UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

X	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the quarterly period ended September 30, 2011
____	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the transition period from _______ to ________

COMMISSION FILE NUMBER 1-5735

PROVIDENT COMMUNITY BANCSHARES, INC.(Exact name of registrant as specified in its Charter)

Delaware	57-1001177
(State or other Jurisdiction of	(I.R.S. Employer
Incorporation or Organization)	Identification No.)

2700 Celanese Road, Rock Hill, South Carolina 29732

(Address of Principal Executive Offices)
 

(803) 325-9400

(Registrant’s telephone number, including area code)

Not Applicable
(Former name, former address and former fiscal year, if changed since last report)

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 (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes X  No

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 o	Accelerated filer o
Non-accelerated filer o	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 Corporation had 1,790,599 shares, $0.01 par value, of common stock issued and outstanding as of November 7, 2011.

1

PROVIDENT COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES

	INDEX
Part I.	Financial Information	Page
	Item 1. Financial Statements
	Consolidated Balance Sheets as of September 30, 2011 and December 31, 2010	3
	Consolidated Statements of Income (Loss) for the three and nine months ended September 30, 2011 and 2010	4
	Consolidated Statements of Cash Flows for the nine months ended September 30, 2011 and 2010	5
	Consolidated Statements of Changes in Shareholders' Equity and Comprehensive Income (Loss) for the nine months ended September 30, 2011 and 2010	6
	Notes to Consolidated Financial Statements	7
	Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations	23
	Item 3. Quantitative and Qualitative Disclosures about Market Risk	46
	Item 4. Controls and Procedures	46
Part II.	Other Information
	Item 1. Legal Proceedings	47
	Item 1A. Risk Factors	47
	Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	47
	Item 3. Defaults Upon Senior Securities	47
	Item 4. Reserved	47
	Item 5. Other Information	47
	Item 6. Exhibits	47
	Signatures	48

2

Part 1. Financial Information
PROVIDENT COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
September 30, 2011 and December 31, 2010
	September 30,			December 31,
ASSETS	2011			2010
	(Unaudited)			(Audited)
	(DOLLARS IN THOUSANDS)
Cash and due from banks	$	4,588		$	4,755
Interest earning balances with the Federal Reserve		4,244			5,638
Federal funds sold		27,751			14,472
Cash and cash equivalents		36,583			24,865
Investment and mortgage-backed securities-available for sale		155,054			148,469
Loans, net of unearned fees		165,989			206,275
Allowance for loan losses (ALLL)		(4,183	)		(7,379	)
Loans, net of ALLL		161,806			198,896
Real estate acquired through foreclosure		9,099			10,618
Office properties and equipment, net		4,837			5,101
Federal Home Loan Bank stock, at cost		3,406			3,526
Federal Reserve Bank stock, at cost		667			832
Accrued interest receivable		1,119			1,575
Cash surrender value of life insurance		7,843			8,623
Other assets		4,465			6,213
TOTAL ASSETS	$	384,879		$	408,718
LIABILITIES
Demand and savings deposits	$	162,290		$	165,985
Time deposits		128,206			147,143
Total deposits		290,496			313,128
Advances from the Federal Home Loan Bank		59,500			59,500
Securities sold under agreements to repurchase		5,365			10,028
Floating rate junior subordinated deferrable interest debentures		12,372			12,372
Accrued interest payable		964			663
Other liabilities		3,128			2,758
TOTAL LIABILITIES		371,825			398,449
Commitments and contingencies-Note 5
SHAREHOLDERS' EQUITY
Serial preferred stock - $0.01 par value
authorized - 500,000 shares
issued and outstanding - 9,266 shares
at September 30, 2011 and December 31, 2010, respectively		9,254			9,250
Common stock - $0.01 par value,
authorized - 5,000,000 shares,
issued and outstanding - 1,790,599 shares at September 30, 2011
and December 31, 2010, respectively		20			20
Common stock warrants		25			25
Additional paid-in capital		12,919			12,919
Accumulated other comprehensive loss		(111	)		(2,778	)
Retained deficit, substantially restricted		(2,753	)		(2,867	)
Treasury stock, at cost		(6,300	)		(6,300	)
TOTAL SHAREHOLDERS' EQUITY		13,054			10,269
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY	$	384,879		$	408,718
See notes to consolidated financial statements.

3

PROVIDENT COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (LOSS)
Three and Nine Months Ended September 30, 2011 and 2010 (unaudited)
	Three Months Ended						Nine Months Ended
	September 30,			September 30,			September 30,			September 30,
	2011			2010			2011			2010
	(DOLLARS IN THOUSANDS EXCEPT PER SHARE)
Interest Income:
Loans	$	2,151		$	2,841		$	6,939		$	8,836
Deposits and federal funds sold		3			9			17			23
Interest and dividends on mortgage-backed securities		677			346			2,038			992
Interest and dividends on investment securities		650			938			1,799			2,923
Total interest income		3,481			4,134			10,793			12,774
Interest Expense:
Deposit accounts		552			1,171			2,095			4,012
Floating rate junior subordinated deferrable interest debentures		118			123			355			359
Advances from the FHLB and other borrowings		632			637			1,875			2,012
Total interest expense		1,302			1,931			4,325			6,383
Net Interest Income		2,179			2,203			6,468			6,391
Provision for loan losses		290			3,947			290			6,030
Net interest income (loss) after
provision for loan losses		1,889			(1,744	)		6,178			361
Non-Interest Income:
Fees for financial services		645			723			1,929			2,119
Other fees, net		5			18			27			52
Other-than-temporary-impairment write-down on securities		(218	)		(660	)		(409	)		(1,127	)
Net gain on sale of investments		419			619			697			1,824
Total non-interest income		851			700			2,244			2,868
Non-Interest Expense:
Compensation and employee benefits		1,008			1,057			3,115			3,239
Occupancy and equipment		623			630			1,911			1,833
Deposit insurance premiums		179			147			536			438
Professional services		144			127			454			325
Advertising and public relations		5			5			25			35
OREO and loan operations		483			475			1,304			733
Items processing		74			102			225			262
Telephone		40			44			133			131
Other		178			180			576			568
Total non-interest expense		2,734			2,767			8,279			7,564
Net income (loss) before income taxes		6			(3,811	)		143			(4,335	)
Expense (benefit) for income taxes		7			(548	)		25			(793	)
Net income (loss)		(1	)		(3,263	)		118			(3,542	)
Accretion of preferred stock to redemption value and preferred dividends accumulated		120			120			355			355
Net loss to common shareholders	$	(121	)	$	(3,383	)	$	(237	)	$	(3,897	)
Net loss per common share (basic)	$	(0.07	)	$	(1.89	)	$	(0.13	)	$	(2.18	)
Net loss per common share (diluted)	$	(0.07	)	$	(1.89	)	$	(0.13	)	$	(2.18	)
Weighted average number of common shares outstanding
Basic		1,790,599			1,790,599			1,790,599			1,790,599
Diluted		1,790,599			1,790,599			1,790,599			1,790,599
See notes to consolidated financial statements.

4

PROVIDENT COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended September 30, 2011 and 2010 (unaudited)
	Nine Months Ended
	September 30,			September 30,
	2011			2010
	(IN THOUSANDS)
OPERATING ACTIVITIES:
Net income (loss)	$	118		$	(3,542	)
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Provision for loan losses		290			6,030
Amortization of securities		495			--
Depreciation expense		292			349
Recognition of deferred income, net of costs		(85	)		(142	)
Deferral of fee income, net of costs		99			26
Other than temporary impairment charge on  AFS securities		409			1,127
Gain on investment transactions		(697	)		(1,824	)
Loss (gain) on OREO sales		14			(15	)
OREO impairment		1,272			--
Changes in operating assets and liabilities:
Decrease in accrued interest receivable		456			730
Increase in cash surrender value of life insurance		(252	)		(283	)
Decrease in other assets		311			594
Increase in other liabilities		370			1,666
Increase (decrease) in accrued interest payable		301			(37	)
Net cash provided by operating activities		3,393			4,679
INVESTING ACTIVITIES:
Purchase of investment and mortgage-backed securities:
Available for sale		(97,885	)		(190,384	)
Proceeds from sale of investment and mortgage-
backed securities:
Available for sale		50,210			84,450
Held to maturity		--			3,934
Proceeds from maturity of investment and mortgage-
backed securities:
Available for sale		37,237			104,583
Principal repayments on mortgage-backed securities:
Available for sale		7,748			14,493
Net decrease in loans		33,489			24,872
Redemption of FHLB/FRB stock		285			283
Proceeds from sales of foreclosed assets, net of costs and improvements		3,532			1,950
Purchase of office properties and equipment		(28	)		(106	)
Net cash provided by investing activities		34,588			44,075
FINANCING ACTIVITIES:
Dividends paid on preferred stock		--			(232	)
Proceeds from redemption of life insurance		1,032			847
Decrease in other borrowings		(4,663	)		(10,919	)
Decrease in deposit accounts		(22,632	)		(14,864	)
Net cash used by financing activities		(26,263	)		(25,168	)
NET INCREASE IN CASH
AND CASH EQUIVALENTS		11,718			23,586
CASH AND CASH EQUIVALENTS
AT BEGINNING OF PERIOD		24,865			15,631
CASH AND CASH EQUIVALENTS
AT END OF PERIOD	$	36,583		$	39,217
SUPPLEMENTAL DISCLOSURES:
Cash paid for:
Income taxes	$	--		$	28
Interest		4,024			6,420
Non-cash transactions:
Loans foreclosed	$	3,299		$	6,091
Unrealized gain (loss) on securities available for sale, net of income tax		2,846			207
See notes to consolidated financial statements.

5

PROVIDENT COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME (LOSS)
Nine Months Ended September 30, 2011 and 2010 (unaudited)
													Retained			Accumulated
											Additional		Earnings,			Other			Treasury			Total
	Preferred Stock				Common Stock						Paid-in		Substantially			Comprehensive			Stock			Shareholders'
	Shares		Amount		Shares		Amount		Warrants		Capital		Restricted			Income (loss)			at Cost			Equity
	(Dollars in Thousands, Except Share Data)
BALANCE AT DECEMBER 31, 2009		9,266	$	9,245		1,790,599	$	20	$	25	$	12,919	$	11,184		$	(972	)	$	(6,300	)	$	26,121
Net loss														(3,542	)								(3,542	)
Other comprehensive income, net of tax of $72 on unrealized holding gains on securities available for sale arising during period																	207						207
Less reclassification adjustment for gains and other than temporary investment charge in net loss, net of tax																	(432	)					(432	)
Comprehensive loss																							(3,767	)
Accretion of Preferred Stock to redemption value				4										(4	)								--
Preferred stock dividend														(232	)								(232	)
BALANCE AT SEPTEMBER 30, 2010		9,266	$	9,249		1,790,599	$	20	$	25	$	12,919	$	7,406		$	(1,197	)	$	(6,300	)	$	22,122
BALANCE AT DECEMBER 31, 2010		9,266	$	9,250		1,790,599	$	20	$	25	$	12,919	$	(2,867	)	$	(2,778	)	$	(6,300	)	$	10,269
Net income														118									118
Other comprehensive income, net of tax of $968 on unrealized holding gains on securities available for sale arising during period																	2,846						2,846
Less reclassification adjustment for gains and other than temporary investment charge in net income, net of tax																	(179	)					(179	)
Comprehensive income																							2,785
Accretion of Preferred Stock to redemption value				4										(4	)								--
BALANCE AT SEPTEMBER 30, 2011		9,266	$	9,254		1,790,599	$	20	$	25	$	12,919	$	(2,753	)	$	(111	)	$	(6,300	)	$	13,054
See notes to consolidated financial statements

6

PROVIDENT COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

1.           Presentation of Consolidated Financial Statements

The accompanying unaudited consolidated financial statements of Provident Community Bancshares, Inc. (the “Corporation”) and Provident Community Bank, N.A. (the “Bank”) were prepared in accordance with instructions for Form 10-Q and, therefore, do not include all disclosures necessary for a complete presentation of consolidated financial condition, results of operations, and cash flows in conformity with accounting principles generally accepted in the United States of America. However, all adjustments which are, in the opinion of management, necessary for the fair presentation of the interim consolidated financial statements have been included. All such adjustments are of a normal and recurring nature. The results of operations for the nine months ended September 30, 2011 are not necessarily indicative of the results which may be expected for the entire calendar year or for any other period. This quarterly report should be read in conjunction with the Corporation’s annual report on Form 10-K for the year ended December 31, 2010. Certain amounts in the prior year’s financial statements have been reclassified to conform to current year classifications.

Recently Issued Accounting Standards

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

In July 2010, the Receivables topic of the 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 Corporation is required to include these disclosures in its interim and annual financial statements. See Note 4.

