely to be adversely affected by job loss, divorce and illness. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans in the case of default. In most cases, any repossessed collateral will not provide an adequate source of repayment of the outstanding loan balance. Although the underwriting process for consumer loans includes a comparison of the value of the security, if any, to the proposed loan amount, the Bank cannot predict the extent to which the borrower’s ability to pay, and the value of the security, will be affected by prevailing economic and other conditions.

Other Services

The Bank participates in a network of automated teller machines that may be used by Bank customers in major cities throughout the United States and the world. The Bank offers both VISA and MasterCard brands of credit and debit cards together with related lines of credit. The lines of credit may be used for overdraft protection as well as pre-authorized credit for personal purchases and expenses. Credit cards are underwritten and funded by a third party provider. The Bank also provides stored value cards, direct deposit of payroll and social security checks, and automatic drafts for various accounts, but does not currently provide international or trust banking services, other than foreign currency exchange through a correspondent bank. The Bank offers an Internet banking product accessible via the Bank’s custom website at www.cornerstonenationalbank.com. The interactive banking product includes an electronic bill payment service that allows customers to make scheduled and/or recurring bill payments electronically. The Bank also offers remote check deposit services to commercial and small business customers. The Bank offers merchant and other business related services to its commercial customers.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

The following information describes various financial aspects of the Bank's business. This information should be read in conjunction with the consolidated financial statements of the Company, which appear elsewhere in this document, and the Company’s Form 10-K, filed with the Securities and Exchange Commission.

Critical Accounting Policies

The Company has adopted various accounting policies, which govern the application of accounting principles generally accepted in the United States of America in the preparation of the Company's financial statements. The significant accounting policies of the Company are described in the notes to the consolidated financial statements.

Certain accounting policies involve significant judgments and assumptions by management, which have a material impact on the carrying value of certain assets and liabilities. Management considers such accounting policies to be critical accounting policies. The judgments and assumptions used by management are based on historical experience and other factors, which are believed to be reasonable under the circumstances. Because of the nature of the judgments and assumptions made by management, actual results could differ from these judgments and estimates, which could have a material impact on the carrying values of assets and liabilities and the results of operations of the Company.

The Company believes the allowance for loan losses is a critical accounting policy that requires the most significant judgments and estimates used in preparation of its consolidated financial statements. Refer to the sections “Allowance for Loan Losses,” “Potential Problem Loans,” “Impaired Loans” and Note 1 to the consolidated financial statements for a detailed description of the Company's estimation process and methodology related to the allowance for loan losses.

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Management also believes that current economic conditions have added complexity to the process involved in evaluating other-than-temporary-impairment (“OTTI”) of the Company’s debt securities. The process of determining OTTI is inherently judgmental, involving the weighing of positive and negative factors and evidence that may be objective or subjective. In the current environment, the factors that must be evaluated are numerous, and changing rapidly, making the evaluation more difficult.

Effect of Economic Trends

Problems in the economy over the last several years have adversely impacted the ability of some borrowers to repay their loans. Although the Company’s market area has not experienced the negative effects of the recession and declines in real estate markets to the same extent as some other markets in the country, these factors have had a significant effect on our operations as evidenced by the increases in our charge-offs, nonaccrual loans and real estate owned. The majority of problem loans in 2010 and 2011 were real estate loans. These loans were often collateralized by newly constructed homes or undeveloped land, and those foreclosed were foreclosed on after real estate sales in the Company’s market area decreased significantly beginning in the summer of 2008. Borrowers were generally builders and developers who did not have the cash flow required to support the level of inventory financed with area banks. The process of foreclosure in South Carolina is lengthy and expensive. The impact of foregone interest on nonaccruing loans in the process of foreclosure combined with attorney’s fees, property taxes, and costs to sell repossessed property negatively impacted the Company’s income in 2009, 2010, and 2011. The residential market for single family homes in South Carolina has significant inventory. This inventory will take time for the market to absorb and the Company expects to continue through 2012 with elevated other real estate owned balances. In addition, the real estate and construction industries have been significant employers in the past in South Carolina, and activity in these industries is not expected to return to pre-2008 levels in 2012. South Carolina is currently looking to other industries to provide job creation and economic prosperity in the State.

The current outlook for the national economy in the United States (“U.S.”) is cautiously optimistic. Throughout 2011 the economy showed mixed signs of recovery, and high unemployment levels persist. The Company expects slow improvement in 2012 in its market areas.

Earnings Performance

The Company reported a loss of $1.5 million or $.71 per common share for the year ended December 31, 2011 compared to a loss of $497,767, or $.24 per common share, for the year ended December 31, 2010. The Company reported a loss of $1.4 million in 2009, or $.62 per basic and diluted common share. The Company’s net loss increased in 2011, in comparison to 2010, due to the recording of a valuation allowance against the Company’s deferred tax assets in the amount of $908,441. On a pre-tax basis the Company lost $580,707 in 2011, $886,040 in 2010, and $2.2 million in 2009. Foreclosure and holding costs associated with repossession of the underlying collateral on nonperforming loans were significant in 2011 as well as 2010.  These costs, combined with the deferred tax asset valuation allowance,  made it impossible to return to profitability in 2011.

 The Company’s net interest income (the difference between interest earned on interest earning assets and interest paid on interest bearing liabilities) decreased to approximately $4.9 million from $5.1 million in 2010. Net interest income was $4.6 million in 2009.  The Company had noninterest income of approximately $746,356 in 2011 compared to $1.1 million in 2010 and $1.2 million in 2009. Noninterest income for 2010 and 2009 included gains on the sale of investments of $325,656 and $299,063, respectively. The Company provided $670,000, $1.26 million, and $2.96 million to the allowance for loan losses in 2011, 2010, and 2009, respectively, and had other operating expenses of $5.5 million, $5.8 million, and $5.1 million in 2011, 2010, and 2009, respectively.

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Net Interest Income

Net interest income is the amount of interest earned on interest earning assets (loans, investment securities, time deposits in other banks and federal funds sold), less the interest expenses incurred on interest bearing liabilities (interest bearing deposits and borrowed money), and is the principal source of the Bank's earnings. Net interest income is affected by the level of interest rates, volume and mix of interest earning assets and the relative funding of these assets. Due to the fact that the Bank’s and therefore, the Company’s, assets are largely monetary in nature, material changes in interest rates can have a material impact on the Bank’s net interest income. The Company and the Bank monitor the Bank’s assets and liabilities and the interest sensitivity of these assets and liabilities using various tools, including models which attempt to calculate the impact on the Bank’s net interest margin as interest rates change. However, these models, as well as the tables included here, employ assumptions about the Bank’s interest sensitive assets and liabilities which may or may not prove to be accurate. Such assumptions include, but are not limited to, repayment patterns of borrowers, calls of securities, and unscheduled redemptions of certificates of deposit. The tables on the following pages include historical analyses of yields earned and rates paid on interest sensitive assets and liabilities, the effects of changes in the volume and relative mix of interest sensitive assets and liabilities, the effect of changes in interest rates, and the ratio of assets and liabilities repricing over specific time horizons. While the Company’s and the Bank’s management cannot predict the timing and extent of changes in interest rates, they do attempt to manage the Bank’s interest rate sensitivity to enable the Company to react to protect the Company’s earnings stream throughout various interest rate cycles.

For the years ended December 31, 2011, 2010, and 2009, net interest income was $4.9 million, $5.1 million, and $4.6 million, respectively. The decrease in 2011 from 2010 is primarily attributable to lower volumes of loans, the asset type with the highest yield for the Bank. The decline was partially offset by decreases in the Bank’s cost of funds (see “Rate/Volume Analysis of Net Interest Income” below). In 2011 total average interest earning assets decreased to $147.3 million from $169.0 million in 2010. Average yields on interest earning assets decreased slightly from 4.64% in 2010 to 4.55% in 2011. The Bank was able to increase average yields on the loan portfolio as loans renewed, increasing yields to 5.52% in 2011 from 5.37% in 2010. However, the increase in yield was not sufficient to offset the decrease in average balances. In 2010 average loan yields increased in comparison to average loan yields in 2009, but overall average earning asset yields declined as a result of the significant decline in average yields on investment securities.  Nonetheless, a significant decline in the cost of funds in 2010 in comparison to 2009 (1.77% in 2010 versus 2.25% in 2009) contributed to an increase in the net interest margin in 2010 of 29 basis points over 2009 levels.

7

The tables, "Average Balances, Yields and Rates," provide a detailed analysis of the effec­tive yields and rates on the categories of interest earning assets and interest bearing liabilities for the Company for the years ended December 31, 2011, 2010, and 2009.

Average Balances, Yields and Rates

(Dollars in thousands)

	Year ended December 31, 2011			Year ended December 31, 2010
	Average Balances(1)	Interest Income/ Expense	Average Yields/ Rates(2)	Average Balances(1)	Interest Income/ Expense	Average Yields/ Rates(2)
Assets

Securities	$	26,277		$	821	3.12	%	$	27,021		$	916	3.39	%
Federal Funds Sold		14,706			17	.12	%		13,349			19	.14	%
Loans (3), (4)		106,301			5,863	5.52	%		128,651			6,913	5.37	%
Total interest earning assets		147,284			6,701	4.55	%		169,021			7,848	4.64	%
Cash and due from banks, non-interest bearing		865							799
Allowance for loan losses		(2,386	)						(2,690	)
Premises and equipment		5,130							5,248
Cash surrender value of life insurance policies		1,940							1,872
Other real estate owned		13,971							8,079
Other assets		1,977							3,091
Total assets	$	168,781						$	185,420
Liabilities and shareholders' equity
Interest bearing liabilities:
Interest bearing transaction accounts	$	13,487			55	.41	%	$	12,887			59	.46	%
Savings and money market		50,479			405	.80	%		50,451			753	1.49	%
Time deposits		63,260			1,007	1.59	%		75,635			1,519	2.01	%
Total interest bearing deposits		127,226			1,467	1.15	%		138,973			2,331	1.68	%
Federal Funds purchased and     customer repurchase agreements		2,176			27	1.23	%		2,864			38	1.33	%
FHLB advances		2,658			94	3.53	%		8,033			201	2.50	%
Broker repurchase agreements(5)		4,874			240	4.92	%		5,000			177	3.54	%
Total interest bearing liabilities		136,934			1,828	1.33	%		154,870			2,747	1.77	%
Noninterest bearing demand deposits and other     liabilities		13,710							12,271
Shareholders' equity		18,137							18,279
Total liabilities and shareholders' equity	$	168,781						$	185,420
Interest rate spread (6)						3.22	%						2.87	%
Net interest income and net yield on     earning assets(7)				$	4,873	3.31	%				$	5,101	3.02	%
Interest free funds supporting earning assets (8)	$	10,350						$	14,151

(1)   Average balances of interest-earning assets and interest-bearing liabilities calculated based on a daily basis.

(2)   Calculated based on the number of days in the year that each type of asset or liability was in existence. Yield calculated on a pre-tax basis. The estimated tax equivalent yield on securities was 3.52% in 2011 and 3.80% in 2010.

(3)   Nonaccruing loans are included in the average loan balances and income on such loans is recognized on a cash basis.

(4)   Interest income on loans includes loan fee income as well as interest income. The amount of loan fees included is $40,033 in 2011 and $91,712 in 2010, respectively.

(5)   Interest expense on broker repurchase agreements includes the prepayment of a repurchase agreement in the amount of $2.0 million, which accelerated interest expense by $67,318 in 2011.

(6)   Total yield on interest earning assets less the rate paid on total interest bearing liabilities.

(7)   Net interest income divided by total interest earning assets.

(8)   Total interest earning assets less total interest bearing liabilities.

8

Average Balances, Yields and Rates

 (Dollars in thousands)

	Year ended December 31, 2010			Year ended December 31, 2009
	Average Balances(1)	Interest Income/ Expense	Average Yields/ Rates(2)	Average Balances(1)	Interest Income/ Expense	Average Yields/ Rates(2)
Assets

Securities	$	27,021		$	916	3.39	%	$	23,652		$	1,026	4.34	%
Federal Funds Sold		13,349			19	.14	%		9,994			16	.16	%
Loans (3), (4)		128,651			6,913	5.37	%		138,066			6,998	5.07	%
Total interest earning assets		169,021			7,848	4.64	%		171,712			8,040	4.68	%
Cash and due from banks, non-interest bearing		799							1,187
Allowance for loan losses		(2,690	)						(1,982	)
Premises and equipment		5,248							5,424
Cash surrender value of life insurance policies		1,872							1,801
Other real estate owned		8,079							2,402
Other assets		3,091							2,308
Total assets	$	185,420						$	182,852
Liabilities and shareholders' equity
Interest bearing liabilities:
Interest bearing transaction accounts	$	12,887			59	.46	%	$	13,169			75	.57	%
Savings and money market		50,451			753	1.49	%		34,936			657	1.88	%
Time deposits		75,635			1,519	2.01	%		86,435			2,199	2.54	%
Total interest bearing deposits		138,973			2,331	1.68	%		134,540			2,931	2.18	%
Federal Funds purchased and     customer repurchase agreements		2,864			38	1.33	%		3,842			78	2.04	%
FHLB advances		8,033			201	2.50	%		8,559			238	2.78	%
Broker repurchase agreements		5,000			177	3.54	%		5,000			177	3.53	%
Total interest bearing liabilities		154,870			2,747	1.77	%		151,941			3,424	2.25	%
Noninterest bearing demand deposits and other     liabilities		12,271							11,941
Shareholders' equity		18,279							18,970
Total liabilities and shareholders' equity	$	185,420						$	182,852
Interest rate spread (5)						2.87	%						2.43	%
Net interest income and net yield on     earning assets(6)				$	5,101	3.02	%				$	4,616	2.69	%
Interest free funds supporting earning assets (7)	$	14,151						$	19,771

(1)   Average balances of interest-earning assets and interest-bearing liabilities calculated based on a daily basis.

(2)   Calculated based on the number of days in the year that each type of asset or liability was in existence. Yield calculated on a pre-tax basis. The estimated tax equivalent yield on securities was 3.80% in 2010 and 4.81% in 2009.

(3)   Nonaccruing loans are included in the average loan balances and income on such loans is recognized on a cash basis.

(4)   Interest income on loans includes loan fee income as well as interest income. The amount of loan fees included is $91,712 and $236,777 in 2010 and 2009, respectively.

(5)   Total yield on interest earning assets less the rate paid on total interest bearing liabilities.

(6)   Net interest income divided by total interest earning assets.

(7)   Total interest earning assets less total interest bearing liabilities.

9

 Rate/Volume Analysis of Net Interest Income

As discussed under the caption “Net Interest Income,” the Bank’s net income is largely dependent on net interest income. The table below calculates the relative impact on net interest income caused by changes in the average balances (volume) of interest sensitive assets and liabilities and the impact caused by changes in interest rates earned or paid. Each table compares two years as indicated below.  The effect of a change in average balance has been determined by applying the average rate in the earlier year to the change in average balance in the later year, as compared with the earlier year. The effect of a change in the average rate has been determined by applying the average balance in the earlier year to the change in the average rate in the later year, as compared with the earlier year. In 2010 and 2009 changes in interest rates had the most significant impact on interest income.

Year ended December 31, 2011 compared to 2010

	Increase (Decrease) Due to
	Rate			Volume			Rate/Volume(1)			Change
Interest earned on:				(Dollars in thousands)
Securities (2)	$	(72	)	$	(25	)	$	2		$	(95	)
Federal Funds sold		(3	)		2			(1	)		(2	)
Loans		183			(1,201	)		(32	)		(1,050	)
Total interest income		108			(1,224	)		(31	)		(1,147	)
Interest paid on:
Deposits		(670	)		(245	)		51			(864	)
Federal Funds purchased and customer              repurchase agreements		(3	)		(9	)		1			(11	)
FHLB advances		83			(134	)		(56	)		(107	)
Broker repurchase agreements		69			(4	)		(2	)		63
Total interest expense		(521	)		(392	)		(6	)		(919	)
Change in Net Interest Income	$	629		$	(832	)	$	(25	)	$	(228	)

(1)   Rate/Volume is calculated as the difference between the average balances for the periods multiplied by the difference between the average rates for the periods.

(2)  Income calculated on a pre-tax basis.

Year ended December 31, 2010 compared to 2009

	Increase (Decrease) Due to
	Rate			Volume			Rate/Volume(1)			Change
Interest earned on:				(Dollars in thousands)
Securities (2)	$	(224	)	$	146		$	(32	)	$	(110	)
Federal Funds sold		(2	)		5			-			3
Loans		421			(477	)		(29	)		(85	)
Total interest income		195			(326	)		(61	)		(192	)
Interest paid on:
Deposits		(613	)		15			(2	)		(600	)
Federal Funds purchased and customer              repurchase agreements		(27	)		(20	)		7			(40	)
FHLB advances		(24	)		(15	)		2			(37	)
Broker repurchase agreements		-			-			-			-
Total interest expense		(664	)		(20	)		7			(677	)
Change in Net Interest Income	$	859		$	(306	)	$	(68	)	$	485

(1)   Rate/Volume is calculated as the difference between the average balances for the periods multiplied by the difference between the average rates for the periods.

(2)   Income calculated on a pre-tax basis.

10

Interest Rate Sensitivity

Interest rate sensitivity measures the timing and magnitude of the repricing of assets compared with the repricing of liabilities and is an important part of asset/liability management. The objective of interest rate sensitivity management is to generate stable growth in net interest income, and to control the risks associated with interest rate movements. Management constantly reviews interest rate risk exposure and the expected interest rate environment so that adjustments in interest rate sensitivity can be made in a timely manner.

When interest sensitive liabilities exceed interest sensitive assets for a specific repricing “horizon,” a negative interest sensitivity gap results. The gap is positive when interest sensitive assets exceed interest sensitive liabilities. For a bank with a negative gap such as the Bank, falling interest rates would be expected to have a positive effect on net interest income and increasing rates would be expected to have the opposite effect.  However, if one or more assumptions prove incorrect, the margin may not be impacted in the manner expected. On a cumulative basis, rate sensitive liabilities exceeded rate sensitive assets, resulting in a liability sensitive position at the end of 2011 of $38.9 million, for a cumulative gap ratio of .62 calculated at the one-year time horizon, assuming that all assets and liabilities would reprice at the earliest possible time. However, this analysis includes mortgage-backed securities in their year of final maturity and assumes that all non-maturing deposits will reprice immediately. Many instruments may not reprice in conjunction with final maturities, and interest-bearing liabilities, in particular, may not reprice in conjunction with or by the same magnitude as movements in market interest rates.

The following table reflects the balances of interest earning assets and interest bearing liabilities at the earlier of their repricing or maturity dates. Amounts of fixed rate loans are reflected at the loans’ final maturity dates. Variable rate loans are reflected at the earlier of their contractual maturity date or the date at which the loan may be repriced contractually. Deposits in other banks and debt securities are reflected at the earlier of each instrument’s repricing date for variable rate instruments or the ultimate maturity date for fixed rate instruments. Overnight federal funds sold are reflected in the earliest repricing interval due to the immediately available nature of these funds. Interest bearing liabilities with no contractual maturity, such as interest bearing transaction accounts and savings deposits are reflected in the earliest repricing interval due to contractual arrangements which give management the opportunity to vary the rates paid on these deposits within a thirty-day or shorter period. However, the Bank is under no obligation to vary the rates paid on those deposits within any given period. Fixed rate time deposits, principally certificates of deposit, are reflected at their contractual maturity dates. Federal funds purchased are presented in the immediate repricing interval because the interest rate paid adjusts at the beginning of each month. The table does not reflect repricing that could occur as a result of prepayment of loans or early withdrawal of time deposits or movement into or out of non-maturing deposit accounts.

11

Interest Sensitivity Analysis

	December 31, 2011
	Immediate			1-3 Months			3-12 Months			1-3 Years			3-5 Years			5-15 Years			> 15 Years		Total
	(Dollars in thousands)
Interest earning assets
Securities (1)	$	-		$	-		$	12		$	295		$	729		$	13,806		$	13,784	$	28,626
Federal funds sold		12,620			-			-			-			-			-			-		12,620
Loans (2)(3)		29,247			4,373			18,118			21,611			14,032			1,895			4,105		93,381
Total interest earning assets		41,867			4,373			18,130			21,906			14,761			15,701			17,889		134,627
Interest bearing deposits
Interest bearing transaction accounts		14,750			-			-			-			-			-			-		14,750
MMDAs & Savings		47,236			-			-			-			-			-			-		47,236
Time deposits		-			11,115			28,235			17,384			3,054			-			-		59,788
Federal Funds purchased and Customer repurchase agreements		68			-			1,700			-			-			-			-		1,768
FHLB advances		-			38			113			232			59			2,000			-		2,442
Broker repurchase agreements		-			-			-			-			3,000			-			-		3,000
Total interest bearing liabilities		62,054			11,153			30,048			17,616			6,113			2,000			-		128,984
Interest sensitivity gap	$	(20,187	)	$	(6,780	)	$	(11,918	)	$	4,290		$	8,648		$	13,701		$	17,889	$	5,643
Cumulative interest sensitivity gap	$	(20,187	)	$	(26,967	)	$	(38,885	)	$	(34,595	)	$	(25,947	)	$	(12,246	)	$	5,643	$	5,643
Gap ratio		.67			.39			.60			1.24			2.41			7.85			-
Cumulative gap ratio		.67			.63			.62			.71			.80			.91			1.04

	December 31, 2010
	Immediate			1-3 Months			3-12 Months			1-3 Years			3-5 Years			5-15 Years			> 15 Years		Total
	(Dollars in thousands)
Interest earning assets
Securities (1)	$	-		$	-		$	-		$	102		$	997		$	10,210		$	13,346	$	24,655
Federal funds sold		5,110			-			-			-			-			-			-		5,110
Loans (2)(3)		47,867			7,844			7,746			24,985			21,687			1,036			8,749		119,914
Total interest earning assets		52,977			7,844			7,746			25,087			22,684			11,246			22,095		149,679
Interest bearing deposits
Interest bearing transaction accounts		12,622			-			-			-			-			-			-		12,622
MMDAs & Savings		50,897			-			-			-			-			-			-		50,897
Time deposits		995			16,252			31,300			14,217			3,981			-			-		66,745
Federal Funds purchased and Customer repurchase agreements		896			-			2,050			-			-			-			-		2,946
FHLB advances		-			4,038			113			301			140			2,000			-		6,592
Broker repurchase agreements		-			-			-			2,000			3,000			-			-		5,000
Total interest bearing liabilities		65,410			20,290			33,463			16,518			7,121			2,000			-		144,802
Interest sensitivity gap	$	(12,433	)	$	(12,446	)	$	(25,717	)	$	8,569		$	15,563		$	9,246		$	22,095	$	4,877
Cumulative interest sensitivity gap	$	(12,433	)	$	(24,879	)	$	(50,596	)	$	(42,027	)	$	(26,464	)	$	(17,218	)	$	4,877	$	4,877
Gap ratio		.81			.39			.23			1.52			3.19			5.62			-
Cumulative gap ratio		.81			.71			.58			.69			.81			.88			1.03

(1)   Securities with call features have been included in the period in which the security matures.

(2)   There were no unamortized deferred loan fees included in the above tables in either year.

(3)   Nonaccruing loans of $4.1 million are included in the 2011 table. Nonaccruing loans of $9.7 million are included in the 2010 table.  All nonaccruing loans are included in the >15 years category.

12

Provision for Loan Losses

The provision for loan losses is charged to earnings based on management's continuing review and evaluation of the loan portfolio and general economic conditions. The following table summarizes the activity in the allowance for loan losses.

	Year ended December 31,
	2011			2010			2009
	(Dollars in thousands)
Allowance for loan losses, beginning of year	$	2,703		$	2,695		$	1,699
Provision for loan losses		670			1,260			2,955
Charge-offs		(1,355	)		(1,252	)		(1,959	)
Recoveries		24			-			-
Allowance for loan losses, end of year	$	2,042		$	2,703		$	2,695

See "Impaired Loans" and "Allowance for Loan Losses" for a discussion of the factors management considers in its review of the adequacy of the allowance and provision for loan losses. Refer to Note 5 to the Company’s Consolidated financial statements contained elsewhere herein for additional information regarding activity in the allowance for loan losses as well as “Allowance for Loan Losses” below.

Noninterest Income

Noninterest income, which consists primarily of service charges on deposit accounts, gains and losses on securities sales, and other fee income, decreased by $322,320 to $746,356 in 2011 from $1.1 million in 2010 and decreased by $141,000 to $1.1 million in 2010 from $1.2 million in 2009. The main reason for the decline was the gain on the sale of securities in 2010. No securities were sold in 2011. Service charges were fairly stable in 2011 and 2010. The Company sold securities with a fair value of $ 8.1 million and $10.8 million in 2010 and 2009, respectively, resulting in a net gain of approximately $326,000 in 2010 and $299,100 in 2009.  Mortgage loan origination fee income continued a trend of decreases in 2009. Effective November 30, 2009, the Company closed its mortgage origination department due to the difficulties involved in brokering mortgage loans to third party investors. When the housing and mortgage markets stabilize, the Company intends to reevaluate offering conventional 30 and 15-year mortgage loans to its customers.

Noninterest Expenses

Noninterest expenses, which consist primarily of salaries and employee benefits, occupancy costs, data processing expenses and professional and regulatory fees, totaled $5.5 million in 2011, down from $5.8 million in 2010, and compared to $5.1 million in 2009. Salaries and employee benefits decreased $57,315 in 2011 compared to 2010 and $154,000 in 2010 from 2009. As of the end of 2011 and 2010, the Company employed 35 full-time employees. Net occupancy and equipment expenses decreased to $530,827 in 2011 from $542,138 in 2010 and $572,025 in 2009. Loan expenses were fairly stable from 2010 to 2011. Both years were lower than 2009 as fewer loans entered the foreclosure process. However, holding costs for other real estate owned increased dramatically as more properties completed the foreclosure process and real estate sales slowed in the Company’s markets. Professional and regulatory fees decreased in 2011 in comparison to 2010 as the Company’s deposit insurance premiums decreased after increasing in 2010 and 2009. Real estate values continued to be depressed in the Company’s market areas in 2011 so losses on sales of foreclosed real estate and impairment charges continued, although not at the same level as that experienced in 2010.  The Company’s efficiency ratio, which is measured as the ratio of noninterest expense to the sum of net interest income plus other income expressed as a percentage, was 98.4% in 2011, 94% in 2010, and 86% in 2009.

Income Taxes

In 2011 the Company recorded income tax expense of $908,441. The expense primarily related to the establishment of a full valuation allowance against the Company’s deferred tax asset. A valuation allowance is recorded against a deferred tax asset in situations where evidence regarding the ability to use the benefit in the near term does not outweigh the likelihood that the benefit will not be available for use. Due to the current outlook for unemployment and interest rates, the Company’s management determined that the situation warranted recognition of a valuation allowance in the third quarter of 2011. In that quarter, the Federal Open Market Committee (“FOMC”) announced that interest rates would remain at historical lows through the middle of the year 2013 due to unemployment rates and other economic issues. Since the announcement was made, the FOMC has made an additional announcement predicting that economic activity will remain restrained and unemployment rates will remain high through 2014, which will keep interest rates low for an additional period of time. A low interest rate environment can create a difficult operating environment for community banks which rely on the net interest margin for a significant portion of their operating revenues. In addition, the FOMC’s evaluation of the overall health of the US economy made it difficult to provide sufficient evidence that the Company would be able to utilize the deferred tax asset in the near term to offset taxable income.

13

 For 2010 the Company recorded an income tax benefit of $388,273 compared to a benefit of $819,737 in 2009. The primary reasons for the benefit recognized in 2010 and 2009 are the exclusions of nontaxable municipal bond income and operating expenses related to nonperforming assets. The financial accounting standard under which the Bank accounts for income taxes  requires certain items of income and expense (principally provision for loan losses, depreciation, and prepaid expenses) to be included in one reporting period for financial accounting purposes and another for income tax purposes. Refer to Notes 1 and 14 to the Company’s consolidated financial statements contained elsewhere herein for more information.

Investment Securities

Management assigns securities upon purchase into one of the categories (trading, available-for-sale and held-to-maturity) designated by accounting principles generally accepted in the United States (“GAAP”) based on intent, taking into consideration other factors including expectations for changes in market rates of interest, liquidity needs, asset/liability management strategies, and capital requirements. The Bank has not historically held securities for trading purposes. As of December 31, 2011, 2010, and 2009, the Bank’s investment portfolio comprised approximately 17.4%, 14.2%, and 15.9%, respectively, of total assets.

The following table summarizes the carrying amounts of securities held by the Bank at December 31, 2011 and 2010. Available-for-sale securities are stated at estimated fair value. The Company had no held-to-maturity securities in either period. Federal Reserve Bank of Richmond and Federal Home Loan Bank of Atlanta stocks have no quoted market value, but have historically been redeemed at par value, and are therefore carried at cost. However, there can be no assurance that these stocks will be redeemed at par value in the future. There are no individual issuers, other than government sponsored enterprises, whose securities represent more than 10% of the Company’s consolidated shareholders’ equity at December 31, 2011. Government sponsored enterprises (“GSEs”) are agencies and corporations established by the U. S. Government, including among others, the Federal Home Loan Banks, Federal National Mortgage Association, Federal Home Loan Mortgage Corporation and Federal Farm Credit Banks.  Until 2008, securities issued by these enterprises were not obligations of the U. S. Government and were not backed by the full faith and credit of the U. S. Government or otherwise guaranteed by the U. S. Government, although they were commonly treated as guaranteed. In 2008, in an attempt to stabilize U.S. and international financial markets, the U.S. Government explicitly guaranteed certain debt instruments of the GSEs. These securities have generally been, and will continue to be, eligible to be used as security for public deposits of the U. S. Treasury, government agencies and corporations, and states and other political subdivisions. At December 31, 2011 and 2010, securities with a fair value of $11.5 million and $17.1 million, respectively, were pledged to collateralize public deposits, sweep accounts, and customer and broker repurchase agreements. FHLB stock is generally pledged against outstanding advances. Fair values are generally determined by a third party pricing service and validated against one or more independent pricing services. Refer to Note 4 to the Company’s consolidated financial statements contained elsewhere herein for more information. The Company had no other-than-temporary impairment losses in 2011 or 2010. The Company does not currently own any private label asset-backed securities, mortgage derivative investments, or investments in trust preferred securities.

14

Investment Securities Portfolio Composition

	December 31,
	2011		2010
(Dollars in thousands)
Available for sale:
Mortgage-backed securities	$	18,972	$	10,993
Municipal bonds		8,770		8,223
Government sponsored enterprise bonds		-		4,377
Total available for sale		27,742		23,593
Federal Reserve Bank of Richmond stock		423		405
Federal Home Loan Bank of Atlanta stock		461		658
Total	$	28,626	$	24,656

The following table presents contractual maturities and weighted average yields of securities at December 31, 2011 and 2010. Securities are presented at their carrying value (available for sale securities are carried at fair value and other securities are carried at book value, which is equal to their amortized cost.)

Investment Securities Portfolio Maturities and Yields

	December 31, 2011		December 31, 2010
	Amount	Yield(1)	Amount	Yield(1)
	(Dollars in thousands)		(Dollars in thousands)
Available for sale securities:
FNMA and FHLMC Mortgage-backed securities (2)

Within one year	$	12	4.16	%	$	-	-	%
After one through five years		31	3.58	%		102	3.82	%
After 10 years		18,929	2.40	%		10,891	2.25	%
Municipal bonds
After one through five years		994	3.69	%		997	3.69	%
After five through ten years		1,431	4.05	%		992	4.04	%
After 10 years		6,345	4.19	%		6,233	4.18	%
Government sponsored enterprises
After five through ten years		-	-	%		2,509	3.88	%
After 10 years		-	-	%		1,868	3.25	%
Other securities
No stated maturity		884	3.02	%		1,063	2.52	%
Total	$	28,626			$	24,655

(1)   Yields calculated on a pre-tax basis.

(2)   These securities mature on an amortizing basis, and are included in the table in the period of final maturity.

While three of the Company’s mortgage-backed securities available-for-sale are in an unrealized loss position as of December 31, 2011, none has been in an unrealized loss position for twelve months or more. None of these securities is expected to have a loss of principal at final maturity. The Company has the intent and ability to hold these securities until such time as the value recovers or the securities mature. The Company’s investments are obligations of the United States, its sponsored enterprises, or municipal securities. In the opinion of Management, there is no concentration of credit risk in the investment portfolio.