Disclosures about Troubled Debt Restructurings (“TDRs”) required by ASU 2010-20 were deferred by the Financial Accounting Standards Board (“FASB”) in ASU 2011-01 issued in January 2011. In April 2011 the FASB issued ASU 2011-02 to assist creditors with their determination of when a restructuring is a TDR.   The determination is based on whether the restructuring constitutes a concession and whether the debtor is experiencing financial difficulties as both events must be present. Disclosures related to TDRs under ASU 2010-20 are disclosed in Note 4.

Also in December 2010, the Business Combinations topic of the ASC was amended to specify that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only.  The amendment also requires that the supplemental pro forma disclosures include a description of the nature and amount of any material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings.  This amendment is effective for the Corporation for business combinations for which the acquisition date is on or after January 1, 2011. The Corporation does not expect the amendment to have any impact on the financial statements.

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 Corporation beginning January 1, 2012 but are not expected to have a material effect on the financial statements.

7

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 Corporation 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 Corporation on January 1, 2012 and will be applied retrospectively.

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

2.Loss Per Common Share

Basic loss per common share amounts for the three and nine months ended September 30, 2011 and 2010 were computed based on the weighted average number of common shares outstanding during the period. Diluted loss per share adjusts for the dilutive effect of outstanding common stock options  and warrants during the periods utilizing the treasury stock method. There were no common stock equivalents included in the diluted loss per share calculation for the three and nine months ended September 30, 2011 and 2010 as all outstanding options had a higher average exercise price than the average market price and were therefore anti-dilutive. Anti-dilutive common stock equivalents that were excluded in the diluted loss per common share calculation for the three and nine months ended September 30, 2011 and 2010 were 265,543 and 269,743, respectively.

3.Assets Pledged

Approximately $85.1 million and $78.5 million of debt securities at September 30, 2011 and December 31, 2010, respectively, were pledged by the Bank as collateral to secure deposits of the State of South Carolina, and Union, Laurens and York counties along with additional borrowings and repurchase agreements. The Bank pledges as collateral for Federal Home Loan Bank (“FHLB”) advances commercial and residential real estate mortgage loans under a collateral agreement with the FHLB whereby the Bank maintains, free of other encumbrances, qualifying mortgages (as defined) with unpaid principal balances equal to, when discounted at 75% of the unpaid principal balances, 100% of total advances. As part of the total assets pledged, the Bank will also pledge securities to cover additional advances from the FHLB that exceed the qualifying mortgages balance along with security repurchase lines with various brokerage houses.

8

4.Loans, net

Information about impaired loans for the periods ended September 30, 2011 and December 31, 2010 is as follows:

	September 30,		December 31,
	2011		2010
Loans receivable for which there is a related allowance
for credit losses determined in accordance with ASC 310-10	$	1,866	$	8,611
Other impaired loans		26,247		25,001
Total impaired loans	$	28,113	$	33,612
Average monthly balance of impaired loans	$	30,862	$	32,439
Specific allowance for credit losses	$	302	$	1,788

Impaired Loans

For the Periods Ended September 30, 2011 and December 31, 2010

	Unpaid						Average
September 30, 2011	Principal		Recorded		Related		Recorded
	Balance		Investment		Allowance		Investment
	(IN THOUSANDS)
With no related allowance recorded:
Commercial
Commercial Real Estate	$	23,019	$	17,610	$	--	$	20,315
Commercial Non Real Estate		2,482		2,199		--		2,341
Consumer
Consumer - other		5,115		4,247		--		4,681
Consumer - home equity		328		315		--		321
Residential Real Estate
1-4 family		1,879		1,876		--		1,877
With an allowance recorded:
Commercial
Commercial Real Estate	$	1,557	$	1,403	$	206	$	1,480
Commercial Non Real Estate		224		224		60		224
Consumer
Consumer - other		239		239		36		239
Residential Real Estate
1-4 family		--		--		--		--
Total:	$	34,843	$	28,113	$	302	$	31,478
Commercial		27,282		21,436		266		24,360
Consumer		5,682		4,801		36		5,241
Residential		1,879		1,876		--		1,877

9

December 31, 2010	Unpaid Principal Balance		Recorded Investment		Related Allowance		Average Recorded Investment
	(IN THOUSANDS)
With no related allowance recorded:
Commercial
Commercial Real Estate	$	23,467	$	16,253	$	--	$	19,860
Commercial Non Real Estate		3,166		2,929		--		3,047
Consumer
Consumer - other		4,710		3,980		--		4,345
Consumer - home equity		162		162		--		162
Residential Real Estate
1-4 Family		1,865		1,677		--		1,771
With a related allowance recorded:
Commercial
Commercial Real Estate		8,379		8,370		1,752		8,375
Consumer
Consumer - other		241		241		36		241
Total:	$	41,990	$	33,612	$	1,788	$	37,801
Commercial		35,012		27,552		1,752		31,282
Consumer		5,113		4,383		36		4,748
Residential		1,865		1,677		--		1,771

At September 30, 2011 and December 31, 2010, loans which are accounted for on a non-accrual basis:

Loans Receivable on Non-accrual Status

As of September 30, 2011 and December 31, 2010

	September 30,		December 31,
	2011		2010
	(IN THOUSANDS)
Commercial
Commercial real estate	$	11,896	$	14,305
Commercial non real estate		1,083		1,048
Consumer
Consumer - other		1,965		1,792
Consumer - automobile		51		--
Consumer - home equity		221		147
Residential Real Estate
1-4 family		1,744		1,534
Total	$	16,960	$	18,826

10

Allowance for Loan Losses and Recorded Investment in Loans Receivable

For the Periods Ended September 30, 2011 and December 31, 2010

	Commercial
	Non Real			Commercial
	Estate			Real Estate			Consumer			Residential			Total
	(IN THOUSANDS)
September 30, 2011
Allowance for loan losses:
Beginning balance	$	2,166		$	4,602		$	335		$	276		$	7,379
Charge-offs		(334	)		(3,217	)		(189	)		(3	)		(3,743	)
Recoveries		35			155			27			40			257
Provisions		--			182			186			(78	)		290
Ending balance	$	1,867		$	1,722		$	359		$	235		$	4,183
Loans receivable:
Ending balance - total	$	13,206		$	101,055		$	38,954		$	13,030		$	166,245
Ending balances:
Individually evaluated
for impairment	$	2,423		$	19,013		$	4,801		$	1,876		$	28,113
Collectively evaluated
for impairment	$	10,783		$	82,042		$	34,153		$	11,154		$	138,132
December 31, 2010
Allowance for loan losses:
Beginning balance	$	1,947		$	2,773		$	502		$	357		$	5,579
Charge-offs		(976	)		(6,044	)		(1,423	)		(262	)		(8,705	)
Recoveries		118			1,203			25			69			1,415
Provisions		1,077			6,670			1,231			112			9,090
Ending balance	$	2,166		$	4,602		$	335		$	276		$	7,379
Loans receivable:
Ending balance - total	$	23,915		$	122,506		$	45,269		$	14,831		$	206,521
Ending balances:
Individually evaluated
for impairment	$	2,929		$	24,623		$	4,383		$	1,677		$	33,612
Collectively evaluated
for impairment	$	20,986		$	97,883		$	40,886		$	13,154		$	172,909

11

Credit Quality Indicators

As of September 30, 2011 and December 31, 2010

Credit Quality Indicators: The Corporation regularly monitors the credit quality of its loan portfolio. Credit quality refers to the current and expected ability of borrowers to repay their obligations according to the contractual terms of such loans. Credit quality is evaluated through assignment of individual loan grades, as well as past-due and performing status analysis. Credit quality indicators allow the Corporation to assess the inherent loss on certain individual and pools of loans.

Corporate Credit Exposure (1)

Credit Risk Profile by Creditworthiness Category
 

	Commercial
	Non Real				Commercial Real
	Estate				Estate
	September 30,		December 31,		September 30,		December 31,
	2011		2010		2011		2010
	(IN THOUSANDS)
Grade 1 Superior Quality	$	54	$	4	$	--	$	--
Grade 2 Good Quality		60		340		--		--
Grade 3 Satisfactory		537		1,879		7,962		8,818
Grade 4 Acceptable		9,111		14,925		64,763		80,670
Grade 5 Special Mention		1,886		2,866		11,498		9,606
Grade 6 Substandard		1,342		3,901		16,832		23,412
Grade 7 Doubtful		216		--		--		--
Total	$	13,206	$	23,915	$	101,055	$	122,506

The Corporation uses an internal risk rating system to classify and monitor the credit quality of loans. Loan risk ratings are based on a graduated scale representing increasing likelihood of loss. Primary responsibility for the assignment of risk ratings of loans is with the individual loan officer assigned to each loan, subject of verification the Credit Administration department. Risk ratings are also reviewed periodically by an independent third party loan review firm that reports directly to the Board of Directors.

(1) Credit quality indicators are reviewed and updated as applicable on an ongoing basis in accordance with credit policies.

Consumer Credit Exposure (1)

Credit Risk Profile by Internally Assigned Grade

	Residential				Consumer
	September 30,		December 31,		September 30,		December 31,
	2011		2010		2011		2010
Grade:	(IN THOUSANDS)
Pass	$	11,612	$	13,282	$	35,167	$	42,273
Special mention		--		--		--		--
Substandard		1,418		1,549		3,787		2,996
Total	$	13,030	$	14,831	$	38,954	$	45,269

(1) Credit quality indicators are reviewed and updated as applicable on an ongoing basis in accordance with credit policies.

Consumer Credit Exposure (1)

Credit Risk Profile Based on Payment Activity

	Consumer												Residential real estate
	Other				Automobile				Home equity				1-4 family
	September 30,		December 31,		September 30,		December 31,		September 30,		December 31,		September 30,		December 31,
	2011		2010		2011		2010		2011		2010		2011		2010
	(IN THOUSANDS)
Performing	$	21,257	$	25,366	$	966	$	1,502	$	14,493	$	16,462	$	11,286	$	13,297
Nonperforming		1,965		1,792		51		--		222		147		1,744		1,534
Total	$	23,222	$	27,158	$	1,017	$	1,502	$	14,715	$	16,609	$	13,030	$	14,831

(1) Credit quality indicators are reviewed and updated as applicable on an ongoing basis in accordance with credit policies.

12

Loans graded one through four are considered “pass” credits.  As of September 30, 2011, approximately 78% of the loan portfolio were considered pass credits.  For loans to qualify for these grades, they must be performing relatively close to expectations, with no significant departures from the intended source and timing of repayment.

Loans with a credit grade of five are not considered classified; however they are categorized as a special mention or watch list credit. This classification is utilized by us when we have an initial concern about the financial health of a borrower.  These loans are designated as such in order to be monitored more closely than other credits in our portfolio.  We then gather current financial information about the borrower and evaluate our current risk in the credit. We will then either reclassify the loan as “substandard” or back to its original risk rating after a review of the information.  There are times when we may leave the loan on the watch list, if, in management’s opinion, there are risks that cannot be fully evaluated without the passage of time, and we determine to review the loan on a more regular basis. Loans on the watch list are not considered problem loans until they are determined by management to be classified as substandard. As of September 30, 2011, we had loans totaling $13.4 million rated as Special Mention.

Loans graded six or greater are considered classified credits. Loans classified as substandard are inadequately protected by the current sound worth and paying capacity of the borrower or of the collateral pledged. The loan has well-defined weaknesses that jeopardize the liquidation value and has the distinct possibility that the Corporation will sustain some loss if the deficiencies are not corrected. Loans classified as doubtful have the weaknesses of Substandard but have additional factors that make collection or liquidation in full highly questionable and improbable. At September 30, 2011, classified loans totaled $23.6 million, with all but one loan being collateralized by real estate.  Classified credits are evaluated for impairment on a quarterly basis.

13

The following are past due loan trends for the Corporation’s loans receivable for the periods ended September 30, 2011 and December 31, 2010.

					Greater
	30 - 59 Days		60 - 89 Days		Than		Total Past				Total Loans
	Past Due		Past Due		90 Days		Due		Current		Receivable
	(IN THOUSANDS)
September 30, 2011
Commercial:
Commercial non real estate	$	124	$	753	$	692	$	1,569	$	11,637	$	13,206
Commercial real estate		244		1,865		8,532		10,641		90,414		101,055
Consumer:
Consumer - other		487		646		1,645		2,778		20,444		23,222
Consumer - automobile		53		--		--		53		964		1,017
Consumer - home equity		105		41		109		255		14,460		14,715
Residential 1-4 family		--		245		749		994		12,036		13,030
Total	$	1,013	$	3,550	$	11,727	$	16,290	$	149,955	$	166,245
December 31, 2010
Commercial:
Commercial non real estate	$	175	$	221	$	1,089	$	1,485	$	22,430	$	23,915
Commercial real estate		1,668		1,883		12,989		16,540		105,966		122,506
Consumer:
Consumer - other		718		472		886		2,076		25,082		27,158
Consumer - automobile		66		32		--		98		1,404		1,502
Consumer - home equity		148		94		14		256		16,353		16,609
Residential 1-4 family		1,060		656		1,119		2,835		11,996		14,831
Total	$	3,835	$	3,358	$	16,097	$	23,290	$	183,231	$	206,521

14

Troubled Debt Restructurings

As a result of adopting the amendments in ASU 2011-02, the Corporation reassessed all restructurings that occurred on or after the beginning of the fiscal year of adoption (January 1, 2011) to determine whether they are considered troubled debt restructurings (TDRs) under the amended guidance. The Corporation identified as TDRs certain loans for which the allowance for loan losses had previously been measured under a general allowance methodology. Upon identifying those loans as TDRs, the Corporation identified them as impaired under the guidance in ASC 310-10-35. The amendments in ASU 2011-02 require prospective application of the impairment measurement guidance in ASC 310-10-35 for those loans newly identified as  impaired. At the end of the first interim period of adoption (September 30, 2011), the recorded investment in loans for which the allowance was previously measured under a general allowance methodology and are now impaired under ASC 310-10-35 was $983,000, and the allowance for loan losses associated with those loans, on the basis of a current evaluation of loss was $111,000. All other restructured loans had been evaluated for impairment individually prior to modification reclassification as a TDR. The following are loan modifications for the Corporation’s loans receivable for the three and nine month periods ended September 30, 2011.

	Three Months Ended September 30, 2011						Nine Months Ended September 30, 2011
			Pre		Post				Pre		Post
			Modification		Modification				Modification		Modification
	Number		Outstanding		Outstanding		Number		Outstanding		Outstanding
Troubled Debt Restructurings	of New		Recorded		Recorded		of New		Recorded		Recorded
Added during current year	Contracts		Investment		Investment		Contracts		Investment		Investment
	(IN THOUSANDS)
Commercial:
Commercial non real estate		3	$	1,121	$	1,121		6	$	1,757	$	1,521
Commercial real estate		8		4,527		4,517		11		6,404		6,375
Consumer:
Consumer - other		2		387		387		4		448		448
Residential 1-4 family		1		88		87		1		88		87
Total		14	$	6,123	$	6,112		22	$	8,697	$	8,431
	Three Months Ended September 30, 2011						Nine Months Ended September 30, 2011
			Post						Post
			Modification						Modification
	Number		Outstanding		Defaulted		Number		Outstanding		Defaulted
Troubled Debt Restructurings	of New		Recorded		Recorded		of New		Recorded		Recorded
Defaulted during the period	Contracts		Investment		Investment		Contracts		Investment		Investment
Added since September 30, 2010		(IN THOUSANDS)
Commercial:
Commercial non real estate		--	$	--	$	--		2	$	346	$	127
Commercial real estate		2		1,157		1,157		5		3,490		3,475
Consumer:
Consumer - other		1		14		14		3		159		159
Total		3	$	1,171	$	1,171		10	$	3,995	$	3,761

During the nine months ended September 30, 2011, the Corporation modified 22 loans that were considered to be troubled debt restructurings. We extended the terms for 12 of these loans and the interest rate was lowered for 10 of these loans. During the nine months ended September 30, 2011, 10 loans that had previously been restructured were in default, 3 of which went into default in the quarter.

15

5.Contingencies and loan commitments

In the ordinary course of business, the Corporation enters into financial instruments with off-balance-sheet risk to meet the financing needs of its customers. These instruments expose the Bank to credit risk in excess of the amount recognized on the balance sheet.

The Corporation’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is represented by the contractual amount of those instruments. The Corporation uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. Total credit exposure at September 30, 2011 related to these items is summarized below:

Loan Commitments:	Contract Amount
Approved loan commitments	$	208,000
Commitments to fund commercial and construction loans		173,000
Unused portions of loans and credit lines		24,131,000
Total loan commitments	$	24,512,000

Loan commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Loan commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained upon extension of credit is based on management’s credit evaluation of the counter party. Collateral held is primarily residential and commercial property. Total loan commitments outstanding at September 30, 2011 consisted of fixed and adjustable rate loans at rates ranging from 4.5% to 6.5%.

6.Fixed/Floating Rate Junior Subordinated Deferrable Interest Debentures

On July 18, 2006, Provident Community Bancshares Capital Trust I (“Capital Trust I”) was formed. The Corporation is the owner of all of the common securities of Capital Trust I. On July 21, 2006, Capital Trust I issued $4.0 million of fixed/floating rate capital securities through a pooled trust preferred securities offering. The proceeds from this issuance, along with the Corporation’s $124,000 capital contribution for Capital Trust I’s common securities, were used to acquire $4.1 million aggregate principal amount of the Corporation’s fixed/floating rate junior subordinated deferrable interest debentures due October 1, 2036, which constitute the sole asset of Capital Trust I. The interest rate on the debentures and the capital securities is equal to 7.393% for the first five years. Thereafter, the interest rate is variable and adjustable quarterly at 1.74% over the three-month London Interbank Offered Rate (“LIBOR”). The debentures are subject to redemption at par at the option of the Corporation, subject to prior regulatory approval, in whole or in part on any interest payment date. The debentures were not redeemed as of the September 30, 2011.

On November 28, 2006, Provident Community Bancshares Capital Trust (“Capital Trust II”) was established. The Corporation is the owner of all of the common securities of  Capital Trust II. On December 15, 2006, Capital Trust II issued $8.0 million of floating rate capital securities through a pooled trust preferred securities offering. The proceeds of Capital Trust II were utilized for the redemption of Union Financial Bancshares Statutory Trust issued on December 18, 2001. The proceeds from this issuance, along with the Corporation’s $248,000 capital contribution for the Capital Trust II common securities, were used to acquire $8.2 million aggregate principal amount of the Corporation’s floating rate junior subordinated deferrable interest debentures due March 1, 2037, which constitute the sole asset of the Capital Trust II. The interest rate on the debentures and the capital securities is variable and adjustable quarterly at 1.74% over the three-month LIBOR. The debentures are subject to redemption at par at the option of the Corporation, subject to prior regulatory approval, in whole or in part on any interest payment date after March 1, 2012. The debentures are also subject to redemption prior to March 1, 2012 at 103.5% of par after the occurrence of certain events.

16

A summary of the Subordinated Deferrable Interest Debentures issued and outstanding follows:

	Amount Outstanding at September 30,
Name	2011		2010		Rate			Prepayment Option Date	Maturity	Distribution Payment Frequency
Provident Community  Bancshares Capital Trust I	$	4,000,000	$	4,000,000		7.39	%	October 1, 2011	October 1, 2036	Quarterly
Provident Community  Bancshares Capital Trust II		8,000,000		8,000,000		2.06	%	March 1, 2012	March 1, 2037	Quarterly
Total	$	12,000,000	$	12,000,000

The Corporation exercised its right on July 22, 2010 to defer the payment of interest on its outstanding subordinated debentures for an indefinite period (which can be no longer than 20 consecutive quarterly periods).  This and any future deferred distributions will continue to accrue interest at a current rate of 7.39% for the $4.0 million of trust preferred securities issued in July 2006 and at a current rate of 2.06% for the $8.0 million of trust preferred securities issued in December 2006. Distributions on the trust preferred securities are cumulative.  Therefore, in accordance with generally accepted accounting principles, the Corporation will continue to accrue the monthly cost of the trust preferred securities as it has since issuance.

7.Fair Value of Financial Instruments

The Corporation utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Effective January 1, 2008, the Corporation adopted FASB ASC Topic 820, Fair Value Measurements and Disclosures which provides a framework for measuring and disclosing fair value under generally accepted accounting principles. FASB ASC Topic 820 requires disclosures about the  fair value of assets and liabilities recognized in the balance sheet in periods subsequent to initial recognition, whether the measurements are made on a recurring basis (for example, available-for-sale investment  securities) or on a nonrecurring basis (for example, impaired loans).

Fair Value Hierarchy

FASB ASC Topic 820 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. FASB ASC Topic 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

Level 1	Valuation is based upon quoted prices in active markets for identical assets or liabilities.
Level 2	Valuation is based upon quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3	Valuation is based upon quoted prices for similar assets or liabilities; quoted prices in markets that are not active; and model-based techniques whose value is determined using pricing models, discounted cash flow methodologies and similar techniques.

17

Following is a description of valuation methodologies used for assets and liabilities recorded at fair value.

Investment Securities Available-for-Sale

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

Loans

The Corporation is predominantly an asset based lender with real estate serving as collateral on a substantial majority of loans. The Corporation does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and the related impairment is charged against the allowance or a specific allowance is established. The Corporation performs its allowance for loan and lease losses calculation on a quarterly basis which also includes an evaluation of all non-performing loans for further impairment even if a new appraisal is not obtained on a quarterly basis. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Loans which are deemed to be impaired are primarily valued at the fair values of the underlying real estate collateral. Such fair values are obtained using collateral net liquidation value, market value of similar debt, enterprise value, and discounted cash flows. Those impaired loans not requiring a specific allowance represent loans for which the fair value of the expected repayment or collateral meet or exceed the recorded investment in such loans. The Corporation considers all non-accrual loans and troubled debt restructurings to be impaired. Therefore, at September 30, 2011, loans classified as impaired totaled $28.1 million. When the fair value of the collateral is based on an observable market price or a current appraised value, the Corporation records the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is not observable market price, the Corporation records the impaired loans as nonrecurring Level 3. Consistent with the regulator’s appraisal guidance dated December 10, 2010, the Corporation has adopted a loan reappraisal policy.  The regulatory guidance states that a bank should establish criteria for assessing whether an existing appraisal or evaluation continues to reflect the market value of the property.  Generally, impaired loans will be evaluated using an existing appraisal if the valuation has been established within the previous twelve months. However, market conditions may dictate an updated appraisal for a lesser timeframe. Factors include deterioration in the credit since origination or changes in market conditions. Changes in market conditions could include material changes in current and projected vacancy, absorption rates, lease terms, rental rates, and sale prices, including concessions and overruns and delays in construction costs.  Fluctuations in discount or direct capitalization rates also are indicators of changing market conditions. In assessing whether changes in market conditions are material, the Corporation considers the individual and aggregate effect of these changes on its collateral protection and the risk in its real estate lending program or credit portfolios. 

18

Real Estate Acquired Through Foreclosure

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

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

The following tables present the balances of assets measured at fair value on a recurring basis by level within the hierarchy as of September 30, 2011 and December 31, 2010 (In thousands).

	Quoted Prices in	Significant Other	Significant
Total	Active Markets for	Observable	Unobservable
September 30,	Identical Assets	Inputs	Inputs

	2011		(Level 1)		(Level 2)		(Level 3)
Investment Securities:
U.S. Agency Obligations	$	1	$	1	$	--	$	--
Government Sponsored Enterprises		69,708		69,708		--		--
Trust Preferred Securities		4,477		--		2,726		1,751
Total Investment Securities		74,186		69,709		2,726		1,751
Mortgage-Backed and Related Securities		80,868		--		80,868		--
Total	$	155,054	$	69,709	$	83,594	$	1,751

	Quoted Prices in	Significant Other	Significant
Total	Active Markets for	Observable	Unobservable
December 31,	Identical Assets	Inputs	Inputs

	2010		(Level 1)		(Level 2)		(Level 3)
Investment Securities:
U.S. Agency Obligations	$	2	$	2	$	--	$	--
Government Sponsored Enterprises		54,772		54,772		--		--
Trust Preferred Securities		4,548		--		2,614		1,934
Total Investment Securities		59,322		54,774		2,614		1,934
Mortgage-Backed and Related Securities		89,147		--		89,147		--
Total	$	148,469	$	54,774	$	91,761	$	1,934

19

The following is a reconciliation of the beginning and ending balances for assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the periods ended September 30, 2011.

Fair Value Measurements Using Significant

Unobservable Inputs (Level 3)

(in thousands)

Investment Securities

Available-for-Sale

Beginning balance at June 30, 2011	$	1,642
Transfers into Level 3		--
Total gains/ (losses) included in:
Net loss		(219	)
Other comprehensive income		322
Purchases, sales, issuances and settlements, net		6
Ending balance at September 30, 2011	$	1,751
Beginning balance at December 31, 2010	$	1,934
Transfers into Level 3		--
Total gains/ (losses) included in:
Net loss		(409	)
Other comprehensive income		417
Purchases, sales, issuances and settlements, net		(191	)
Ending balance at September 30, 2011	$	1,751

Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis

The Corporation may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with U.S. generally accepted accounting principles. These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period and assumes all non-performing assets have specific reserves or have been written down to fair value.