15

Loan Portfolio

The Bank offers a range of lending services, including commercial loans, consumer loans, and real estate mortgage loans. (Refer to “BUSINESS OF THE COMPANY- Services of the Bank- Lending Activities” above for additional information regarding the types of loans made by the Company and risks inherent in each individual type of loan.) To address the risks inherent in making loans, management maintains an allowance for loan losses based on, among other things, an evaluation of the Bank’s loan loss experience, management’s experience at other financial institutions in the market area, peer data, the amount of and trends in past due and nonperforming loans, current economic conditions and the values of loan collateral. (Refer to Note 5 to the Company’s consolidated financial statements contained elsewhere herein for more information, including portfolio segmentation methodology, delinquent loan information, and information regarding the allowance for loan losses.) Based upon such factors, management makes various assumptions and judgments about the ultimate collectibility of the loan portfolio and provides an allowance for loan losses based upon a percentage of the outstanding balances and specific loans. However, because there are certain risks that cannot be precisely quantified, management’s judgment of the allowance is necessarily approximate and imprecise. The adequacy and methodology of the allowance for loan losses are also subject to regulatory examination. See “BUSINESS OF THE COMPANY-Services of the Bank- Lending Activities”above for more information regarding the types of loans offered by the Company and the risks associated with each major portfolio segment.

Management believes the loan portfolio is adequately diversified, although real estate collateral is the predominant collateral in the portfolio. There are no signifi­cant concentrations of loans to any particular individuals, and there are no foreign loans. The Bank does have loans in certain broad categories that comprise over 25% of Tier 1 Capital adjusted for the allowance for loan losses. Those categories are as follows: real estate rental and leasing, accommodation and food services, construction, retail trade, health care and social assistance, and other services. The Company believes that the Bank has appropriate controls in place to monitor risks that may arise due to concentrations in the loan portfolio. Additionally, because the Bank is engaged in the business of community banking, its borrowers are geographically concentrated in the Upstate area of South Carolina, as is the real estate collateral for loans secured by real estate.

Loans made outside the loan policy guidelines may present additional credit risk to the Company. In order to monitor these loans and the total number and amount of loans made with exceptions to loan policies, the Bank monitors all loans approved with policy exceptions. Statistics regarding the number of loans and the amount of loans with policy exceptions are reported to the Board of Directors monthly. One of the policy exceptions reported is for loans exceeding the regulatory guidelines on loan to value ratios. The regulatory loan to value guidelines permit exceptions to the guidelines not to exceed 100% of Total Regulatory Capital for single family residential mortgage loans ($18.1 million at December 31, 2011), or 30% of Total Regulatory Capital for real estate loans other than single family residential loans ($5.4 million as of December 31, 2011). As of December 31, 2011, the Bank had $3.7 million of loans which exceeded regulatory loan to value guidelines. This amount is within the allowable maximum of exceptions to the guidelines.  Of the total exceptions, 63.2% were not exceptions at the time the loans were made, but became exceptions upon reappraisal. Reappraisals are routinely ordered when a loan is collateral dependent and showing signs of weakness. Specifically, the Company’s reappraisal policy states that collateral for single family construction loans will be reappraised if the home is complete and remains unsold for twelve months, or if the original loan has been outstanding for eighteen months. For development loans, if lot absorption varies from the original appraiser’s estimates by 25% or more, the collateral will be reappraised. Additionally, the Company’s guidelines require that real property be appraised prior to renewal, modification, or extension of the loan. Collateral will also be reappraised if there is any indication that the collateral may have decreased significantly in value. An evaluation, rather than a full, certified appraisal, may or may not be used after consideration of the risk involved with the transaction, and the need to remain within safe and sound banking practices. If the value of collateral decreases significantly upon reappraisal, the Company may take any one or a combination of steps to protect its position. Possible actions include requesting additional collateral from the borrower, requiring the borrower to make principal reductions on the loan, or charge-off of a portion of the loan balance.

The Company currently has concentrations in real estate lending, including construction and development loans. This segment of the Bank’s business is managed in specific ways in order to minimize the risks normally associated with construction lending. Management requires lending personnel to visit job sites, maintain frequent contact with borrowers and perform or commission inspections of completed work prior to issuing additional construction loan draws. In addition, management employs additional procedures for monitoring construction loans such as engaging an independent appraiser to perform routine inspections of construction work to determine the percentage complete prior to approval of draws on construction loans. However, even tight internal controls and management oversight will not prevent some borrowers from defaulting on these types of loans. Where declining market conditions persist for a long period of time, many participants in the housing and real estate construction industries cannot continue to perform as specified in their loan agreements without sales activity. In such cases, the Bank attempts to work with various borrowers in the real estate and construction industry to minimize the effect on the Bank and the borrowers. Loans in this situation are placed on nonaccrual, and included in the Company’s impaired loans. See “Impaired Loans” below.

16

The banking industry offers products that can increase credit risk should economic conditions change over the course of a loan’s life. Interest-only loans, adjustable rate loans, and loans with amortization periods that differ from the maturity date (i.e., balloon payment loans) are examples of products that could subject the Company to increased credit risk in periods of changing economic conditions. The Company evaluates each customer’s credit worthiness based on current and expected economic conditions and underwrites and monitors each such loan for associated risks. Therefore, Management does not believe that these particular products subject the Company to unusual credit risk. As of December 31, 2011, the Bank did not have in its portfolio any residential mortgage loans with negative amortization features, long term interest only payment features, or loan to value ratios at origination in excess of 100%.

Until November 2009, the Bank had a mortgage loan brokerage department that accepted mortgage applications for mortgages with terms greater than 15 years. Mortgage applications were processed and sent to third parties for underwriting. Approved loans were funded by, and closed in the name of third parties and the Bank received an origination fee. However, effective November 2009, the Bank suspended such mortgage originations. When the housing and mortgage loan markets stabilize, the Bank intends to reevaluate offering this service to its customers.

The amount of loans outstanding at December 31, 2011 and 2010 are shown in the following table according to type of loan. These are the same portfolio segments that management uses to manage and evaluate the loan portfolio. These are also consistent with regulatory segments of the portfolio.

Loan Portfolio Composition

	December 31,
	2011		2010
(Dollars in thousands)
	Amount	% of Loans	Amount	% of Loans

Real estate loans – construction /development	$	26,811		28.7	%	$	41,855		34.9	%
Real Estate – single family, including HELOC		14,341		15.4			19,605		16.4
Real Estate – Nonfarm, nonresidential		40,006		42.9			43,080		35.9
Real Estate – Multifamily residential		1,694		1.8			1,794		1.5
Commercial and industrial and other		9,842		10.5			12,581		10.5
Consumer installment		687		.7			999		.8
Total Loans		93,381		100.0	%		119,914		100.0	%
Less allowance for loan losses		(2,042	)				(2,703	)
Net Loans	$	91,339				$	117,211

Maturity Distribution of Loans

The Bank’s loan portfolio contains a component of adjustable rate loans. As of December 31, 2011, approximately $30.9 million or 33.1% of the Bank’s loan portfolio was variable rate. These loans are generally tied to the prime rate and may or may not have minimum or maximum rates included in the terms.

The following table sets forth the maturity distribution of the Bank's loans, by type, as of December 31, 2011, as well as the type of interest requirement on loans with maturities greater than one year. For purposes of this table, variable rate loans are included in the period of their final maturity, as opposed to their repricing date.

17

Maturity Distribution on Loans
	December 31, 2011
	(Dollars in Thousands)
	1 Year			1-5	5 Years
	or Less		Years		or More		Total
Loans secured by real estate-construction/development	$	15,375	$	11,175	$	261	$	26,811
Loans secured by real estate- single family, including HELOC		1,723		6,430		6,188		14,341
Loans secured by real estate- nonfarm, non-residential		11,507		26,839		1,660		40,006
Loans secured by real estate- multifamily		146		1,548		-		1,694
Commercial and industrial		6,065		3,761		16		9,842
Consumer		463		224		-		687
Total	$	35,279	$	49,977	$	8,125	$	93,381
Predetermined rate, maturity greater than one year			$	35,431	$	1,875	$	37,306
Variable rate, maturity greater than one year			$	14,546	$	6,250	$	20,796

Impaired Loans

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

Generally, the accrual of interest will be discontinued on impaired loans when principal or interest becomes 90 days past due, or when payment in full is not anticipated, and any previously accrued interest on such loans will be reversed against current income. Any subsequent interest income will be recognized on a cash basis when received unless collectibil­ity of a significant amount of principal is in serious doubt. In such cases, collections are credited first to the remaining principal balance on a cost recovery basis. An impaired loan will not be returned to accrual status unless principal and interest are current and the borrower has demonstrated the ability to continue making payments as agreed.

Loans which management identifies as impaired generally will be nonperforming loans. Nonperforming loans include nonaccrual loans or loans which are 90 days or more delinquent as to principal or interest payments and can include others deemed to be impaired for circumstances other than delinquency over 90 days. As of December 31, 2011, the Bank had nonaccrual loans of $4.1 million and other impaired loans totaling $1.1 million, including troubled debt restructurings. Nonaccruals include nine loans. All of the loans on non-accrual are collateral dependent. All but one of these loans are in the process of foreclosure or other collection processes as of December 31, 2011. If these loans had been current, the Company would have recorded additional interest income of approximately $204,476 in 2011. All previously accrued but uncollected income on these loans has been eliminated from the accompanying consolidated income statement. Impairment reserves of $40,379 are included in the allowance for loan losses related to impaired loans as of December 31, 2011. The Company has already charged-off $333,303 (included in total charge-offs for 2011 or 2010) related to these loans as of December 31, 2011. The Company’s investment in nonaccruing loans increased throughout 2009 and 2010, but has declined in 2011. Impaired loans by portfolio segment are included in note 5 to the Company’s Consolidated Financial Statements contained elsewhere herein.

The Company considers restructured loans to be impaired under the definition of an impaired loan. As of December 31, 2011 the bank had seven loans totaling approximately $989,000 that are restructured in some manner (included above) but were not on nonaccrual as of December 31, 2011. (See table below.) All of these loans are in compliance with their restructured terms, but deemed to be impaired due to changes in the original terms, or due to the absence of terms that would be in effect under normal conditions, such as interest-only payment requirements. The Company has not charged off amounts associated with accruing impaired loans as of December 31, 2011. Refer to Note 5 to the Company’s consolidated financial statements contained elsewhere herein for more information. The allowance for loan losses includes management’s best estimate of the probable losses on these loans. At December 31, 2010, the Bank had $9.7 million of nonaccrual loans or loans 90 days or more past due.

18

Troubled Debt Restructurings (“TDRs”) are included in the table below by portfolio segment.

December 31, 2011
TDRs Performing according to restructured terms	TDRs in default or nonaccruing
(Dollars in thousands)

Loans secured by real estate – construction/development	$	288	$	2,057
Loans secured by real estate – single family (1)		339		-
Loans secured by real estate – multi-family		-		-
Loans secured by real estate –nonfarm, nonresidential		308		238
Commercial and industrial loans		54		-
Consumer loans		-		-
Total	$	989	$	2,295

(1)   Includes HELOC loans.

Delinquent loans and loans on non-accrual are presented by portfolio segment in the table below.

	December 31, 2011				December 31, 2010
	Past due 30-89 Days		Nonaccrual or Past due over 90 Days (2)		Past due 30-89 Days		Nonaccrual or Past due over 90 Days (2)
	(Dollars in thousands)
Loans secured by real estate –         construction/development	$	-	$	2,387	$	891	$	7,218
Loans secured by real estate – single family (1)		141		105		1,978		1,522
Loans secured by real estate – multi-family		-		693		-		-
Loans secured by real estate –nonfarm, nonresidential		309		900		-		-
Commercial and industrial loans		18		-		-		992
Consumer loans		-		-		-		-
Total	$	468	$	4,085	$	2,869	$	9,732

(2)   Includes HELOC loans.

(3)   As of December 31, 2011 and 2010 all of the loans past due more than 90 days were on nonaccrual.

Potential Problem Loans

Management identifies and maintains a list of potential problem loans. A loan is added to the potential problem list when management becomes aware of information about possible credit problems of borrowers that causes serious doubts as to the ability of such borrowers to comply with the current loan repayment terms. These loans are designated as such in order to be monitored more closely than other credits in the Bank’s portfolio. Potential problem loans include loans such as loans that are not included in nonaccrual status, or loans that are past due 90 days or more and still accruing interest. Loans in the amount of $2.3 million (including $788,000 of loans secured by real estate- construction/development) had been determined by management to be potential problem loans at December 31, 2011. The majority of these loans are secured by real estate. These loans have not been restructured as of December 31, 2011 and are not on nonaccrual, but they exhibit some weaknesses. Management is currently assessing the potential impact on the Bank and the Company and closely monitoring these loans. Reassessment would be in the form of a new appraisal on, or evaluation of, the collateral supporting the loan if the loan is collateral dependent.

19

Allowance for Loan Losses

The allowance for loan losses is increased by provisions that are direct charges to operating expense. Losses on loans are charged against the allowance in the period in which management determines that it is likely that such loans have become uncollectible. Recoveries of previously charged off loans will be credited to the allowance. In reviewing the adequacy of the allowance for loan losses, management takes into consideration the historical loan losses experienced by the Bank, current economic conditions affecting the borrowers' ability to repay, the volume of loans, and the trends in delinquent, nonaccruing, and any potential problem loans, and the quality of collateral securing nonperforming and problem loans. Management considers the allowance for loan losses to be adequate to cover its estimate of loan losses inherent in the loan portfolio as of December 31, 2011.

In calculating the amount required in the allowance for loan losses, management applies a consistent methodology that is updated quarterly. The method­ology utilizes a loan risk grading system and detailed loan reviews to assess credit risks and the overall quality of the loan portfolio. The calculation also provides for management's assessment of trends in national and local economic conditions that might affect the general quality of the loan portfolio. The loan portfolio is segmented by management into the classifications used by the regulatory agencies. Those categories are listed in the table “Loan Portfolio Composition” above. These categories are used for analyzing the portfolio and for purposes of calculating the allowance for loan losses because they have specific, defined characteristics that can be used for consistent evaluation and reporting by management internally and to regulatory agencies. For more information refer to Note 5 to the Company’s Consolidated financial statements included elsewhere herein.

Since the Bank generally lends on various types of real-estate collateral, the regulatory definitions, which split real estate collateral into several sub-types, provide a defined, consistent system for tracking loan balances and charge-offs. These categories are also useful in comparing the Bank to its regional community bank peers. The Bank’s historical charge-off rates, by regulatory category, are calculated, reviewed for additional subjective factors that should be considered for the current outlook, and then applied to ending balances of loans not specifically reviewed for impairment. These estimates, along with the loans specifically reviewed for impairment, are used in the analysis of the adequacy of the allowance for loan losses completed on a quarterly basis. As described in Notes 1 and 5 to the Company’s consolidated financial statements, loans rated Other Assets Especially Mentioned (“or Special Mention”), Substandard, Doubtful, or Loss are individually evaluated for impairment, and the estimate of the amount of allowance for loan losses is computed based on individual facts and circumstances, such as appraised value of collateral, and similar factors. See notes 1 and 5 to the Company’s consolidated financial statements for further information, including the amount of loans in each rating category as described above.

20

The table below summarizes the Company’s loan loss experience in 2011 and 2010.

Summary of Loan Loss Experience
	Year ended December 31,
	2011			2010
	(Dollars in thousands)
Total loans outstanding at end of period	$	93,381		$	119,914
Average amount of loans outstanding		106,301			128,652
Balance of allowance for loan losses-beginning	$	2,703		$	2,695
Loans charged-off
Loan secured by real estate – construction/development		783			979
Loan secured by real estate – single family		352			249
Loan secured by real estate –nonfarm, nonresidential		100			-
Commercial and industrial loans		120			21
Loans to consumers		-			3
Total charge-offs		1,355			1,252
Recoveries of loans previously charged-off  (commercial)		24			-
Net charge-offs		(1,331	)		(1,252	)
Additions to allowance charged to expense Additions to allowance charged to expense		670			1,260
Balance of allowance for loan losses-ending	$	2,042		$	2,703
Ratios
Net charge-offs to average loans outstanding		(1.25	%)		(.973	%)
Net charge-offs to loans at end of period		(1.43	%)		(1.04	%)
Allowance for loan losses to average loans		1.92	%		2.10	%
Allowance for loan losses to loans at end of period		2.19	%		2.25	%
Net charge-offs to allowance for loan losses		(65.17	%)		(46.31	%)
Net charge-offs to provision for loan losses		(198.65	%)		(99.36	%)

Activity for the year ended December 31, 2011 in the allowance, by portfolio segment, is presented in the table below.

Loans Secured by Real Estate

		Construction/			Single family (1)			Nonfarm, nonresidential			Multifamily			Commercial and industrial			Consumer			Unallocated			Total
											(Dollars in thousands)
Beginning Balance	$	1,093		$	361		$	341		$	4		$	526		$	16		$	362		$	2,703
Provision		485			407			299			(2	)		(303	)		(1	)		(215	)		670
Charge-offs		(783	)		(352	)		(100	)		-			(120	)		-			-			(1,355	)
Recoveries		-			-			-			-			24			-			-			24
Ending Balance	$	795		$	416		$	540		$	2		$	127		$	15		$	147		$	2,042

(1)   Includes home equity lines of credit.

The allowance for loan losses is not restricted to specific categories of loans and is available to absorb losses in all categories. However, the Company has allocated the allowance for loan losses among the various segments of the portfolio. The allowance allocations as of December 31, 2011 and December 31, 2010 are presented in the table below.

21

	December 31,
	2011					2010
	(Dollars in thousands)
	Amount		% of loans in each category to total loans			Amount		% of loans in each category to total loans
Loans secured by real estate – construction/development	$	795		28.7	%	$	1,093		34.9	%
Loans secured by real estate – single family (1),		416		15.4			361		16.4
Loans secured by real estate – nonfarm, nonresidential		540		42.9			341		35.9
Loans secured by real estate – multifamily		2		1.8			4		1.5
Commercial and industrial		127		10.5			526		10.5
Consumer installment		15		.7			16		.8
Unallocated		147		-			362		-
Total allowance for loan losses	$	2,042		100.0	%	$	2,703		100.0	%

(1)   Includes HELOC

Each category of loans is reviewed for characteristics that increase or decrease risk of loss, such as the availability and marketability of collateral, degree of susceptibility to changes in economic conditions, and similar factors, for purposes of estimating the allowance for loan losses. (See “Business of the Company--Services of the Bank” for a discussion of risk characteristics for each loan category.) Individual loans are graded using an internal grading system that takes into account information specific to the loan (Refer to Notes 1 and 5 to the Company’s consolidated financial statements contained herein). If warranted, a specific allocation may be associated with that loan for purposes of estimating the adequacy of the allowance for loan losses.

Loans Secured by Real Estate – Construction/Development

The Loans Secured by Real Estate – Construction/Development segment of the Company’s loan portfolio has been the source of approximately two-thirds of the amount of loans charged-off in 2011 and 2010.  At December 31, 2011 there were 93 loans with an aggregate book value of $26.8 million remaining in this segment of the portfolio (See Loan Portfolio Composition above.)  None of the loans in the Bank’s portfolio have interest reserves. This segment covers a variety of loan types, including vacant land that is not currently planned for development or construction purposes. In addition, many of the remaining loans are outside the category of single family residential construction- speculative, which accounted for a significant portion of charge-offs in the construction category in 2011 and 2010.  During 2011 the Company did not originate speculative construction loans, except in rare cases, and balances in the category declined by 36% from December 31, 2010 to December, 31, 2011. Delinquent loan balances in the category have significantly declined as well at December 31, 2011 in comparison to December 31, 2010. The following table sets forth additional information about construction/development loans. See Loan Portfolio above for additional information regarding inspections of collateral securing construction loans, reappraisals, and other processes designed to mitigate risk in this segment of the portfolio.

Loans Secured by Real Estate – Construction/Development

	Year Ended December 31, 2011
	(Dollars in thousands)
					Impaired				Potential Problem
Type	# of Loans		Total Amount		# of Loans		Total Amount		# of Loans		Total Amount
Single Family Residential –
Construction Speculative/Rental		12	$	2,610		2	$	634		-	$	-
Commercial – Construction		-		-		-		-		-		-
Residential development		11		6,969		-		-		-		-
Vacant Land
Residential investment		21		4,803		1		330		-		-
Commercial investment		13		6,450		-		-		-		-
Vacant land other		36		5,979		2		1,822		1		788
Total		93	$	26,811		5	$	2,786		1	$	788

22

Management believes, based on previous experience, that this segment contains the greatest potential risk of loss of all of the segments of the Company’s loan portfolio.  This belief is reflected by the fact that the portion of the allowance for loans losses allocated to this segment is greater than the portion allocated to any other segment.  The Company seeks to mitigate the risk by giving particularly close attention to loans in this segment and by its tightening of the requirements for new loans in this segment.  However, a major contributor to losses in this segment has been the recent history of declining real estate values in the Company’s market area, a trend which appears to have slowed in 2011.  A stabilization of such real estate values, or a trend of increasing real estate values, could significantly reduce the risk in this segment of the loan portfolio.

Property Acquired in Foreclosure

The Bank had $16.5 million and $10.3 million of property acquired in foreclosure at December 31, 2011 and 2010, respectively. Property acquired in foreclosure is initially recorded at its estimated fair market value less estimated selling costs. The estimated fair value at the time of acquisition is generally determined by appraisal. Reappraisals are performed annually. The Bank’s investment in foreclosed property is comprised of approximately 60 properties at December 31, 2011. The properties are a mixture of commercial lots, residential lots, newly constructed houses, and several commercial properties. The Company’s plan for liquidating these properties involves listing the properties with experienced local real estate agents and pricing the properties appropriately for sale. Sales plans for properties listed but unsold for more than six months will be reevaluated.  The Company also had an investment in repossessed equipment totaling approximately $23,000 included in other assets as of December 31, 2011. See Note 7 to the consolidated financial statements for further information. A summary of the activity in property (real estate) acquired in foreclosure follows:

	December 31,
	2011			2010
	(Dollars in thousands)
Beginning balance	$	10,279		$	6,713
Additions from foreclosures and capitalized improvements		11,281			8,403
Write downs of value		(431	)		(710	)
Sales		(4,584	)		(4,128	)
Ending other real estate owned	$	16,545		$	10,278

Deposits

The amounts and percentage composition of deposits held by the Bank as of December 31, 2011 and 2010 are summa­rized below:

Deposit Composition

	December 31,
	2011				2010
	(Dollars in thousands)
		Amount	% of Deposits			Amount	% of Deposits
Noninterest bearing demand	$	17,088	12.3	%	$	10,383	7.4	%
Interest bearing transaction accounts		14,750	10.6			12,621	9.0
Savings		32,392	23.3			35,344	25.1
Money market		14,844	10.7			15,553	11.0
Time deposits $100,000 and over		20,037	14.5			15,739	11.2
Other time deposits		39,752	28.6			51,006	36.3
Total deposits	$	138,863	100.0	%	$	140,646	100.0	%

23

The average amounts of and average rates paid on deposits held by the Bank for the years ended December 31, 2011 and 2010, are summa­rized below:

Average Deposits

Year ended December 31,
2011		2010
Amount	Rate	Amount	Rate
(Dollars in thousands)

Noninterest bearing demand	$	13,017	-	%	$	11,568	-	%
Interest bearing transaction accounts		13,487	.41	%		12,887	.46	%
Savings and money market		50,479	.80	%		50,451	1.49	%
Time deposits		63,260	1.59	%		75,635	2.01	%
Total average deposits	$	140,243			$	150,541

As of December 31, 2011, the Bank held $­­­­25.9 million of time deposits with balances of $100,000 or more, including some brokered deposits. Of that amount, $2.0 million mature within three months, $5.9 million mature over three through six months, $6.9 million mature over six through twelve months, and $11.1 million mature over twelve months. One account in the amount of $100,000 is at a floating rate of interest at December 31, 2011. Total brokered deposits were $7.3 million as of December 31, 2011. All time deposits over $100,000 involve the maintenance of an appropriate matching of maturity distribu­tion and a diversification of sources to achieve an appropriate level of liquidity. While many of the large time deposits are acquired from customers with standing relationships with the Bank, it is a common industry practice not to consider these types of deposits as core deposits because their retention can be expected to be heavily influenced by rates offered, and therefore such deposits may have the characteristics of shorter-term purchased funds. Certain deposits included in total deposits over $100,000 are brokered deposits. Brokered deposits are acquired in the wholesale market. The majority of these deposits are not redeemable prior to maturity except in the case of death. The majority of the Bank’s brokered deposits are in certificates where the denominations held by individual depositors are less than $100,000, which allows for pass through of FDIC deposit insurance.  One of the requirements of the Bank’s formal agreement with the OCC requires that the bank seek a “notice of no supervisory objection” prior to replacing maturing brokered deposits or increasing brokered deposits.

Customer Repurchase Agreements

Customer repurchase agreements consist of sweep accounts and retail repurchase agreements, and totaled $1.8 million and $2.9 million as of December 31, 2011 and 2010, respectively. Securities issued by government sponsored enterprises with an amortized cost of $2.5 million and $3.3 million (fair value of $2.6 million and $3.1 million) were pledged as collateral for the sweep accounts and repurchase agreements, at December 31, 2011 and 2010, respectively. All of the sweep accounts pay interest on a floating rate basis. The customer repurchase agreements pay interest on a fixed rate basis and have maturities of varying lengths. As of December 31, 2011 all of the Bank’s customer repurchase agreements mature in 2012. During 2011 sweeps and customer repurchase agreements averaged $2.2 million. The average rate paid on these balances was 1.23% during 2011 and the highest balance at any month end was $3.3 million.

Broker Repurchase Agreements

Broker repurchase agreements consist of one repurchase agreement totaling $3.0 million as of December 31, 2011. The borrowing carries a fixed rate of interest with a call feature. The agreement matures on January 15, 2015, and is callable by the broker quarterly after January 15, 2012. The Company prepaid another repurchase agreement in the amount of $2.0 million during December 2011. The agreement was set to mature on January 15, 2013 and was callable by the broker quarterly, beginning January 10, 2010.  Prepaying the agreement required acceleration of interest in the amount of $67,318. The additional amount is included in “Interest expense- broker repurchase agreements” in the accompanying Consolidated Statement of Income (Loss). Prepayment of the $2.0 million agreement lowered capital requirements and eliminated a negative impact on the Company’s net interest margin in future periods. Securities with fair value of $4.1 million and amortized cost of $3.9 million collateralize the remaining agreement. During 2011 the highest balance as of any month end for broker repurchase agreements was $5.0 million and the average balance for 2011 was $4.9 million. The average rate paid on broker repurchase agreements during 2011 was 4.92%. If the prepayment penalty had not been paid, the average rate paid on broker repurchase agreements during 2011would have been 3.54%. During 2010, the highest balance as of any month end for broker repurchase agreements was $5.0 million and the average balance for 2010 was $5.0 million. The average rate paid on broker repurchase agreements during 2010 was 3.54%.

24

Liquidity

Liquidity is the ability to meet current and future obliga­tions through liquidation or maturity of existing assets or the acquisition of additional liabilities. Adequate liquidity is necessary to meet the requirements of customers for loans and deposit withdrawals in the most timely and economical manner. Some liquidity is ensured by maintaining assets that may be immediately converted into cash at minimal cost (amounts due from banks and federal funds sold). However, the most manageable sources of liquidity are composed of liabilities, with the primary focus on liquidity management being on the ability to obtain deposits within the Bank's service area. Core deposits (total deposits less time deposits greater than $100,000 and brokered deposits) provide a relatively stable funding base, and were equal to 67.8% of total assets at December 31, 2011. The regulatory definition of core deposits may undergo a change due to the increase in Federal deposit insurance to $250,000 per account holder. If core deposits were defined as total deposits less time deposits over $250,000 and brokered deposits, the Company’s core deposits as a percentage of total assets would increase to 77.9%.

Asset liquidity is provided from several sources, including amounts due from banks and federal funds sold, unpledged securities, and funds from maturing loans. The Company had $19.4 million in cash and cash equivalents at December 31, 2011. The Bank has access to a line of credit with the Federal Home Loan Bank of Atlanta (“FHLB”), which is subject to various conditions and may be terminated at the option of the lender, as an additional source of liquidity funding. The line with the FHLB is equal to 10% of assets, provided that adequate collateral is available for pledging. The line may be used for short or long term funding needs and may be used on a fixed or variable-rate basis. As of December 31, 2011, the Bank had $2.4 million borrowed from the FHLB at a weighted average rate of interest equal to 3.74%, maturing at various dates through 2018. During 2011 the highest balance as of any month end for borrowings from the FHLB was $2.6 million. The average rate paid on advances during 2011 was 3.53%. The average balance of FHLB advances for 2011 was $2.7 million. During 2010, the highest balance as of any month end for borrowings from the FHLB was $9.7 million. The average rate paid on advances during 2010 was 2.50%. The average balance of FHLB advances for 2010 was $8.0 million.

At December 31, 2011, approximately $14.0 million of additional funds were available under the FHLB line provided that eligible collateral is available. The Bank primarily uses bonds and mortgage-backed securities issued by US Government agencies to collateralize advances, but can also pledge loans as collateral. As of December 31, 2011 securities or loans with a collateral value of $4.6 million were pledged as collateral to the FHLB above current required collateral amounts. Additional securities with a market value of $16.2 million were unpledged and could be used as collateral for borrowings should the Company require additional funding. Management believes that the Bank's overall liquidity sources are adequate to meet its operating needs in the ordinary course of its business.

Off-Balance Sheet Risk

The Company, through the operations of the Bank, makes contractual commitments to extend credit in the ordinary course of its business activities. These commitments are legally binding agreements to lend money to customers of the Bank at predetermined interest rates for a specified period of time. At December 31, 2011 and 2010, unfunded commitments to extend credit were $10.9 million and $10.8 million, respectively. At December 31, 2011, the unfunded commitments consisted of $8.5 million at variable rates and $2.4 million at fixed rates with $4.8 million expiring within one year. Past experience indicates that many of these commitments to extend credit will expire unused and it is unlikely that a large portion would be used in a short period of time. However, through its various sources of liquidity discussed above, the Bank believes that it will have the necessary resources to meet these obligations should the need arise.

In addition to commitments to extend credit, the Bank also issues standby letters of credit which are assurances to a third party that it will not suffer a loss if the Bank's customer fails to meet its contractual obligation to the third party. Standby letters of credit totaled approximately $1.0 million at December 31, 2011. Past experience indicates that many of these standby letters of credit will expire unused. However, through its various sources of liquidity discussed above, the Bank believes that it will have the necessary resources to meet these obligations should the need arise.

25

The Bank offers an automatic overdraft protection product. Approximately $1.1 million of overdraft protection is available under this product as of December 31, 2011. The Bank expects the majority of this capacity will not be utilized. During 2011, the average balance of demand deposit overdrafts was approximately $24,000.

Neither the Company nor the Bank is involved in other off-balance sheet contractual relationships, unconsolidated related entities that have off-balance sheet arrangements, or transactions that could result in liquidity needs or other commitments or significantly impact earnings. The Company did not maintain any obligations under non-cancelable operating lease agreements at December 31, 2011. The Company has approximately three years remaining on a five-year contract with a company which provides data, item and ATM processing services. The monthly costs are approximately $20,000. Refer to Notes 12 and 16 to the Company’s consolidated financial statements for additional discussion on these and other commitments and contingencies and financial instruments with off-balance sheet risk.

Capital Resources

At December 31, 2011, total shareholders’ equity decreased by approximately $876,000 from $18.4 million at December 31, 2010 to $17.5 million at December 31, 2011. The decrease was due the net loss, most of which related to recording of a valuation allowance on the Company’s deferred tax asset. The loss was partially offset by an increase in accumulated other comprehensive income related to market value increases on the Company’s available for sale securities,  and items related to stock based compensation. The Company does not anticipate it will need to raise additional capital in 2012 if the economy does not deteriorate further. The Company’s current plan is to maintain its overall asset size in 2012, and return to modest growth in 2013.

The Company made capital expenditures for furniture and equipment in 2011 totaling approximately $33,000. Capital expenditures for premises and equipment planned for 2012 consist of replacements of outdated computer equipment and an automated teller machine. There are no plans for additional premises in 2012.