Assets  and liabilities measured at fair value on a nonrecurring basis at September 30, 2011 are as follows: (in thousands)

	Total		(Level 1)		(Level 2)		(Level 3)
Impaired loans	$	16,658	$	--	$	16,658	$	--
Troubled debt restructurings		7,725		--		7,725		--
Other real estate owned		9,099		--		9,099		--
Total assets at fair value	$	33,482	$	--	$	33,482	$	--

Assets and liabilities measured at fair value on a nonrecurring basis at December 31, 2010 are as follows: (in thousands)

	Total		(Level 1)		(Level 2)		(Level 3)
Impaired loans	$	17,038	$	--	$	17,038	$	--
Troubled debt restructurings		5,667		--		5,667		--
Other real estate owned		10,618		--		10,618		--
Total assets at fair value	$	33,323	$	--	$	33,323	$	--

Impaired loan totals represent non-performing loans for the periods indicated.

20

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

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

Securities - Fair values for securities are based on quoted market prices.  The carrying values of restricted equity securities approximate fair values.If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions.

Loans - The Corporation is predominantly an asset based lender with real estate serving as collateral on a substantial majority of loans. The Corporation does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and the related impairment is charged against the allowance or a specific allowance is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Loans which are deemed to be impaired are primarily valued at the fair values of the underlying real estate collateral. Such fair values are obtained using collateral net liquidation value, market value of similar debt, enterprise value, and discounted cash flows. Those impaired loans not requiring a specific allowance represent loans for which the fair value of the expected repayment or collateral meet or exceed the recorded investment in such loans. The Corporation considers all non-accrual loans and troubled debt restructurings to be impaired.
 

Cash surrender value of life insurance - The carrying amounts of cash surrender values of life insurance approximate their fair value.

Deposit liabilities - The fair values disclosed for demand deposits are, by definition, equal to the amount payable on demand at the reporting date (that is, their carrying amounts). The carrying amounts of variable-rate, fixed-term money-market accounts and certificates of deposit (CDs) approximate their fair values at the reporting date. Fair values for fixed-rate CDs are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.

Advances from the FHLB and other borrowings - The fair values of the Corporation’s borrowings are estimated using discounted cash flow analysis based on the Corporation’s current incremental borrowing rates for similar types of borrowing arrangements.

Securities sold under agreements to repurchase - The fair values of the Corporation’s repurchase agreements are estimated using discounted cash flow analysis based on the Corporation’s current incremental borrowing rates for similar types of borrowing arrangements.

Accrued interest - The carrying amounts of accrued interest approximate their fair values.

Floating rate junior subordinated deferrable interest debentures - The fair values of the Corporation’s floating rate debentures are estimated using discounted cash flow analysis based on the Corporation’s current incremental borrowing rates for similar types of borrowing arrangements.

Off-balance-sheet instruments - Fair values for 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 counter parties’ credit standings.

21

The estimated fair values of the Corporation’s financial instruments were as follows at September 30, 2011

(in thousands):

	September 30, 2011
	Carrying Amount		Fair Value
Financial assets
Cash and cash equivalents	$	36,583	$	36,583
Securities available for sale		155,054		155,054
Federal Home Loan Bank stock, at cost		3,406		3,406
Federal Reserve Bank stock, at cost		667		667
Loans, net		161,806		164,735
Accrued interest receivable		1,119		1,119
Cash surrender value of life insurance		7,843		7,843
Financial liabilities
Deposits	$	290,496	$	286,690
Advances from FHLB		59,500		65,993
Securities sold under agreements to repurchase		5,365		5,365
Floating rate junior subordinated deferrable interest debentures		12,372		12,372
Accrued interest payable		964		964
Off-balance-sheet assets (liabilities)	Notional Amount		Fair Value
Commitments to extend credit	$	24,512	$	--

The estimated fair values of the Corporation’s financial instruments were as follows at December 31, 2010

 (in thousands):

	December 31, 2010
	Carrying Amount		Fair Value
Financial assets
Cash and cash equivalents	$	24,865	$	24,865
Securities available for sale		148,469		148,469
Federal Home Loan Bank stock, at cost		3,526		3,526
Federal Reserve Bank stock, at cost		832		832
Loans, net		198,896		198,279
Accrued interest receivable		1,575		1,575
Cash surrender value of life insurance		8,623		8,623
Financial liabilities
Deposits	$	313,128	$	299,950
Advances from FHLB		59,500		61,357
Securities sold under agreements to repurchase		10,028		10,027
Floating rate junior subordinated deferrable interest debentures		12,372		12,372
Accrued interest payable		663		663
Off-balance-sheet assets (liabilities)	Notional Amount		Fair Value
Commitments to extend credit	$	29,575	$	--

8.Preferred Stock

On March 13, 2009, as part of the Capital Purchase Program of the Troubled Asset Relief Program (“TARP”) United States Department of the Treasury’s Capital Purchase Program, the Corporation issued 9,266 shares of Fixed Rate Cumulative Perpetual Preferred Stock, Series A, $1,000 per share liquidation preference (“TARP Preferred Stock”), and a warrant to purchase up to 178,880 shares of the Corporation’s common stock for a period of ten years at an exercise price of $7.77 per share, in exchange for $9.3 million in cash from the United States Department of the Treasury.  The proceeds, net of issuance costs consisting primarily of legal fees, were allocated between the preferred stock and the warrant on a pro rata basis, based upon the estimated market values of the preferred stock and the warrant.  As a result, $25,000 of the proceeds were allocated to the warrant, which increased additional paid-in-capital from common stock.  The amount allocated to the warrant is considered a discount on the preferred stock and will be amortized using the level yield method over a five-year period through a charge to retained earnings.  Such amortization will not reduce net income, but will reduce income available for common shares.

22

The preferred stock pays cumulative dividends of 5% per year for the first five years and 9% per year thereafter. The Corporation may redeem the preferred stock at its liquidation preference plus accrued and unpaid dividends at any time with prior regulatory approval.  The securities purchase agreement between the Corporation and the United States Department of the Treasury limits, for three years, the rate of dividend payments on the Corporation’s common stock to the amount of its last quarterly cash dividend before participation in the program of $0.03 per share unless an increase is approved by the Department of the Treasury, limits the Corporation’s ability to repurchase its common stock for three years and subjects the Corporation to certain executive compensation limitations included in the Emergency Economic Stabilization Act of 2008, as amended by the American Recovery and Reinvestment Act of 2009.

Under the terms of the TARP Preferred Stock, the Corporation is required to pay on a quarterly basis a dividend rate of 5% per year for the first five years, after which the dividend rate automatically increases to 9% per year.  Dividend payments may be deferred, but the dividend is a cumulative dividend and failure to pay dividends for six dividend periods would trigger board appointment rights for the holder of the TARP Preferred Stock.

The Corporation exercised its right on July 22, 2010 to defer the regularly scheduled quarterly distribution on its $12.4 million in subordinated debentures related to its two outstanding trust preferred security issuances and its regular quarterly cash dividend on its TARP Preferred Stock.

9.Subsequent Events

Subsequent events are events or transactions that occur after the balance sheet date but before 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. Non-recognized 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 issued and no subsequent events have occurred requiring accrual or disclosure.

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

Critical Accounting Policies

The Corporation has adopted various accounting policies which govern the application of accounting principles generally accepted in the United States of America in the preparation of financial statements.

Certain accounting policies involve significant judgments and assumptions by management. 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 Corporation.

23

The Corporation’s critical accounting policies are listed below:

Allowance for Loan Losses

We consider our accounting policies related to the allowance for loan losses to be critical, as these policies involve considerable subjective judgment and estimation by management. The allowance for loan losses is established through a provision for loan losses charged to expense. Our allowance for loan losses methodology is based on historical loss experience by loan type, specific homogeneous risk pools, and specific loss allocations. Our process for determining the appropriate level of the allowance for losses is designed to account for asset deterioration as it occurs. The provision for loan losses reflects loan quality trends, including the levels of and trends related to non-accrual loans, potential problem loans, criticized loans, and loans charged-off or recovered, among other factors.

The allowance is an amount that management believes will be adequate to absorb estimated losses relating to specifically identified loans, as well as probable credit losses inherent in the balance of the loan portfolio, based on an evaluation of the collectability of existing loans and prior loss experience.  This evaluation also takes into consideration such factors as changes in the size and composition of the loan portfolio, overall portfolio quality, review of specific problem loans, and current economic conditions that may affect the borrower’s ability to pay. The evaluation also includes a component for expected losses on groups of loans that are related to future events or expected changes in economic conditions. While management uses the best information available to make its evaluation, future adjustments to the allowance may be necessary if there are significant changes in economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Corporation’s allowance for loan losses, and may require the Corporation to make additions to the allowance based on their judgment about information available to them at the time of their examinations.

The allowance consists of specific, general and unallocated components. The specific component relates to loans that are classified as either impaired, substandard or special mention. For such loans that are also accounted for as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors.  An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

The general allocated segment for loan loss calculation includes a stratification of loan categories subdivided by residential mortgage, commercial, commercial real estate and consumer loans. These stratifications are further divided in individual segments by call report groupings. The portfolio is segregated into risk-similar segments for which historical loss ratios are calculated and adjusted for identified changes in current portfolio characteristics. The allowance for each portfolio segment is developed from a combination of factors that reflects management’s best judgment of the extent to which environmental factors, current trends and historical loss levels are more or less accurate indicators of current losses in the portfolio. Each category is rated for all loans including pass rated groups, special mention loans, and adversely classified non-impaired credits. The weights assigned to each performing group are developed from previous loan loss experience and as the loss experience changes, the category weight is adjusted accordingly. In addition, as the amount of loans in each category increases and decreases, the provision for loan loss calculation adjusts accordingly. Recovery of the carrying value of loans is dependent to some extent on the future economic environment and operating and other conditions that may be beyond the Corporation’s control.  Unanticipated future adverse changes in such conditions could result in material adjustments to the allowance (and future results of operation).

24

We review each impaired loan on a loan-by-loan basis to determine whether the impairment should be recorded as a charge-off or a reserve based on our assessment of the status of the borrower and the underlying collateral. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical matter, at the loan's observable market value or fair value of the collateral less cost to sell if the loan is collateral dependent. If the resulting value of the impaired non-collateral loan is less than the recorded balance, the impairment must be recognized by creating a valuation allowance for the difference and recognizing a corresponding bad debt expense. The amount of impairment, if any, and any subsequent changes are included in the allowance for loan losses.  The risk characteristics used to aggregate loans are collateral type, borrower’s financial condition and geographic location. Impairment of a collateral dependent loan is immediately charged-off against the allowance for loan and lease losses unless the fair value was based on an internal valuation pending receipt of a third party appraisal or other extenuating circumstances. Consumer loans are charged-off generally based on pre-defined past due periods.

Fair Value Measurements

A number of valuation techniques are used to determine the fair value of assets and liabilities in our financial statements.  These include quoted market prices for securities, interest rate valuations based on the modeling of termination values adjusted for credit spreads with counterparties, and appraisals of real estate from independent licensed appraisers, among other valuation techniques.  Fair value measures for assets and liabilities where there exists limited or no observable market data are based primarily on estimates, and are often calculated based on the economic and competitive environment, the characteristics of the asset or liability, and other factors.  Therefore, the results cannot be determined with precision and may not be realized in an actual sale or immediate settlement of the asset or liability.  Additionally, there are inherent weaknesses in any calculation technique, and changes in the underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the results of current or future values.  Significant changes in the aggregate fair value of assets or liabilities required to be measured at fair value or for impairment will be recognized in the statement of operations.

Other-Than-Temporary Impairment

One of the significant estimates related to securities is the evaluation of investments for other-than-temporary impairment. Marketable equity securities are evaluated for other-than-temporary impairment based on the severity and duration of the impairment and, if deemed to be other-than-temporary, the declines in fair value are reflected in earnings as realized losses.  For those debt securities for which the fair value is less than its amortized cost and the Corporation does not intend to sell such security and it is not more likely than not that it will be required to sell such security prior to the recovery of its amortized cost basis (which may be maturity) less any credit losses, the credit-related other-than-temporary impairment loss is recognized as a charge to earnings.  Noncredit-related other-than-temporary impairment losses for debt securities are recognized in other comprehensive income (loss), net of applicable taxes.

The evaluation of securities for impairment is a quantitative and qualitative process, which is subject to risks and uncertainties and is intended to determine whether declines in the fair value of investments should be recognized in current period earnings.  The risks and uncertainties include changes in general economic conditions, the issuer’s financial condition or future prospects, the effects of changes in interest rates or credit spreads and the expected recovery period. Management evaluates securities for other-than-temporary impairment at least on a quarterly basis and more frequently when economic or market conditions warrant such evaluation.

25

Income Taxes

The Corporation uses the asset and liability method of accounting for income taxes.  Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. If current available information raises doubt as to the realization of the deferred tax asset, a valuation allowance is established.  Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.  The Corporation exercises significant judgment in evaluating the amount and timing of recognition of the resulting tax assets and liabilities. These judgments require us to make projections of future taxable income. These judgments and estimates, which are inherently subjective, are reviewed periodically as regulatory and business factors change.  Due to the doubt of our ability to utilize the portion of the deferred tax asset that is not able to be offset against net operating loss carry backs and reversals of future taxable temporary differences that occurred in 2010, management has established a valuation allowance for the portion of the net deferred tax asset that is not recoverable through loss carry backs. At December 31, 2010, the Corporation's net deferred tax asset totaled $10.8 million.  Based on the Corporation's projections for future taxable income over the next three years, cumulative tax losses over the previous three years and available tax planning strategies, the Corporation recorded a valuation allowance in the amount of $7.7 million through a charge against income tax expense (benefit).  The Corporation has net operating loss carry-forwards of approximately $30.0 million which will expire by  December 31, 2030 if not utilized to offset taxable income prior to that date. It is management’s belief that realization of the deferred tax asset, after the valuation allowance, is more likely than not that it will realized the deferred tax asset.

Forward Looking Statements

Management’s discussion and analysis of financial condition and results of operations and other portions of this Form 10-Q may contain certain “forward-looking statements” concerning the future operations, plans or strategies of the Corporation and the Bank. These forward-looking statements are generally identified by the use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project,” or similar expressions. Management intends to take advantage of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and is including this statement for the express purpose of availing the Corporation of the protections of such safe harbor with respect to all forward-looking statements contained in this report. Management’s ability to predict results or the effect of future plans or strategies is inherently uncertain. Factors which could affect actual results include interest rate trends, the general economic climate in the Corporation’s and the Bank’s market area and the country as a whole, real estate values in the Bank’s market area, the ability of the Corporation and the Bank to control costs and expenses, competitive products and pricing and the demand for such products, loan delinquency rates, the quality and composition of the loan and investment portfolios, changes in accounting principles and guidelines and changes in federal and state laws and regulations. The Corporation provides greater detail regarding some of these factors in its Form 10-K for the year ended December 31, 2010, including in the Risk Factors section of that report, and in its other SEC reports. These factors should be considered in evaluating the forward-looking statements, and undue reliance should not be placed on such statements.

Except as required by applicable law or regulation, the Corporation does not undertake, and specifically disclaims any obligation, to release publicly the result of any revisions that may be made to any forward looking statements to reflect events or circumstances after the date of these statements or to reflect the occurrence of anticipated or unanticipated events.

26

Financial Condition

Assets

Assets decreased $23.8 million, or 5.8%, to $384.9 million at September 30, 2011 from $408.7 million at December 31, 2010. Starting in 2010, as part of its strategic plan, the Corporation implemented a program to shrink its balance sheet in order to increase its regulatory capital ratios. This shrinkage was accomplished with reductions in borrowings and higher cost deposits.The largest decrease in assets was the decrease in loans, whichdecreased $37.1 million from December 31, 2010 to September 30, 2011, due primarily to a significant reduction in loan demand as a result of economic conditions currently present in South Carolina and more stringent underwriting standards. This decrease was offset by an increase in securities and cash and cash equivalents. Investment securities at September 30, 2011 increased $6.6 million, or 4.4%, to $155.1 million from $148.5 million at December 31, 2010. Federal funds sold at September 30, 2011 increased $13.3 million to $27.8 million from $14.5 million at December 31, 2010 as a result of funds invested with proceeds from sales and maturities of securities.

Available for Sale- Securities classified as available for sale consisted of the following (in thousands):

September 30, 2011		December 31, 2010
Amortized	Fair	Amortized	Fair
Cost	Value	Cost	Value

Investment Securities:
U.S. Agency Obligations	$	1	$	1	$	2	$	2
Government Sponsored Enterprises		69,372		69,708		55,881		54,772
Trust Preferred Securities		6,670		4,477		7,271		4,548
Total Investment Securities		76,043		74,186		63,154		59,322
Mortgage-Backed Securities:
Fannie Mae		20,460		20,877		11,307		11,458
Ginnie Mae		36,436		37,541		61,617		61,312
Freddie Mac		21,907		22,080		16,216		15,962
Collateralized Mortgage Obligations		379		370		448		415
Total Mortgage-Backed Securities		79,182		80,868		89,588		89,147
Total Available for Sale	$	155,225	$	155,054	$	152,742	$	148,469

The Corporation uses the investment securities portfolio for several purposes. It serves as a vehicle to manage interest rate and prepayment risk, to generate interest and dividend income from investment of funds, to provide liquidity to meet funding requirements, and to provide collateral for pledges on public funds and FHLB borrowings. The average yield on investments at September 30, 2011 was 2.92% compared to 3.52% at December 31, 2010.

27

The carrying values of the investment securities at September 30, 2011 and December 31, 2010 and percentage of each category to total investments are as follows: (dollars in thousands)

	September 30, 2011					December 31, 2010
Available for sale:	Fair Value		Percent of Portfolio			Fair Value		Percent of Portfolio
Investment Securities:
U.S. Agency Obligations	$	1		0.00	%	$	2		0.01	%
Government Sponsored Enterprises		69,708		44.96			54,772		36.89
Trust Preferred Securities		4,477		2.89			4,548		3.06
Total Investment Securities		74,186		47.85			59,322		39.96
Mortgage-Backed Securities		80,868		52.15			89,147		60.04
Total	$	155,054		100.00	%	$	148,469		100.00	%

The Corporation decreased its level of mortgage-backed securities for the nine months ended September 30, 2011 to $80.9 million compared to $89.1 million for the year ended December 31, 2010. This decrease was due to the high prepayment speeds of the mortgage-backed securities and was offset with additions in government sponsored enterprises securities to $69.7 million at September 30, 2011 compared to $54.8 million at December 31, 2010.

The Corporation accounts for investment securities in accordance with FASB ASC Topic 320: Investments in Debt and Equity Securities. In accordance with FASB ASC Topic 320, debt securities that the Corporation has the positive intent and ability to hold to maturity are classified as “held to maturity” securities and reported at amortized cost. Debt and equity securities that are bought and held principally for the purpose of selling in the near term are classified as “trading” securities and reported at fair value, with unrealized gains and losses included in earnings.  Debt and equity securities not classified as either held to maturity or trading securities are classified as “available for sale” securities and reported at fair value with unrealized gains and losses excluded from earnings and reported as a separate component of shareholders’ equity. All securities were classified as available for sale at September 30, 2011.

Purchases and sales of securities are accounted for on a settlement date basis. Premiums and discounts on debt securities are amortized or accreted as adjustments to income over the estimated life of the security using a method approximating the level yield method. Gains or losses on the sale of securities are based on the specific identification method. The fair value of securities is based on quoted market prices or dealer quotes. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.

The amortized cost and fair value of investment securities are summarized as follows:

Available for Sale - Securities classified as available for sale consisted of the following (in thousands):

	As of September 30, 2011
	Amortized		Gross Unrealized					Fair
	Cost		Gain		Losses			Value
Investment Securities:
U.S. Agency Obligations	$	1	$	–	$	--		$	1
Government Sponsored Enterprises		69,372		381		(45	)		69,708
Trust Preferred Securities		6,670		–		(2,193	)		4,477
Total Investment Securities		76,043		381		(2,238	)		74,186
Mortgage-Backed Securities:
Fannie Mae		20,460		422		(5	)		20,877
Ginnie Mae		36,436		1,129		(24	)		37,541
Freddie Mac		21,907		201		(28	)		22,080
Collateralized Mortgage Obligations		379		–		(9	)		370
Total Mortgage-Backed Securities		79,182		1,752		(66	)		80,868
Total Available for Sale	$	155,225	$	2,133	$	(2,304	)	$	155,054

28

	As of December 31, 2010
	Amortized		Gross Unrealized					Fair
	Cost		Gains		Losses			Value
Investment Securities:
U.S. Agency Obligations	$	2	$	--	$	--		$	2
Government Sponsored Enterprises		55,881		49		(1,158	)		54,772
Trust Preferred Securities		7,271		--		(2,723	)		4,548
Total Investment Securities		63,154		49		(3,881	)		59,322
Mortgage-Backed Securities:
Fannie Mae		11,307		270		(119	)		11,458
Ginnie Mae		61,617		180		(485	)		61,312
Freddie Mac		16,216		10		(264	)		15,962
Collateralized Mortgage Obligations		448		--		(33	)		415
Total Mortgage-Backed Securities		89,588		460		(901	)		89,147
Total Available for Sale	$	152,742	$	509	$	(4,782	)	$	148,469

The maturities of securities at September 30, 2011 are as follows (in thousands):

	Available for Sale
	Amortized Cost		Fair Value
Due in one year or less	$	4,001	$	4,005
Due after one year through five years		25		27
Due after five years through ten years		42,527		42,866
Due after ten years		108,672		108,156
Total Investment and Mortgage-Backed Securities	$	155,225	$	155,054

The following table shows gross unrealized losses and fair value, aggregated by investment category, and length of time that individual securities have been in a continuous unrealized loss position at September 30, 2011 (in thousands).

	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Available for Sale
Government Sponsored Enterprises	$	11,307	$	45	$	–	$	–	$	11,307	$	45
Trust Preferred Securities		–		–		4,477		2,193		4,477		2,193
Mortgage-Backed
Securities		14,232		57		397		9		14,629		66
Total	$	25,5394	$	102	$	4,874	$	2,202	$	30,413	$	2,304

29

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

	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Available for Sale
Government Sponsored Enterprises	$	43,531	$	1,158	$	–	$	–	$	43,531	$	1,158
Trust Preferred Securities		–		–		4,548		2,723		4,548		2,723
Mortgage-Backed
Securities		59,963		868		444		33		60,407		901
Total	$	103,494	$	2,026	$	4,992	$	2,756	$	108,486	$	4,782

Management reviews securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Corporation to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.

To determine which individual securities are at risk for other-than-temporary impairment, the Corporation considers various characteristics of each security including but not limited to the credit rating, the duration and amount of the unrealized loss, and any credit enhancements. The relative importance of this information varies based on the facts and circumstances surrounding each security, as well as the economic environment at the time of the assessment. As a result of this review, the Corporation identifies individual securities believed to be at risk for other-than-temporary impairment. These securities are evaluated by estimating projected cash flows based on the structure of the security and certain assumptions, such as prepayments, default rates, and loss severity to determine whether the Corporation expects to receive all of the contractual cash flows as scheduled. The Corporation recognizes an other-than-temporary impairment credit loss when the present value of the investment security’s cash flows expected to be collected are less than the amortized cost basis.

An other-than-temporary impairment charge of $219,000 was recognized on trust preferred securities during the three months ended September 30, 2011.

To determine impairment charges for the Corporation’s collateralized debt obligations (“CDO”), which are included as mortgage-backed securities in the tables above, we performed discounted cash flow valuations through a static default model test. The default model used assumed a 3.6% rate, which is three times the historic default rates, a 0% recovery on all banks in deferral of interest payments and a 0% prepayment rate. Cash flow valuations with a premium mark up of 300 basis points were also used to determine the fair market values of the Corporation’s collateralized debt obligations. Valuation documentation for the cash flow analysis is provided by an independent third party.

Loans

Net loans decreased to $161.8 million at September 30, 2011 compared to $198.9 million at December 31, 2010. The decrease was due to a significant reduction in loan demand as a result of economic conditions currently present in South Carolina and more conservative underwriting standards. Consumer loans decreased $6.3 million, or 13.9%, commercial loans, primarily lines of credit, and commercial real estate loans decreased $32.2 million, or 22.0%, and residential mortgage loans decreased $1.8 million, or 12.5%, for the period ended September 30, 2011.

30

Loans receivable consisted of the following (dollars in thousands):

	September 30,			December 31,
	2011			2010
Mortgage loans:
Fixed-rate residential	$	8,304		$	9,102
Adjustable-rate residential		4,092			5,064
Commercial real estate		101,055			122,506
Construction		634			665
Total mortgage loans		114,085			137,337
Commercial non-real estate		13,206			23,915
Consumer loans:
Home equity		14,715			16,409
Consumer and installment		23,960			28,553
Consumer lines of credit		279			307
Total consumer loans		38,954			45,269
Total loans		166,245			206,521
Less:
Undisbursed portion of interim
construction loans		(173	)		(143	)
Unamortized loan discount		(239	)		(269	)
Allowance for loan losses		(4,183	)		(7,379	)
Net deferred loan origination costs		156			166
Total, net	$	161,806		$	198,896
Weighted-average interest rate of loans		5.05	%		4.97	%

31

The following table sets forth information with respect to the Bank’s non-performing assets at the dates indicated (dollars in thousands):

	September 30, 2011			December 31, 2010
Non-accruing loans which are
contractually past due 90 days
or more:
Residential real estate	$	1,744		$	1,534
Commercial		12,986			15,353
Consumer		2,230			1,939
Total non-accrual loans		16,960			18,826
Loans past due 90 days
and still accruing interest		291			125
Troubled debt restructurings		7,725			5,667
Real estate acquired through
Foreclosure		9,099			10,618
Total non-performing assets	$	34,075		$	35,236
Non-performing loans to total loans, net		10.48	%		9.46	%
Non-performing assets to total assets		8.85	%		8.62	%
Allowance for loan losses to total
loans outstanding		2.52	%		3.58	%
Allowance for loan losses to
non-performing loans		24.66	%		39.20	%
Allowance for loan losses	$	4,183		$	7,379

Loans classified as impaired generally will be non-performing loans, and the accrual of interest is discontinued at the time the loan is 90 days delinquent.  At September 30, 2011, loans totaling $291,000 were 90 days or more past due and accruing interest. At December 31, 2010, loans totaling $125,000 were 90 days or more past due and accruing interest.