The Company and the Bank are subject to regulatory capital adequacy standards. Under these standards, financial institutions are required to maintain certain minimum ratios of capital to risk-weighted assets and adjusted total assets (Tier 1 leverage ratio). Under the provisions of the Federal Deposit Insurance Corporation Improvements Act of 1991, federal financial institution regulatory authorities are required to implement prescribed "prompt corrective action" upon the deterioration of the capital position of a bank. If the capital position of an affected institution were to fall below certain levels, increasingly stringent regulatory corrective actions are mandated. Additionally, the OCC may require higher minimum capital ratios for an individual bank in view of its circumstances.  The Company’s and the Bank’s regulatory capital requirements and positions are summarized in Note 20 to the consolidated financial statements contained elsewhere herein.

In addition to the FDIC requirements detailed above, the Bank is currently required to maintain individual minimum capital ratios by the OCC. Those required ratios are: Total capital to risk weighted assets- 12.0%; Tier 1 capital to risk weighted assets- 11.0%; and Tier 1 capital to average assets- 9.0%.

The Federal Reserve has also established guidelines for capital requirements for bank holding companies that are similar to the FDIC’s guidelines for banks. At December 31, 2011 the Company exceeded all of the minimum requirements of the Federal Reserve guidelines.

Regulatory Actions

The Company has entered into a memorandum of understanding with the Federal Reserve Bank of Richmond (“FRB”). The memorandum of understanding requires the Company to seek permission from the FRB before it takes certain actions such as payment of cash dividends, redemption of outstanding stock, etc. The Company believes it is in compliance with the memorandum of understanding with the FRB as of December 31, 2011.

26

On May 12, 2010, the Bank entered into a formal agreement with the OCC requiring the Bank to take specified actions with respect to the operation of the Bank. The actions include: creation of a committee of the Bank's board of directors to monitor compliance with the agreement and make quarterly reports to the board of directors and the OCC; assessment and evaluation of management and members of the board; development, implementation and adherence to a written program to improve the bank's loan portfolio management; protection of its interest in its criticized assets; implementation of a program that identifies and manages concentrations of credit risk; extension of the Bank’s strategic plan; extension of the Bank’s capital program and profit plan; additional plans for ensuring that the level of liquidity at the Bank is sufficient to sustain the current operations and withstand any anticipated or extraordinary demand; and a requirement for obtaining a determination of no supervisory objection from the OCC before accepting brokered deposits. The substantive actions called for by the agreement should strengthen the Bank and make it more efficient in the long-term. The Bank believes it is in compliance with the requirements included in the formal agreement at December 31, 2011.

The OCC’s concern as of the date of the Formal Agreement was related to a concentration in Commercial Real Estate (“CRE”) lending. Specifically, total reported loans for construction, land development and other land loans represented 100% or more of the Bank’s total capital as of the examination date, and total CRE loans represented 300% or more of the Bank’s total capital.

Since the Bank entered into the Formal Agreement with the OCC, the Bank’s management has been monitoring concentrations according to the same methodology as that used by the regulatory agencies. Concentrations of credit are being controlled through modified credit underwriting standards and the immediate suspension of origination of residential speculative construction loans and residential development loans.  The Bank is located in a market where real estate is a major industry. It adopted more stringent underwriting standards through loan policy changes approved by the Board of Directors in early 2010 that have strengthened credit quality.  Furthermore, CRE loans are being underwritten in a manner such that repayment of the loan is not dependent solely on the sale of subject real estate.  A strong secondary source of repayment must exist and must be verified during the underwriting process to increase the probability that the loan will be paid according to the terms of the note.  Additionally, management is emphasizing owner-occupied CRE loans rather than non-owner occupied loans.  A CRE concentration report provides management and the Board data to ensure we are properly controlling concentrations.

Return on Equity and Assets

The following table shows the return on assets (net income divided by average total assets), return on equity (net income divided by average equity), dividend payout ratio (cash dividends declared per share divided by net income per share), and equity to assets ratio (average equity divided by average total assets) for the years ended December 31, 2011 and 2010.

	2011 December 31,			2010
Return on assets		(.88	%)		(.27	%)
Return on equity		(8.21	%)		(2.72	%)
Dividend payout ratio		-			-
Equity to assets ratio (average)		10.7	%		9.93	%

During 2012, the Bank’s plan of operation is to continue to attract new deposit customers, convert our nonperforming assets into interest earning assets, to increase the ratio of services per customer and increase the account profitability of the Bank’s current customers. The Bank plans to seek deposit accounts from individuals and businesses in the Easley, Berea, Powdersville and surrounding markets. The Bank intends to offer competitive rates for such accounts and may seek new accounts by offering rates slightly above those prevailing in the market. Management will continue to emphasize personal service, accessibility, and flexibility as reasons for customers to do business with the Bank. Personal contacts by management, advertising, and competitive prices and services will be the Bank’s principal marketing tools.

Inflation

Since the assets and liabilities of a bank are primarily monetary in nature (payable in fixed, determinable amounts), the performance of a bank is affected more by changes in interest rates than by inflation. Interest rates generally increase as the rate of inflation increases, but the magnitude of the change in rates may not be the same.

While the effect of inflation on banks is normally not as significant as is its influence on those businesses that have large investments in plant and inventories, it does have an effect. During periods of high inflation, there are normally corresponding increases in the money supply, and banks will normally experience above-average growth in assets, loans and deposits. Additionally, general increases in the prices of goods and services usually result in increased operating expenses.

27

Market for Common Equity and Related Stockholder Matters

The following table shows prices of our common stock reported by the OTC Bulletin Board for the past two years. The prices shown reflect actual trades as reported by the OTC Bulletin Board. No bid or ask prices were reported by OTC Bulletin Board for 2011 or 2010.

	Year ended December 31, 2011				Year ended December 31, 2010
	Low		High		Low		High
First Quarter	$	1.50	$	2.75	$	3.33	$	3.81
Second Quarter	$	1.25	$	1.60	$	4.28	$	4.52
Third Quarter	$	1.01	$	1.40	$	2.90	$	3.50
Fourth Quarter	$	1.27	$	1.30	$	1.70	$	2.80

Although the common stock of the Company may be traded from time to time on an individual basis, no active trading market has developed and none may develop in the foreseeable future. The common stock is not listed on any exchange. The stock is quoted (in terms of actual trades) on the OTC Bulletin Board under the symbol “CTOT.OB.”

As of February 22, 2012, there were 573 holders of record of the Company's common stock, excluding individual participants in security position listings.

The dividend policy of the Company is subject to the discretion of the Board of Directors and depends upon a number of factors, including earnings, financial conditions, cash needs and general business conditions, as well as applicable regulatory considerations, and the Company’s agreement with the FRB. Because the Company has no operations other than those of the Bank and only has limited income of its own, the Company would rely on dividends from the Bank as its principal source of cash to pay cash dividends.

Each national banking association is required by federal law to obtain the prior approval of the OCC, the primary Federal regulator of national banks, for the payment of dividends if the total of all dividends declared by the board of directors of such bank in any year will exceed the total of (i) such bank’s net profits (as defined and interpreted by regulation) for that year plus (ii) the retained net profits (as defined and interpreted by regulation) for the preceding two years, less any required transfers to surplus. In addition, national banks can only pay dividends to the extent that retained net profits (including the portion transferred to surplus) exceed bad debts (as defined by regulation).

The payment of dividends by the Company and the Bank may also be affected or limited by other factors, such as the requirements to maintain adequate capital above regulatory guidelines. In addition, if, in the opinion of the applicable regulatory authority, a bank under its jurisdiction is engaged in or is about to engage in an unsafe or unsound practice (which, depending on the financial condition of the Bank, could include the payment of dividends), such authority may require, after notice and hearing, that such bank cease and desist from such practice. The OCC has indicated that paying dividends that deplete a national bank’s capital base to an inadequate level would be an unsafe and unsound banking practice. The Federal Reserve, the OCC and the FDIC have issued policy statements, which provide that bank holding companies and insured banks should generally only pay cash dividends out of current operating earnings. Under its Memorandum of understanding with the FRB, the company is required to seek permission of the FRB prior to paying dividends.

28

Management's Annual Report on Internal Control Over Financial Reporting

Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f).  A system of internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.

Under the supervision and with the participation of management, including the principal executive officer and the principal financial officer, the Company’s management has evaluated the effectiveness of its internal control over financial reporting as of December 31, 2011 based on the criteria established in a report entitled “Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission” and the interpretive guidance issued by the Securities and Exchange Commission in Release No. 34-55929.  Based on this evaluation, the Company’s management has concluded that the Company's internal control over financial reporting was effective as of December 31, 2011.

29

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Shareholders and Board of Directors

Cornerstone Bancorp and Subsidiary

Easley, South Carolina

We have audited the accompanying consolidated balance sheets of Cornerstone Bancorp and Subsidiary (the “Company”) as of December 31, 2011 and 2010, and the related consolidated statements of income (loss), shareholders’ equity and comprehensive income (loss) and cash flows for each of the three years in the period ended December 31, 2011.  These consolidated financial statements are the responsibility of the Company's management.  Our responsibility is to express an opinion on these financial statements based on our audits.

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

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Cornerstone Bancorp and Subsidiary as of December 31, 2011 and 2010, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2011, in conformity with United States generally accepted accounting principles.

 /s/ Elliott Davis, LLC

Greenville, South Carolina

March 28, 2012

30

CORNERSTONE BANCORP AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

	December 31,
	2011			2010
Assets
Cash and due from banks	$	6,803,057		$	7,043,911
Federal funds sold		12,620,000			5,110,000
Cash and cash equivalents		19,423,057			12,153,911
Investment securities
Available-for-sale		27,742,623			23,592,336
Other investments		883,850			1,063,350
Loans, net		91,338,925			117,210,770
Property and equipment, net		5,024,113			5,230,835
Cash surrender value of life insurance policies		1,975,187			1,908,112
Property acquired in foreclosure		16,545,488			10,278,599
Other assets		1,390,168			2,530,552
Total assets	$	164,323,411		$	173,968,465
Liabilities And Shareholders’ Equity
Liabilities
Deposits
Noninterest bearing	$	17,087,736		$	10,382,882
Interest bearing		121,774,858			130,263,510
Total deposits		138,862,594			140,646,392
Customer repurchase agreements		1,767,550			2,945,937
Borrowings from Federal Home Loan Bank of Atlanta		2,441,505			6,592,338
Broker repurchase agreements		3,000,000			5,000,000
Other liabilities		769,152			425,086
Total liabilities		146,840,801			155,609,753
Commitments and contingencies – Notes 12 and 16
Shareholders’ equity
Preferred stock, 10,000,000 shares authorized, 1,038 shares issued at            December 31, 2011 and 2010		998,538			998,538
Common stock, no par value, 20,000,000 shares authorized, 2,210,769 shares issued at December 31, 2011 and 2010		18,909,600			18,859,924
Retained deficit		(2,907,929	)		(1,418,781	)
Accumulated other comprehensive (loss) income		482,401			(80,969	)
Total shareholders’ equity		17,482,610			18,358,712
Total liabilities and shareholders’ equity	$	164,323,411		$	173,968,465

The accompanying notes are an integral part of these consolidated financial statements.

31

CORNERSTONE BANCORP AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME (LOSS)

	Year ended December 31,
	2011			2010			2009
Interest Income
Loans and fees on loans	$	5,862,832		$	6,912,550		$	6,997,466
Investment securities		820,729			916,464			1,025,983
Federal funds sold and other		17,132			18,968			16,378
Total interest income		6,700,693			7,847,982			8,039,827
Interest Expense
Deposits		1,467,215			2,331,067			2,930,929
Federal funds and customer repurchase agreements		26,718			38,259			78,438
Federal Home Loan Bank advances		93,871			200,885			237,870
Broker repurchase agreements		239,746			177,103			176,619
Total interest expense		1,827,550			2,747,314			3,423,856
Net interest income		4,873,143			5,100,668			4,615,971
Provision for loan losses		670,000			1,260,000			2,955,000
Net interest income after provision for loan losses		4,203,143			3,840,668			1,660,971
Noninterest Income
Service fees on deposit accounts		531,437			536,480			572,973
Gain on sale of available-for-sale investments		-			325,656			299,063
Mortgage loan origination fees		-			-			154,905
Other		214,919			206,540			183,225
Total noninterest income		746,356			1,068,676			1,210,166
Noninterest Expenses
Salaries and benefits		2,181,085			2,238,400			2,392,717
Occupancy and equipment		530,827			542,138			572,025
Data processing		240,702			233,631			218,110
Advertising		27,171			21,225			30,258
Supplies		76,596			67,136			69,383
Professional and regulatory fees		574,367			584,539			551,330
Directors’ fees		130,550			137,025			138,475
Loan expenses		222,515			213,035			322,687
Holding costs of foreclosed property		527,850			461,598			117,272
Loss on sale of foreclosed property		193,693			180,397			228,547
Impairment of foreclosed property		430,513			709,751			-
Other operating expenses		394,337			406,509			411,344
Total noninterest expenses		5,530,206			5,795,384			5,052,148
Loss before income taxes		(580,707	)		(886,040	)		(2,181,011	)
Income tax expense (benefit)		908,441			(388,273	)		(819,737	)
Net loss		(1,489,148	)		(497,767	)		(1,361,274	)
Dividend on preferred stock		(88,077	)		(30,476	)		-
Loss available to common shareholders	$	(1,577,225	)	$	(528,243	)	$	(1,361,274	)
Loss Per Common Share
Basic	$	(.71	)	$	(.24	)	$	(.62	)
Diluted	$	(.71	)	$	(.24	)	$	(.62	)
Weighted Average Common Shares Outstanding
Basic		2,210,769			2,210,769			2,208,191
Diluted		2,210,769			2,210,769			2,208,191

The accompanying notes are an integral part of these consolidated financial statements.

32

CORNERSTONE BANCORP AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

 AND COMPREHENSIVE INCOME (LOSS)

									Retained			Accumulated other			Total
	Preferred stock			Common stock					earnings			comprehensive			shareholders’
	Shares		Amount	Shares		Amount			(deficit)			income (loss)			equity
Balance, December 31, 2008	-	$	-	1,991,565	$	18,323,333		$	765,906		$	47,708		$	19,136,947
Net loss	-		-	-		-			(1,361,274	)		-			(1,361,274	)
Other comprehensive income,   net of income taxes:
Unrealized gain on investment securities	-		-	-		-			-			112,983			112,983
Comprehensive loss															(1,248,291	)
Stock based compensation	-		-	-		72,464			-			-			72,464
Stock option exercises	-		-	14,172		80,000			-			-			80,000
Stock dividend (5%), net of cash in lieu of fractional shares	-		-	100,001		323,931			(325,646	)		-			(1,715	)
Balance, December 31, 2009	-		-	2,105,738		18,799,728			(921,014	)		160,691			18,039,405
Net loss	-		-	-		-			(497,767	)		-			(497,767	)
Other comprehensive income, net of income taxes:
Unrealized loss on investment securities	-		-	-		-			-			(241,660	)		(241,660	)
Comprehensive loss															(739,427	)
Stock based compensation	-		-	-		61,220			-			-			61,220
Preferred stock issuance, net of offering expenses	1,038		998,538	-		-			-			-			998,538
Stock dividend (5%), net of cash in lieu of  fractional shares	-		-	105,031		(1,024	)		-			-			(1,024	)
Balance, December 31, 2010	1,038		998,538	2,210,769		18,859,924			(1,418,781	)		(80,969	)		18,358,712
Net loss	-		-	-		-			(1,489,148	)		-			(1,489,148	)
Other comprehensive income, net of       income taxes:
Unrealized gain on investment securities	-		-	-		-			-			563,370			563,370
Comprehensive loss															(925,778	)
Stock based compensation	-		-	-		49,676			-			-			49,676
Balance, December 31, 2011	1,038	$	998,538	2,210,769	$	18,909,600		$	(2,907,929	)	$	482,401		$	17,482,610

The accompanying notes are an integral part of these consolidated financial statements

33

CORNERSTONE BANCORP AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

	Year ended December 31,
	2011			2010			2009
Operating Activities
Net loss	$	(1,489,148	)	$	(497,767	)	$	(1,361,274	)
Adjustments to reconcile net loss to net cash provided by (used for) operating activities
Depreciation and net amortization		538,477			484,081			351,303
Deferred income tax expense (benefit)		908,441			(132,306	)		(37,863	)
Provision for loan losses		670,000			1,260,000			2,955,000
Impairment of foreclosed property		430,513			709,751			-
Gain on sale of available-for-sale investments		-			(325,656	)		(299,063	)
Loss on sale of repossessed collateral		193,693			180,397			228,547
(Gain) loss on sale/disposal of property and equipment		3,539			1,881			(625	)
Non-cash option expense		49,676			61,220			72,464
(Increase) decrease in other assets		164,868			1,508,383			(2,459,514	)
Increase in other liabilities		53,844			101			145,474
Net cash provided by (used for) operating activities		1,523,903			3,250,085			(405,551	)
Investing Activities
Proceeds from maturities and principal paydowns of investment securities		8,932,818			8,277,549			5,901,304
Proceeds from sale of investment securities		-			8,120,975			10,752,749
Proceeds from sale of foreclosed property		4,389,988			3,947,388			2,498,705
Purchase of investment securities		(12,532,290	)		(11,385,110	)		(25,495,248	)
(Purchase) sale of FHLB and Federal Reserve stock, net		179,500			78,700			(27,900	)
(Increase) decrease in loans, net		14,112,651			8,558,681			(17,167,459	)
Proceeds from sale of property and equipment		425			-			625
Capitalization of improvements to foreclosed property		(191,889	)		(364,989	)		(63,943	)
Purchase of property and equipment		(32,942	)		(169,697	)		(5,448	)
Net cash provided by (used for) investing activities		14,858,261			17,063,497			(23,606,615	)
Financing Activities
Net (decrease) increase in deposits		(1,783,798	)		(11,734,882	)		29,799,700
Net decrease in customer repurchase agreements		(1,178,387	)		(311,065	)		(1,325,617	)
Net decrease Federal funds purchased		-			-			(1,810,000	)
Borrowings from Federal Home Loan Bank of Atlanta		-			-			4,500,000
Repayments to Federal Home Loan Bank of Atlanta		(4,150,833	)		(3,150,834	)		(5,150,833	)
Proceeds from sale of preferred stock, net of expenses		-			998,538			-
Repayments of broker repurchase agreements		(2,000,000	)		-			-
Proceeds from exercise of stock options		-			-			80,000
Cash paid in lieu of fractional shares		-			(1,024	)		(1,715	)
Net cash (used for) provided by financing activities		(9,113,018	)		(14,199,267	)		26,091,535
Net increase in cash and cash equivalents		7,269,146			6,114,315			2,079,369
Cash and cash equivalents, beginning of year		12,153,911			6,039,596			3,960,227
Cash and cash equivalents, end of year	$	19,423,057		$	12,153,911		$	6,039,596
Cash paid for:
Interest	$	1,860,780		$	2,776,547		$	3,457,004
Income taxes (refunds, received)	$	(208,897	)	$	(892,557	)	$	54,946
Non-cash Supplemental information:
Loans transferred to foreclosed property	$	11,089,194		$	8,038,463		$	8,922,517
Loans charged-off, net	$	1,330,990		$	1,251,907		$	1,958,726

The accompanying notes are an integral part of these consolidated financial statements

34

CORNERSTONE BANCORP AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES

Cornerstone Bancorp, (the "Company") was incorporated under the laws of the State of South Carolina for the purpose of operating as a bank holding company for Cornerstone National Bank (the "Bank"). The Company obtained regulatory approval to acquire the Bank and opened the Bank for business in 1999 with a total capitalization of $6.0 million. To increase capital available for growth, the Company offered 445,000 shares of its common stock pursuant to a prospectus dated October 4, 2005. Upon completion in January 2006, the offering added approximately $6.0 million to the Company’s total capitalization. In 2010 the Company offered 8% cumulative perpetual preferred stock (“the Preferred”) to accredited investors. The Company sold 1,038 shares of the Preferred, raising $998,538 net of offering expenses. The Company increased its investment in the Bank by approximately $500,000 and held the remaining cash in order to pay future expenses and dividends on the Preferred.

The Bank provides full commercial banking services to customers and is subject to regulation by the Office of the Comptroller of the Currency (“OCC”) and the Federal Deposit Insurance Corporation. The Company is subject to regulation by the Federal Reserve and to limited regulation by the South Carolina State Board of Financial Institutions. The Bank maintains branch locations in the Berea area of Greenville County and the Powdersville area of Anderson County, South Carolina in addition to its headquarters in Easley in Pickens County, South Carolina. In 2004, the Bank established a wholly owned subsidiary, Crescent Financial Services, Inc. (“Crescent”), which is an insurance agency. In 2011, 2010 and 2009, Crescent’s transactions were immaterial to the consolidated financial statements.

Basis of presentation

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, the Bank. The Company operates as one business segment. All significant intercompany balances and transactions have been eliminated. The accounting and reporting policies conform to accounting principles generally accepted in the United States of America (“GAAP”) and to general practices in the banking industry. The Company uses the accrual basis of accounting.

Estimates

The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amount of income and expenses during the reporting periods. Actual results could differ from those estimates.

Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses, including valuation allowances for impaired loans, and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans.  In connection with the determination of the allowance for loan losses and the valuation of foreclosed real estate, management obtains independent appraisals for significant properties and takes into account other current market information.  While management uses available information to recognize losses on loans and foreclosed real estate, future additions to the allowance for loan losses and changes to valuation of foreclosed real estate may be necessary based on changes in local economic conditions.  In addition, regulatory agencies, as an  integral  part of their  examination  process,  periodically  review  the Company's  allowance  for  loan losses  and  valuation of foreclosed  real  estate.  Such agencies may require the Company to recognize additions to the allowance for loan losses or additional write-downs on foreclosed real estate based on their judgments about information available to them at the time of their examination.  Because of these factors, it is reasonably possible that estimates related to the allowance for loan losses and valuation of foreclosed real estate may change materially in the near term.

Investment securities

The Company accounts for investment securities in accordance with financial accounting standards which require investments in equity and debt securities to be classified into three categories:

(Continued)

35

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES, Continued

1.   Available-for-sale securities: These are securities that are not classified as either held to maturity or as trading securities. These securities are reported at fair market value. Unrealized gains and losses are reported, net of income taxes, as separate components of shareholders’ equity (accumulated other comprehensive income).

2.   Held-to-maturity securities: These are investment securities that the Company has the ability and intent to hold until maturity. These securities are stated at cost, adjusted for amortization of premiums and the accretion of discounts. The Company has no held-to-maturity securities.

3.   Trading securities: These are securities that are bought and held principally for the purpose of selling in the near future. Trading securities are reported at fair market value, and related unrealized gains and losses are recognized in the income statement. The Company has no trading securities.

The Company reviews all investments with unrealized losses as of the balance sheet date for possible impairment. Our review consists of an examination of each security with regard to its issuer, credit rating, time to maturity and likelihood of sale prior to maturity. Any losses determined to be other than temporary are recognized through the income statement. Unrealized gains and losses are determined using fair values estimated by the Company’s bond accounting vendor. The vendor uses several pricing services for valuing securities, depending on the issuer of the security. Management reviews the fair values for appropriateness and consults an additional vendor to ensure that fair value estimates are reasonable. The portfolio contained Agency mortgage backed securities and municipal bonds as of December 31, 2011. There were no private-label mortgage-backed securities, collateralized mortgage obligations, or derivative products in the portfolio as of December 31, 2011. The fair values of the Company's available for sale investments,  other than municipal bonds, are measured on a recurring basis using  quoted  market  prices  in  active  markets  for  identical   assets  and liabilities ("Level 1 inputs" under the standard). Due to the lower level of trading activity in municipal  bonds,  the fair market values of these  investments are measured based on other inputs such as inputs that are  observable  or can be corroborated by observable market data for similar assets with substantially the same terms ("Level 2 inputs" under the standard.)

Other investments include the Bank’s stock investments in the Federal Reserve Bank of Richmond (“Reserve Bank”) and the Federal Home Loan Bank of Atlanta (“FHLB”). The Bank, as a member institution, is required to own certain stock investments in the Reserve Bank and FHLB. The stock is generally pledged against any borrowings from the Reserve Bank and FHLB. No ready market exists for the stock and it has no quoted market value. Redemption of these stock investments has historically been (including redemptions during 2011) at par value. However, there can be no assurance that future redemptions will be at par value. Other investments are carried at cost.

Gains or losses on dispositions of investment securities are based on the differences between the net proceeds and the adjusted carrying amount of the securities sold, using the specific identification method.

Loans, interest and fee income on loans

Loans are stated at the principal balance outstanding. Unearned discount and the allowance for possible loan losses are deducted from total loans in the balance sheet. Interest income is recognized over the term of the loan based on the principal amount outstanding.

Generally, the accrual of interest will be discontinued on impaired loans when principal or interest becomes 90 days past due, or when payment in full is not anticipated, and any previously accrued interest on such loans will be reversed against current income. Any subsequent interest income will be recognized on a cash basis when received unless collectibil­ity of a significant amount of principal is in serious doubt. In such cases, collections are credited first to the remaining principal balance on a cost recovery basis. An impaired loan will not be returned to accrual status unless principal and interest are current and the borrower has demonstrated the ability to continue making payments as agreed. The ability to continue making payments as agreed is determined on a case-by-case basis due to the mainly commercial nature of the Bank’s portfolio. Non-performing assets include real estate acquired through foreclosure or deed taken in lieu of foreclosure, and loans on non-accrual status. Fee income on loans is recognized as income at the time loans are originated. Due

(Continued)

36

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES, Continued

to the short-term nature of the majority of the Bank’s loans and the immateriality of the net deferred amount, this method approximates the income that would be earned if the Company deferred loan fees and costs.

Allowance for loan losses

The Company provides for loan losses using the allowance method. Loans that are determined to be uncollectible are charged against the allowance. Provisions for loan losses and recoveries on loans previously charged off are added to the allowance. The provision for loan losses charged to operating expenses reflects the amount deemed appropriate by management to establish an adequate reserve to meet the probable loan losses incurred in the current loan portfolio. Management’s judgment is based on periodic and regular evaluation of individual loans, the overall risk characteristics of the various portfolio segments, past experience with losses, delinquency trends, and prevailing economic conditions. To estimate the amount of allowance necessary the Company separates the portfolio into segments. The portfolio is first separated into groups according to the internal loan rating assigned by management. Loans rated “Other Assets Especially Mentioned” (“OAEM”) or “Special Mention”, “Substandard”, “Doubtful”, or “Loss” as defined in the Bank’s loan policy, are evaluated individually for impairment. The Company uses regulatory call report codes to stratify the remaining portfolio and tracks the Bank’s own charge-offs and those of peer banks using FDIC Call Report Data. The Bank’s own charge-off ratios by call code are used to project potential loan losses in the future on loans that are rated “Satisfactory” or better. Charge-off ratios may be increased or decreased based on other environmental factors which may need to be considered, such as unemployment rates and volatility of real estate values. While management uses the best information available to make evaluations, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the evaluations. The allowance for loan losses is also subject to periodic evaluation by various regulatory authorities and may be subject to adjustment upon their examination. Refer to Note 5 for additional information.

The Bank accounts for impaired loans in accordance with a financial accounting standard that requires all lenders to value a loan at the loan’s fair value if it is probable that the lender will be unable to collect all amounts due according to the terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis taking into consideration all the circumstances of the loan and the borrower, including the length of the delay, reasons for the delay, the borrower’s payment record and the amount of the shortfall in relation to the principal and interest owed. The fair value of an impaired loan may be determined based upon the present value of expected cash flows, market price of the loan, if available, or value of the underlying collateral. Expected cash flows are required to be discounted at the loan’s effective interest rate. The Bank’s loan portfolio is largely dependent on collateral for repayment if the borrower’s financial position deteriorates. Therefore, the most common type of valuation is to determine collateral value less disposal costs in order to determine carrying values for loans deemed impaired. If an impaired loan is collateral dependent and the fair value is less than the outstanding principal balance, the short-fall is charged-off to the allowance for loan losses. Costs to sell the collateral may be specifically reserved in the allowance for loan losses until the foreclosure of the collateral is complete and the balance is moved to foreclosed property.

When the ultimate collectibility of an impaired loan’s principal is in doubt, wholly or partially, all cash receipts are applied to principal. Once the reported principal balance has been reduced to zero, future cash receipts are applied to interest income, to the extent that any interest has been foregone. Further cash receipts are recorded as recoveries of any amounts previously charged off. A loan is also considered impaired if its terms are modified in a troubled debt restructuring. For these accruing impaired loans, cash receipts are typically applied to principal and interest receivable in accordance with the terms of the restructured loan agreement. Interest income is recognized on these loans using the accrual method of accounting.

Property acquired in foreclosure

Property acquired in foreclosure is carried at fair value (market value less estimated selling cost), determined using an independent appraisal. Write-downs of value occur if properties are determined to have lost value based on updated appraisals. Costs to complete properties are capitalized if the as-complete market value less estimated cost is higher than the recorded investment including the cost to complete.

(Continued)

37

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES, Continued

Holding costs are charged to expense as incurred.

Property and equipment

Property and equipment are stated at cost, net of accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets. Maintenance and repairs are charged to operations, while major improvements are capitalized. Upon retirement, sale or other disposition of property and equipment, the cost and accumulated depreciation are eliminated from the accounts, and gain or loss is included in income from operations.

Income taxes

The Company accounts for income taxes in accordance with a financial accounting standard that requires that deferred tax assets and liabilities be recognized for the expected future tax consequences of events that have been recognized in the consolidated financial statements or tax returns. Deferred tax assets and liabilities are measured using the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be realized or settled. During 2011 the Company recorded a valuation allowance against all net deferred tax assets. Refer to Note 14 for additional information.

The Company has analyzed its filing positions in the federal and state jurisdictions where it is required to file income tax returns, as well as all open tax years in these jurisdictions. The Company believes that income tax filing positions taken or expected to be taken in its tax returns will more likely than not be sustained upon audit by the taxing authorities and does not anticipate any adjustments that will result in a material adverse impact on the Company’s financial condition, results of operations, or cash flows. Therefore, no reserves for uncertain income tax positions have been recorded. The Company’s federal and state income tax returns are open and subject to examination from the 2008 tax return and forward.

Advertising and public relations expense

Advertising, promotional and other business development costs are generally expensed as incurred. External costs incurred in producing media advertising are expensed the first time the advertising takes place. External costs relating to direct mailing costs are expensed in the period in which the direct mailings are sent.

Earnings per common share

Basic earnings (loss) per common share is computed on the basis of the weighted average number of common shares outstanding. The treasury stock method is used to compute the effect of stock options on the weighted average number of common shares outstanding for diluted earnings (loss) per common share. As of December 31, 2011, 2010, and 2009 there were no common stock equivalents included in the Company’s loss per share calculation. Options to purchase 102,169 shares, 111,565 shares and 106,255 shares of common stock were antidilutive as of December 31, 2011, 2010 and 2009, respectively, and were excluded from the diluted share calculation. The Company declared a five percent stock dividend to shareholders of record on May 11, 2010. For 2009, per share amounts on the Consolidated Statements of income (loss) have been retroactively restated to reflect the 2010 stock dividend.

Cash surrender value of life insurance policies

Cash surrender value of life insurance policies represents the cash value of policies on certain officers of the Bank.

Statement of cash flows

For purposes of reporting cash flows, cash and cash equivalents are those amounts which have an original maturity of three months or less.

Fair values of financial instruments

        The Company discloses fair value information for financial instruments, whether or not recognized in the balance

(Continued)

38

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES, Continued

sheet, when it is practicable to estimate the fair value. Under GAAP, a financial instrument is defined as cash, evidence of an ownership interest in an entity or contractual obligations that require the exchange of cash or other financial instruments. Certain items are specifically excluded from the disclosure requirements, including the Company's common stock. In addition, other nonfinancial instruments such as premises and equipment and other assets and liabilities are not subject to the disclosure requirements.

The following methods and assumptions were used by the Company in estimating fair values of financial instruments as disclosed herein:

Cash and due from banks -The carrying amounts of cash and due from banks approximate their fair value.

Federal funds sold - The carrying amounts of federal funds sold approximate their fair value.