Non-performing assets decreased $1.2 million to $34.1 million at September 30, 2011, or 8.85% of total assets, as compared to $35.2 million or 8.62% of total assets at December 31, 2010. Slow housing conditions have affected borrowers’ abilities to sell completed projects in a timely manner. 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 loans until the collateral has been acquired and liquidated or other arrangements can be made.

Interest income that would have been recorded for the nine months ended September 30, 2011 had non-accruing loans been current in accordance with their original terms amounted to approximately $915,000. Interest earned on loans that were contractually past due 90 days or more at September 30, 2011 was $7,994.

Management has allocated specific reserves to its non-performing assets that it believes will offset losses, if any, arising from less than full recovery of the loans from the supporting collateral. Specific reserves for non-performing loans are allocated to the loan as a write-down after completion of the impairment analysis for all collateral dependent loans. These additional reserves are based on management’s evaluation of a number of factors, including the estimated value of the collateral supporting each of these loans. Management believes that the combination of additional reserves and established impairment of these loans will be adequate to account for the current risk associated with these loans as of September 30, 2011. Management continues to evaluate and assess all non-performing assets on a regular basis as part of its well-established loan monitoring and review process. At September 30, 2011, criticized and classified loans, which include all non-performing loans, totaled $37.3 million, compared to $44.7 million at December 31, 2010 and $37.2 million at September 30, 2010. Impaired loans totaled $28.1 million at September 30, 2011 compared to $33.6 million at December 31, 2010. While management uses the best information available to establish the allowance for loan losses, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the valuations. Such adjustments would be made in the relevant period and may be material to the financial statements.

32

Real estate acquired through foreclosure decreased $1.5 million to $9.1 million at September 30, 2011 from $10.6 million at December 31, 2010, as a result of  the sales of fourteen commercial real estate properties totaling $3.5 million. The sales were offset by the addition of eight commercial real estate properties totaling $3.3 million. OREO is adjusted to fair value upon transfer of the loans to OREO. Subsequently, OREO is carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. The properties are being actively marketed and maintained with the primary objective of liquidating the collateral at a level which most accurately approximates fair market value and allows recovery of as much of the unpaid balance as possible upon the sale of the properties in a reasonable period of time. The carrying values of these assets are believed to be representative of their fair market value, although there can be no assurance that the ultimate proceeds from the sale of these assets will be equal to or greater than the carrying values.

Real estate acquired in settlement of loans through foreclosure is summarized as follows:

	September 30,			December 31,
	2011			2010
Balance at beginning of period	$	10,618		$	5,917
Foreclosures added during the period		3,299			9,271
Sales of foreclosed property		(3,546	)		(2,739	)
Provision charged as a write-down		(1,272	)		(1,831	)
Balance at the end of period	$	9,099		$	10,618

Liabilities

Total liabilities decreased $26.6 million to $371.8 million at September 30, 2011 from $398.4 million at December 31, 2010. Deposits decreased $22.6 million, or 7.2%, to $290.5 million at September 30, 2011 from $313.1 million at December 31, 2010. The decrease was due to a $18.9 million decrease in certificates of deposit along with a $3.7 million decrease in transaction accounts. Security agreements to repurchase decreased $4.7 million to $5.4 million at September 30, 2011 from $10.0 million at December 31, 2010 due to the pay-down of these instruments.

33

Deposit accounts were as follows (dollars in thousands):

	September 30, 2011								December 31, 2010
	Rate			Balance		%			Rate			Balance		%
Account Type
NOW accounts:
Commercial non-interest-bearing		--		$	20,343		7.00	%		--		$	18,414		5.88	%
Non-commercial		0.53	%		89,034		30.65	%		1.60	%		98,075		31.32	%
Money market checking accounts		0.40	%		25,433		8.76	%		0.53	%		21,066		6.73	%
Regular savings		0.43	%		27,480		9.46	%		0.84	%		28,430		9.08	%
Total demand and savings deposits		0.48	%		162,290		55.87	%		1.15	%		165,985		53.01	%
Time deposits:
Up to 3.00%					126,069		43.40	%					143,562		45.85	%
3.01 %- 4.00%					54		0.02	%					206		0.07	%
4.01 %- 5.00%					1,831		0.63	%					2,800		0.89	%
5.01 %- 6.00%					252		0.08	%					575		0.18	%
Total time deposits		1.05	%		128,206		44.13	%		1.55	%		147,143		46.99	%
Total deposit accounts		0.70	%	$	290,496		100.00	%		1.34	%	$	313,128		100.00	%

The maturities of the advances from the FHLB are as follows (dollars in thousands):

	September 30, 2011					December 31, 2010
	Balance		Wtd Avg Rate			Balance		Wtd Avg Rate
Contractual Maturity:
Within one year - adjustable rate	$	22,000		4.58	%	$	--		--	%
After one but within three years - adjustable rate		--		--	%		22,000		4.58	%
Greater than five years - adjustable rate		37,500		3.89	%		37,500		3.89	%
Total advances	$	59,500		4.14	%	$	59,500		4.14	%

The Bank pledges as collateral for the advances its investment securities and has entered into a blanket collateral agreement with the FHLB whereby the Bank maintains, free of other encumbrances, qualifying loans with unpaid principal balances equal to, when discounted at 50% to 75% of the unpaid principal balances, 100% of total advances.

Shareholders’ Equity

Shareholders’ equity increased $2.8 million, or 27.1%, to $13.1 million at September 30, 2011 from $10.3 million at December 31, 2010 primarily due to a $2.8 million decrease in unrealized losses on securities available for sale along with net operating income of $118,000.

Liquidity

Liquidity is the ability to meet demand for loan disbursements, deposit withdrawals, repayment of debt, payment of interest on deposits and other operating expenses. The primary sources of liquidity are deposits, loan repayments, borrowings, maturity and sale of securities and interest payments.

While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit outflows, security sales and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition. The primary investing activities of the Corporation are the origination of commercial and consumer loans, and the purchase of investment and mortgage-backed securities. These activities are funded primarily by principal and interest payments on loans and investment securities, deposit growth, securities sold under agreements to repurchase and FHLB advances.

34

At September 30, 2011, the Corporation’s investment in marketable securities totaled $155.1 million, all of which was available for sale. In addition, the Corporation had $27.8 million in federal funds sold at September 30, 2011 compared to $14.5 million at December 31, 2010. Approximately $85.1 million and $78.5 million of debt securities at September 30, 2011 and December 31, 2010, respectively, were pledged by the Corporation as collateral to secure deposits of the State of South Carolina, and Union, Laurens and York counties along with additional borrowings and repurchase agreements.

Outstanding loan commitments (including commitments to fund credit lines) totaled $24.5 million at September 30, 2011. Management of the Corporation anticipates that it will have sufficient funds available to meet its current loan commitments.

The Corporation closely monitors its liquidity position on a daily basis. Time deposits that are scheduled to  mature in one year or less from September 30, 2011, totaled $93.8 million or 32.3% of total deposits. The Corporation relies primarily on competitive rates, customer service, and long-standing relationships with customers to retain deposits. From time to time, the Corporation will also offer special products to its customers to increase retention and to attract new deposits. Based upon the Corporation’s experience with deposit retention and current retention strategies, management believes that, although it is not possible to predict future terms and conditions upon renewal, a significant portion of such deposits will remain with the Corporation. If the Corporation requires funds beyond its ability to generate them internally, additional sources of funds are available through FHLB advances, securities sold under agreements to repurchase and lines of credit. At September 30, 2011, the Corporation had outstanding $59.5 million of FHLB borrowings and $5.4 million of securities sold under agreements to repurchase. At September 30, 2011, the Corporation had unused short-term lines of credit to purchase federal funds from unrelated banks totaling $4.0 million and the ability to borrow an additional $17.5 million from secured borrowing lines. Lines of credit are available on a one-to-ten day basis for general purposes of the Corporation.  All of the lenders have reserved the right to withdraw these lines at their option.

Provident Community Bancshares, Inc., the holding company,  is a separate legal entity from the Bank and must provide for its own liquidity. In addition to its operating expenses, Provident Community Bancshares is responsible for paying any dividends declared to its shareholders and paying the obligations on its outstanding debentures and preferred stock. Provident Community Bancshares’ primary sources of income are proceeds that it retained from its offering of preferred stock and dividends received from the Bank. The dividends that may be paid by the Bank to the Corporation are subject to legal limitations and regulatory capital requirements. The amount of dividends that the Bank may declare and pay to Provident Community Bancshares in any calendar year, without the receipt of prior approval from the Office of the Comptroller of the Currency (“OCC”) cannot exceed retained net income for that year combined with retained net income for the prior two years less any transfers to surplus and capital distributions. Further, the Corporation cannot pay cash dividends on its common stock during any calendar quarter unless full dividends on the Preferred Stock. However, restrictions currently exist, including within the Consent Order the Bank signed with the OCC on December 21, 2010, that prohibit the Bank from paying cash dividends to the Corporation.  See “Consent Order and Written Agreement”. For the three and nine month periods ended September 30, 2011, no cash dividends have been declared or paid by the Bank or the Corporation. 

The Corporation is exercising its right to defer the regularly scheduled quarterly distribution on its $12.6 million in subordinated debentures related to its two outstanding trust preferred security issuances and its regular quarterly cash dividend on its Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the “TARP Preferred Stock”) issued to the U.S. Treasury Department in connection with the Corporation’s participation in the Treasury’s TARP Capital Purchase Program.

35

Capital Management and Regulatory Matters

Dividend Restrictions

The Bank is prohibited from declaring cash dividends on its common stock or repurchasing its common stock if the effect thereof would cause its net worth to be reduced below the amount required for the minimum regulatory capital requirement.  In addition, the Bank is also prohibited from declaring cash dividends without prior regulatory approval if the total amount of all dividends or stock repurchases (including any proposed dividends) for the applicable calendar year exceeds its current year’s net income plus its retained net income for the preceding two years. Under current OCC regulations, the Bank is limited in the amount it may loan to affiliates, including the Corporation. Loans to a single affiliate may not exceed 10%, and the aggregate of loans to all affiliates may not exceed 20% of bank capital and surplus.

As part of the Corporation’s participation in the Capital Purchase Program of the U.S. Department of Treasury’s TARP, prior to the earlier of March 6, 2012 or the date on which the preferred stock issued in that transaction has been redeemed in full or the Treasury has transferred its shares to non-affiliates, the Corporation cannot increase its quarterly cash dividend above $0.03 per share, without prior approval by the Treasury.

Capital Guidelines

The Bank and the Corporation are subject to various regulatory capital requirements administered by banking regulators. Failure to meet minimum capital requirements can initiate certain mandatory - and possibly additional discretionary - actions by regulators that, if undertaken, could have a direct material effect on the Corporation’s financial statements. Under capital adequacy guidelines and the regulatory framework for Prompt Corrective Action (“PCA”), the Bank must meet specific capital guidelines that involve quantitative measures of its 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. PCA provisions are not applicable to bank holding companies.

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.

Under present regulations of the OCC, the Bank must have core capital (leverage requirement) equal to 4.0% of assets. The Bank must also maintain risk-based regulatory capital as a percent of risk weighted assets at least equal to 8.0%.In addition, for an institution to be classified as well capitalized under present regulations of the OCC, the Bank must have core capital (leverage requirement) equal to 5.0% of assets and total risk-based of 10%. In measuring compliance with capital standards, certain adjustments must be made to capital and total assets.

The Bank is required by the consent order to maintain Tier 1 capital at least equal to 8% of adjusted total assets and total capital of at least 12% of risk-weighted assets. So long as the Bank is subject to the enforcement action executed with the OCC on December 21, 2010, it will not be deemed to be well-capitalized even if it maintains the minimum capital ratios to be well-capitalized unless it achieves the higher thresholds required by the consent order. At September 30, 2011, the Bank did not meet the higher tier 1 capital requirements required by the consent order and is evaluating alternatives to increase capital. The Bank’s capital category as of September 30, 2011, is determined solely for the purpose of applying the PCA restrictions, and the Bank’s capital category as of September 30, 2011 may not constitute an accurate representation of the Bank’s overall financial condition or prospects.

36

The following tables present the total risk-based, Tier 1 risk-based and Tier 1 leverage requirements for the Corporation and the Bank (in thousands).

											Minimum Capital Levels
	Actual					Regulatory Minimum					From Consent Order
	Amount		Ratio			Amount		Ratio			Amount		Ratio
Leverage ratio
Corporation	$	16,500		4.29	%	$	15,374		4.00	%	$	n/a		n/a	%
Bank		24,502		6.38			15,358		4.00			30,717		8.00
Tier 1 capital ratio
Corporation		16,500		7.70			8,567		4.00			n/a		n/a
Bank		24,502		11.46			8,551		4.00			n/a		n/a
Total risk-based capital ratio
Corporation		26,803		12.51			17,133		8.00			n/a		n/a
Bank		27,193		12.72			17,102		8.00			25,654		12.00

(1) Minimum capital amounts and ratios presented for the Bank as of September 30, 2011, are the minimum levels set forth in the Consent Order.  No minimum Tier 1 capital to risk-weighted assets ratio was specified in the Consent Order. 

Under current Federal Reserve guidelines, the Corporation includes trust preferred securities in Tier 1 capital.

The Bank is required to maintain reserves, in the form of cash and balances with the Federal Reserve Bank, against its deposit liabilities. The amounts of such reserves totaled $4.2 million at September 30, 2011.

Consent Order and Written Agreement

Due to the Bank’s financial condition, the OCC required that the Bank’s Board of Directors sign a formal enforcement action (“Consent Order”) with the OCC which conveys specific actions needed to address certain findings from their examination and to address the Bank’s current financial condition.  The Bank entered into a Consent Order with the OCC on December 21, 2010, which contained a list of strict requirements ranging from a capital directive, which required it to achieve and maintain minimum regulatory capital levels in excess of the statutory minimums to be well-capitalized, to developing a liquidity risk management and contingency funding plan, in connection with which it is subject to limitations on the maximum interest rates it can pay on deposit accounts.

In addition, the Consent Order required the Bank to develop by March 21, 2011, a three-year capital plan, which includes, among other things, specific plans for maintaining adequate capital, a discussion of the sources and timing of additional capital, as well as contingency plans for alternative sources of capital. The Consent Order also required the Bank to develop by March 21, 2011, a strategic plan covering at least a three-year period, which among other things, included a specific description of the strategic goals and objectives to be achieved, the targeted markets, the specific Bank personnel who are responsible and accountable for the plan, and a description of systems to monitor our progress. On March 19, 2011, the Bank’s Board submitted a written strategic plan and capital plan to the OCC covering a three-year period which included an action plan for increasing the Bank’s capital ratios to the minimums set forth in the order. The consent order also required the Bank to achieve and maintain total capital of at least equal to 12% of risk-weighted assets and at least equal to 8% of adjusted total assets by April 21, 2011.  The Bank has been working on efforts to achieve the tier 1 capital levels imposed under the Consent Order. Once the Bank receives the OCC’s written determination of no supervisory objection, the Bank’s Board of Directors will adopt and implement the plans.

37

The Consent Order also contained restrictions on future extensions of credit and required the development of various programs and procedures to improve the Bank’s asset quality as well as routine reporting on its progress toward compliance with the Consent Order to the Board of Directors and the OCC. 

The Bank’s compliance committee  monitors and coordinates compliance with the Consent Order.  The committee consists of five members of its Board of Directors and meets at least monthly to receive written progress reports from management on the results and status of actions needed to achieve full compliance with each article of the Consent Order.

In order to comply with the Consent Order, the Bank:

●       Revised its liquidity risk management program, which assesses, on an ongoing basis, the Bank’s current and projected funding needs, and ensures that sufficient funds exist to meet those needs.  The plan specifies how the Bank intends to comply with regulatory restrictions which limit the interest rates the Bank can offer to depositors;

●   revised its loan policy, and created a commercial real estate concentration management program.  The Bank also established a new loan review program to ensure the timely and independent identification of problem loans and  modified  its existing program for the maintenance of an adequate allowance for loan and lease losses;

●   took immediate and continuing action to protect the Bank’s interest in certain assets identified by the OCC and developed a criticized assets report covering the entire credit relationship with respect to such assets;

●   implemented and adhered to a program for the maintenance of an adequate allowance for loan and lease loss (“ALLL”) that is consistent with OCC requirements; and

●   ensured that the Bank has competent management in place on a full-time basis to carry out the Board’s policies and operate the Bank in a safe and sound manner.

Overall, the Bank is not well capitalized and must increase its capital or it may face further regulatory action. If the Bank does not obtain additional capital or sell assets to reduce the size of its balance sheet to a level which can be supported by its capital levels, it will not meet the capital minimums set forth in the Consent Order.  Failure to meet the minimum ratios set forth in the Consent Order could result in regulators taking additional enforcement actions against the Bank.  Its ability to raise capital is contingent on the current capital markets and on its financial performance.  Available capital markets are not currently favorable, and management cannot be certain of the Corporation’s ability to raise capital on any terms.
 

Off-Balance Sheet Risk

In the normal course of operations, the Corporation engages in a variety of financial transactions that, in accordance with generally accepted accounting principles are not recorded in its financial statements. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are used primarily to manage customers’ requests for funding and take the form of legally binding agreements to lend money to customers at predetermined interest rates for a specified period of time. Outstanding loan commitments (including commitments to fund credit lines) totaled $24.5 million at September 30, 2011. Each customer's credit worthiness is evaluated on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Corporation upon extension of credit, is based on the credit evaluation of the borrower. Collateral varies but may include accounts receivable, inventory, property, plant and equipment, commercial and residential real estate. The credit risk on these commitments is managed by subjecting each customer to normal underwriting and risk management processes. For the quarter ended September 30, 2011, the Corporation did not engage in any off-balance sheet transactions reasonably likely to have a material effect on its financial condition, results of operations or cash flows.

38

Results of operations for the three months ended September 30, 2011 and 2010

General

The Corporation recorded a net loss to common shareholders of $120,000 for the three months ended September 30, 2011 as compared to a net loss to common shareholders of $3.4 million for the same period in 2010. The decrease in the loss in 2011 was primarily due to a reduction in the provision for loan losses in 2011 due  to a net reduction in total loans of $8.3 million and in loan charge-offs along with a reduction in other than temporary impairment write-down on securities, offset by a decrease in the gain on the sale of investments.

39

Average Yields and Rates

    (dollars in thousands)

	Three Months Ended September 30,
	2011							2010
	Average Balance		Interest		Average Yield/Cost(2)			Average Balance		Interest		Average Yield/Cost(2)
Interest-earning assets:
Loans (1)	$	170,060	$	2,151		5.06	%	$	225,656	$	2,841		5.04	%
Mortgage-backed securities		77,669		677		3.49	%		30,734		346		4.50	%
Investment securities		83,691		650		3.11	%		121,072		938		3.10	%
Deposits and fed funds sold		19,492		3		0.06	%		19,196		9		0.19	%
Total interest-earning assets		350,912		3,481		3.97	%		396,658		4,134		4.17	%
Non-interest-earning assets		34,287							37,921
Total assets	$	385,199						$	434,579
Interest-bearing liabilities:
Deposits	$	272,431		552		0.81	%	$	304,320		1,171		1.54	%
Floating rate junior subordinated deferrable interest debentures		12,372		118		3.82	%		12,372		122		3.94	%
FHLB advances and other borrowings		64,923		632		3.89	%		71,208		638		3.58	%
Total interest-bearing liabilities		349,726		1,302		1.49	%		387,900		1,931		1.99	%
Non-interest-bearing sources:
Non-interest-bearing deposits		20,659							18,110
Non-interest-bearing liabilities		3,712							3,120
Total liabilities		374,097							409,130
Shareholders’ equity		11,102							25,449
Total liabilities and shareholders’ equity	$	385,199						$	434,579
Net interest income			$	2,178						$	2,203
Interest rate spread						2.48	%						2.18	%
Impact of non-interest-bearing deposits						0.06	%						0.04	%
Net interest margin						2.54	%						2.22	%

(1) Average balances of loans include non-accrual loans.

(2) Annualized

40

Interest Income

Interest income decreased $653,000, or 15.8%, to $3.5 million for the three months ended September 30, 2011 as compared to the same period in 2010. Interest income on loans decreased by 24.3%, or $691,000, to $2.2 million for the three months ended September 30, 2011 from $2.8 million for the three months ended September 30, 2010, due primarily to lower average balances due to lower demand. Interest on deposits and federal funds sold, combined with interest and dividends on investment and mortgage-backed securities, increased $37,000 for the three months ended September 30, 2011compared to the same period in 2010 due  primarily to higher average balances partially offset by lower interest rates.

Interest Expense

Interest expense decreased $629,000, or 32.6%, to $1.3 million for the three months ended September 30, 2011 as compared to $1.9 million for the three months ended September 30, 2010. Interest expense on deposit accounts decreased $619,000, or 52.9%, to $552,000 for the three months ended September 30, 2011 from $1.2 million during the same period in 2010 due primarily to lower average balances as a result of reductions in funding needs and lower market interest rates.

Provision for Loan Losses

We have developed policies and procedures for evaluating the overall quality of our credit portfolio and the timely identification of potential problem credits. The Board of Directors reviews and ratifies the appropriate level for

the allowance for loan losses quarterly based upon management’s recommendations, the results of the internal monitoring and reporting system, quarterly external independent loan reviews and the analysis of economic conditions in our local markets. Additions to the allowance for loan losses, which are expensed as the provision for loan losses on our income statement, are periodically made to maintain the allowance at an appropriate level based on our analysis of the potential risk in the loan portfolio. Loan losses, which include write downs and charge-offs, are charged directly to the allowance while recoveries are credited against the allowance. The amount of the provision is a function of the amount and composition of loans outstanding, the level of classified, non-performing and impaired loans, the number of troubled debt restructurings and impairment analysis of such loans, historical loan loss experience, the amount of loan losses actually charged against the reserve during the given period, and current and anticipated economic conditions.

Our allowance for loan losses is based upon judgments and assumptions of risk elements in the portfolio, future economic conditions and other factors affecting borrowers. The process includes identification and analysis of loss potential in various portfolio segments utilizing a credit risk grading process and specific reviews and evaluations of significant problem credits. In addition, we monitor overall portfolio quality through observable trends in delinquency, charge offs, and general and economic conditions in the market area. The adequacy of the allowance for loan losses and the effectiveness of our monitoring and analysis system are also reviewed periodically by the banking regulators which may require that we increase the allowance for loan losses. Risks are inherent in making all loans, including risks with respect to the period of time over which loans may be repaid, risks resulting from changes in economic and industry conditions, risks inherent in dealing with individual borrowers, and, in the case of a collateralized loan, risks resulting from uncertainties about the future value of the collateral.

Our judgment about the adequacy of the allowance is based upon a number of assumptions about future events, which we believe to be reasonable, but which may not prove to be accurate. Thus, charge-offs in future periods could exceed the allowance for loan losses, or substantial additional increases in the allowance for loan losses could be required. Additions to the allowance for loan losses would result in a decrease of our net income and, possibly, our capital. Based on present information, we believe the allowance for loan losses is adequate at September 30, 2011 to meet presently known and inherent risks in the loan portfolio.

During the three months ended September 30, 2011, the provision for loan losses was $290,000 compared to a provision of $3.9 million for the same period in the previous year. The decrease was due to a reduction in net loans of $8.3 million and non-performing loans along with lower write-downs and charge-offs. Non-performing loans decreased $8.5 million from $23.9 million at September 30, 2010 to $16.9 million at September 30, 2011. The high level of non-performing loans relates primarily to commercial real estate relationships that have been affected by the downturn in the residential housing market. Slow housing conditions have affected these borrowers’ ability to sell the completed projects in a timely manner.

41

Loan charge-offs and recoveries consisted of the following for the three months ended September 30, 2011 and 2010.

(In Thousands)

	Commercial			Consumer			Residential			Total
September 30, 2011
Charge-offs	$	2,440		$	8		$	--		$	2,448
Recoveries		(18	)		(2	)		(39	)		(59	)
Net Charge-offs	$	2,422		$	6		$	(39	)	$	2,389
	Commercial			Consumer			Residential			Total
September 30, 2010
Charge-offs	$	3,245		$	214		$	120		$	3,579
Recoveries		(488	)		(7	)		--			(495	)
Net Charge-offs	$	2,757		$	207		$	120		$	3,084

Specific reserves for non-performing loans at September 30, 2011 were $302,000 compared to $636,000 for non-performing loans at September 30, 2010. Management believes the specific reserves allocated to these and other non-accrual loans will offset losses, if any, arising from less than full recovery of the loans from the supporting collateral. Management has sought to provide the amount estimated to be necessary to maintain an allowance for loan losses that is adequate to cover the level of loss that management believes to be inherent in the portfolio as a whole, taking into account the Corporation’s experience, economic conditions and information about borrowers available at the time of the analysis. However, management expects that further deterioration of economic conditions in the Corporation’s market areas is likely in the short-term, especially with respect to real estate related activities and real property values. In such events, further provisions for loan losses could be needed in the future.