Cash surrender value of life insurance policies - The cash surrender value of life insurance policies held by the Bank approximates fair values of the policies.

Loans - For variable rate loans that reprice frequently and for loans that mature within one year, fair values are based on carrying values. Fair values for all other loans are estimated using discounted cash flow analyses, with interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Fair values for impaired loans are estimated using discounted cash flow analyses or underlying collateral values less cost to sell, where applicable.

Deposits - Fair values for deposits are estimated using a discounted cash flow calculation that applies interest rates currently being offered on similar accounts to a schedule of aggregated expected monthly maturities. Repricing time frames for non-maturing deposits are estimated using Federal Deposit Insurance Corporation Improvement Act Section 305 guidelines.

Customer repurchase agreements - Fair values of repurchase agreements are estimated using a discounted cash flow analysis that applies interest rates currently being offered on similar accounts to a schedule of aggregated expected monthly maturities.

Borrowings from Federal Home Loan Bank of Atlanta -Borrowings from the FHLB which have variable rates of interest are deemed to be carried at fair value. Fair values of fixed rate advances are estimated using a discounted cash flow calculation that applies interest rates currently being offered on advances to a schedule of aggregated expected maturities.

Broker repurchase agreements - Fair values of broker repurchase agreements are estimated using a discounted cash flow analysis that applies interest rates currently being offered on similar accounts to a schedule of aggregated expected monthly maturities.

Stock Based Compensation

The Company has a stock-based director and employee compensation plan (the “2003 Plan”) as further described in Note 18. Stock dividends were declared subsequent to the grant dates of the options. Pursuant to the terms of the 2003 Plan option agreements, the number of options outstanding was increased and the exercise price was decreased to give effect to these stock dividends.

The Company accounts for stock based compensation in accordance with GAAP. Fair value of an option grant is estimated on the date of grant using the Black-Scholes option pricing model.

Cumulative Perpetual Preferred Stock (8%)

During the third quarter of 2010, the Company offered up to $2,500,000 of 8% Series A Cumulative Perpetual Preferred Stock (“the Preferred”) to accredited investors and up to 35 non-accredited investors. The Preferred was offered by the Company’s directors and executive officers, and no selling agents or underwriters were used. 1,038 shares of the Preferred were sold. Proceeds of the offering, net of offering expenses totaled

(Continued)

39

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES, Continued

$998,538. The Preferred is scheduled to pay a dividend quarterly. However, pursuant to the Company’s Memorandum of Understanding with the Federal Reserve, the Federal Reserve has declined to approve the dividends scheduled for payment to date. Dividends that have accumulated, but have not been declared or

accrued since inception of the Preferred, total $118,553 as of December 31, 2011. See Note 20 for more information about the Memorandum of Understanding.

Recently issued accounting standards

The following is a summary of recent authoritative pronouncements that affect accounting, reporting, and disclosure of financial information by the Company:

In July 2010, the Receivables topic of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) was amended by Accounting Standards Update (“ASU”) 2010-20 to require expanded disclosures related to a company’s allowance for credit losses and the credit quality of its financing receivables. The amendments require the allowance disclosures to be provided on a disaggregated basis.  The Company included these disclosures in its financial statements (see Note 5).

In April 2011, FASB issued ASU 2011-02 to assist creditors with their determination of when a restructuring is a Troubled Debt Restructuring (“TDR”).   The determination is based on both whether the restructuring constitutes a concession and whether the debtor is experiencing financial difficulties. Disclosures related to TDRs under ASU 2010-20 were effective for reporting periods beginning after June 15, 2011.  Adoption of the standard did not have a material effect on the financial statements.  Disclosures related to TDRs under ASU 2010-20 have been presented in Note 5.

In April 2011, the criteria used to determine effective control of transferred assets in the Transfers and Servicing topic of the ASC was amended by ASU 2011-03.  The requirement for the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms and the collateral maintenance implementation guidance related to that criterion were removed from the assessment of effective control.  The other criteria to assess effective control were not changed.  The amendments are effective for the Company beginning January 1, 2012 but are not expected to have a material effect on the financial statements.

ASU 2011-04 was issued in May 2011 to amend the Fair Value Measurement topic of the ASC by clarifying the application of existing fair value measurement and disclosure requirements and by changing particular principles or requirements for measuring fair value or for disclosing information about fair value measurements.  The amendments will be effective for the Company beginning January 1, 2012 but are not expected to have a material effect on the financial statements.

The Comprehensive Income topic of the ASC was amended in June 2011.  The amendment eliminates the option to present other comprehensive income as a part of the statement of changes in stockholders’ equity.  The amendment requires consecutive presentation of the statement of net income and other comprehensive income and requires an entity to present reclassification adjustments from other comprehensive income to net income on the face of the financial statements.  The amendments will be applicable to the Company on January 1, 2012 and will be applied retrospectively.  They are not expected to have an effect on the financial statements.

 Accounting standards that have been issued or proposed by the Financial Accounting Standards Board that do not require adoption until a future date are not expected to have a material impact on the consolidated financial statements upon adoption.

Subsequent events

Subsequent events are events or transactions that occur after the balance sheet date but before the financial statements are issued. Recognized subsequent events are events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements. Nonrecognized subsequent events are events that provide evidence

(Continued)

40

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES, Continued

about conditions that did not exist at the date of the balance sheet but arose after that date. Management has reviewed events occurring through the date the financial statements were available to be issued and no subsequent events occurred requiring accrual or disclosure.

Formal Agreement with the Office of the Comptroller of the Currency

On May 12, 2010, the Bank entered into a formal agreement with the OCC for the Bank to take various actions with respect to the operation of the Bank. The actions include creation of a committee of the Bank's board of directors to monitor compliance with the agreement and make quarterly reports to the board of directors and the OCC; assessment and evaluation of management and members of the board; development, implementation and adherence to a written program to improve the Bank's loan portfolio management; protection of the Bank’s interest in its criticized assets; implementation of a program that identifies and manages concentrations of credit risk (see Note 5); extension of the Bank’s strategic plan; extension of the Bank’s capital program and profit plan; additional plans for ensuring that the level of liquidity at the Bank is sufficient to sustain the current operations and withstand any anticipated or extraordinary demand; and a requirement for obtaining a determination of no supervisory objection from the OCC before accepting brokered deposits. The substantive actions called for by the agreement should strengthen the Bank and make it more efficient in the long-term. The Bank believes it has taken appropriate actions at December 31, 2011 to comply with the requirements included in the formal agreement.

Risks and Uncertainties

In the normal course of its business the Company encounters two significant types of risks: economic and regulatory. There are three main components of economic risk: interest rate risk, credit risk and market risk. The Company is subject to interest rate risk to the degree that its interest-bearing liabilities mature or reprice at different times, or on different bases, than its interest-earning assets. Credit risk is the risk of default on the Company’s loan and investment portfolios that results from borrowers’ inability or unwillingness to make contractually required payments. Market risk reflects changes in the value of collateral underlying loans receivable and the valuation of real estate held by the Company.

The Company is subject to the regulations of various governmental agencies (regulatory risk). These regulations can and do change significantly from period to period. The Company also undergoes periodic examinations by the regulatory agencies, which may subject it to further changes with respect to asset valuations, amounts of required loss allowances and operating restrictions as a result of the regulators’ judgments based on information available to them at the time of their examination.

Reclassification

Certain amounts in prior years’ financial statements have been reclassified to conform to current year presentation. No changes have been made that affect the reported results of operations, financial condition or cash flows.

NOTE 2 – RESTRICTIONS ON CASH AND DUE FROM BANKS

The Bank is required to maintain average reserve balances, computed by applying prescribed percentages to its various types of deposits, either at the Bank or on deposit with the Reserve Bank. At December 31, 2011 and 2010 these required reserves were met by vault cash.

NOTE 3 - FEDERAL FUNDS SOLD

When the Bank's cash reserves (Note 2) are in excess of the required amount, it may lend any excess to other banks on a daily basis. As of December 31, 2011 and 2010 federal funds sold amounted to $12,620,000 and $5,110,000, respectively.

41

NOTE 4 – INVESTMENT SECURITIES

The amortized cost and fair value of investment securities available-for-sale are as follows:

	December 31, 2011
	Amortized		Gross unrealized				Fair
	Cost		Gains		Losses		Value
Mortgage-backed securities	$	18,702,842	$	291,211	$	21,567	$	18,972,486
Municipal bonds		8,308,992		461,145		-		8,770,137
Total investment securities available- for-sale	$	27,011,834	$	752,356	$	21,567	$	27,742,623
	December 31, 2010
	Amortized		Gross unrealized				Fair
	Cost		Gains		Losses		Value
Government sponsored enterprise bonds	$	4,486,806	$	21,597	$	131,752	$	4,376,651
Mortgage-backed securities		10,909,120		132,800		48,842		10,993,078
Municipal bonds		8,319,212		123,001		219,606		8,222,607
Total investment securities available- for-sale	$	23,715,138	$	277,398	$	400,200	$	23,592,336

While three of the Company’s securities available-for-sale are in an unrealized loss position as of December 31, 2011, none have been in an unrealized loss position for twelve months or more. None of these securities are expected to have a loss of principal at final maturity. The unrealized losses were primarily attributable to changes in interest rates, rather than deterioration in credit quality. These securities are agency mortgage-backed securities and therefore pose minimal credit risk. The Company believes it is more likely than not it will hold these securities until such time as the value recovers or the securities mature. During 2008, the Company recognized other-than-temporary-impairment on the FNMA preferred stock of $606,054, net of tax, based on FNMA’s being placed into conservatorship by the U.S. Treasury Department.  The Company sold the FNMA preferred stock in 2009 at an additional loss of $58,788.

The table below summarizes, by investment category, the length of time that individual securities have been in a continuous loss position as of December 31, 2011 and 2010.

	December 31, 2011
	Less than Twelve Months				Over Twelve Months				Total Unrealized Losses
	Gross Unrealized Losses		Fair Value		Gross Unrealized Losses		Fair Value
Mortgage-backed securities	$	21,567	$	5,944,428	$	-	$	-	$	21,567
Municipal bonds		-		-		-		-		-
Total	$	21,567	$	5,944,428	$	-	$	-	$	21,567

December 31, 2010
Less than Twelve Months		Over Twelve Months				Total Unrealized Losses
Gross Unrealized Losses	Fair Value	Gross Unrealized Losses		Fair Value
			-		-

Government sponsored enterprise bonds	$	131,752	$	1,868,247	$	-	$	-	$	131,752
Mortgage-backed securities		48,842		5,279,417		-		-		48,842
Municipal bonds		219,606		4,755,566		-		-		219,606
Total	$	400,200	$	11,903,230	$	-	$	-	$	400,200

(Continued)

42

NOTE 4 – INVESTMENT SECURITIES, Continued

At December 31, 2011 and 2010, securities with a fair value of $11,527,285 and $17,091,060, respectively, were pledged to collateralize public deposits, sweep accounts, advances from the FHLB, and repurchase agreements. During 2011 the Company sold no securities. During 2010, the Company sold securities with a fair value of $8,120,975 and recognized a net gain on the sale of those securities of $325,656. During 2009, the Company sold securities with a fair value of $10,752,749 and recognized a net gain on the sale of those securities of $299,063.

The amortized cost and fair value of securities at December 31, 2011, by contractual maturity, are shown in the following chart. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

	December 31, 2011
	Amortized Cost		Fair Value
Due within one year	$	11,648	$	11,790
Due after one through five years		984,346		1,024,805
Due after five through ten years		1,316,163		1,431,382
After ten years or no maturity		24,699,677		25,274,646
Total investment securities	$	27,011,834	$	27,742,623

The Bank, as a member institution, is required to own stock in the Reserve Bank and the FHLB. These stocks are included at cost in the accompanying Consolidated Balance Sheets under the caption “Other investments.” No ready market exists for these stock investments and they have no quoted market value. Redemption of these stocks has historically been at par value. Redemption of the FHLB stock may be subject to limitations regarding timing and amounts may be subject to impairment risk in the future. The Company evaluates the FHLB stock for impairment based on the probability of ultimate recoverability or the recorded amount of the investment. The FHLB redeemed stock at par from the Bank and other members in 2011. No impairment has been recognized based on this evaluation. Stock held in the FHLB is pledged as collateral against advances from the FHLB.

NOTE 5 – LOANS

The composition of net loans by category as used by management to evaluate the quality of the portfolio is presented below.

	December 31,
	2011			2010
Loans secured by real estate-construction	$	26,811,333		$	41,855,338
Loans secured by real estate- single family (1)		14,341,533			19,604,943
Loans secured by real estate-nonfarm, non-residential		40,005,619			43,080,225
Loans secured by real estate-multifamily		1,694,088			1,793,400
Commercial and industrial		9,841,720			12,580,841
Consumer		687,072			999,453
Loans, gross		93,381,365			119,914,200
Less allowance for loan losses		(2,042,440	)		(2,703,430	)
Loans, net	$	91,338,925		$	117,210,770

 (1)The category includes HELOCs and junior liens. HELOCs totaled $6.0 million and $7.6 million as of December 31, 2011 and 2010, respectively. Closed-end junior liens totaled $111,841 and $155,219 as of December 31, 2011 and 2010, respectively

Loan Portfolio Composition

One of the primary components of the Bank’s loan portfolio is loans secured by first or second mortgages on residential and commercial real estate. These loans generally consist of short to mid-term commercial real estate loans, construction and development loans, and residential real estate loans (including home equity and second mortgage loans).  Interest rates may be fixed or adjustable and the Bank frequently charges an origination fee. The Bank has not purchased any loans. The Bank seeks to manage market and credit risk in the commercial real estate portfolio by emphasizing loans on owner-occupied office and retail buildings where the loan-to-value ratio at origination,

(Continued)

43

NOTE 5 – LOANS, Continued

established by independent appraisals, does not exceed 80%. In addition, the Bank generally requires personal guarantees of the principal owners of the property. The loan-to-value ratio at origination for first and second mortgage loans generally does not exceed 80%, and for construction loans, generally does not exceed 75% of cost. The Bank employs a reappraisal policy to routinely monitor real estate collateral values on real estate loans where the repayment is dependent on sale of the collateral. The Bank generally does not offer development loans with interest reserve features. In addition, in an effort to control interest rate risk, long term residential mortgages are not originated for the Bank’s portfolio.

The Bank does not make long term (more than 15 years) mortgage loans to be held in its portfolio, and does not offer loans with negative amortization features or long-term interest only features, or loans with loan to collateral value ratios in excess of 100% at the time the loan is made. The Bank does offer loan products with features that can increase credit risk during periods of declining economic conditions, such as adjustable rate loans, short-term interest-only loans, and loans with amortization periods that differ from the maturity date (i.e., balloon payment loans). However, the Bank evaluates each customer’s creditworthiness based on the customer’s individual circumstances, and current and expected economic conditions, and underwrites and monitors each loan for associated risks. Loans made with exceptions to internal loan guidelines and those with loan-to-value ratios in excess of regulatory loan-to-value guidelines are monitored and reported to the Board of Directors on a monthly basis. The regulatory loan-to-value guidelines permit exceptions to the guidelines up to a maximum of 30% of total capital for commercial loans and exceptions for all types of real estate loans up to a maximum of 100% of total capital. As of December 31, 2011, the Bank had $3.7 million of loans which exceeded the regulatory loan to value guidelines. This amount is within the maximum allowable exceptions to the guidelines. Of the $3.7 million of loans with exceptions to the regulatory loan to value guidelines, $2.4 million, or approximately 63%, were not exceptions at the time the loans were made, but became exceptions upon reappraisal. Management routinely reappraises real estate collateral based on specific criteria and circumstances. If additional collateral is available, the Bank may require the borrower to commit additional collateral to the loan or take other actions to mitigate the Bank’s risk.

The Bank makes loans for commercial purposes in various lines of business. Commercial loans include both secured and unsecured loans for working capital (including inventory and receivables), loans for business expansion (including acquisition of real estate and improvements), and loans for purchases of equipment and machinery. Equipment loans are typically made for a term of five years or less at either fixed or variable rates, with the loan fully amortized over the term and secured by the financed equipment. Working capital loans typically have terms not exceeding one year and are usually secured by accounts receivable, inventory or personal guarantees of the principals of the business. Commercial loans vary greatly depending upon the circumstances, and loan terms are structured on a case-by-case basis to better serve customer needs.

The risks associated with commercial loans vary with many economic factors, including the economy in the Bank’s market areas. The well-established banks in the Bank’s market areas make proportionately more loans to medium- to large-sized businesses than the Bank makes. Many of the Bank’s commercial loans are made to small- to medium-sized businesses, which typically are not only smaller, but also have shorter operating histories and less sophisticated record keeping systems than larger entities. As a result, these smaller entities may be less able to withstand adverse competitive, economic and financial conditions than larger borrowers. In addition, because payments on loans secured by commercial property generally depend to a large degree on the results of operations and management of the properties, repayment of such loans may be subject, to a greater extent than other loans, to adverse conditions in the real estate market or the economy.

The Bank makes a variety of loans to individuals for personal and household purposes, including secured and unsecured installment and term loans, and unsecured revolving lines of credit.  The secured installment and term loans to consumers generally consist of loans to purchase automobiles, boats, recreational vehicles, mobile homes and household furnishings, with the collateral for each loan being the purchased property.

Consumer loans generally involve more credit risks than other loans because of the type and nature of the underlying collateral or because of the absence of any collateral. Consumer loan repayments are dependent on the borrower’s continuing financial stability and are likely to be adversely affected by job loss, divorce and illness. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans in the case of default. In many cases, any repossessed personal property will not provide an adequate source of repayment of the outstanding loan balance.

 (Continued)

44

NOTE 5 – LOANS, Continued

Portfolio Segment Methodology

The Bank segments its loan portfolio into groups of loans that mirror the regulatory reporting segments for loans, which are based on specific definitions in the Code of Federal Regulations and used in the regulatory call report. Those categories are presented in the table above and are the same categories used by management to analyze credit quality and the adequacy of the allowance for loan losses.  The Bank has been, and will continue to be, reliant on loans with real estate collateral. Under the regulatory guidelines loans with real estate collateral are reported based on various additional sub-categories, such as construction loans, loans collateralized by single family homes, including home equity lines of credit (“HELOC”), and non-residential properties.

Allowance for loan losses

The provision for loan losses charged to operating expenses reflects the amount deemed appropriate by management to establish an adequate reserve to meet the probable loan losses incurred in the current loan portfolio. Management’s judgment is based on periodic and regular evaluation of individual loans, the overall risk characteristics of the various portfolio segments, past experience with losses, delinquency trends, and prevailing economic conditions. To estimate the amount of allowance necessary the Company separates the portfolio into segments. The portfolio is first separated into groups according to the internal loan rating assigned by management. Loans rated “Special Mention”, “Substandard”, “Doubtful” or “Loss,” as defined in the Bank’s loan policy (and below), are evaluated individually for impairment. The Company uses regulatory call report codes to stratify the remaining portfolio and tracks the Bank’s own charge-offs and those of peer banks using FDIC Call Report data. The Bank’s own charge-off ratios by call report code are used to project potential loan losses in the future on loans that are rated “Satisfactory” or better. Charge-off ratios may be increased or decreased based on other environmental factors which may need to be considered, such as unemployment rates and volatility of real estate values. While management uses the best information available to it to make evaluations, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the evaluations. The allowance for loan losses is also subject to periodic evaluation by various regulatory authorities and may be subject to adjustment upon their examination.

Credit Quality Indicators

Loans on the Bank’s watch list (including loans rated Special Mention, Substandard, Doubtful or Loss as defined below and in the Bank’s loan policy) are evaluated individually for impairment and are shown in the table below. Loans rated Doubtful or Loss are generally charged-off, unless specific circumstances warrant the loan’s remaining in the portfolio, even with a grade of Doubtful or Loss. Loans rated Satisfactory are also summarized in the table below.

	December 31, 2011
	Special Mention		Substandard		Doubtful/ Loss		Satisfactory
Loans secured by real estate – construction	$	2,175,614	$	8,414,868	$	-	$	16,220,851
Loans secured by real estate – single family (1)		621,891		1,243,161		-		12,476,481
Loans secured by real estate – multi-family		-		692,673		-		1,001,415
Loans secured by real estate –nonfarm, nonresidential		4,087,623		1,963,116		-		33,954,880
Commercial and industrial loans		225,310		303,192		-		9,313,218
Consumer loans		-		216		-		686,856
Total	$	7,110,438	$	12,617,226	$	-	$	73,653,701
	December 31, 2010
	Special Mention		Substandard		Doubtful/Loss		Satisfactory
Loans secured by real estate – construction	$	2,217,173	$	10,608,496	$	-	$	29,029,669
Loans secured by real estate – single family (1)		1,389,483		2,894,266		-		15,321,194
Loans secured by real estate – multi-family		-		-		-		1,793,400
Loans secured by real estate –nonfarm, nonresidential		1,439,121		661,532		-		40,979,572
Commercial and industrial loans (2)		79,744		86,379		992,027		11,422,691
Consumer loans		1,796		1,869		-		995,788
Total	$	5,127,317	$	14,252,542	$	992,027	$	99,542,314

(1)   Includes HELOC loans.

(2)   The total loans classified as doubtful as of December 31, 2010 were repaid in full in 2011 (with no loss to the principal balance for the Company). They were classified as doubtful as of December 31, 2010 because of the possibility that legal proceedings would lengthen the collection time significantly.

 (Continued)

45

NOTE 5 – LOANS, Continued

A loan classified as Special Mention has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may affect the likelihood of repayment for the loan or result in deterioration of the bank’s credit position at some future date.  The Substandard rating is applicable to loans having a well-defined weakness in the liquidity or net worth of the borrower or the collateral that could jeopardize the liquidation of the debt. Well-defined weaknesses could include deterioration in the borrower’s financial condition or cash flows, significant changes in the value of underlying collateral, or other indicators of weakness.  A loan classified as Doubtful has all the weaknesses inherent in one classified substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. Loans classified Loss are considered uncollectible and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off this asset even though partial recovery may be affected in the future.

Loans in all of the above categories (special mention, substandard, doubtful, and loss) are reviewed individually for impairment (see table below) and to determine which category they will be placed in for purposes of the calculation of the allowance for loan losses. Additional assets may also be individually evaluated for impairment. Credit quality indicators are updated semi-annually unless circumstances warrant a change in the rating, which is updated as soon as practicable.

Delinquent loans and loans on non-accrual are presented by portfolio segment in the table below.

	December 31, 2011				December 31, 2010
	Past due 30-89 Days		Nonaccrual or Past due over 90 Days		Past due 30-89 Days		Nonaccrual or Past due over 90 Days
Loans secured by real estate – construction	$	-	$	2,387,142	$	891,035	$	7,218,012
Loans secured by real estate – single family (1)		141,289		105,541		1,977,519		1,522,290
Loans secured by real estate – multi-family		-		692,673		-		-
Loans secured by real estate –nonfarm, nonresidential		308,700		899,932		-		-
Commercial and industrial loans		18,055		-		-		992,027
Consumer loans		-		-		-		-
Total	$	468,044	$	4,085,288	$	2,868,554	$	9,732,329

(1)   Includes HELOC loans.

Management closely monitors delinquent loans. Construction loans past due on nonaccrual as of December 31, 2011 decreased from December 31, 2010 primarily due to completion of the foreclosure process. As of December 30, 2011 construction loans on nonaccrual are comprised of three loans. Of those three, one loan continues to pay as agreed and is not in foreclosure. Of the remaining 2 loans, one loan represents 84% of the remaining balance, and is collateralized by vacant commercial property. Management has evaluated the relationship and the underlying collateral and believes that the value of the collateral is adequate to cover the Company’s investment in the related loans if foreclosure is ultimately required.

(Continued)

46

NOTE 5 – LOANS, Continued

The table below details amounts of loans collectively or individually evaluated for impairment by portfolio segment.

	December 31, 2011				December 31, 2010
	Collectively reviewed for impairment		Individually reviewed for impairment		Collectively reviewed for impairment		Individually reviewed for impairment
Loans secured by real estate – construction	$	16,220,851	$	10,590,482	$	29,029,669	$	12,825,669
Loans secured by real estate – single family (1)		12,476,480		1,865,052		15,321,194		4,283,749
Loans secured by real estate –nonfarm, nonresidential		33,809,132		6,196,487		40,979,572		2,100,653
Loans secured by real estate – multifamily		1,001,415		692,673		1,793,400		-
Commercial and industrial loans		9,313,218		528,502		11,422,691		1,158,150
Consumer loans		686,857		216		995,788		3,665
Total	$	73,507,953	$	19,873,412	$	99,542,314	$	20,371,886

(1)   Includes HELOC loans.

Impaired loans by portfolio segment, the majority of which are included in the table above, as of the dates indicated, were as follows:

December 31, 2011

	Unpaid Principal Balance		Recorded Investment			Related Specific Reserves		Average Impaired Investment		Interest Income
Loans secured by real estate – construction/development	$	3,026,785	$	2,785,868		$	16,492	$	4,062,190	$	97,871
Loans secured by real estate – single family		477,466		472,012			6,287		485,819		27,347
Loans secured by real estate – multi-family		692,673		692,673			-		694,595		39,848
Loans secured by real estate –nonfarm, nonresidential		1,387,683		1,207,728			17,600		1,300,751		68,453
Commercial and industrial		53,607		53,607			-		60,096		5,027
Consumer loans		-		-			-		-		-
Total impaired loans (1)	$	5,545,191		5,211,888		$	40,379	$	6,603,451	$	235,548
Less related allowance for              loan losses				(40,379	)
Net nonperforming loans			$	5,171,509

 (1)   Includes loans on nonaccrual.

December 31, 2010

	Unpaid Principal Balance		Recorded Investment			Related Specific Reserves		Average Impaired Investment		Interest Income
Loans secured by real estate – construction/development	$	7,355,282	$	7,218,013		$	51,280	$	7,780,357	$	106,259
Loans secured by real estate – single family		2,269,366		2,137,335			3,287		2,185,276		82,340
Loans secured by real estate – multi-family		-		-			-		-		-
Loans secured by real estate – nonfarm, nonresidential		152,310		152,310			-		155,526		10,946
Commercial and industrial		1,129,662		1,129,662			292,000		1,137,190		9,681
Consumer loans		1,869		1,869			1,869		2,158		415
Total impaired loans (1)	$	10,908,489		10,639,189		$	348,436	$	11,260,507	$	209,641
Less related allowance for              loan losses				(348,436	)
Net nonperforming loans			$	10,290,753

 (1)   Includes loans on nonaccrual.

(Continued)

47

NOTE 5 – LOANS, Continued

Reappraisals are routinely ordered when a loan is collateral dependent and showing signs of weakness. Specifically, the Company’s reappraisal policy states that collateral for single family construction loans will be reappraised if the home is complete and remains unsold for twelve months, or if the original loan has been outstanding for eighteen months. For development loans, if lot absorption varies from the original appraiser’s estimates by 25% or more, the collateral will be reappraised. Additionally, the Company’s guidelines require that real property be appraised prior to renewal, modification, or extension of the loan. Collateral will also be reappraised if there is any indication that the collateral may have decreased significantly in value. An evaluation, rather than a full, certified appraisal, may or may not be used after consideration of the risk involved with the transaction, and the need to remain within safe and sound banking practices. If the value of collateral decreases significantly upon reappraisal, the Company may take any one or a combination of steps to protect its position. Possible actions include requesting additional collateral from the borrower, requiring the borrower to make principal reductions on the loan, or charge-off of a portion of the loan balance.

The Bank accounts for impaired loans in accordance with a financial accounting standard that requires all lenders to value a loan at the loan’s fair value if it is probable that the lender will be unable to collect all amounts due according to the terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis taking into consideration all the circumstances of the loan and the borrower, including the length of the delay, reasons for the delay, the borrower’s payment record and the amount of the shortfall in relation to the principal and interest owed. The fair value of an impaired loan may be determined based upon the present value of expected cash flows, market price of the loan, if available, or value of the underlying collateral. Expected cash flows are required to be discounted at the loan’s effective interest rate. The Bank’s loan portfolio is largely dependent on collateral for repayment if the borrower’s financial position deteriorates. Therefore, the most common type of valuation is to determine collateral value less disposal costs in order to determine carrying values for loans deemed impaired. The Company has no interest income recognized on impaired loans that represents the change in present value attributable to passage of time.

Troubled Debt Restructurings

Loans which management identifies as impaired generally will be nonperforming loans or restructured loans (also known as “troubled debt restructurings” or “TDR’s”). As a result of adopting the amendments in ASU 2011-02,  at the end of the third quarter of 2011 the Company reassessed all restructurings that occurred on or after the beginning of the fiscal year of adoption (January 1, 2011) to determine whether they were considered troubled

debt restructurings under the amended guidance. The Company identified no loans as TDRs for which the allowance for loan losses had previously been measured under a general allowance methodology.

The table below summarizes loans designated as TDR’s during the year ended December 31, 2011.

	For the year ended December 31, 2011
Troubled Debt Restructurings	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Real estate-construction/development		2	$	1,993,166	$	1,993,166
Real estate-single family		3		339,430		339,430
Real estate- nonfarm, nonresidential		2		489,248		489,248
Total		7	$	2,821,844	$	2,821,844

Troubled Debt Restructurings that subsequently defaulted (1) during the period:	Number of Contracts		Recorded Investment
Real estate-construction/development		2	$	2,087,285
Real estate-nonfarm, nonresidential		1		238,400
Total		3	$	2,325,685

 (1)   Loans are considered in default when the situation indicates that the loan will be repaid via foreclosure of the collateral, or if the loan is placed on nonaccrual for specific circumstances other than foreclosure of the collateral.

(Continued)

48

NOTE 5 – LOANS, Continued

During the year ended December 31, 2011, the Bank modified seven loans that were considered to be troubled debt restructurings. We extended the terms for three of these loans and the interest rate was lowered for one of these loans. For three of the loans, payments were changed from amortizing payments to interest only payments.

Nonperforming Loans

Nonperforming loans include nonaccrual loans or loans which are 90 days or more delinquent as to principal or interest payments. As of December 31, 2011, the Bank had nonaccrual loans of $4.1 million representing 9 loans, a decrease of $5.6 million from December 31, 2010. All of these loans are secured by real estate. In addition to loans on nonaccrual, as of December 31, 2011, management considers another $1.1 million of loans impaired, all of which are TDR’s. Management routinely assesses the collateral and other circumstances associated with impaired loans in an effort to determine the amount of potential impairment. These loans are currently being carried at management’s best estimate of net realizable value, although no assurance can be given that no further losses will be incurred on these loans until the collateral has been acquired and liquidated or other arrangements can be made.

The foreclosure process is lengthy (generally a minimum of six months and often much longer), so loans may be on nonaccrual status for a significant time period prior to moving to other real estate owned. As soon as the amount of impairment is estimable, the amount of principal impairment is generally charged-off against the allowance for loan losses. However, until losses and selling costs can be estimated via appraisal or other means, a portion of the allowance may be allocated to specific impaired loans. The timing of the appraisal varies from loan to loan depending on the Bank’s ability to access the property.  As of December 31, 2011 the allowance for loan losses included approximately $40,379 of reserves specifically related to impaired loans. Of that amount, a majority is related to selling costs.

Management’s estimates of net realizable value or fair value of real estate collateral are obtained (on a nonrecurring basis) using independent appraisals, less estimated selling costs. Estimates of net realizable value for equipment and other types of personal property collateral are estimated based on input from equipment dealers and other professionals. If an appraisal is not available or management determines that 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 determined by Level 3 inputs as defined by FASB ASC 820, “Fair Value Measurements and Disclosures.”

Potential Problem Loans

Management identifies and maintains a list of potential problem loans. These are loans that are not included in nonaccrual status or impaired loans. A loan is added to the potential problem list when management becomes aware of information about possible credit problems of borrowers that causes serious doubts as to the ability of such borrowers to comply with the current loan repayment terms. These loans are designated as such in order to be monitored more closely than other credits in the Bank’s portfolio. There were loans in the amount of $2.3 million that have been determined by management to be potential problem loans at December 31, 2011. These loans are generally secured by various types of real estate, but may also be secured with other types of collateral. Should potential problem loans become impaired, management will charge-off any impairment amount as soon as the amount of impairment can be determined.

Concentrations of Credit

The Company makes loans to individuals and businesses in and around Upstate South Carolina for various personal and commercial purposes. The Bank has a diversified loan portfolio and the borrowers’ ability to repay their loans is not dependent upon any specific economic sector. The Bank monitors concentrations in its customer base using the North American Industry Codes (“NAIC”) and using certain regulatory definitions. As of December 31, 2011, the Bank has concentrations of credit in real estate rental and leasing, accommodation and food services, construction, retail trade, health care and social assistance, and other services, which by NAIC category comprise over 25% of Tier 1 Capital adjusted for the allowance for loan losses. The Bank also has concentrations in loans collateralized by real estate according to the regulatory definition. Included in this segment of the portfolio is the category for construction and development loans.  While the Bank does have a concentration of loans in this category, the Bank’s business is managed in a manner intended to help reduce the risks normally associated with construction lending. Management requires lending personnel to visit job sites, maintain frequent contact with borrowers and perform or commission inspections of completed work prior to issuing additional construction loan draws. Under current policy, loans are limited to 80% of cost of construction projects, and borrowers are required to meet minimum net worth requirements and debt service coverage ratios.

(Continued)

49

NOTE 5 – LOANS, Continued

Projects for construction of single family homes are generally limited to those projects with contracts for sale where the ultimate owner has a significant investment in the contract. These policies may be considered stricter than policies in place when some of the Bank’s currently outstanding loans were originated. However, as loans mature or as new loans are made, the current guidelines described above would be used to underwrite construction loans.  The Company does not currently have any acquisition and development loans with interest reserves.

Construction loans in the Company’s portfolio can be further divided into the following sub categories as of December 31, 2011:

	December 31, 2011
Single family residential construction loans	$	2,610,422
Acquisition and development loans		6,968,599
Other construction and land loans (1)		17,232,312
	$	26,811,333

(1)   Includes loans collateralized by vacant land and loans not development-related.

Reappraisals are routinely ordered when a loan is collateral dependent and showing signs of weakness. Specifically, the Company’s reappraisal policy states that collateral for single family construction loans will be reappraised if the home is complete and remains unsold for twelve months, or if the original loan has been outstanding for eighteen months. For development loans, if lot absorption varies from the original appraiser’s estimates by 25% or more, the collateral will be reappraised. Loans with weaknesses that are collateralized with partially constructed projects are generally appraised both “as is” and “as completed.” A determination is then made as to the likely disposition of the loan, whether the borrower retains the collateral and completes the project or whether the Company will ultimately foreclose and complete the construction following foreclosure. If foreclosure and completion by the Company are deemed the most likely scenario, and the cost to complete exceeds the collateral value, then the amount of cost to complete in excess of the as completed value of the collateral will generally be charged to the allowance for loan losses. To date very few impaired loans have been returned to accrual status as the result of updated appraisals. However, depending on specific circumstances, loans could potentially return to accrual status if the repayment prospects for the loan have changed significantly. Loans returned to accrual status will generally need to perform for a period of six months prior to being returned to accrual status, unless the underlying characteristics have significantly been altered in a positive manner.

The category “Loans secured by real estate- single family, including HELOC” contains home equity lines of credit in the amount of $6.0 million and $7.6 million as of December 31, 2011 and 2010, respectively. This portion of the single family real estate secured portfolio includes some loans with first liens on the underlying collateral and some second liens. All home equity line loans are variable rate loans with interest rate floors. As of December 31, 2011, approximately $30.9 million or 33.1% of total gross loans, including home equity line loans, were variable rate loans.

The FHLB has a blanket lien on certain types of the Company’s loans as collateral for FHLB advance borrowings. See Note 10. The Reserve Bank has a lien on certain other loan types should the Bank borrow from the Discount Window. As of December 31, 2011 there were no borrowings from the Discount Window of the Reserve Bank.

Activity in the allowance for loan losses for the years ended December 31, 2011, 2010, and 2009 is summarized in the table below.

	Year ended December 31,
		2011			2010			2009
Allowance for loan losses, beginning of year	$	2,703,430		$	2,695,337		$	1,698,563
Provision for loan losses		670,000			1,260,000			2,955,000
Charge-offs		(1,355,328	)		(1,251,907	)		(1,958,726	)
Recoveries		24,338			-			500
Allowance for loan losses, end of year	$	2,042,440		$	2,703,430		$	2,695,337

(Continued)

50

NOTE 5 – LOANS, Continued

Activity for the year ended December 31, 2011 in the allowance, by portfolio segment, is presented in the table below.

		Construction/			Single family (1)			Nonfarm, nonresidential				Multifamily			Commercial and industrial			Cosumer			Unallocated			Total
										(Dollars in thousands)
Beginning Balance	$	1,093		$	361		$	341			$	4		$	526		$	16		$	362		$	2,703
Provision		485			407			299				(2	)		(303	)		(1	)		(215	)		670
Charge-offs		(783	)		(352	)		(100	)			-			(120	)		-						(1,355	)
Recoveries		-			-			-				-			24			-			-			24
Ending Balance	$	795		$	416		$	540			$	2		$	127		$	15		$	147		$	2,042

(1)   Includes home equity lines of credit.

The Company, through the Bank, analyzes charge-offs and calculates its estimate of the allowance for loan losses using regulatory call report codes. The codes are well-defined categories for loans and are generally based on various types of collateral. Since the Bank generally lends on various types of real-estate collateral, the regulatory call report codes provide a defined, consistent system for tracking loan balances and charge-offs. These codes are also useful in comparing the Bank to its regional community bank peers. The Bank’s historical charge-off rates, by call code, are calculated, reviewed for additional subjective factors that should be considered for the current outlook, and then applied to ending balances of loans not specifically reviewed for impairment. These estimates, along with the loans specifically reviewed for impairment, are used in the analysis of the adequacy of the allowance for loan losses completed on a quarterly basis. As described in Note 1, loans rated OAEM (or Special Mention), Substandard, Doubtful, or Loss are individually evaluated for impairment, and the estimate of the amount of allowance for loan losses is computed based on individual facts and circumstances, such as appraised value of collateral, and similar factors.

Charge-offs, net of recoveries, for the years ended 2011, 2010 and 2009 were categorized by regulatory call report code as follows:

	Year ended December 31,
	2011			2010		2009
Loan secured by real estate –construction/development	$	783,211		$	978,425	$	882,684
Loan secured by real estate –single family		351,549			249,034		250,072
Loan secured by real estate –nonfarm, nonresidential		100,527			-		156,643
Commercial and industrial loans		120,041			21,315		668,829
Loans to consumers		-			3,133		500
Total charge-offs		1,355,328			1,251,907		1,958,728
Recoveries		(24,338	)		-		(500	)
Total net charge-offs	$	1,330,990		$	1,251,907	$	1,958,228

The allowance for loan losses is not restricted to specific categories of loans and is available to absorb losses in all categories. However, the Company has allocated the allowance for loan losses among the various segments of the portfolio. The allowance allocations as of December 31, 2011 and December 31, 2010 are presented in the table below.

	December 31,
	2011		2010
Loans secured by real estate –construction/development	$	794,604	$	1,093,200
Loans secured by real estate –single family, including HELOC		416,168		361,096
Loans secured by real estate –nonfarm, nonresidential		539,932		341,377
Loans secured by real estate –multifamily		2,504		4,484
Commercial and industrial		127,068		525,567
Consumer installment		15,439		15,914
Unallocated		146,725		361,792
Total allowance for loan losses	$	2,042,440	$	2,703,430

51

NOTE 6 – PROPERTY AND EQUIPMENT

Components of property and equipment included in the balance sheet are as follows:

	December 31,
	2011			2010
Land and improvements	$	1,468,480		$	1,468,480
Bank premises		4,271,773			4,271,773
Furniture, equipment and software		1,594,600			1,594,038
Vehicles		58,005			58,005
Property and equipment		7,392,858			7,392,296
Accumulated depreciation		(2,368,745	)		(2,161,461	)
Property and equipment, net	$	5,024,113		$	5,230,835

Depreciation expense for the years ended December 31, 2011, 2010, and 2009 amounted to $235,700, $228,184, and $265,520, respectively. Depreciation is charged to operations over the estimated useful lives of the assets. The estimated useful lives and methods of depreciation for the principal items follow:

Type of Asset	Life in Years		Depreciation Method
Furniture, equipment and software		3 to 7	Straight-line
Improvements		5 to 40	Straight-line
Vehicles		5	Straight-line

NOTE 7– PROPERTY ACQUIRED IN FORECLOSURE

The Company has acquired a significant number of real estate properties in settlement of loans. A summary of the activity in property acquired in foreclosure follows:

	December 31,
	2011			2010
Beginning balance	$	10,278,599		$	6,712,948
Additions from foreclosures and capitalized improvements		11,281,083			8,403,452
Write downs of value		(430,513	)		(709,751	)
Sales		(4,583,681	)		(4,128,050	)
Ending other real estate owned	$	16,545,488		$	10,278,599

The Company recognized net losses of $193,693, $180,397 and $228,547 on sales of all types of repossessed collateral for the years ended December 31, 2011, 2010 and 2009, respectively.

NOTE 8 – DEPOSITS

The following is a detail of the deposit accounts as of:

	December 31,
	2011		2010
Noninterest bearing	$	17,087,736	$	10,382,882
Interest bearing:
NOW accounts		14,749,804		12,621,719
Money market accounts		14,844,247		15,552,889
Savings		32,392,335		35,344,088
Time, less than $100,000		39,751,568		51,005,987
Time, $100,000 and over (1)		20,036,904		15,738,827
Total deposits	$	138,862,594	$	140,646,392
(1)Does not include some brokered deposits issued in denominations less than $100,000 per depositor.

(Continued)

52

NOTE 8 – DEPOSITS, Continued

The Company’s deposits included brokered deposits of approximately $7.4 million and $19.7 million as of December 31, 2011 and 2010, respectively. Interest expense on time deposits greater than $100,000 (including brokered deposits) was approximately $460,000 in 2011, $851,000 in 2010, and $1.3 million in 2009. Securities issued by government sponsored enterprises with an amortized cost of $1.3 million and $696,858 (fair value of $1.4 million and $703,970) in 2011 and 2010, respectively, were pledged as collateral for public funds.

At December 31, 2011 the scheduled maturities of time deposits are as follows:

2012	$	39,350,130
2013		12,307,388
2014		5,076,418
2015		656,429
2016 and thereafter		2,398,107
	$	59,788,472

NOTE 9 – CUSTOMER REPURCHASE AGREEMENTS

Customer repurchase agreements consist of the following:

	December 31,
	2011		2010
Sweep accounts	$	67,550	$	895,937
Retail repurchase agreements		1,700,000		2,050,000
	$	1,767,550	$	2,945,937

The Bank enters into sweep and retail repurchase agreements with its customers. The sweep agreements generally mature overnight. At December 31, 2011, the Bank had two retail repurchase agreements both of which mature in 2012. Securities issued by government sponsored enterprises with an amortized cost of $2.5 million and $3.3 million (fair value of $2.6 million and $3.1 million) were pledged as collateral for the sweep accounts and repurchase agreements, at December 31, 2011 and 2010, respectively. During 2011 sweeps and customer repurchase agreements averaged $2.2 million. The average rate paid on these balances was 1.23% during 2011 and the highest balance at any month end was $3.3 million. During 2010 sweeps and customer repurchase agreements averaged $2.9 million. The average rate paid was 1.34% and the highest balance at any month end during the year was $3.4 million.

NOTE 10 –  BORROWINGS FROM FEDERAL HOME LOAN BANK OF ATLANTA

At December 31, 2011 and 2010, the Bank had a line of credit to borrow funds from the FHLB in the amount of 10% of the Bank’s assets. Funds borrowed from the FHLB are collateralized by a lien on certain of the Bank’s available for sale securities and loans. At December 31, the Bank had advances outstanding as follows:

			December 31,
Terms	Interest Rate	Maturity Date	2011	2010

Fixed rate, convertible	3.52	%	1/16/2018	$	2,000,000	$	2,000,000
Fixed rate	1.07		1/10/2011		-		3,000,000
Fixed rate	2.72		1/25/2011		-		1,000,000
Fixed rate, amortizing	4.49		12/01/2013		88,889		133,333
Fixed rate, amortizing	4.89		4/14/2014		90,741		129,630
Fixed rate, amortizing	4.78		7/27/2015		261,875		329,375
				$	2,441,505	$	6,592,338

The Company’s convertible advance from the FHLB is convertible to a variable rate instrument at the option of the FHLB on January 16, 2013.  During 2011 the highest balance as of any month end for borrowings from the FHLB was $2.6 million. The average rate paid on advances during 2011 was 3.53%. The average balance of FHLB advances for 2011 was $2.7 million. During 2010 the highest balance as of any month end for borrowings from the FHLB was $­­­9.7 million. The average rate paid on advances during 2010 was 2.50%. The average balance of FHLB advances for 2010 was $8.0 million.

53

NOTE 11 – BROKER REPURCHASE AGREEMENTS

Broker repurchase agreements consist of one repurchase agreement totaling $3.0 million as of December 31, 2011. The borrowing carries a fixed rate of interest with a call feature. The agreement matures on January 15, 2015, and is callable by the broker quarterly after January 15, 2012. The Company prepaid another repurchase agreement in the amount of $2.0 million during December, 2011. That agreement was set to mature on January 15, 2013 and was callable by the broker quarterly, beginning January 10, 2010.  Prepaying the agreement required an acceleration of interest payments of $67,318. The additional amount is included in “Interest Expense- Broker repurchase agreements” in the accompanying Consolidated Statement of Income (Loss). The agreement was prepaid to reduce capital requirements and to remove a negative impact on the Company’s net interest margin in future periods. Securities with fair value of $4.1 million and amortized cost of $3.9 million collateralize the remaining agreement. During 2011 the highest balance as of any month end for broker repurchase agreements was $5.0 million and the average balance for 2011 was $4.9 million. The average rate paid on broker repurchase agreements during 2011 was 4.92%. Without the prepayment interest of $67,318 the average rate paid on broker repurchase agreements in 2011 would have been 3.54%. During 2010 the highest balance as of any month end for broker repurchase agreements was $5.0 million and the average balance for 2010 was $5.0 million. The average rate paid on broker repurchase agreements during 2010 was 3.54%.

NOTE 12 – COMMITMENTS AND CONTINGENCIES

The Bank may become party to litigation and claims arising in the normal course of business. As of December 31, 2011, there was no litigation pending other than foreclosure or similar collection actions initiated by the Bank.

The Bank entered into a five-year contract with a data, item, and ATM processing service in 2010. Minimum monthly costs for these services are currently approximately $20,000. Volume-related costs may increase as volume increases.

The Company has signed change of control agreements with three of its executive officers. These agreements provide for various payments to the executives in the event of a change in control of the Company.

From time to time the Bank may guarantee merchant credit card accounts on behalf of certain customers. At December 31, 2011 the total amount guaranteed by the Bank related to credit card accounts was immaterial.

Refer to Note 16 concerning financial instruments with off balance sheet risk.

NOTE 13 – CUMULATIVE PERPETUAL PREFERRED STOCK (8%)

During the third quarter of 2010, the Company offered up to $2,500,000 of 8% Series A Cumulative Perpetual Preferred Stock (“the Preferred”) to accredited investors and up to 35 non-accredited investors. The Preferred was offered by the Company’s directors and executive officers, and no selling agents or underwriters were used. 1,038 shares of the Preferred were sold. Proceeds of the offering, net of offering expenses totaled $998,538. The Preferred is scheduled to pay a dividend quarterly. However, pursuant to the Company’s Memorandum of Understanding with the Federal Reserve, the Federal Reserve has declined to approve the dividends scheduled for payment to date. Dividends that have accumulated, but have not been declared or accrued since inception of the Preferred, total $118,553 as of December 31, 2011.

54

NOTE 14 – INCOME TAXES

The provision for income taxes is reconciled to the amount of income tax computed at the federal statutory rate on income (loss) before income taxes as follows:

	Year ended December 31,
	2011					2012					2009
Tax benefit at statutory rate	$	(197,440	)	(34	)%	$	(301,254	)	(34	)%	$	(741,544	)	(34	)%
Increase (decrease) in taxes resulting from:
State income taxes, net of  federal benefit		-		-			-		-			-		-
Tax-exempt investments		(78,400	)	(14	)		(77,747	)	(9	)		(78,845	)	(5	)
Increase in cash value of  life insurance		(22,806	)	(4	)		(23,613	)	(3	)		(23,849	)	(2	)
Increase in valuation allowance		1,197,779		206			-		-			-		-
Other		9,308		2			14,341		1			24,501		2

 Income tax expense (benefit) $ 908,441 156 % $ (388,273 ) (45 )% $ (819,737 ) (39 )%

The income tax effects of cumulative temporary differences at December 31, 2011 and 2010 are as follows:

	2011			2010
Deferred tax assets:
Allowance for loan losses	$	398,065		$	665,122
Unrealized net loss on securities available for sale		-			41,753
Stock based compensation		56,062			47,622
Other real estate owned		140,717			179,374
Net operating loss carryforward		624,792			-
Other		70,387			157,528
		1,290,023			1,091,399
Deferred tax liabilities:
Unrealized net gain on securities available for sale		248,468			-
Depreciation		76,261			95,659
Prepaid expenses		21,984			25,074
		346,713			120,733
Deferred tax asset, net		943,310			970,666
Valuation allowance		(1,191,779	)		-
Net deferred tax asset (liability)	$	(248,469	)	$	970,666

Deferred tax assets represent the future tax benefit of deductible differences and, if it is more-likely-than-not that a tax asset will not be realized, a valuation allowance is required to reduce the recorded deferred tax assets to net realizable value.  During the year ended December 31, 2011 the company recorded a full valuation allowance against the Company’s net deferred tax asset to reduce the total to an amount that management believes will ultimately be realized. Realization of deferred tax assets is dependent upon sufficient taxable income during the period that deductible temporary differences and carryforwards are expected to be available to reduce taxable income. Based on management’s projections, the deferred tax assets are not more-likely-than-not to be recovered with projected taxable income from the three years through 2014.

The following summary of the provision for income taxes includes tax deferrals that arise from temporary differences in the recognition of certain items of revenue and expense for tax and financial reporting purposes:

	Year ended December 31,
	2011			2010			2009
Income taxes currently payable (receivable)	$	(1,000	)	$	(255,967	)	$	(781,874	)
Deferred income tax benefit		909,441			(132,306	)		( 37,863	)
Income tax benefit	$	908,441		$	(388,273	)	$	(819,737	)

(Continued)

55

NOTE 14 – INCOME TAXES, Continued

The Company and its subsidiaries file a consolidated federal income tax return and consolidated or separate state income tax returns. With few exceptions the company is no longer subject to federal or state income tax examinations by tax authorities for years before 2008. The Company has net operating loss carryforwards for tax purposes of approximately $1.8 million with an expiration date in 2031. The Company has analyzed the tax positions taken or expected to be taken in its tax returns and concluded it has no liability related to uncertain tax positions.

NOTE 15 – RELATED PARTY TRANSACTIONS

Certain directors, executive officers and companies with which they are affiliated, are customers of and have loan transactions with the Bank in the ordinary course of business. These loans were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable arms-length transactions.

A summary of loan transactions with directors, including their affiliates, and executive officers is as follows:

	Year ended December 31,
	2011			2010			2009
Balance, beginning of year	$	6,002,606		$	7,638,399		$	5,958,663
New loans or lines of credit		175,300			209,100			2,588,627
Payments on loans or lines of credit		(1,174,257	)		(1,844,893	)		(908,891	)
Balance, end of year	$	5,003,649		$	6,002,606		$	7,638,399

Deposits by directors, executive officers, and their related interests, at December 31, 2011 and 2010 were $1.1 million and $2.6 million, respectively.

NOTE 16 – FINANCIAL INSTRUMENTS WITH OFF BALANCE SHEET RISK

In the ordinary course of business, and to meet the financing needs of its customers, the Bank is a party to various financial instruments with off balance sheet risk. These financial instruments, which include commitments to extend credit and standby letters of credit, involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the balance sheet. The contract amounts of those instruments reflect the extent of involvement the Bank has in particular classes of financial instruments.

The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amounts of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on balance sheet instruments.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any material condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require the payment of a fee. At December 31, 2011 and 2010, unfunded commitments to extend credit were $10.9 million and $10.8 million, respectively, and outstanding letters of credit were approximately $1.0 million and $715,000, respectively.

At December 31, 2011, the unfunded commitments consisted of $8.5 million at variable rates and $2.4 million at fixed rates with $4.8 million expiring within one year. The Bank evaluates each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management’s credit evaluation of the borrower. Collateral varies but may include accounts receivable, inventory, property, plant and equipment, and commercial and residential real estate.

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, and were immaterial in 2011 and 2010.

The Bank offers an automatic overdraft protection product. Approximately $1.1 million of overdraft protection is available under this product as of December 31, 2011. The Bank expects that much of this capacity will not be utilized. During 2011 the average balance of total demand deposit overdrafts was approximately $24,000.

56

NOTE 17 – EMPLOYEE BENEFIT PLAN

The Company sponsors a Simple IRA Plan for the benefit of all eligible employees. The Bank contributes up to three percent of the employee’s compensation. Employer contributions made to the Plan in 2011, 2010, and 2009 amounted to $44,212, $47,207, and $53,458, respectively.

NOTE 18 – STOCK OPTION PLANS

In 2003, the Company’s shareholders approved the Cornerstone Bancorp 2003 Stock Option Plan (the “2003 Plan”), which reserved 125,000 shares of the Company’s common stock for issuance upon exercise of options. Pursuant to the 2003 Plan as further discussed below, the number of shares reserved for issuance has been increased to 201,771 shares as a result of the 10% stock dividends declared from 2004 to 2007 and 5% stock dividends in each of 2010 and 2009 as discussed in Note 19 below. Employees and Directors are eligible to participate in the 2003 Plan, which has a term of 10 years. Awards under the 2003 Plan must be made by the Board of Directors, or by a Committee of Directors designated by the Board, at an exercise price equal to the fair market value of the Company’s common stock on the date of grant. During 2011, no options to purchase common shares were granted and none were exercised. Options to purchase 9,396 shares were forfeited. As of December 31, 2011, 102,169 options to purchase common shares remain outstanding under the 2003 Plan.

Under the 2003 Plan, options to purchase 18,000 shares were granted during each of the years 2004, 2005, 2006 and 2007. Options to purchase 19,200 shares were granted in 2008. Options to purchase 15,600 shares of common stock were granted in 2009.  The risk free interest rates used for the 2009, 2008, and 2007 grants were 2.34%, 3.91%, and 4.68%, respectively, which was the 10 Year Constant Maturity Rate on U.S. Treasury Securities during the months in which the options were granted. The assumed dividend rate was zero and the expected option life was 10 years for 2009, 2008, and 2007 grants. Volatility is difficult to measure accurately due to the low volume of trading of the Company’s stock. The common stock is not listed on any exchange and has no active trading market. Since 2006, the stock has been quoted on the OTC Bulletin Board. Based on information available at the date of the grant, the volatility assumption used for 2009 option grants was 38.71%, for 2008 option grants was 28%, and for 2007 option grants was 12%.

A summary of the activity in the plans is presented below:

	Shares			Weighted Average Exercise Price(1)		Aggregate Intrinsic Value (2)
Outstanding at December 31, 2008		131,812		$	9.46
Granted (3)		22,241		$	9.45
Exercised		(14,172	)	$	5.64
Forfeited or expired		(33,626	)	$	6.39
Outstanding at December 31, 2009		106,255		$	10.49
Granted as a result of stock dividend 5% (3)		5,310		$	9.99
Exercised		-			-
Forfeited or expired		-			-
Outstanding at December 31, 2010		111,565		$	9.99
Granted (3)		-
Exercised		-
Forfeited or expired		(9,396	)	$	9.89
Total outstanding options		102,169		$	10.00
Options exercisable at end of year		82,793		$	9.87	$	-
Shares available for grant		63,785

(1)   The weighted average exercise price has been adjusted to reflect 10% stock dividends declared by the Company’s Board of Directors annually from 2002 through 2007 and a 5% stock dividend declared by the Company’s Board of Directors in each of 2010 and 2009.

(2)   The aggregate intrinsic value of a stock option in the table above represents the total pre-tax intrinsic value (the amount by which the current market value of the underlying stock exceeds the exercise price of the option). At December 31, 2011 the amount represents the value that would have been received by the option holders had all option holders exercised their options on that date. This amount changes based on changes in the market value of the Company’s common stock. At December 31, 2011 the OTCBB quoted price was $1.27 Therefore, none of the Company’s options had intrinsic value as of that date.

(3)   Granted options include new grants in years prior to 2010 as well as adjustments of previous grants as a result of 10% stock dividends declared by the Company’s Board of Directors annually from 2002 through 2007 and a 5% stock dividend in each of 2009 and 2010.

(Continued)

57

NOTE 18 – STOCK OPTION PLANS, Continued

Options granted after 2005 vest over a five-year period, according to the option agreements. All options granted prior to 2006 have fully vested. The weighted average life of options outstanding was 4.40 years and 5.43 years  at December 31, 2011 and 2010, respectively. Expense related to stock based compensation recorded in the accompanying consolidated statements of income (loss) was $49,676, $61,220, and $72,464 for the years ended 2011, 2010, and 2009, respectively. There were 35,169 non-vested options outstanding (estimated fair value of $198,166) at the beginning of 2011. During 2011, 13,043 options vested (estimated fair value of $74,243). No options were granted. Non-vested options to purchase 2,752 shares were forfeited. At December 31, 2011, 19,376 non-vested options (estimated fair value of $108,430) were outstanding.

NOTE 19 – DIVIDENDS

No dividends were paid during the year ended December 31, 2011. The Company paid a 5 percent stock dividend in 2010 to shareholders of record on May 11, 2010 and in 2009 to shareholders of record on May 12, 2009. The Company’s payment of cash dividends is within the discretion of its Board of Directors, subject to compliance with Federal Reserve guidance, and is dependent on the Company’s receiving cash dividends from the Bank. Federal banking regulations restrict the amount of dividends that the Bank can pay to the Company. Future dividend policy will depend on the Company’s earnings, capital requirements, financial condition and other factors considered relevant by the Company’s Board of Directors. Under its Memorandum of understanding with the FRB, the Company is required to seek permission of the FRB prior to paying dividends.

NOTE 20 – REGULATORY MATTERS

The Bank is 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 direct material effect on the Bank’s financial statements.  Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices.

The Bank’s capital amounts and classification 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 Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital to risk-weighted assets, and of Tier 1 capital to adjusted total assets (“Tier 1 leverage ratio”). Management believes, as of December 31, 2011, that the Bank meets all capital adequacy requirements to which it is subject.

 The Bank’s actual capital amounts and ratios and minimum regulatory amounts and ratios established by regulations adopted pursuant to the prompt corrective action provisions of the Federal Deposit Insurance Corporation Improvement Act are presented as follows:

						For capital adequacy purposes					To be well capitalized under prompt corrective action provisions
	Actual					Minimum					Minimum
						(Dollars in thousands)
	Amount		Ratio			Amount		Ratio			Amount		Ratio
As of December 31, 2011
Total Capital (to risk weighted assets)	$	18,086		14.81	%	$	9,769		8.0	%	$	12,211		10.0	%
Tier 1 Capital (to risk weighted assets)		16,544		13.55			4,884		4.0			7,327		6.0
Tier 1 leverage ratio		16,544		9.99			6,626		4.0			8,282		5.0
As of December 31, 2010
Total Capital (to risk weighted assets)	$	19,307		13.8	%	$	11,234		8.0	%	$	14,043		10.0	%
Tier 1 Capital (to risk weighted assets)		17,531		12.5			5,617		4.0			8,426		6.0
Tier 1 leverage ratio		17,531		9.8			7,188		4.0			8,985		5.0

(Continued)

58

NOTE 20 – REGULATORY MATTERS, Continued

In addition to the FDIC requirements shown above, the Bank is currently required to maintain individual minimum capital ratios by the OCC. Those required ratios are: Total capital to risk weighted assets– 12.0%; Tier 1 capital to risk weighted assets – 11.0%; and Tier 1 capital to average assets– 9.0%. The Bank exceeded these requirements at December 31, 2011 and 2010.

The Federal Reserve has also established guidelines for capital requirements for bank holding companies that are similar to the FDIC’s guidelines for banks. At December 31, 2011and 2010 the Company exceeded all of the minimum requirements of the Federal Reserve guidelines.

On May 12, 2010, the Bank entered into a formal agreement with the OCC for the Bank to take various actions with respect to the operation of the Bank. The actions include: creation of a committee of the Bank's board of directors to monitor compliance with the agreement and make quarterly reports to the board of directors and the OCC; assessment and evaluation of management and members of the board; development, implementation and adherence to a written program to improve the bank's loan portfolio management; protection of its interest in its criticized assets; implementation of a program that identifies and manages concentrations of credit risk; extension of the Bank’s strategic plan; extension of the Bank’s capital program and profit plan; additional plans for ensuring that the level of liquidity at the Bank is sufficient to sustain the current operations and withstand any anticipated or extraordinary demand; and a requirement for obtaining a determination of no supervisory objection from the OCC before accepting brokered deposits. The substantive actions called for by the agreement should strengthen the Bank and make it more efficient in the long-term. The Bank believes it is in compliance with the requirements included in the formal agreement at December 31, 2011.

The Company has entered into a memorandum of understanding with the Federal Reserve Bank of Richmond (“FRB”). The memorandum of understanding requires the Company to seek permission from the FRB before it takes certain actions such as payment of cash dividends, redemption of outstanding stock, etc. The Company believes it is in compliance with the memorandum of understanding with the FRB as of December 31, 2011.

NOTE 21 - ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS

The estimated fair values of the Company's financial instruments were as follows:

	December 31,
	2011				2010
	Carrying		Fair		Carrying		Fair
Financial Assets	Amount		Value		Amount		Value
Cash and due from banks	$	6,803,057	$	6,803,057	$	7,043,911	$	7,043,911
Federal funds sold		12,620,000		12,620,000		5,110,000		5,110,000
Investment securities		28,626,473		28,626,473		24,655,686		24,655,686
Loans, gross		93,381,365		94,402,712		119,914,200		120,947,231
Cash surrender value of life insurance policies		1,975,187		1,975,187		1,908,112		1,908,112
Financial Liabilities
Deposits		138,862,594		137,939,619		140,646,392		139,176,006
Fed Funds purchased and customer sweeps		67,550		67,550		895,937		895,937
Customer repurchase agreements		1,700,000		1,700,000		2,050,000		2,137,395
Borrowings from FHLB		2,441,505		2,615,148		6,592,338		6,731,378
Broker repurchase agreements		3,000,000		3,095,282		5,000,000		5,212,655

(Continued)

59

NOTE 21 - ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS, continued

The table below presents the balances of assets measured at fair value on a recurring or nonrecurring basis by level within the hierarchy of inputs that may be used to measure fair value.  Assets valued at fair value on a recurring basis are those valued at fair value at each balance sheet date, whereas those valued on a nonrecurring basis are not re-measured as of each balance sheet date. There are no liabilities measured at fair value on a recurring basis.