Non-Interest Income

Total non-interest income increased $151,000, or 21.6%, to $851,000 for the three months ended September 30, 2011 from $700,000 for the same period in the previous year. The increase was due primarily to lower other than temporary impairment write-down on securities partially offset by lower gains on the sale of investments. The Corporation recorded a $419,000 gain on sale of investments from security sales of $26.1 million for the three months ended September 30, 2011 compared to a gain of $619,000 from security sales of $33.0 million for the same period in the previous year, as the Corporation continues to better position the investment portfolio for the potential of rising interest rates. An other-than-temporary impairment charge of $218,000 was  required for write-downs on trust preferred securities as a result of projected shortfalls of interest and principal payments in the cash flow analysis of the securities for the three months ended September 30, 2011 compared to $660,000 for the same period in 2010. Net fees from financial services decreased $78,000, or 10.8%, to $645,000 for the three months ended September 30, 2011 from $723,000 for the same period in the previous year. The decrease was due to lower return check charges as a result of new government regulations on checking accounts.

42

Non-Interest Expense

For the three months ended September 30, 2011, total non-interest expense decreased $33,000, or 1.2%, to $2.7 million from $2.8 million for the same period in 2010. Compensation and employee benefits decreased $49,000, or 4.6%, due primarily to reductions in employee compensation costs due to prior year staffing reductions. Deposit insurance premiums expense increased $32,000 to $179,000 for the three months ended September 30, 2011 from $147,000 for the same period in 2010, due to higher assessments. Professional services expense increased $17,000, or 13.4%, to $144,000 for the three months ended September 30, 2011 from $127,000 for the same period in 2010 due primarily to higher regulatory examination expense and higher legal expense associated with loan collections. Items processing expense decreased $28,000, or 27.5%, to $74,000 for the three months ended September 30, 2011 from $102,000 for the same period in 2010, due primarily to lower NOW account balances due to rate reductions.

Income taxes

Our expense for income taxes was $7,000 for the three months ended September 30, 2011 as compared to a benefit of $548,000 for the same period in 2010. The Corporation has net operating loss carry-forwards of approximately $30.0 million which will expire by December 31, 2030 if not utilized to offset taxable income prior to that date. Therefore, federal income tax expense is not being recognized on taxable income.

Results of operations for the nine months ended September 30, 2011 and 2010

General

The Corporation recorded a net loss to common shareholders of $237,000 for the nine months ended September 30, 2011 as compared to a net loss of $3.9 million for the same period in 2010. The decrease in the loss in 2011 was primarily due to a lower provision for loan losses in 2011 due primarily to a net reduction in total loans of $37.1 million, and a decrease in the other-than-temporary impairment of securities, offset by a decrease in the gain on the sale of investments and an increase of $715,000 in expenses primarily related to the holding and disposition of foreclosed properties.

43

Average Yields and Rates

    (dollars in thousands)

	Nine Months Ended September 30,
	2011							2010
	Average Balance		Interest		Average Yield/Cost(2)			Average Balance		Interest		Average Yield/Cost(2)
Interest-earning assets:
Loans (1)	$	184,719	$	6,939		5.01	%	$	236,235	$	8,836		4.99	%

Mortgage-backed securities		77,504		2,038	3.51	%		32,243		992	4.10	%
Investment securities		74,491		1,799	3.22	%		116,828		2,923	3.33	%
Deposits and fed funds sold		24,367		17	0.09	%		18,196		23	0.17	%
Total interest-earning assets		361,081		10,793	3.99	%		403,502		12,774	4.22	%
Non-interest-earning assets		34,343						37,925
Total assets	$	395,424					$	441,427
Interest-bearing liabilities:
Deposits	$	282,370		2,095	0.99	%	$	306,687		4,012	1.74	%
Floating rate junior subordinated deferrable interest debentures		12,372		355	3.83	%		12,372		359	3.87	%
FHLB advances and other borrowings		66,319		1,875	3.77	%		74,606		2,012	3.60	%
Total interest-bearing liabilities		361,061		4,325	1.60	%		393,665		6,383	2.16	%
Non-interest-bearing sources:
Non-interest-bearing deposits		20,456						18,637
Non-interest-bearing liabilities		3,537						3,139
Total liabilities		385,054						415,441
Shareholders’ equity		10,370						25,986
Total liabilities and shareholders’ equity	$	395,424					$	441,427
Net interest income			$	6,468					$	6,391
Interest rate spread					2.39	%					2.06	%
Impact of non-interest-bearing deposits					0.07	%					0.05	%
Net interest margin					2.46	%					2.11	%

(1) Average balances of loans include non-accrual loans.

(2) Annualized

Interest Income

Interest income decreased $2.0 million, or 15.5%, to $10.8 million for the nine months ended September 30, 2011 as compared to the same period in 2010. Interest income on loans decreased by 21.5%, or $1.9 million, to $6.9 million for the nine months ended September 30, 2011 from $8.8 million for the nine months ended September 30, 2010, due primarily to lower average balance of loans as a result of a decrease in demand. Interest on deposits and federal funds sold, combined with interest and dividends on investment and mortgage-backed securities decreased $84,000, or 2.1%, for the nine months ended September 30, 2011 due to lower investment yields due to declining market interest rates, offset by higher average balances.

44

Interest Expense

Interest expense decreased $2.1 million, or 32.2%, to $4.3 million for the nine months ended September 30, 2011 as compared to $6.4 million for the nine months ended September 30, 2010. Interest expense on deposit accounts decreased $1.9 million, or 47.8%, to $2.1 million for the nine months ended September 30, 2011 from $4.0 million during the same period in 2010 due primarily to lower market interest rates, a shift in the composition of the deposit portfolio from certificates of deposits to transaction accounts with lower average balances. Interest expense on borrowings decreased $137,000, or 6.8%, for the nine months ended September 30, 2011 as compared to the same period in the previous year due to lower average balances.

Provision for Loan Losses

During the nine months ended September 30, 2011, the provision for loan losses was $290,000 compared to $6.0 million for the same period in the previous year. The reduction was due to a decrease in net loans of $37.1 million and lower write-downs and charge-offs. During the nine months ended September 30, 2011, bad debt charge-offs, net of recoveries, were $3.5 million as compared to $5.8 million for the same period in the previous year. The Corporation’s loan loss allowance at September 30, 2011 was approximately 2.5% of the Corporation’s outstanding loan portfolio compared to 2.7% of the Corporation’s outstanding loan portfolio at September 30, 2010.

The changes in the allowance for loan losses consisted of the following for the nine months ended September 30, 2011.

		September 30,			September 30,
		2011			2010
Balance at beginning of period	$	7,379		$	5,579
Provision for loan losses		290			6,030
Charge-offs, net		(3,486	)		(5,775	)
Balance at end of period	$	4,183		$	5,834

Non-Interest Income

Total non-interest income decreased $624,000, or 21.8%, to $2.2 million for the nine months ended September 30, 2011 from $2.9 million for the same period in the previous year. The decrease was due primarily to lower gain on sale of investment securities, partially offset by a reduction in other than temporary impairment write-downs on securities. Gains on sale of investments were $697,000 from security sales of $50.2 million for the nine months ended September 30, 2011 compared to $1.8 million from security sales of $88.4 million for the same period in the previous year, as the Corporation continues to better position the investment portfolio for the potential of rising interest rates. Other than temporary impairment write-downs on securities were $409,000 for the nine months ended September 30, 2011 compared to $1.1 million for the same period in 2010 from write-downs recorded on trust preferred securities as a result of projected shortfalls of interest and principal payments in the cash flow analysis of the securities. Fees from financial services decreased $190,000, or 9.0%, to $1.9 million for the nine months ended September 30, 2011 from $2.1 million for the same period in the previous year. The decrease was due to lower return check charges as a result of new government regulations on checking accounts.

45

Non-Interest Expense

For the nine months ended September 30, 2011, total non-interest expense increased $715,000, or 9.4%, to $8.3 million from $7.6 million for the same period in 2010. Compensation and employee benefits decreased $124,000, or 3.8%, to $3.1 million for the nine months ended September 30, 2011 from $3.2 million for the same period in 2010 due primarily to reductions in employee compensation costs due to prior year staffing reductions. Occupancy and equipment expense increased $78,000, or 4.3%, to $1.9 million for the nine months ended September 30, 2011 from $1.8 million for the same period in 2010 due primarily to higher ATM expense due to higher usage and higher system maintenance expense. Deposit insurance premiums expense increased $98,000, to $536,000 for the nine months ended September 30, 2011 from $438,000 for the same period in 2010, due to higher FDIC premium assessments. Professional services expense increased $129,000, or 39.7%, to $454,000 for the nine months ended September 30, 2011 from $325,000 for the same period in 2010 due primarily to higher legal, audit and regulatory examination expense. Advertising/public relations expense decreased $10,000, or 28.6%, to $25,000 for the nine months ended September 30, 2011 from $35,000 for the same period in 2010 due primarily to lower deposit product and promotion expenses. OREO and loan operations expense increased $571,000, or 77.9%, to $1.3 million for the nine months ended September 30, 2011 from $733,000 for the same period in 2010, due primarily to higher costs associated with loan foreclosures and write-downs required to adjust other real estate owned to fair market value. Items processing expense decreased $37,000, or 14.1%, to $225,000 for the nine months ended September 30, 2011 from $262,000 for the same period in 2010, due primarily to lower NOW account balances due to rate reductions.

Income taxes

Our expense for income taxes was $25,000 for the nine months ended September 30, 2011 as compared to a benefit of $793,000 for the same period in 2010. The Corporation has net operating loss carry-forwards of approximately $30.0 million which will expire by December 31, 2030 if not utilized to offset taxable income prior to that date. Therefore, federal income tax expense is not being recognized on taxable income.

Item 3.Quantitative and Qualitative Disclosures about Market Risk

Not applicable as the registrant is a smaller reporting company.

Item 4.Controls and Procedures

The Corporation’s management, including the Corporation’s principal executive officer and principal financial officer, have evaluated the effectiveness of the Corporation’s “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”). Based upon their evaluation, the principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, the Corporation’s disclosure controls and procedures were effective for the purpose of ensuring that the information required to be disclosed in the reports that the Corporation files or submits under the Exchange Act with the Securities and Exchange Commission (the “SEC”) (1) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (2) is accumulated and communicated to the Corporation’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.

There has been no change in the Corporation’s internal control over financial reporting identified in connection with the evaluation required by Rule 13(a)-15(e) that occurred during the quarter that has materially affected or is reasonably likely to materially affect, the Corporation’s internal control over financial reporting.

46

PART II - OTHER INFORMATION

Item  1. Legal Proceedings

The Corporation is not involved in any legal proceedings. The Bank is not involved in any pending legal proceedings other than routine legal proceedings occurring in the normal course of business. Management believes that these proceedings are immaterial to the Corporation’s financial condition and results of operations.

Item  1A.Risk Factors

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2010, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K are not the only risks that we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

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

In May 2005, the Corporation implemented a share repurchase program under which the Board of Directors of the Corporation authorized the repurchase of up to 5% of the outstanding shares or 98,000 shares. The program was expanded by an additional 5%, or 92,000 shares, in August 2006. As part of the Corporation’s participation in the Troubled Asset Relief Program, prior to the earlier of March 6, 2012 or the date on which the preferred stock issued to the Treasury Department has been redeemed in full or transferred to non-affiliates, the Corporation cannot repurchase any shares of its common stock without the prior approval of the Treasury Department. The Corporation did not repurchase any shares during the three months ended September 30, 2011 and 36,034 shares remain under the previously authorized plans.

Item  3. Defaults upon Senior Securities

Not applicable.

Item  4. [Removed and Reserved]

Item 5. Other Information

None

Item  6. Exhibits

31(a)	Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer
31(b)	Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer
32(a)	Chief Executive Officer Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32(b)	Chief Financial Officer Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101	Interactive Data File
	The following materials from Provident Community Bancshares, Inc.'s Quarterly Report on Form 10-Q for the quarter ended September 30, 2011 formatted in Extensible Business Reporting Language (XBRL): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income (Loss), (iii) the Consolidated Statements of Cash Flows and (iv) related notes, tagged as blocks of text.

47

SIGNATURES

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

	PROVIDENT COMMUNITY BANCSHARES, INC.
	(Registrant)
Date: November 14, 2011		By:	/s/ Dwight V. Neese
			Dwight V. Neese, President and
			Chief Executive Officer
Date: November 14, 2011		By:	/s/ Richard H. Flake
			Richard H. Flake, Executive Vice President and Chief Financial Officer

48