	December 31, 2011
	Total		Level 1		Level 2		Level 3
Investment securities, recurring	$	28,626,473	$	18,972,486	$	8,770,137	$	883,850
Other real estate owned, nonrecurring	$	16,545,488	$	-	$	-	$	16,545,488
Impaired loans, nonrecurring	$	5,211,888	$	-	$	-	$	5,211,888
	December 31, 2010
	Total		Level 1		Level 2		Level 3
Investment securities, recurring	$	24,655,686	$	15,369,729	$	8,222,607	$	1,063,350
Other real estate owned, nonrecurring	$	10,278,599	$	-	$	-	$	10,278,599
Impaired loans, nonrecurring	$	10,414,838	$	-	$	-	$	10,414,838

The table below represents the activity in Level 3 assets that are measured at fair value on a recurring basis for the period January 1, to December 31,

Other Investments	2011			2010
Beginning balance	$	1,063,350		$	1,142,050
Total realized and unrealized gains or losses:
Included in earnings		-			-
Included in other comprehensive income		-			-
Purchases (Federal Reserve Bank stock)		17,900			-
Sales (redemptions by FHLB)		(197,400	)		(78,700	)
Principal reductions		-			-
Transfers in and/or out of Level 3		-			-
Ending balance	$	883,850		$	1,063,350

NOTE 22 - PARENT COMPANY INFORMATION

Following is condensed financial information of Cornerstone Bancorp (parent company only):

Condensed Balance Sheets
	December 31,
	2011	2010
Assets
Cash and interest bearing deposits	$      452,354	$      525,773
Investment in subsidiary	17,026,225	17,827,490
Other assets	10,991	8,996
Total Assets	$ 17,489,570	$ 18,362,259
Liabilities And Shareholders’ Equity
Accrued expenses	$          6,960	$          3,547
Shareholders’ equity	17,482,610	18,358,712
Total Liabilities and Shareholders’ Equity	$ 17,489,570	$ 18,362,259

(Continued)

60

NOTE 22 - PARENT COMPANY INFORMATION, continued

Condensed Statements of Income

	Year ended December 31,
	2011			2010			2009
Income
Interest	$	4,249		$	4,848		$	4,645
Expenses
Sundry		79,086			61,502			58,893
Loss before equity in undistributed net                loss of bank subsidiary		(74,837	)		(56,654	)		(54,248	)
Equity in undistributed net loss of                subsidiary		(1,414,311	)		(441,113	)		(1,307,026	)
Net loss	$	(1,489,148	)	$	(497,767	)	$	(1,361,274	)

Condensed Statements of Cash Flows

	Year ended December 31,
	2011			2010			2009
Operating Activities
Net loss	$	(1,489,148	)	$	(497,767	)	$	(1,361,274	)
Adjustments to reconcile net loss to net cash used for operating activities
Equity in undistributed net loss of subsidiary		1,414,311			441,113			1,307,026
Decrease (increase) in other assets		(1,995	)		724			(715	)
Increase (decrease) in accrued expenses		3,413			(10,314	)		(489	)
Net cash used for operating activities		(73,419	)		(66,244	)		(55,452	)
Investing Activities
Investment in bank subsidiary		-			(499,999	)		(299,999	)
Financing Activities
Cash paid in lieu of fractional shares		-			(1,024	)		(1,715	)
Issuance of preferred stock, net of expenses		-			998,538			-
Exercise of stock options, net of tax		-			-			80,000
Net cash provided by financing                       activities		-			997,514			78,285
Net increase (decrease) in cash		(73,419	)		431,271			(277,166	)
Cash, beginning of year		525,773			94,502			371,668
Cash, end of year	$	452,354		$	525,773		$	94,502

61

EX-21

Exhibit 21

Subsidiaries of the Registrant

Cornerstone National Bank (Incorporated under the laws of the United States of America) and Subsidiary, Crescent Financial Services, Inc. (Incorporated under the laws of South Carolina) (subsidiary of Cornerstone National Bank)

EX-31

Exhibit 31-1

CERTIFICATIONS   

I, J. Rodger Anthony, certify that:

1.           I have reviewed this annual report on Form 10-K of Cornerstone Bancorp;

2.           Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.           Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.           The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e))  and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a)           Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b)           Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c)           Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d)           Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.           The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a)           All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b)           Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: March 28, 2012                                                                         s/J. Rodger Anthony

J. Rodger Anthony

Chief Executive Officer

EX-31

CERTIFICATIONS

Exhibit 31-2

I, Jennifer M. Champagne, certify that:

1.           I have reviewed this annual report on Form 10-K of Cornerstone Bancorp;

2.           Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.           Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.           The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e))  and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a)           Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b)           Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c)           Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d)           Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.           The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a)           All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b)           Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: March 28, 2012                                                                         s/Jennifer M. Champagne

Jennifer M. Champagne

Chief Financial Officer

EX-32

Exhibit 32

Certifications Pursuant to 18 U.S.C. Section 1350

The undersigned, who are the chief executive officer and the chief financial officer of Cornerstone Bancorp, each hereby certifies that, to the best of his/her knowledge, the accompanying Form 10-K of the issuer fully complies with the requirements of Section 13(a)or 15(d) of the Securities Exchange Act of 1934, and that information contained in the report fairly presents, in all material respects, the financial condition and results of operations of the issuer.

March 28, 2012

s/J. Rodger Anthony

J. Rodger Anthony

Chief Executive Officer

s/Jennifer M. Champagne

Jennifer M. Champagne

Chief Financial Officer

XML

Stock Option Plans

12 Months Ended

Dec. 31, 2011

Stock Option Plans [Abstract]

Stock Option Plans

NOTE 18 – STOCK OPTION PLANS

     In 2003, the Company's shareholders approved the Cornerstone Bancorp 2003 Stock Option Plan (the "2003 Plan"), which reserved 125,000 shares of the Company's common stock for issuance upon exercise of options. Pursuant to the 2003 Plan as further discussed below, the number of shares reserved for issuance has been increased to 201,771 shares as a result of the 10% stock dividends declared from 2004 to 2007 and 5% stock dividends in each of 2010 and 2009 as discussed in Note 19 below. Employees and Directors are eligible to participate in the 2003 Plan, which has a term of 10 years. Awards under the 2003 Plan must be made by the Board of Directors, or by a Committee of Directors designated by the Board, at an exercise price equal to the fair market value of the Company's common stock on the date of grant. During 2011, no options to purchase common shares were granted and none were exercised. Options to purchase 9,396 shares were forfeited. As of December 31, 2011, 102,169 options to purchase common shares remain outstanding under the 2003 Plan.

     Under the 2003 Plan, options to purchase 18,000 shares were granted during each of the years 2004, 2005, 2006 and 2007. Options to purchase 19,200 shares were granted in 2008. Options to purchase 15,600 shares of common stock were granted in 2009. The risk free interest rates used for the 2009, 2008, and 2007 grants were 2.34%, 3.91%, and 4.68%, respectively, which was the 10 Year Constant Maturity Rate on U.S. Treasury Securities during the months in which the options were granted. The assumed dividend rate was zero and the expected option life was 10 years for 2009, 2008, and 2007 grants. Volatility is difficult to measure accurately due to the low volume of trading of the Company's stock. The common stock is not listed on any exchange and has no active trading market. Since 2006, the stock has been quoted on the OTC Bulletin Board. Based on information available at the date of the grant, the volatility assumption used for 2009 option grants was 38.71%, for 2008 option grants was 28%, and for 2007 option grants was 12%.

A summary of the activity in the plans is presented below:

	Shares		Weighted Average Exercise Price(1)		Aggregate Intrinsic Value (2)
Outstanding at December 31, 2008	131,812		$	9.46
Granted (3)	22,241		$	9.45
Exercised	(14,172	)	$	5.64
Forfeited or expired	(33,626	)	$	6.39
Outstanding at December 31, 2009	106,255		$	10.49
Granted as a result of stock dividend 5% (3)	5,310		$	9.99
Exercised	-			-
Forfeited or expired	-			-
Outstanding at December 31, 2010	111,565		$	9.99
Granted (3)	-
Exercised	-
Forfeited or expired	(9,396	)	$	9.89
Total outstanding options	102,169		$	10.00
Options exercisable at end of year	82,793		$	9.87	$	-
Shares available for grant	63,785

(1)	The weighted average exercise price has been adjusted to reflect 10% stock dividends declared by the Company's Board of Directors annually from 2002 through 2007 and a 5% stock dividend declared by the Company's Board of Directors in each of 2010 and 2009.
(2)	The aggregate intrinsic value of a stock option in the table above represents the total pre-tax intrinsic value (the amount by which the current market value of the underlying stock exceeds the exercise price of the option). At December 31, 2011 the amount represents the value that would have been received by the option holders had all option holders exercised their options on that date. This amount changes based on changes in the market value of the Company's common stock. At December 31, 2011 the OTCBB quoted price was $1.27 Therefore, none of the Company's options had intrinsic value as of that date.
(3)	Granted options include new grants in years prior to 2010 as well as adjustments of previous grants as a result of 10% stock dividends declared by the Company's Board of Directors annually from 2002 through 2007 and a 5% stock dividend in each of 2009 and 2010.

     Options granted after 2005 vest over a five-year period, according to the option agreements. All options granted prior to 2006 have fully vested. The weighted average life of options outstanding was 4.40 years and 5.43 years at December 31, 2011 and 2010, respectively. Expense related to stock based compensation recorded in the accompanying consolidated statements of income (loss) was $49,676, $61,220, and $72,464 for the years ended 2011, 2010, and 2009, respectively. There were 35,169 non-vested options outstanding (estimated fair value of $198,166) at the beginning of 2011. During 2011, 13,043 options vested (estimated fair value of $74,243). No options were granted. Non-vested options to purchase 2,752 shares were forfeited. At December 31, 2011, 19,376 non-vested options (estimated fair value of $108,430) were outstanding.

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Restrictions On Cash And Due From Banks

12 Months Ended

Dec. 31, 2011

Restrictions On Cash And Due From Banks [Abstract]

Restrictions On Cash And Due From Banks

NOTE 2 – RESTRICTIONS ON CASH AND DUE FROM BANKS

     The Bank is required to maintain average reserve balances, computed by applying prescribed percentages to its various types of deposits, either at the Bank or on deposit with the Reserve Bank. At December 31, 2011 and 2010 these required reserves were met by vault cash.

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Parent Company Information

12 Months Ended

Dec. 31, 2011

Parent Company Information [Abstract]

Parent Company Information

NOTE 22 - PARENT COMPANY INFORMATION

Following is condensed financial information of Cornerstone Bancorp (parent company only):

Condensed Balance Sheets

	December 31,
	2011		2010
Assets
Cash and interest bearing deposits	$	452,354	$	525,773
Investment in subsidiary		17,026,225		17,827,490
Other assets		10,991		8,996
Total Assets	$	17,489,570	$	18,362,259
Liabilities And Shareholders' Equity
Accrued expenses	$	6,960	$	3,547
Shareholders' equity		17,482,610		18,358,712
Total Liabilities and Shareholders' Equity	$	17,489,570	$	18,362,259

Condensed Statements of Income

	Year ended December 31,
		2011			2010			2009
Income
Interest	$	4,249		$	4,848		$	4,645
Expenses
Sundry		79,086			61,502			58,893
Loss before equity in undistributed net
loss of bank subsidiary		(74,837	)		(56,654	)		(54,248	)
Equity in undistributed net loss of
subsidiary		(1,414,311	)		(441,113	)		(1,307,026	)
Net loss	$	(1,489,148	)	$	(497,767	)	$	(1,361,274	)

Condensed Statements of Cash Flows

	Year ended December 31,
		2011			2010			2009
Operating Activities
Net loss	$	(1,489,148	)	$	(497,767	)	$	(1,361,274	)
Adjustments to reconcile net loss to net cash used
for operating activities
Equity in undistributed net loss of subsidiary		1,414,311			441,113			1,307,026
Decrease (increase) in other assets		(1,995	)		724			(715	)
Increase (decrease) in accrued expenses		3,413			(10,314	)		(489	)
Net cash used for operating activities		(73,419	)		(66,244	)		(55,452	)
Investing Activities
Investment in bank subsidiary		-			(499,999	)		(299,999	)
Financing Activities
Cash paid in lieu of fractional shares		-			(1,024	)		(1,715	)
Issuance of preferred stock, net of expenses		-			998,538			-
Exercise of stock options, net of tax		-			-			80,000
Net cash provided by financing
activities		-			997,514			78,285
Net increase (decrease) in cash		(73,419	)		431,271			(277,166	)
Cash, beginning of year		525,773			94,502			371,668
Cash, end of year	$	452,354		$	525,773		$	94,502

XML

Estimated Fair Value Of Financial Instruments

12 Months Ended

Dec. 31, 2011

Estimated Fair Value Of Financial Instruments [Abstract]

Estimated Fair Value Of Financial Instruments

NOTE 21 - ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS

The estimated fair values of the Company's financial instruments were as follows:

	December 31,
	2011				2010
		Carrying		Fair		Carrying		Fair
		Amount		Value		Amount		Value
Financial Assets
Cash and due from banks	$	6,803,057	$	6,803,057	$	7,043,911	$	7,043,911
Federal funds sold		12,620,000		12,620,000		5,110,000		5,110,000
Investment securities		28,626,473		28,626,473		24,655,686		24,655,686
Loans, gross		93,381,365		94,402,712		119,914,200		120,947,231
Cash surrender value of life insurance policies		1,975,187		1,975,187		1,908,112		1,908,112
Financial Liabilities
Deposits		138,862,594		137,939,619		140,646,392		139,176,006
Fed Funds purchased and customer sweeps		67,550		67,550		895,937		895,937
Customer repurchase agreements		1,700,000		1,700,000		2,050,000		2,137,395
Borrowings from FHLB		2,441,505		2,615,148		6,592,338		6,731,378
Broker repurchase agreements		3,000,000		3,095,282		5,000,000		5,212,655

     The table below presents the balances of assets measured at fair value on a recurring or nonrecurring basis by level within the hierarchy of inputs that may be used to measure fair value. Assets valued at fair value on a recurring basis are those valued at fair value at each balance sheet date, whereas those valued on a nonrecurring basis are not re-measured as of each balance sheet date. There are no liabilities measured at fair value on a recurring basis.

	December 31, 2011
		Total		Level 1	Level 2			Level 3
Investment securities, recurring	$	28,626,473	$	18,972,486	$	8,770,137	$	883,850
Other real estate owned, nonrecurring	$	16,545,488	$	-	$	-	$	16,545,488
Impaired loans, nonrecurring	$	5,211,888	$	-	$	-	$	5,211,888
	December 31, 2010
		Total		Level 1	Level 2			Level 3
Investment securities, recurring	$	24,655,686	$	15,369,729	$	8,222,607	$	1,063,350
Other real estate owned, nonrecurring	$	10,278,599	$	-	$	-	$	10,278,599
Impaired loans, nonrecurring	$	10,414,838	$	-	$	-	$	10,414,838

The table below represents the activity in Level 3 assets that are measured at fair value on a recurring basis for the period January 1, to December 31,

Other Investments		2011			2010
Beginning balance	$	1,063,350		$	1,142,050
Total realized and unrealized gains or losses:
Included in earnings		-			-
Included in other comprehensive income		-			-
Purchases (Federal Reserve Bank stock)		17,900			-
Sales (redemptions by FHLB)		(197,400	)		(78,700	)
Principal reductions		-			-
Transfers in and/or out of Level 3		-			-
Ending balance	$	883,850		$	1,063,350

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Summary Of Significant Accounting Policies And Activities

12 Months Ended

Dec. 31, 2011

Summary Of Significant Accounting Policies And Activities [Abstract]

Summary Of Significant Accounting Policies And Activities

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES

     Cornerstone Bancorp, (the "Company") was incorporated under the laws of the State of South Carolina for the purpose of operating as a bank holding company for Cornerstone National Bank (the "Bank"). The Company obtained regulatory approval to acquire the Bank and opened the Bank for business in 1999 with a total capitalization of $6.0 million. To increase capital available for growth, the Company offered 445,000 shares of its common stock pursuant to a prospectus dated October 4, 2005. Upon completion in January 2006, the offering added approximately $6.0 million to the Company's total capitalization. In 2010 the Company offered 8% cumulative perpetual preferred stock ("the Preferred") to accredited investors. The Company sold 1,038 shares of the Preferred, raising $998,538 net of offering expenses. The Company increased its investment in the Bank by approximately $500,000 and held the remaining cash in order to pay future expenses and dividends on the Preferred.

     The Bank provides full commercial banking services to customers and is subject to regulation by the Office of the Comptroller of the Currency ("OCC") and the Federal Deposit Insurance Corporation. The Company is subject to regulation by the Federal Reserve and to limited regulation by the South Carolina State Board of Financial Institutions. The Bank maintains branch locations in the Berea area of Greenville County and the Powdersville area of Anderson County, South Carolina in addition to its headquarters in Easley in Pickens County, South Carolina. In 2004, the Bank established a wholly owned subsidiary, Crescent Financial Services, Inc. ("Crescent"), which is an insurance agency. In 2011, 2010 and 2009, Crescent's transactions were immaterial to the consolidated financial statements.

Basis of presentation

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, the Bank. The Company operates as one business segment. All significant intercompany balances and transactions have been eliminated. The accounting and reporting policies conform to accounting principles generally accepted in the United States of America ("GAAP") and to general practices in the banking industry. The Company uses the accrual basis of accounting.

Estimates

The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amount of income and expenses during the reporting periods. Actual results could differ from those estimates.

Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses, including valuation allowances for impaired loans, and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans. In connection with the determination of the allowance for loan losses and the valuation of foreclosed real estate, management obtains independent appraisals for significant properties and takes into account other current market information. While management uses available information to recognize losses on loans and foreclosed real estate, future additions to the allowance for loan losses and changes to valuation of foreclosed real estate may be necessary based on changes in local economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Company's allowance for loan losses and valuation of foreclosed real estate. Such agencies may require the Company to recognize additions to the allowance for loan losses or additional write-downs on foreclosed real estate based on their judgments about information available to them at the time of their examination. Because of these factors, it is reasonably possible that estimates related to the allowance for loan losses and valuation of foreclosed real estate may change materially in the near term.

Investment securities

The Company accounts for investment securities in accordance with financial accounting standards which require investments in equity and debt securities to be classified into three categories:

1. Available-for-sale securities: These are securities that are not classified as either held to maturity or as trading securities. These securities are reported at fair market value. Unrealized gains and losses are reported, net of income taxes, as separate components of shareholders' equity (accumulated other comprehensive income).

2. Held-to-maturity securities: These are investment securities that the Company has the ability and intent to hold until maturity. These securities are stated at cost, adjusted for amortization of premiums and the accretion of discounts. The Company has no held-to-maturity securities.

3. Trading securities: These are securities that are bought and held principally for the purpose of selling in the near future. Trading securities are reported at fair market value, and related unrealized gains and losses are recognized in the income statement. The Company has no trading securities.

The Company reviews all investments with unrealized losses as of the balance sheet date for possible impairment. Our review consists of an examination of each security with regard to its issuer, credit rating, time to maturity and likelihood of sale prior to maturity. Any losses determined to be other than temporary are recognized through the income statement. Unrealized gains and losses are determined using fair values estimated by the Company's bond accounting vendor. The vendor uses several pricing services for valuing securities, depending on the issuer of the security. Management reviews the fair values for appropriateness and consults an additional vendor to ensure that fair value estimates are reasonable. The portfolio contained Agency mortgage backed securities and municipal bonds as of December 31, 2011. There were no private-label mortgage-backed securities, collateralized mortgage obligations, or derivative products in the portfolio as of December 31, 2011. The fair values of the Company's available for sale investments, other than municipal bonds, are measured on a recurring basis using quoted market prices in active markets for identical assets and liabilities ("Level 1 inputs" under the standard). Due to the lower level of trading activity in municipal bonds, the fair market values of these investments are measured based on other inputs such as inputs that are observable or can be corroborated by observable market data for similar assets with substantially the same terms ("Level 2 inputs" under the standard.)

Other investments include the Bank's stock investments in the Federal Reserve Bank of Richmond ("Reserve Bank") and the Federal Home Loan Bank of Atlanta ("FHLB"). The Bank, as a member institution, is required to own certain stock investments in the Reserve Bank and FHLB. The stock is generally pledged against any borrowings from the Reserve Bank and FHLB. No ready market exists for the stock and it has no quoted market value. Redemption of these stock investments has historically been (including redemptions during 2011) at par value. However, there can be no assurance that future redemptions will be at par value. Other investments are carried at cost.

Gains or losses on dispositions of investment securities are based on the differences between the net proceeds and the adjusted carrying amount of the securities sold, using the specific identification method.

Loans, interest and fee income on loans

Loans are stated at the principal balance outstanding. Unearned discount and the allowance for possible loan losses are deducted from total loans in the balance sheet. Interest income is recognized over the term of the loan based on the principal amount outstanding.

Generally, the accrual of interest will be discontinued on impaired loans when principal or interest becomes 90 days past due, or when payment in full is not anticipated, and any previously accrued interest on such loans will be reversed against current income. Any subsequent interest income will be recognized on a cash basis when received unless collectibility of a significant amount of principal is in serious doubt. In such cases, collections are credited first to the remaining principal balance on a cost recovery basis. An impaired loan will not be returned to accrual status unless principal and interest are current and the borrower has demonstrated the ability to continue making payments as agreed. The ability to continue making payments as agreed is determined on a case-by-case basis due to the mainly commercial nature of the Bank's portfolio. Non-performing assets include real estate acquired through foreclosure or deed taken in lieu of foreclosure, and loans on non-accrual status. Fee income on loans is recognized as income at the time loans are originated.

Due to the short-term nature of the majority of the Bank's loans and the immateriality of the net deferred amount, this method approximates the income that would be earned if the Company deferred loan fees and costs.

Allowance for loan losses

The Company provides for loan losses using the allowance method. Loans that are determined to be uncollectible are charged against the allowance. Provisions for loan losses and recoveries on loans previously charged off are added to the allowance. The provision for loan losses charged to operating expenses reflects the amount deemed appropriate by management to establish an adequate reserve to meet the probable loan losses incurred in the current loan portfolio. Management's judgment is based on periodic and regular evaluation of individual loans, the overall risk characteristics of the various portfolio segments, past experience with losses, delinquency trends, and prevailing economic conditions. To estimate the amount of allowance necessary the Company separates the portfolio into segments. The portfolio is first separated into groups according to the internal loan rating assigned by management. Loans rated "Other Assets Especially Mentioned" ("OAEM") or "Special Mention", "Substandard", "Doubtful", or "Loss" as defined in the Bank's loan policy, are evaluated individually for impairment. The Company uses regulatory call report codes to stratify the remaining portfolio and tracks the Bank's own charge-offs and those of peer banks using FDIC Call Report Data. The Bank's own charge-off ratios by call code are used to project potential loan losses in the future on loans that are rated "Satisfactory" or better. Charge-off ratios may be increased or decreased based on other environmental factors which may need to be considered, such as unemployment rates and volatility of real estate values. While management uses the best information available to make evaluations, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the evaluations. The allowance for loan losses is also subject to periodic evaluation by various regulatory authorities and may be subject to adjustment upon their examination. Refer to Note 5 for additional information.

The Bank accounts for impaired loans in accordance with a financial accounting standard that requires all lenders to value a loan at the loan's fair value if it is probable that the lender will be unable to collect all amounts due according to the terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis taking into consideration all the circumstances of the loan and the borrower, including the length of the delay, reasons for the delay, the borrower's payment record and the amount of the shortfall in relation to the principal and interest owed. The fair value of an impaired loan may be determined based upon the present value of expected cash flows, market price of the loan, if available, or value of the underlying collateral. Expected cash flows are required to be discounted at the loan's effective interest rate. The Bank's loan portfolio is largely dependent on collateral for repayment if the borrower's financial position deteriorates. Therefore, the most common type of valuation is to determine collateral value less disposal costs in order to determine carrying values for loans deemed impaired. If an impaired loan is collateral dependent and the fair value is less than the outstanding principal balance, the short-fall is charged-off to the allowance for loan losses. Costs to sell the collateral may be specifically reserved in the allowance for loan losses until the foreclosure of the collateral is complete and the balance is moved to foreclosed property.

When the ultimate collectibility of an impaired loan's principal is in doubt, wholly or partially, all cash receipts are applied to principal. Once the reported principal balance has been reduced to zero, future cash receipts are applied to interest income, to the extent that any interest has been foregone. Further cash receipts are recorded as recoveries of any amounts previously charged off. A loan is also considered impaired if its terms are modified in a troubled debt restructuring. For these accruing impaired loans, cash receipts are typically applied to principal and interest receivable in accordance with the terms of the restructured loan agreement. Interest income is recognized on these loans using the accrual method of accounting.

Property acquired in foreclosure

Property acquired in foreclosure is carried at fair value (market value less estimated selling cost), determined using an independent appraisal. Write-downs of value occur if properties are determined to have lost value based on updated appraisals. Costs to complete properties are capitalized if the as-complete market value less estimated cost is higher than the recorded investment including the cost to complete.

Holding costs are charged to expense as incurred.

Property and equipment

Property and equipment are stated at cost, net of accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets. Maintenance and repairs are charged to operations, while major improvements are capitalized. Upon retirement, sale or other disposition of property and equipment, the cost and accumulated depreciation are eliminated from the accounts, and gain or loss is included in income from operations.

Income taxes

The Company accounts for income taxes in accordance with a financial accounting standard that requires that deferred tax assets and liabilities be recognized for the expected future tax consequences of events that have been recognized in the consolidated financial statements or tax returns. Deferred tax assets and liabilities are measured using the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be realized or settled. During 2011 the Company recorded a valuation allowance against all net deferred tax assets. Refer to Note 14 for additional information.

The Company has analyzed its filing positions in the federal and state jurisdictions where it is required to file income tax returns, as well as all open tax years in these jurisdictions. The Company believes that income tax filing positions taken or expected to be taken in its tax returns will more likely than not be sustained upon audit by the taxing authorities and does not anticipate any adjustments that will result in a material adverse impact on the Company's financial condition, results of operations, or cash flows. Therefore, no reserves for uncertain income tax positions have been recorded. The Company's federal and state income tax returns are open and subject to examination from the 2008 tax return and forward.

Advertising and public relations expense

Advertising, promotional and other business development costs are generally expensed as incurred. External costs incurred in producing media advertising are expensed the first time the advertising takes place. External costs relating to direct mailing costs are expensed in the period in which the direct mailings are sent.

Earnings per common share

Basic earnings (loss) per common share is computed on the basis of the weighted average number of common shares outstanding. The treasury stock method is used to compute the effect of stock options on the weighted average number of common shares outstanding for diluted earnings (loss) per common share. As of December 31, 2011, 2010, and 2009 there were no common stock equivalents included in the Company's loss per share calculation. Options to purchase 102,169 shares, 111,565 shares and 106,255 shares of common stock were antidilutive as of December 31, 2011, 2010 and 2009, respectively, and were excluded from the diluted share calculation. The Company declared a five percent stock dividend to shareholders of record on May 11, 2010. For 2009, per share amounts on the Consolidated Statements of income (loss) have been retroactively restated to reflect the 2010 stock dividend.

Cash surrender value of life insurance policies

Cash surrender value of life insurance policies represents the cash value of policies on certain officers of the Bank.

Statement of cash flows

For purposes of reporting cash flows, cash and cash equivalents are those amounts which have an original maturity of three months or less.

Fair values of financial instruments

The Company discloses fair value information for financial instruments, whether or not recognized in the balance sheet, when it is practicable to estimate the fair value. Under GAAP, a financial instrument is defined as cash, evidence of an ownership interest in an entity or contractual obligations that require the exchange of cash or other financial instruments. Certain items are specifically excluded from the disclosure requirements, including the Company's common stock. In addition, other nonfinancial instruments such as premises and equipment and other assets and liabilities are not subject to the disclosure requirements.

The following methods and assumptions were used by the Company in estimating fair values of financial instruments as disclosed herein: Cash and due from banks - The carrying amounts of cash and due from banks approximate their fair value.

Federal funds sold - The carrying amounts of federal funds sold approximate their fair value.

Cash surrender value of life insurance policies - The cash surrender value of life insurance policies held by the Bank approximates fair values of the policies.

Loans - For variable rate loans that reprice frequently and for loans that mature within one year, fair values are based on carrying values. Fair values for all other loans are estimated using discounted cash flow analyses, with interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Fair values for impaired loans are estimated using discounted cash flow analyses or underlying collateral values less cost to sell, where applicable.

Deposits - Fair values for deposits are estimated using a discounted cash flow calculation that applies interest rates currently being offered on similar accounts to a schedule of aggregated expected monthly maturities. Repricing time frames for non-maturing deposits are estimated using Federal Deposit Insurance Corporation Improvement Act Section 305 guidelines.

Customer repurchase agreements - Fair values of repurchase agreements are estimated using a discounted cash flow analysis that applies interest rates currently being offered on similar accounts to a schedule of aggregated expected monthly maturities.

Borrowings from Federal Home Loan Bank of Atlanta - Borrowings from the FHLB which have variable rates of interest are deemed to be carried at fair value. Fair values of fixed rate advances are estimated using a discounted cash flow calculation that applies interest rates currently being offered on advances to a schedule of aggregated expected maturities.

Broker repurchase agreements - Fair values of broker repurchase agreements are estimated using a discounted cash flow analysis that applies interest rates currently being offered on similar accounts to a schedule of aggregated expected monthly maturities.

Stock Based Compensation

The Company has a stock-based director and employee compensation plan (the "2003 Plan") as further described in Note 18. Stock dividends were declared subsequent to the grant dates of the options. Pursuant to the terms of the 2003 Plan option agreements, the number of options outstanding was increased and the exercise price was decreased to give effect to these stock dividends.

The Company accounts for stock based compensation in accordance with GAAP. Fair value of an option grant is estimated on the date of grant using the Black-Scholes option pricing model.

Cumulative Perpetual Preferred Stock (8%)

During the third quarter of 2010, the Company offered up to $2,500,000 of 8% Series A Cumulative Perpetual Preferred Stock ("the Preferred") to accredited investors and up to 35 non-accredited investors. The Preferred was offered by the Company's directors and executive officers, and no selling agents or underwriters were used. 1,038 shares of the Preferred were sold. Proceeds of the offering, net of offering expenses totaled $998,538. The Preferred is scheduled to pay a dividend quarterly. However, pursuant to the Company's Memorandum of Understanding with the Federal Reserve, the Federal Reserve has declined to approve the dividends scheduled for payment to date. Dividends that have accumulated, but have not been declared or accrued since inception of the Preferred, total $118,553 as of December 31, 2011. See Note 20 for more information about the Memorandum of Understanding.

Recently issued accounting standards

The following is a summary of recent authoritative pronouncements that affect accounting, reporting, and disclosure of financial information by the Company:

In July 2010, the Receivables topic of the Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") was amended by Accounting Standards Update ("ASU") 2010-20 to require expanded disclosures related to a company's allowance for credit losses and the credit quality of its financing receivables. The amendments require the allowance disclosures to be provided on a disaggregated basis. The Company included these disclosures in its financial statements (see Note 5).

In April 2011, FASB issued ASU 2011-02 to assist creditors with their determination of when a restructuring is a Troubled Debt Restructuring ("TDR"). The determination is based on both whether the restructuring constitutes a concession and whether the debtor is experiencing financial difficulties. Disclosures related to TDRs under ASU 2010-20 were effective for reporting periods beginning after June 15, 2011. Adoption of the standard did not have a material effect on the financial statements. Disclosures related to TDRs under ASU 2010-20 have been presented in Note 5.

In April 2011, the criteria used to determine effective control of transferred assets in the Transfers and Servicing topic of the ASC was amended by ASU 2011-03. The requirement for the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms and the collateral maintenance implementation guidance related to that criterion were removed from the assessment of effective control. The other criteria to assess effective control were not changed. The amendments are effective for the Company beginning January 1, 2012 but are not expected to have a material effect on the financial statements.

ASU 2011-04 was issued in May 2011 to amend the Fair Value Measurement topic of the ASC by clarifying the application of existing fair value measurement and disclosure requirements and by changing particular principles or requirements for measuring fair value or for disclosing information about fair value measurements. The amendments will be effective for the Company beginning January 1, 2012 but are not expected to have a material effect on the financial statements.

The Comprehensive Income topic of the ASC was amended in June 2011. The amendment eliminates the option to present other comprehensive income as a part of the statement of changes in stockholders' equity. The amendment requires consecutive presentation of the statement of net income and other comprehensive income and requires an entity to present reclassification adjustments from other comprehensive income to net income on the face of the financial statements. The amendments will be applicable to the Company on January 1, 2012 and will be applied retrospectively. They are not expected to have an effect on the financial statements.

Accounting standards that have been issued or proposed by the Financial Accounting Standards Board that do not require adoption until a future date are not expected to have a material impact on the consolidated financial statements upon adoption.

Subsequent events

Subsequent events are events or transactions that occur after the balance sheet date but before the financial statements are issued. Recognized subsequent events are events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements. Nonrecognized subsequent events are events that provide evidence about conditions that did not exist at the date of the balance sheet but arose after that date. Management has reviewed events occurring through the date the financial statements were available to be issued and no subsequent events occurred requiring accrual or disclosure.

Formal Agreement with the Office of the Comptroller of the Currency

On May 12, 2010, the Bank entered into a formal agreement with the OCC for the Bank to take various actions with respect to the operation of the Bank. The actions include creation of a committee of the Bank's board of directors to monitor compliance with the agreement and make quarterly reports to the board of directors and the OCC; assessment and evaluation of management and members of the board; development, implementation and adherence to a written program to improve the Bank's loan portfolio management; protection of the Bank's interest in its criticized assets; implementation of a program that identifies and manages concentrations of credit risk (see Note 5); extension of the Bank's strategic plan; extension of the Bank's capital program and profit plan; additional plans for ensuring that the level of liquidity at the Bank is sufficient to sustain the current operations and withstand any anticipated or extraordinary demand; and a requirement for obtaining a determination of no supervisory objection from the OCC before accepting brokered deposits. The substantive actions called for by the agreement should strengthen the Bank and make it more efficient in the long-term. The Bank believes it has taken appropriate actions at December 31, 2011 to comply with the requirements included in the formal agreement.

Risks and Uncertainties

In the normal course of its business the Company encounters two significant types of risks: economic and regulatory. There are three main components of economic risk: interest rate risk, credit risk and market risk. The Company is subject to interest rate risk to the degree that its interest-bearing liabilities mature or reprice at different times, or on different bases, than its interest-earning assets. Credit risk is the risk of default on the Company's loan and investment portfolios that results from borrowers' inability or unwillingness to make contractually required payments. Market risk reflects changes in the value of collateral underlying loans receivable and the valuation of real estate held by the Company.

The Company is subject to the regulations of various governmental agencies (regulatory risk). These regulations can and do change significantly from period to period. The Company also undergoes periodic examinations by the regulatory agencies, which may subject it to further changes with respect to asset valuations, amounts of required loss allowances and operating restrictions as a result of the regulators' judgments based on information available to them at the time of their examination.

Reclassification

Certain amounts in prior years' financial statements have been reclassified to conform to current year presentation. No changes have been made that affect the reported results of operations, financial condition or cash flows.

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Consolidated Balance Sheets (USD $)	Dec. 31, 2011	Dec. 31, 2010
Assets
Cash and due from banks	$ 6,803,057	$ 7,043,911
Federal funds sold	12,620,000	5,110,000
Cash and cash equivalents	19,423,057	12,153,911
Investment securities
Available-for-sale	27,742,623	23,592,336
Other investments	883,850	1,063,350
Loans, net	91,338,925	117,210,770
Property and equipment, net	5,024,113	5,230,835
Cash surrender value of life insurance policies	1,975,187	1,908,112
Property acquired in foreclosure	16,545,488	10,278,599
Other assets	1,390,168	2,530,552
Total assets	164,323,411	173,968,465
Liabilities And Shareholders' Equity
Noninterest bearing	17,087,736	10,382,882
Interest bearing	121,774,858	130,263,510
Total deposits	138,862,594	140,646,392
Customer repurchase agreements	1,767,550	2,945,937
Borrowings from Federal Home Loan Bank of Atlanta	2,441,505	6,592,338
Broker repurchase agreements	3,000,000	5,000,000
Other liabilities	769,152	425,086
Total liabilities	146,840,801	155,609,753
Commitments and contingencies - Notes 12 and 16
Shareholders' equity
Preferred stock, 10,000,000 shares authorized, 1,038 shares issued at December 31, 2011 and 2010	998,538	998,538
Common stock, no par value, 20,000,000 shares authorized, 2,210,769 shares issued at December 31, 2011 and 2010	18,909,600	18,859,924
Retained deficit	(2,907,929)	(1,418,781)
Accumulated other comprehensive (loss) income	482,401	(80,969)
Total shareholders' equity	17,482,610	18,358,712
Total liabilities and shareholders' equity	$ 164,323,411	$ 173,968,465

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Consolidated Statements Of Shareholders' Equity And Comprehensive Income (Loss) (Parenthetical)	12 Months Ended
	Dec. 31, 2010	Dec. 31, 2009
Consolidated Statements Of Shareholders' Equity And Comprehensive Income (Loss) [Abstract]
Stock dividend declared, percentage	5.00%	5.00%

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Related Party Transactions

12 Months Ended

Dec. 31, 2011

Related Party Transactions [Abstract]

Related Party Transactions

NOTE 15 – RELATED PARTY TRANSACTIONS

     Certain directors, executive officers and companies with which they are affiliated, are customers of and have loan transactions with the Bank in the ordinary course of business. These loans were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable arms-length transactions.

A summary of loan transactions with directors, including their affiliates, and executive officers is as follows:

	Year ended December 31,
	2011			2010			2009
Balance, beginning of year	$	6,002,606		$	7,638,399		$	5,958,663
New loans or lines of credit		175,300			209,100			2,588,627
Payments on loans or lines of credit		(1,174,257	)		(1,844,893	)		(908,891	)
Balance, end of year	$	5,003,649		$	6,002,606		$	7,638,399

     Deposits by directors, executive officers, and their related interests, at December 31, 2011 and 2010 were $1.1 million and $2.6 million, respectively.

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Employee Benefit Plan

12 Months Ended

Dec. 31, 2011

Employee Benefit Plan [Abstract]

Employee Benefit Plan

NOTE 17 – EMPLOYEE BENEFIT PLAN

     The Company sponsors a Simple IRA Plan for the benefit of all eligible employees. The Bank contributes up to three percent of the employee's compensation. Employer contributions made to the Plan in 2011, 2010, and 2009 amounted to $44,212, $47,207, and $53,458, respectively.

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Consolidated Statements Of Cash Flows (USD $)	12 Months Ended
	Dec. 31, 2011	Dec. 31, 2010	Dec. 31, 2009
Operating Activities
Net loss	$ (1,489,148)	$ (497,767)	$ (1,361,274)
Adjustments to reconcile net loss to net cash provided by (used for) operating activities
Depreciation and net amortization	538,477	484,081	351,303
Deferred income tax expense (benefit)	908,441	(132,306)	(37,863)
Provision for loan losses	670,000	1,260,000	2,955,000
Impairment of foreclosed property	430,513	709,751
Gain on sale of available-for-sale investments		(325,656)	(299,063)
Loss on sale of repossessed collateral	193,693	180,397	228,547
(Gain) loss on sale/disposal of property and equipment	3,539	1,881	(625)
Non-cash option expense	49,676	61,220	72,464
(Increase) decrease in other assets	164,868	1,508,383	(2,459,514)
Increase in other liabilities	53,844	101	145,474
Net cash provided by (used for) operating activities	1,523,903	3,250,085	(405,551)
Investing Activities
Proceeds from maturities and principal paydowns of investment securities	8,932,818	8,277,549	5,901,304
Proceeds from sale of investment securities		8,120,975	10,752,749
Proceeds from sale of foreclosed property	4,389,988	3,947,388	2,498,705
Purchase of investment securities	(12,532,290)	(11,385,110)	(25,495,248)
(Purchase) sale of FHLB and Federal Reserve stock, net	179,500	78,700	(27,900)
(Increase) decrease in loans, net	14,112,651	8,558,681	(17,167,459)
Proceeds from sale of property and equipment	425		625
Capitalization of improvements to foreclosed property	(191,889)	(364,989)	(63,943)
Purchase of property and equipment	(32,942)	(169,697)	(5,448)
Net cash provided by (used for) investing activities	14,858,261	17,063,497	(23,606,615)
Financing Activities
Net (decrease) increase in deposits	(1,783,798)	(11,734,882)	29,799,700
Net decrease in customer repurchase agreements	(1,178,387)	(311,065)	(1,325,617)
Net decrease Federal funds purchased			(1,810,000)
Borrowings from Federal Home Loan Bank of Atlanta			4,500,000
Repayments to Federal Home Loan Bank of Atlanta	(4,150,833)	(3,150,834)	(5,150,833)
Proceeds from sale of preferred stock, net of expenses		998,538
Repayments of broker repurchase agreements	(2,000,000)
Proceeds from exercise of stock options			80,000
Cash paid in lieu of fractional shares		(1,024)	(1,715)
Net cash (used for) provided by financing activities	(9,113,018)	(14,199,267)	26,091,535
Net increase in cash and cash equivalents	7,269,146	6,114,315	2,079,369
Cash and cash equivalents, beginning of year	12,153,911	6,039,596	3,960,227
Cash and cash equivalents, end of year	19,423,057	12,153,911	6,039,596
Cash paid for:
Interest	1,860,780	2,776,547	3,457,004
Income taxes (refunds, received)	(208,897)	(892,557)	54,946
Non-cash Supplemental information:
Loans transferred to foreclosed property	11,089,194	8,038,463	8,922,517
Loans charged-off, net	$ 1,330,990	$ 1,251,907	$ 1,958,726

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Consolidated Balance Sheets (Parenthetical) (USD $)	Dec. 31, 2011	Dec. 31, 2010
Consolidated Balance Sheets [Abstract]
Preferred stock, shares authorized	10,000,000	10,000,000
Preferred stock, shares issued	1,038	1,038
Common stock, no par value
Common stock, shares authorized	20,000,000	20,000,000
Common stock, shares issued	2,210,769	2,210,769

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Borrowings From Federal Home Loan Bank Of Atlanta

12 Months Ended

Dec. 31, 2011

Borrowings From Federal Home Loan Bank Of Atlanta [Abstract]

Borrowings From Federal Home Loan Bank Of Atlanta

NOTE 10 – BORROWINGS FROM FEDERAL HOME LOAN BANK OF ATLANTA

     At December 31, 2011 and 2010, the Bank had a line of credit to borrow funds from the FHLB in the amount of 10% of the Bank's assets. Funds borrowed from the FHLB are collateralized by a lien on certain of the Bank's available for sale securities and loans. At December 31, the Bank had advances outstanding as follows:

					December 31,
Terms	Interest Rate		Maturity Date		2011		2010
Fixed rate, convertible	3.52	%	1/16/2018	$	2,000,000	$	2,000,000
Fixed rate	1.07		1/10/2011		-		3,000,000
Fixed rate	2.72		1/25/2011		-		1,000,000
Fixed rate, amortizing	4.49		12/01/2013		88,889		133,333
Fixed rate, amortizing	4.89		4/14/2014		90,741		129,630
Fixed rate, amortizing	4.78		7/27/2015		261,875		329,375
				$	2,441,505	$	6,592,338

     The Company's convertible advance from the FHLB is convertible to a variable rate instrument at the option of the FHLB on January 16, 2013. During 2011 the highest balance as of any month end for borrowings from the FHLB was $2.6 million. The average rate paid on advances during 2011 was 3.53%. The average balance of FHLB advances for 2011 was $2.7 million. During 2010 the highest balance as of any month end for borrowings from the FHLB was $9.7 million. The average rate paid on advances during 2010 was 2.50%. The average balance of FHLB advances for 2010 was $8.0 million.

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Document And Entity Information (USD $)	12 Months Ended
	Dec. 31, 2011	Mar. 14, 2012	Jun. 30, 2011
Document And Entity Information [Abstract]
Document Type	10-K
Amendment Flag	false
Document Period End Date	Dec. 31, 2011
Document Fiscal Period Focus	FY
Document Fiscal Year Focus	2011
Entity Registrant Name	CORNERSTONE BANCORP/SC
Entity Central Index Key	0001087455
Current Fiscal Year End Date	--12-31
Entity Filer Category	Smaller Reporting Company
Entity Common Stock, Shares Outstanding		2,210,769
Entity Voluntary Filers	No
Entity Current Reporting Status	Yes
Entity Well-known Seasoned Issuer	No
Entity Public Float			$ 1,906,692

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Broker Repurchase Agreements

12 Months Ended

Dec. 31, 2011

Broker Repurchase Agreements [Abstract]

Broker Repurchase Agreements

NOTE 11 – BROKER REPURCHASE AGREEMENTS

     Broker repurchase agreements consist of one repurchase agreement totaling $3.0 million as of December 31, 2011. The borrowing carries a fixed rate of interest with a call feature. The agreement matures on January 15, 2015, and is callable by the broker quarterly after January 15, 2012. The Company prepaid another repurchase agreement in the amount of $2.0 million during December, 2011. That agreement was set to mature on January 15, 2013 and was callable by the broker quarterly, beginning January 10, 2010. Prepaying the agreement required an acceleration of interest payments of $67,318. The additional amount is included in "Interest Expense- Broker repurchase agreements" in the accompanying Consolidated Statement of Income (Loss). The agreement was prepaid to reduce capital requirements and to remove a negative impact on the Company's net interest margin in future periods. Securities with fair value of $4.1 million and amortized cost of $3.9 million collateralize the remaining agreement. During 2011 the highest balance as of any month end for broker repurchase agreements was $5.0 million and the average balance for 2011 was $4.9 million. The average rate paid on broker repurchase agreements during 2011 was 4.92%. Without the prepayment interest of $67,318 the average rate paid on broker repurchase agreements in 2011 would have been 3.54%. During 2010 the highest balance as of any month end for broker repurchase agreements was $5.0 million and the average balance for 2010 was $5.0 million. The average rate paid on broker repurchase agreements during 2010 was 3.54%.

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Consolidated Statements Of Income (Loss) (USD $)	12 Months Ended
	Dec. 31, 2011	Dec. 31, 2010	Dec. 31, 2009
Interest Income
Loans and fees on loans	$ 5,862,832	$ 6,912,550	$ 6,997,466
Investment securities	820,729	916,464	1,025,983
Federal funds sold and other	17,132	18,968	16,378
Total interest income	6,700,693	7,847,982	8,039,827
Interest Expense
Deposits	1,467,215	2,331,067	2,930,929
Federal funds and customer repurchase agreements	26,718	38,259	78,438
Federal Home Loan Bank advances	93,871	200,885	237,870
Broker repurchase agreements	239,746	177,103	176,619
Total interest expense	1,827,550	2,747,314	3,423,856
Net interest income	4,873,143	5,100,668	4,615,971
Provision for loan losses	670,000	1,260,000	2,955,000
Net interest income after provision for loan losses	4,203,143	3,840,668	1,660,971
Noninterest Income
Service fees on deposit accounts	531,437	536,480	572,973
Gain on sale of available-for-sale investments		325,656	299,063
Mortgage loan origination fees			154,905
Other	214,919	206,540	183,225
Total noninterest income	746,356	1,068,676	1,210,166
Noninterest Expenses
Salaries and benefits	2,181,085	2,238,400	2,392,717
Occupancy and equipment	530,827	542,138	572,025
Data processing	240,702	233,631	218,110
Advertising	27,171	21,225	30,258
Supplies	76,596	67,136	69,383
Professional and regulatory fees	574,367	584,539	551,330
Directors' fees	130,550	137,025	138,475
Loan expenses	222,515	213,035	322,687
Holding costs of foreclosed property	527,850	461,598	117,272
Loss on sale of foreclosed property	193,693	180,397	228,547
Impairment of foreclosed property	430,513	709,751
Other operating expenses	394,337	406,509	411,344
Total noninterest expenses	5,530,206	5,795,384	5,052,148
Loss before income taxes	(580,707)	(886,040)	(2,181,011)
Income tax expense (benefit)	908,441	(388,273)	(819,737)
Net loss	(1,489,148)	(497,767)	(1,361,274)
Dividend on preferred stock	(88,077)	(30,476)
Loss available to common shareholders	$ (1,577,225)	$ (528,243)	$ (1,361,274)
Loss Per Common Share
Basic	$ (0.71)	$ (0.24)	$ (0.62)
Diluted	$ (0.71)	$ (0.24)	$ (0.62)
Weighted Average Common Shares Outstanding
Basic	2,210,769	2,210,769	2,208,191
Diluted	2,210,769	2,210,769	2,208,191

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Loans

12 Months Ended

Dec. 31, 2011

Loans [Abstract]

Loans

NOTE 5 – LOANS

The composition of net loans by category as used by management to evaluate the quality of the portfolio is presented below.

	December 31,
	2011	2010
Loans secured by real estate-construction/development	$  26,811,333	$  41,855,338
Loans secured by real estate- single family (1)	14,341,533	19,604,943
Loans secured by real estate-nonfarm, non-residential	40,005,619	43,080,225
Loans secured by real estate-multifamily	1,694,088	1,793,400
Commercial and industrial	9,841,720	12,580,841
Consumer	687,072	999,453
Loans, gross	93,381,365	119,914,200
Less allowance for loan losses	(2,042,440)	(2,703,430)
Loans, net	$  91,338,925	$  117,210,770
(1)The category includes HELOCs and junior liens.  HELOCs totaled $6.0 million and $7.6 million as of December 31, 2011 and 2010, respectively. Closed-end junior liens totaled $111,841 and $155,219 as of December 31, 2011 and 2010, respectively.

Loan Portfolio Composition

One of the primary components of the Bank's loan portfolio is loans secured by first or second mortgages on residential and commercial real estate. These loans generally consist of short to mid-term commercial real estate loans, construction and development loans, and residential real estate loans (including home equity and second mortgage loans). Interest rates may be fixed or adjustable and the Bank frequently charges an origination fee. The Bank has not

purchased any loans. The Bank seeks to manage market and credit risk in the commercial real estate portfolio by emphasizing loans on owner-occupied office and retail buildings where the loan-to-value ratio at origination, established by independent appraisals, does not exceed 80%. In addition, the Bank generally requires personal guarantees of the principal owners of the property. The loan-to-value ratio at origination for first and second mortgage loans generally does not exceed 80%, and for construction loans, generally does not exceed 75% of cost. The Bank employs a reappraisal policy to routinely monitor real estate collateral values on real estate loans where the repayment is dependent on sale of the collateral. The Bank generally does not offer development loans with interest reserve features. In addition, in an effort to control interest rate risk, long term residential mortgages are not originated for the Bank's portfolio.

The Bank does not make long term (more than 15 years) mortgage loans to be held in its portfolio, and does not offer loans with negative amortization features or long-term interest only features, or loans with loan to collateral value ratios in excess of 100% at the time the loan is made. The Bank does offer loan products with features that can increase credit risk during periods of declining economic conditions, such as adjustable rate loans, short-term interest-only loans, and loans with amortization periods that differ from the maturity date (i.e., balloon payment loans). However, the Bank evaluates each customer's creditworthiness based on the customer's individual circumstances, and current and expected economic conditions, and underwrites and monitors each loan for associated risks. Loans made with exceptions to internal loan guidelines and those with loan-to-value ratios in excess of regulatory loan-to-value guidelines are monitored and reported to the Board of Directors on a monthly basis. The regulatory loan-to-value guidelines permit exceptions to the guidelines up to a maximum of 30% of total capital for commercial loans and exceptions for all types of real estate loans up to a maximum of 100% of total capital. As of December 31, 2011, the Bank had $3.7 million of loans which exceeded the regulatory loan to value guidelines. This amount is within the maximum allowable exceptions to the guidelines. Of the $3.7 million of loans with exceptions to the regulatory loan to value guidelines, $2.4 million, or approximately 63%, were not exceptions at the time the loans were made, but became exceptions upon reappraisal. Management routinely reappraises real estate collateral based on specific criteria and circumstances. If additional collateral is available, the Bank may require the borrower to commit additional collateral to the loan or take other actions to mitigate the Bank's risk.

The Bank makes loans for commercial purposes in various lines of business. Commercial loans include both secured and unsecured loans for working capital (including inventory and receivables), loans for business expansion (including acquisition of real estate and improvements), and loans for purchases of equipment and machinery. Equipment loans are typically made for a term of five years or less at either fixed or variable rates, with the loan fully amortized over the term and secured by the financed equipment. Working capital loans typically have terms not exceeding one year and are usually secured by accounts receivable, inventory or personal guarantees of the principals of the business. Commercial loans vary greatly depending upon the circumstances, and loan terms are structured on a case-by-case basis to better serve customer needs.

                The risks associated with commercial loans vary with many economic factors, including the economy in the Bank's market areas. The well-established banks in the Bank's market areas make proportionately more loans to medium- to large-sized businesses than the Bank makes. Many of the Bank's commercial loans are made to small- to medium-sized businesses, which typically are not only smaller, but also have shorter operating histories and less sophisticated record keeping systems than larger entities. As a result, these smaller entities may be less able to withstand adverse competitive, economic and financial conditions than larger borrowers. In addition, because payments on loans secured by commercial property generally depend to a large degree on the results of operations and management of the properties, repayment of such loans may be subject, to a greater extent than other loans, to adverse conditions in the real estate market or the economy.

The Bank makes a variety of loans to individuals for personal and household purposes, including secured and unsecured installment and term loans, and unsecured revolving lines of credit. The secured installment and term loans to consumers generally consist of loans to purchase automobiles, boats, recreational vehicles, mobile homes and household furnishings, with the collateral for each loan being the purchased property.

Consumer loans generally involve more credit risks than other loans because of the type and nature of the underlying collateral or because of the absence of any collateral. Consumer loan repayments are dependent on the borrower's continuing financial stability and are likely to be adversely affected by job loss, divorce and illness. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans in the case of default. In many cases, any repossessed personal property will not provide an adequate source of repayment of the outstanding loan balance.

Portfolio Segment MethodologyThe Bank segments its loan portfolio into groups of loans that mirror the regulatory reporting segments for loans, which are based on specific definitions in the Code of Federal Regulations and used in the regulatory call report. Those categories are presented in the table above and are the same categories used by management to analyze credit quality and the adequacy of the allowance for loan losses.  The Bank has been, and will continue to be, reliant on loans with real estate collateral. Under the regulatory guidelines loans with real estate collateral are reported based on various additional sub-categories, such as construction loans, loans collateralized by single family homes, including home equity lines of credit ("HELOC"), and non-residential properties.

Allowance for loan losses

                The provision for loan losses charged to operating expenses reflects the amount deemed appropriate by management to establish an adequate reserve to meet the probable loan losses incurred in the current loan portfolio. Management's judgment is based on periodic and regular evaluation of individual loans, the overall risk characteristics of the various portfolio segments, past experience with losses, delinquency trends, and prevailing economic conditions. To estimate the amount of allowance necessary the Company separates the portfolio into segments. The portfolio is first separated into groups according to the internal loan rating assigned by management. Loans rated "Special Mention", "Substandard", "Doubtful" or "Loss," as defined in the Bank's loan policy (and below), are evaluated individually for impairment. The Company uses regulatory call report codes to stratify the remaining portfolio and tracks the Bank's own charge-offs and those of peer banks using FDIC Call Report data. The Bank's own charge-off ratios by call report code are used to project potential loan losses in the future on loans that are rated "Satisfactory" or better. Charge-off ratios may be increased or decreased based on other environmental factors which may need to be considered, such as unemployment rates and volatility of real estate values. While management uses the best information available to it to make evaluations, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the evaluations. The allowance for loan losses is also subject to periodic evaluation by various regulatory authorities and may be subject to adjustment upon their examination.

Credit Quality Indicators

Loans on the Bank's watch list (including loans rated Special Mention, Substandard, Doubtful or Loss as defined below and in the Bank's loan policy) are evaluated individually for impairment and are shown in the table below. Loans rated Doubtful or Loss are generally charged-off, unless specific circumstances warrant the loan's remaining in the portfolio, even with a grade of Doubtful or Loss. Loans rated Satisfactory are also summarized in the table below.

	December 31, 2011
	Special Mention	Substandard	Doubtful/ Loss	Satisfactory
Loans secured by real estate – construction	$  2,175,614	$  8,414,868	$                -	$ 16,220,851
Loans secured by real estate – single family (1)	621,891	1,243,161	-	12,476,481
Loans secured by real estate – multi-family	-	692,673	-	1,001,415
Loans secured by real estate –nonfarm, nonresidential	4,087,623	1,963,116	-	33,954,880
Commercial and industrial loans	225,310	303,192	-	9,313,218
Consumer loans	-	216	-	686,856
Total	$ 7,110,438	$ 12,617,226	$                 -	$ 73,653,701
	December 31, 2010
	Special Mention	Substandard	Doubtful/Loss	Satisfactory
Loans secured by real estate – construction	$   2,217,173	$ 10,608,496	$                -	$ 29,029,669
Loans secured by real estate – single family (1)	1,389,483	2,894,266	-	15,321,194
Loans secured by real estate – multi-family	-	-	-	1,793,400
Loans secured by real estate –nonfarm, nonresidential	1,439,121	661,532	-	40,979,572
Commercial and industrial loans (2)	79,744	86,379	992,027	11,422,691
Consumer loans	1,796	1,869	-	995,788
Total	$  5,127,317	$ 14,252,542	$     992,027	$ 99,542,314

(1)Includes HELOC loans.

(2)The total loans classified as doubtful as of December 31, 2010 were repaid in full in 2011 (with no loss to the principal balance for the Company). They were classified as doubtful as of December 31, 2010 because of the possibility that legal proceedings would lengthen the collection time significantly.

A loan classified as Special Mention has potential weaknesses that deserve management's close attention. If left uncorrected, these potential weaknesses may affect the likelihood of repayment for the loan or result in deterioration of the bank's credit position at some future date. The Substandard rating is applicable to loans having a well-defined weakness in the liquidity or net worth of the borrower or the collateral that could jeopardize the liquidation of the debt. Well-defined weaknesses could include deterioration in the borrower's financial condition or cash flows, significant changes in the value of underlying collateral, or other indicators of weakness. A loan classified as Doubtful has all the weaknesses inherent in one classified substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. Loans classified Loss are considered uncollectible and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off this asset even though partial recovery may be affected in the future.

Loans in all of the above categories (special mention, substandard, doubtful, and loss) are reviewed individually for impairment (see table below) and to determine which category they will be placed in for purposes of the calculation of the allowance for loan losses. Additional assets may also be individually evaluated for impairment. Credit quality indicators are updated semi-annually unless circumstances warrant a change in the rating, which is updated as soon as practicable.

Delinquent loans and loans on non-accrual are presented by portfolio segment in the table below.

	December 31, 2011		December 31, 2010
	Past due 30-89 Days	Nonaccrual or Past due over 90 Days	Past due 30-89 Days	Nonaccrual or Past due over 90 Days
Loans secured by real estate – construction	$               -	$  2,387,142	$     891,035	$  7,218,012
Loans secured by real estate – single family (1)	141,289	105,541	1,977,519	1,522,290
Loans secured by real estate – multi-family	-	692,673	-	-
Loans secured by real estate –nonfarm, nonresidential	308,700	899,932	-	-
Commercial and industrial loans	18,055	-	-	992,027
Consumer loans	-	-	-	-
Total	$  468,044	$ 4,085,288	$ 2,868,554	$  9,732,329

(1)Includes HELOC loans.

Management closely monitors delinquent loans. Construction loans past due on nonaccrual as of December 31, 2011 decreased from December 31, 2010 primarily due to completion of the foreclosure process. As of December 30, 2011 construction loans on nonaccrual are comprised of three loans. Of those three, one loan continues to pay as agreed and is not in foreclosure. Of the remaining 2 loans, one loan represents 84% of the remaining balance, and is collateralized by vacant commercial property. Management has evaluated the relationship and the underlying collateral and believes that the value of the collateral is adequate to cover the Company's investment in the related loans if foreclosure is ultimately required.

The table below details amounts of loans collectively or individually evaluated for impairment by portfolio segment.

	December 31, 2011		December 31, 2010
	Collectively reviewed for impairment	Individually reviewed for impairment	Collectively reviewed for impairment	Individually reviewed for impairment
Loans secured by real estate – construction	$ 16,220,851	$ 10,590,482	$ 29,029,669	$ 12,825,669
Loans secured by real estate – single family (1)	12,476,480	1,865,052	15,321,194	4,283,749
Loans secured by real estate –nonfarm, nonresidential	33,809,132	6,196,487	40,979,572	2,100,653
Loans secured by real estate – multifamily	1,001,415	692,673	1,793,400	-
Commercial and industrial loans	9,313,218	528,502	11,422,691	1,158,150
Consumer loans	686,857	216	995,788	3,665
Total	$ 73,507,953	$19,873,412	$ 99,542,314	$ 20,371,886

(1)Includes HELOC loans.

Impaired loans by portfolio segment, the majority of which are included in the table above, as of the dates indicated, were as follows:

	December 31, 2011
	Unpaid Principal Balance	Recorded Investment	Related Specific Reserves	Average Impaired Investment	Interest Income
Loans secured by real estate – construction/development	$  3,026,785	$   2,785,868	$   16,492	$  4,062,190	$   97,871
Loans secured by real estate – single family	477,466	472,012	6,287	485,819	27,347
Loans secured by real estate – multi-family	692,673	692,673	-	694,595	39,848
Loans secured by real estate –nonfarm, nonresidential	1,387,683	1,207,728	17,600	1,300,751	68,453
Commercial and industrial	53,607	53,607	-	60,096	5,027
Consumer loans	-	-	-	-	-
Total impaired loans (1)	$   5,545,191	5,211,888	$ 40,379	$ 6,603,451	$ 235,548
Less related allowance for              loan losses		(40,379)
Net nonperforming loans		$  5,171,509

(1)Includes loans on nonaccrual.

	December 31, 2010
	Unpaid Principal Balance	Recorded Investment	Related Specific Reserves	Average Impaired Investment	Interest Income
Loans secured by real estate – construction/development	$  7,355,282	$   7,218,013	$    51,280	$  7,780,357	$ 106,259
Loans secured by real estate – single family	2,269,366	2,137,335	3,287	2,185,276	82,340
Loans secured by real estate – multi-family	-	-	-	-	-
Loans secured by real estate –nonfarm, nonresidential	152,310	152,310	-	155,526	10,946
Commercial and industrial	1,129,662	1,129,662	292,000	1,137,190	9,681
Consumer loans	1,869	1,869	1,869	2,158	415
Total impaired loans (1)	$ 10,908,489	10,639,189	$ 348,436	$ 11,260,507	$ 209,641
Less related allowance for              loan losses		(348,436)
Net nonperforming loans		$ 10,290,753

(1)Includes loans on nonaccrual.

Reappraisals are routinely ordered when a loan is collateral dependent and showing signs of weakness. Specifically, the Company's reappraisal policy states that collateral for single family construction loans will be reappraised if the home is complete and remains unsold for twelve months, or if the original loan has been outstanding for eighteen months. For development loans, if lot absorption varies from the original appraiser's estimates by 25% or more, the collateral will be reappraised. Additionally, the Company's guidelines require that real property be appraised prior to renewal, modification, or extension of the loan. Collateral will also be reappraised if there is any indication that the collateral may have decreased significantly in value. An evaluation, rather than a full, certified appraisal, may or may not be used after consideration of the risk involved with the transaction, and the need to remain within safe and sound banking practices. If the value of collateral decreases significantly upon reappraisal, the Company may take any one or a combination of steps to protect its position. Possible actions include requesting additional collateral from the borrower, requiring the borrower to make principal reductions on the loan, or charge-off of a portion of the loan balance.

The Bank accounts for impaired loans in accordance with a financial accounting standard that requires all lenders to value a loan at the loan's fair value if it is probable that the lender will be unable to collect all amounts due according to the terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis taking into consideration all the circumstances of the loan and the borrower, including the length of the delay, reasons for the delay, the borrower's payment record and the amount of the shortfall in relation to the principal and interest owed. The fair value of an impaired loan may be determined based upon the present value of expected cash flows, market price of the loan, if available, or value of the underlying collateral. Expected cash flows are required to be discounted at the loan's effective interest rate. The Bank's loan portfolio is largely dependent on collateral for repayment if the borrower's financial position deteriorates. Therefore, the most common type of valuation is to determine collateral value less disposal costs in order to determine carrying values for loans deemed impaired. The Company has no interest income recognized on impaired loans that represents the change in present value attributable to passage of time.

Troubled Debt Restructurings

Loans which management identifies as impaired generally will be nonperforming loans or restructured loans (also known as "troubled debt restructurings" or "TDR's"). As a result of adopting the amendments in ASU 2011-02, at the end of the third quarter of 2011 the Company reassessed all restructurings that occurred on or after the beginning of the fiscal year of adoption (January 1, 2011) to determine whether they were considered troubled

debt restructurings under the amended guidance. The Company identified no loans as TDRs for which the allowance for loan losses had previously been measured under a general allowance methodology.

The table below summarizes loans designated as TDR's during the year ended December 31, 2011.

	For the year ended December 31, 2011
Troubled Debt Restructurings	Number of Contracts		Pre-Modification Outstanding Recorded Investment	Post-Modification Outstanding Recorded Investment
Real estate-construction/development	2		$  1,993,166	$  1,993,166
Real estate-single family	3		339,430	339,430
Real estate- nonfarm, nonresidential	2		489,248	489,248
Total	7		$  2,821,844	$  2,821,844
Troubled Debt Restructurings that subsequently defaulted (1) during the period:		Number of Contracts		Recorded Investment
Real estate-construction/development		2		$ 2,087,285
Real estate-nonfarm, nonresidential		1		238,400
Total		3		$ 2,325,685
(1)Loans are considered in default when the situation indicates that the loan will be repaid via foreclosure of the collateral, or if the loan is placed on nonaccrual for specific circumstances other than foreclosure of the collateral.

During the year ended December 31, 2011, the Bank modified seven loans that were considered to be troubled debt restructurings. We extended the terms for three of these loans and the interest rate was lowered for one of these loans. For three of the loans, payments were changed from amortizing payments to interest only payments.

Nonperforming Loans

Nonperforming loans include nonaccrual loans or loans which are 90 days or more delinquent as to principal or interest payments. As of December 31, 2011, the Bank had nonaccrual loans of $4.1 million representing 9 loans, a decrease of $5.6 million from December 31, 2010. All of these loans are secured by real estate. In addition to loans on nonaccrual, as of December 31, 2011, management considers another $1.1 million of loans impaired, all of which are TDR's. Management routinely assesses the collateral and other circumstances associated with impaired loans in an effort to determine the amount of potential impairment. These loans are currently being carried at management's best estimate of net realizable value, although no assurance can be given that no further losses will be incurred on these loans until the collateral has been acquired and liquidated or other arrangements can be made.

The foreclosure process is lengthy (generally a minimum of six months and often much longer), so loans may be on nonaccrual status for a significant time period prior to moving to other real estate owned. As soon as the amount of impairment is estimable, the amount of principal impairment is generally charged-off against the allowance for loan losses. However, until losses and selling costs can be estimated via appraisal or other means, a portion of the allowance may be allocated to specific impaired loans. The timing of the appraisal varies from loan to loan depending on the Bank's ability to access the property. As of December 31, 2011 the allowance for loan losses included approximately $40,379 of reserves specifically related to impaired loans. Of that amount, a majority is related to selling costs.

Management's estimates of net realizable value or fair value of real estate collateral are obtained (on a nonrecurring basis) using independent appraisals, less estimated selling costs. Estimates of net realizable value for equipment and other types of personal property collateral are estimated based on input from equipment dealers and other professionals. If an appraisal is not available or management determines that 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 determined by Level 3 inputs as defined by FASB ASC 820, "Fair Value Measurements and Disclosures."

Potential Problem Loans

Management identifies and maintains a list of potential problem loans. These are loans that are not included in nonaccrual status or impaired loans. A loan is added to the potential problem list when management becomes aware of information about possible credit problems of borrowers that causes serious doubts as to the ability of such borrowers to comply with the current loan repayment terms. These loans are designated as such in order to be monitored more closely than other credits in the Bank's portfolio. There were loans in the amount of $2.3 million that have been determined by management to be potential problem loans at December 31, 2011. These loans are generally secured by various types of real estate, but may also be secured with other types of collateral. Should potential problem loans become impaired, management will charge-off any impairment amount as soon as the amount of impairment can be determined.

Concentrations of Credit

The Company makes loans to individuals and businesses in and around Upstate South Carolina for various personal and commercial purposes. The Bank has a diversified loan portfolio and the borrowers' ability to repay their loans is not dependent upon any specific economic sector. The Bank monitors concentrations in its customer base using the North American Industry Codes ("NAIC") and using certain regulatory definitions. As of December 31, 2011, the Bank has concentrations of credit in real estate rental and leasing, accommodation and food services, construction, retail trade, health care and social assistance, and other services, which by NAIC category comprise over 25% of Tier 1 Capital adjusted for the allowance for loan losses. The Bank also has concentrations in loans collateralized by real estate according to the regulatory definition. Included in this segment of the portfolio is the category for construction and development loans. While the Bank does have a concentration of loans in this category, the Bank's business is managed in a manner intended to help reduce the risks normally associated with construction lending. Management requires lending personnel to visit job sites, maintain frequent contact with borrowers and perform or commission inspections of completed work prior to issuing additional construction loan draws. Under current policy, loans are limited to 80% of cost of construction projects, and borrowers are required to meet minimum net worth requirements and debt service coverage ratios.

Projects for construction of single family homes are generally limited to those projects with contracts for sale where the ultimate owner has a significant investment in the contract. These policies may be considered stricter than policies in place when some of the Bank's currently outstanding loans were originated. However, as loans mature or as new loans are made, the current guidelines described above would be used to underwrite construction loans. The Company does not currently have any acquisition and development loans with interest reserves.

Construction loans in the Company's portfolio can be further divided into the following sub categories as of December 31, 2011:

	December 31, 2011
Single family residential construction loans	$    2,610,422
Acquisition and development loans	6,968,599
Other construction and land loans (1)	17,232,312
	$  26,811,333

(1)Includes loans collateralized by vacant land and loans not development-related.

Reappraisals are routinely ordered when a loan is collateral dependent and showing signs of weakness. Specifically, the Company's reappraisal policy states that collateral for single family construction loans will be reappraised if the home is complete and remains unsold for twelve months, or if the original loan has been outstanding for eighteen months. For development loans, if lot absorption varies from the original appraiser's estimates by 25% or more, the collateral will be reappraised. Loans with weaknesses that are collateralized with partially constructed projects are generally appraised both "as is" and "as completed." A determination is then made as to the likely disposition of the loan, whether the borrower retains the collateral and completes the project or whether the Company will ultimately foreclose and complete the construction following foreclosure. If foreclosure and completion by the Company are deemed the most likely scenario, and the cost to complete exceeds the collateral value, then the amount of cost to complete in excess of the as completed value of the collateral will generally be charged to the allowance for loan losses. To date very few impaired loans have been returned to accrual status as the result of updated appraisals. However, depending on specific circumstances, loans could potentially return to accrual status if the repayment prospects for the loan have changed significantly. Loans returned to accrual status will generally need to perform for a period of six months prior to being returned to accrual status, unless the underlying characteristics have significantly been altered in a positive manner.

The category "Loans secured by real estate- single family, including HELOC" contains home equity lines of credit in the amount of $6.0 million and $7.6 million as of December 31, 2011 and 2010, respectively. This portion of the single family real estate secured portfolio includes some loans with first liens on the underlying collateral and some second liens. All home equity line loans are variable rate loans with interest rate floors. As of December 31, 2011, approximately $30.9 million or 33.1% of total gross loans, including home equity line loans, were variable rate loans.

The FHLB has a blanket lien on certain types of the Company's loans as collateral for FHLB advance borrowings. See Note 10. The Reserve Bank has a lien on certain other loan types should the Bank borrow from the Discount Window. As of December 31, 2011 there were no borrowings from the Discount Window of the Reserve Bank.

Activity in the allowance for loan losses for the years ended December 31, 2011, 2010, and 2009 is summarized in the table below.

	Year ended December 31,
	2011		2010		2009
Allowance for loan losses, beginning of year	$  2,703,430	$  2,695,337		$  1,698,563
Provision for loan losses	670,000	1,260,000		2,955,000
Charge-offs	(1,355,328)	(1,251,907)		(1,958,726)
Recoveries	24,338	-		500
Allowance for loan losses, end of year	$  2,042,440	$  2,703,430		$  2,695,337

Activity for the year ended December 31, 2011 in the allowance, by portfolio segment, is presented in the table below.

	Loans Secured by Real Estate
	Construction	Single family (1)		Nonfarm, nonresidential		Multifamily	Commercial and industrial	Consumer	Unallocated	Total
	(Dollars in thousands)
Beginning Balance	$ 1,093		$  361		$  341	$    4	$  526	$  16	$     362	$ 2,703
Provision	485		407		299	(2)	(303)	(1)	(215)	670
Charge-offs	(783)		(352)		(100)	-	(120)	-		(1,355)
Recoveries	-		-		-	-	24	-	-	24
Ending Balance	$    795		$ 416		$ 540	$    2	$  127	$  15	$    147	$ 2,042

(1)Includes home equity lines of credit.

The Company, through the Bank, analyzes charge-offs and calculates its estimate of the allowance for loan losses using regulatory call report codes. The codes are well-defined categories for loans and are generally based on various types of collateral. Since the Bank generally lends on various types of real-estate collateral, the regulatory call report codes provide a defined, consistent system for tracking loan balances and charge-offs. These codes are also useful in comparing the Bank to its regional community bank peers. The Bank's historical charge-off rates, by call code, are calculated, reviewed for additional subjective factors that should be considered for the current outlook, and then applied to ending balances of loans not specifically reviewed for impairment. These estimates, along with the loans specifically reviewed for impairment, are used in the analysis of the adequacy of the allowance for loan losses completed on a quarterly basis. As described in Note 1, loans rated OAEM (or Special Mention), Substandard, Doubtful, or Loss are individually evaluated for impairment, and the estimate of the amount of allowance for loan losses is computed based on individual facts and circumstances, such as appraised value of collateral, and similar factors.

Charge-offs, net of recoveries, for the years ended 2011, 2010 and 2009 were categorized by regulatory call report code as follows:

	Year ended December 31,
	2011	2010	2009
Loan secured by real estate –construction/development	$   783,211	$  978,425	$  882,684
Loan secured by real estate –single family	351,549	249,034	250,072
Loan secured by real estate –nonfarm, nonresidential	100,527	-	156,643
Commercial and industrial loans	120,041	21,315	668,829
Loans to consumers	-	3,133	500
Total charge-offs	1,355,328	1,251,907	1,958,728
Recoveries	(24,338)	-	(500)
Total net charge-offs	$ 1,330,990	$ 1,251,907	$ 1,958,228

The allowance for loan losses is not restricted to specific categories of loans and is available to absorb losses in all categories. However, the Company has allocated the allowance for loan losses among the various segments of the portfolio. The allowance allocations as of December 31, 2011 and December 31, 2010 are presented in the table below.

	December 31,
	2011	2010
Loans secured by real estate –construction/development	$   794,604	$ 1,093,200
Loans secured by real estate –single family, including HELOC	416,168	361,096
Loans secured by real estate –nonfarm, nonresidential	539,932	341,377
Loans secured by real estate –multifamily	2,504	4,484
Commercial and industrial	127,068	525,567
Consumer installment	15,439	15,914
Unallocated	146,725	361,792
Total allowance for loan losses	$ 2,042,440	$ 2,703,430

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Investment Securities

12 Months Ended

Dec. 31, 2011

Investment Securities [Abstract]

Investment Securities

NOTE 4 – INVESTMENT SECURITIES

The amortized cost and fair value of investment securities available-for-sale are as follows:

	December 31, 2011
		Amortized	Gross unrealized					Fair
		Cost		Gains		Losses		Value
Mortgage-backed securities	$	18,702,842	$	291,211	$	21,567	$	18,972,486
Municipal bonds		8,308,992		461,145		-		8,770,137
Total investment securities available-
for-sale	$	27,011,834	$	752,356	$	21,567	$	27,742,623
	December 31, 2010
		Amortized	Gross unrealized					Fair
		Cost		Gains		Losses		Value
Government sponsored enterprise bonds	$	4,486,806	$	21,597	$	131,752	$	4,376,651
Mortgage-backed securities		10,909,120		132,800		48,842		10,993,078
Municipal bonds		8,319,212		123,001		219,606		8,222,607
Total investment securities available-	$	23,715,138	$	277,398	$	400,200	$	23,592,336
for-sale

     While three of the Company's securities available-for-sale are in an unrealized loss position as of December 31, 2011, none have been in an unrealized loss position for twelve months or more. None of these securities are expected to have a loss of principal at final maturity. The unrealized losses were primarily attributable to changes in interest rates, rather than deterioration in credit quality. These securities are agency mortgage-backed securities and therefore pose minimal credit risk. The Company believes it is more likely than not it will hold these securities until such time as the value recovers or the securities mature. During 2008, the Company recognized other-than-temporary-impairment on the FNMA preferred stock of $606,054, net of tax, based on FNMA's being placed into conservatorship by the U.S. Treasury Department. The Company sold the FNMA preferred stock in 2009 at an additional loss of $58,788.

     The table below summarizes, by investment category, the length of time that individual securities have been in a continuous loss position as of December 31, 2011 and 2010.

	December 31, 2011
	Less than Twelve Months				Over Twelve Months				Total Unrealized Losses
	Gross Unrealized Losses		Fair Value		Gross Unrealized Losses		Fair Value
Mortgage-backed securities	$	21,567	$	5,944,428	$	-	$	-	$	21,567
Municipal bonds		-		-		-		-		-
Total	$	21,567	$	5,944,428	$	-	$	-	$	21,567
	December 31, 2010
	Less than Twelve Months				Over Twelve Months				Total Unrealized Losses
	Gross Unrealized Losses		Fair Value		Gross Unrealized Losses		Fair Value
Government sponsored enterprise bonds	$	131,752	$	1,868,247	$	-	$	-	$	131,752
Mortgage-backed securities		48,842		5,279,417		-		-		48,842
Municipal bonds		219,606		4,755,566		-		-		219,606
Total	$	400,200	$	11,903,230	$	-	$	-	$	400,200

     At December 31, 2011 and 2010, securities with a fair value of $11,527,285 and $17,091,060, respectively, were pledged to collateralize public deposits, sweep accounts, advances from the FHLB, and repurchase agreements. During 2011 the Company sold no securities. During 2010, the Company sold securities with a fair value of $8,120,975 and recognized a net gain on the sale of those securities of $325,656. During 2009, the Company sold securities with a fair value of $10,752,749 and recognized a net gain on the sale of those securities of $299,063.

     The amortized cost and fair value of securities at December 31, 2011, by contractual maturity, are shown in the following chart. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

	December 31, 2011
	Amortized Cost		Fair Value
Due within one year	$	11,648	$	11,790
Due after one through five years		984,346		1,024,805
Due after five through ten years		1,316,163		1,431,382
After ten years or no maturity		24,699,677		25,274,646
Total investment securities	$	27,011,834	$	27,742,623

     The Bank, as a member institution, is required to own stock in the Reserve Bank and the FHLB. These stocks are included at cost in the accompanying Consolidated Balance Sheets under the caption "Other investments." No ready market exists for these stock investments and they have no quoted market value. Redemption of these stocks has historically been at par value. Redemption of the FHLB stock may be subject to limitations regarding timing and amounts may be subject to impairment risk in the future. The Company evaluates the FHLB stock for impairment based on the probability of ultimate recoverability or the recorded amount of the investment. The FHLB redeemed stock at par from the Bank and other members in 2011. No impairment has been recognized based on this evaluation. Stock held in the FHLB is pledged as collateral against advances from the FHLB.

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Financial Instruments With Off Balance Sheet Risk

12 Months Ended

Dec. 31, 2011

Financial Instruments With Off Balance Sheet Risk [Abstract]

Financial Instruments With Off Balance Sheet Risk

NOTE 16 – FINANCIAL INSTRUMENTS WITH OFF BALANCE SHEET RISK

     In the ordinary course of business, and to meet the financing needs of its customers, the Bank is a party to various financial instruments with off balance sheet risk. These financial instruments, which include commitments to extend credit and standby letters of credit, involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the balance sheet. The contract amounts of those instruments reflect the extent of involvement the Bank has in particular classes of financial instruments.

     The Bank's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amounts of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on balance sheet instruments.

     Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any material condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require the payment of a fee. At December 31, 2011 and 2010, unfunded commitments to extend credit were $10.9 million and $10.8 million, respectively, and outstanding letters of credit were approximately $1.0 million and $715,000, respectively.

     At December 31, 2011, the unfunded commitments consisted of $8.5 million at variable rates and $2.4 million at fixed rates with $4.8 million expiring within one year. The Bank evaluates each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management's credit evaluation of the borrower. Collateral varies but may include accounts receivable, inventory, property, plant and equipment, and commercial and residential real estate.

     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, and were immaterial in 2011 and 2010.

     The Bank offers an automatic overdraft protection product. Approximately $1.1 million of overdraft protection is available under this product as of December 31, 2011. The Bank expects that much of this capacity will not be utilized. During 2011 the average balance of total demand deposit overdrafts was approximately $24,000.

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Commitments And Contingencies

12 Months Ended

Dec. 31, 2011

Commitments And Contingencies [Abstract]

Commitments And Contingencies

NOTE 12 – COMMITMENTS AND CONTINGENCIES

     The Bank may become party to litigation and claims arising in the normal course of business. As of December 31, 2011, there was no litigation pending other than foreclosure or similar collection actions initiated by the Bank.

     The Bank entered into a five-year contract with a data, item, and ATM processing service in 2010. Minimum monthly costs for these services are currently approximately $20,000. Volume-related costs may increase as volume increases.

     The Company has signed change of control agreements with three of its executive officers. These agreements provide for various payments to the executives in the event of a change in control of the Company.

     From time to time the Bank may guarantee merchant credit card accounts on behalf of certain customers. At December 31, 2011 the total amount guaranteed by the Bank related to credit card accounts was immaterial.

Refer to Note 16 concerning financial instruments with off balance sheet risk.

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Deposits

12 Months Ended

Dec. 31, 2011

Deposits [Abstract]

Deposits

NOTE 8 – DEPOSITS

The following is a detail of the deposit accounts as of:
	December 31,
		2011		2010
Noninterest bearing	$	17,087,736	$	10,382,882
Interest bearing:
NOW accounts		14,749,804		12,621,719
Money market accounts		14,844,247		15,552,889
Savings		32,392,335		35,344,088
Time, less than $100,000		39,751,568		51,005,987
Time, $100,000 and over (1)		20,036,904		15,738,827
Total deposits	$	138,862,594	$	140,646,392

(1)      Does not include some brokered deposits issued in denominations less than $100,000 per depositor.

     The Company's deposits included brokered deposits of approximately $7.4 million and $19.7 million as of December 31, 2011 and 2010, respectively. Interest expense on time deposits greater than $100,000 (including brokered deposits) was approximately $460,000 in 2011, $851,000 in 2010, and $1.3 million in 2009. Securities issued by government sponsored enterprises with an amortized cost of $1.3 million and $696,858 (fair value of $1.4 million and $703,970) in 2011 and 2010, respectively, were pledged as collateral for public funds.

At December 31, 2011 the scheduled maturities of time deposits are as follows:

2012	$	39,350,130
2013		12,307,388
2014		5,076,418
2015		656,429
2016 and thereafter		2,398,107
	$	59,788,472

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Property And Equipment

12 Months Ended

Dec. 31, 2011

Property And Equipment [Abstract]

Property And Equipment

NOTE 6 – PROPERTY AND EQUIPMENT

Components of property and equipment included in the balance sheet are as follows:

	December 31,
	2011			2010
Land and improvements	$	1,468,480		$	1,468,480
Bank premises		4,271,773			4,271,773
Furniture, equipment and software		1,594,600			1,594,038
Vehicles		58,005			58,005
Property and equipment		7,392,858			7,392,296
Accumulated depreciation		(2,368,745	)		(2,161,461	)
Property and equipment, net	$	5,024,113		$	5,230,835

     Depreciation expense for the years ended December 31, 2011, 2010, and 2009 amounted to $235,700, $228,184, and $265,520, respectively. Depreciation is charged to operations over the estimated useful lives of the assets. The estimated useful lives and methods of depreciation for the principal items follow:

Type of Asset	Life in Years	Depreciation Method
Furniture, equipment and software	3 to 7	Straight-line
Improvements	5 to 40	Straight-line
Vehicles	5	Straight-line

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Property Acquired In Foreclosure

12 Months Ended

Dec. 31, 2011

Property Acquired In Foreclosure [Abstract]

Property Acquired In Foreclosure

NOTE 7– PROPERTY ACQUIRED IN FORECLOSURE

     The Company has acquired a significant number of real estate properties in settlement of loans. A summary of the activity in property acquired in foreclosure follows:

		December 31,
		2011			2010
Beginning balance	$	10,278,599		$	6,712,948
Additions from foreclosures and capitalized improvements		11,281,083			8,403,452
Write downs of value		(430,513	)		(709,751	)
Sales		(4,583,681	)		(4,128,050	)
Ending other real estate owned	$	16,545,488		$	10,278,599

     The Company recognized net losses of $193,693, $180,397 and $228,547 on sales of all types of repossessed collateral for the years ended December 31, 2011, 2010 and 2009, respectively.

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Customer Repurchase Agreements

12 Months Ended

Dec. 31, 2011

Customer Repurchase Agreements [Abstract]

Customer Repurchase Agreements

NOTE 9 – CUSTOMER REPURCHASE AGREEMENTS

Customer repurchase agreements consist of the following:

	December 31,
		2011		2010
Sweep accounts	$	67,550	$	895,937
Retail repurchase agreements		1,700,000		2,050,000
	$	1,767,550	$	2,945,937

     The Bank enters into sweep and retail repurchase agreements with its customers. The sweep agreements generally mature overnight. At December 31, 2011, the Bank had two retail repurchase agreements both of which mature in 2012. Securities issued by government sponsored enterprises with an amortized cost of $2.5 million and $3.3 million (fair value of $2.6 million and $3.1 million) were pledged as collateral for the sweep accounts and repurchase agreements, at December 31, 2011 and 2010, respectively. During 2011 sweeps and customer repurchase agreements averaged $2.2 million. The average rate paid on these balances was 1.23% during 2011 and the highest balance at any month end was $3.3 million. During 2010 sweeps and customer repurchase agreements averaged $2.9 million. The average rate paid was 1.34% and the highest balance at any month end during the year was $3.4 million.

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Income Taxes

12 Months Ended

Dec. 31, 2011

Income Taxes [Abstract]

Income Taxes

NOTE 14 – INCOME TAXES

     The provision for income taxes is reconciled to the amount of income tax computed at the federal statutory rate on income (loss) before income taxes as follows:

	Year ended December 31,
	2011					2010					2009
Tax benefit at statutory rate	$	(197,440	)	(34	)%	$	(301,254	)	(34	)%	$	(741,544	)	(34	)%
Increase (decrease) in taxes resulting from:
State income taxes, net of federal benefit		-		-			-		-			-		-
Tax-exempt investments		(78,400	)	(14	)		(77,747	)	(9	)		(78,845	)	(5	)
Increase in cash value of life insurance		(22,806	)	(4	)		(23,613	)	(3	)		(23,849	)	(2	)
Increase in valuation allowance		1,197,779		206			-		-			-		-
Other		9,308		2			14,341		1			24,501		2
Income tax expense (benefit)	$	908,441		156	%	$	(388,273	)	(45	)%	$	(819,737	)	(39	)%

The income tax effects of cumulative temporary differences at December 31, 2011 and 2010 are as follows:

		2011			2010
Deferred tax assets:
Allowance for loan losses	$	398,065		$	665,122
Unrealized net loss on securities available for sale		-			41,753
Stock based compensation		56,062			47,622
Other real estate owned		140,717			179,374
Net operating loss carryforward		624,792			-
Other		70,387			157,528
		1,290,023			1,091,399
Deferred tax liabilities:
Unrealized net gain on securities available for sale		248,468			-
Depreciation		76,261			95,659
Prepaid expenses		21,984			25,074
		346,713			120,733
Deferred tax asset, net		943,310			970,666
Valuation allowance		(1,191,779	)		-
Net deferred tax asset (liability)	$	(248,469	)	$	970,666

     Deferred tax assets represent the future tax benefit of deductible differences and, if it is more-likely-than-not that a tax asset will not be realized, a valuation allowance is required to reduce the recorded deferred tax assets to net realizable value. During the year ended December 31, 2011 the company recorded a full valuation allowance against the Company's net deferred tax asset to reduce the total to an amount that management believes will ultimately be realized. Realization of deferred tax assets is dependent upon sufficient taxable income during the period that deductible temporary differences and carryforwards are expected to be available to reduce taxable income. Based on management's projections, the deferred tax assets are not more-likely-than-not to be recovered with projected taxable income from the three years through 2014.

     The following summary of the provision for income taxes includes tax deferrals that arise from temporary differences in the recognition of certain items of revenue and expense for tax and financial reporting purposes:

	Year ended December 31,
		2011			2010			2009
Income taxes currently payable (receivable)	$	(1,000	)	$	(255,967	)	$	(781,874	)
Deferred income tax benefit		909,441			(132,306	)		( 37,863	)
Income tax benefit	$	908,441		$	(388,273	)	$	(819,737	)

     The Company and its subsidiaries file a consolidated federal income tax return and consolidated or separate state income tax returns. With few exceptions the company is no longer subject to federal or state income tax examinations by tax authorities for years before 2008. The Company has net operating loss carryforwards for tax purposes of approximately $1.8 million with an expiration date in 2031. The Company has analyzed the tax positions taken or expected to be taken in its tax returns and concluded it has no liability related to uncertain tax positions.

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Dividends

12 Months Ended

Dec. 31, 2011

Dividends [Abstract]

Dividends

NOTE 19 – DIVIDENDS

     No dividends were paid during the year ended December 31, 2011. The Company paid a 5 percent stock dividend in 2010 to shareholders of record on May 11, 2010 and in 2009 to shareholders of record on May 12, 2009. The Company's payment of cash dividends is within the discretion of its Board of Directors, subject to compliance with Federal Reserve guidance, and is dependent on the Company's receiving cash dividends from the Bank. Federal banking regulations restrict the amount of dividends that the Bank can pay to the Company. Future dividend policy will depend on the Company's earnings, capital requirements, financial condition and other factors considered relevant by the Company's Board of Directors. Under its Memorandum of understanding with the FRB, the Company is required to seek permission of the FRB prior to paying dividends.

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Consolidated Statements Of Shareholders' Equity And Comprehensive Income (Loss) (USD $)	Preferred Stock [Member]	Common Stock [Member]	Retained Earnings (Deficit) [Member]	Accumulated Other Comprehensive Income (Loss) [Member]	Total
Balance at Dec. 31, 2008		$ 18,323,333	$ 765,906	$ 47,708	$ 19,136,947
Balance, shares at Dec. 31, 2008		1,991,565
Net loss			(1,361,274)		(1,361,274)
Other comprehensive income, net of income taxes:
Unrealized gain/loss on investment securities				112,983	112,983
Comprehensive loss					(1,248,291)
Stock based compensation		72,464			72,464
Stock option exercises		80,000			80,000
Stock option exercises, shares		14,172
Stock dividend (5%), net of cash in lieu of fractional shares		323,931	(325,646)		(1,715)
Stock dividend (5%), net of cash in lieu of fractional shares, shares		100,001
Balance at Dec. 31, 2009		18,799,728	(921,014)	160,691	18,039,405
Balance, shares at Dec. 31, 2009		2,105,738
Net loss			(497,767)		(497,767)
Other comprehensive income, net of income taxes:
Unrealized gain/loss on investment securities				(241,660)	(241,660)
Comprehensive loss					(739,427)
Stock based compensation		61,220			61,220
Preferred stock issuance, net of offering expenses	998,538				998,538
Preferred stock issuance, net of offering expenses, shares	1,038
Stock dividend (5%), net of cash in lieu of fractional shares		(1,024)			(1,024)
Stock dividend (5%), net of cash in lieu of fractional shares, shares		105,031
Balance at Dec. 31, 2010	998,538	18,859,924	(1,418,781)	(80,969)	18,358,712
Balance, shares at Dec. 31, 2010	1,038	2,210,769
Net loss			(1,489,148)		(1,489,148)
Other comprehensive income, net of income taxes:
Unrealized gain/loss on investment securities				563,370	563,370
Comprehensive loss					(925,778)
Stock based compensation		49,676			49,676
Balance at Dec. 31, 2011	$ 998,538	$ 18,909,600	$ (2,907,929)	$ 482,401	$ 17,482,610
Balance, shares at Dec. 31, 2011	1,038	2,210,769

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Federal Funds Sold

12 Months Ended

Dec. 31, 2011

Federal Funds Sold [Abstract]

Federal Funds Sold

NOTE 3 - FEDERAL FUNDS SOLD

     When the Bank's cash reserves (Note 2) are in excess of the required amount, it may lend any excess to other banks on a daily basis. As of December 31, 2011 and 2010 federal funds sold amounted to $12,620,000 and $5,110,000, respectively.

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Regulatory Matters

12 Months Ended

Dec. 31, 2011

Regulatory Matters [Abstract]

Regulatory Matters

NOTE 20 – REGULATORY MATTERS

     The Bank is 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 direct material effect on the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices.

     The Bank's capital amounts and classification 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 Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital to risk-weighted assets, and of Tier 1 capital to adjusted total assets ("Tier 1 leverage ratio"). Management believes, as of December 31, 2011, that the Bank meets all capital adequacy requirements to which it is subject.

     The Bank's actual capital amounts and ratios and minimum regulatory amounts and ratios established by regulations adopted pursuant to the prompt corrective action provisions of the Federal Deposit Insurance Corporation Improvement Act are presented as follows:

	Actual				For capital adequacy purposes				To be well capitalized under prompt corrective action provisions
					Minimum				Minimum
	(Dollars in thousands)
	Amount		Ratio		Amount		Ratio		Amount		Ratio
As of December 31, 2011
Total Capital (to risk weighted assets)	$	18,086	14.81	%	$	9,769	8.0	%	$	12,211	10.0	%
Tier 1 Capital (to risk weighted assets)		16,544	13.55			4,884	4.0			7,327	6.0
Tier 1 leverage ratio		16,544	9.99			6,626	4.0			8,282	5.0
As of December 31, 2010
Total Capital (to risk weighted assets)	$	19,307	13.8	%	$	11,234	8.0	%	$	14,043	10.0	%
Tier 1 Capital (to risk weighted assets)		17,531	12.5			5,617	4.0			8,426	6.0
Tier 1 leverage ratio		17,531	9.8			7,188	4.0			8,985	5.0

     In addition to the FDIC requirements shown above, the Bank is currently required to maintain individual minimum capital ratios by the OCC. Those required ratios are: Total capital to risk weighted assets– 12.0%; Tier 1 capital to risk weighted assets – 11.0%; and Tier 1 capital to average assets– 9.0%. The Bank exceeded these requirements at December 31, 2011 and 2010.

     The Federal Reserve has also established guidelines for capital requirements for bank holding companies that are similar to the FDIC's guidelines for banks. At December 31, 2011and 2010 the Company exceeded all of the minimum requirements of the Federal Reserve guidelines.

     On May 12, 2010, the Bank entered into a formal agreement with the OCC for the Bank to take various actions with respect to the operation of the Bank. The actions include: creation of a committee of the Bank's board of directors to monitor compliance with the agreement and make quarterly reports to the board of directors and the OCC; assessment and evaluation of management and members of the board; development, implementation and adherence to a written program to improve the bank's loan portfolio management; protection of its interest in its criticized assets; implementation of a program that identifies and manages concentrations of credit risk; extension of the Bank's strategic plan; extension of the Bank's capital program and profit plan; additional plans for ensuring that the level of liquidity at the Bank is sufficient to sustain the current operations and withstand any anticipated or extraordinary demand; and a requirement for obtaining a determination of no supervisory objection from the OCC before accepting brokered deposits. The substantive actions called for by the agreement should strengthen the Bank and make it more efficient in the long-term. The Bank believes it is in compliance with the requirements included in the formal agreement at December 31, 2011.

     The Company has entered into a memorandum of understanding with the Federal Reserve Bank of Richmond ("FRB"). The memorandum of understanding requires the Company to seek permission from the FRB before it takes certain actions such as payment of cash dividends, redemption of outstanding stock, etc. The Company believes it is in compliance with the memorandum of understanding with the FRB as of December 31, 2011.

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Cumulative Perpetual Preferred Stock (8%)

12 Months Ended

Dec. 31, 2011

Cumulative Perpetual Preferred Stock (8%) [Abstract]

Cumulative Perpetual Preferred Stock (8%)

NOTE 13 – CUMULATIVE PERPETUAL PREFERRED STOCK (8%)

     During the third quarter of 2010, the Company offered up to $2,500,000 of 8% Series A Cumulative Perpetual Preferred Stock ("the Preferred") to accredited investors and up to 35 non-accredited investors. The Preferred was offered by the Company's directors and executive officers, and no selling agents or underwriters were used. 1,038 shares of the Preferred were sold. Proceeds of the offering, net of offering expenses totaled $998,538. The Preferred is scheduled to pay a dividend quarterly. However, pursuant to the Company's Memorandum of Understanding with the Federal Reserve, the Federal Reserve has declined to approve the dividends scheduled for payment to date. Dividends that have accumulated, but have not been declared or accrued since inception of the Preferred, total $118,553 as of December 31, 2011.