Unassociated Document
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 March 31, 2011

o Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Commission file number: 0-27702

Bank of South Carolina Corporation
(Exact name of registrant issuer as specified in its charter)
 
South Carolina
57-1021355
(State or other jurisdiction of
(IRS Employer
incorporation or organization)
Identification Number)
 
256 Meeting Street, Charleston, SC 29401
(Address of principal executive offices)

(843) 724-1500
(Registrant’s telephone number)

Indicate by check mark whether the issuer (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 o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its Company Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes x No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.

Large accelerated filer o     Accelerated Filer o
Non-accelerated filer   o     Smaller reporting Company x
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o No x

As of May 5, 2011 there were 4,434,488 Common Shares outstanding.
 
 
 

 
 
Table of Contents
 
BANK OF SOUTH CAROLINA CORPORATION

Report on Form 10-Q
for quarter ended
March 31, 2011


   
Page
 
PART I - FINANCIAL INFORMATION
     
       
Item 1. Financial Statements (Unaudited)
     
       
Consolidated Balance Sheets –
     
March 31, 2011 and December 31, 2010
    3  
Consolidated Statements of Income –
       
Three months ended March 31, 2011 and 2010
    4  
Consolidated Statements of Shareholders’ Equity and Comprehensive Income –
       
Three months ended March 31, 2011 and 2010
    5  
Consolidated Statements of Cash Flows –
       
Three months ended March 31, 2011 and 2010
    6  
Notes to Consolidated Financial Statements
    7  
         
Item 2. Management's Discussion and Analysis of Financial
       
Condition and Results of Operations
    16  
Off-Balance Sheet Arrangements
    30  
Liquidity
    31  
Capital Resources
    32  
         
Item 3. Quantitative and Qualitative Disclosures About Market Risk
    32  
         
Item 4. Controls and Procedures
    32  
         
PART II - OTHER INFORMATION
       
         
Item 1. Legal Proceedings
    33  
Item 1A Risk Factors
    33  
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    33  
Item 3. Defaults Upon Senior Securities
    33  
Item 4. Removed and Reserved
    33  
Item 5. Other Information
    33  
Item 6. Exhibits
    33  
         
Signatures
    35  
Certifications
       
 
 
2

 
 
PART I - ITEM 1 - FINANCIAL STATEMENTS

BANK OF SOUTH CAROLINA CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
 
   
(Unaudited)
   
(Audited)
 
   
March 31,
2011
   
December 31,
2010
 
Assets:
           
Cash and due from banks
  $ 6,210,726     $ 5,404,379  
Interest bearing deposits in other banks
    8,309       8,302  
Federal funds sold
    34,227,475       19,018,104  
Investment securities available for sale
    49,017,775       39,379,613  
Mortgage loans to be sold
    2,119,227       5,908,316  
Loans
    204,736,188       208,025,664  
Allowance for loan losses
    (2,763,745 )     (2,938,588 )
Net loans
    201,972,443       205,087,076  
Premises and equipment, net
    2,406,099       2,436,526  
Other real estate owned
    659,430       659,492  
Accrued interest receivable
    933,805       1,054,791  
Other assets
    1,567,266       1,564,668  
                 
Total assets
  $ 299,122,555     $ 280,521,267  
                 
Liabilities and Shareholders' Equity:
               
Deposits:
               
Non-interest bearing demand
  $ 57,417,806     $ 56,884,235  
Interest bearing demand
    54,724,732       50,394,101  
Money market accounts
    80,809,316       68,007,823  
Certificates of deposit $100,000 and over
    45,280,146       45,523,280  
Other time deposits
    17,647,120       17,760,278  
Other savings deposits
    12,294,734       11,867,258  
Total deposits
    268,173,854       250,436,975  
                 
Short-term borrowings
    414,432       767,497  
Accrued interest payable and other liabilities
    1,194,732       597,913  
Total liabilities
    269,783,018       251,802,385  
                 
Common Stock - No par value;
               
12,000,000 shares authorized; Shares issued 4,651,148
               
at March 31, 2011 and 4,649,317 at December 31, 2010;
               
Shares outstanding 4,431,697 at March 31, 2011
               
and 4,429,866 shares at December 31, 2010
    -       -  
Additional paid in capital
    28,228,467       28,202,939  
Retained earnings
    2,374,126       2,167,927  
Treasury stock – 219,451 shares at March 31, 2011 and December 31, 2010
    (1,902,439 )     (1,902,439 )
Accumulated other comprehensive income, net of income taxes
    639,383       250,455  
                 
Total shareholders' equity
    29,339,537       28,718,882  
                 
Total liabilities and shareholders' equity
  $ 299,122,555     $ 280,521,267  
 
See accompanying notes to consolidated financial statements
 
 
3

 
 
BANK OF SOUTH CAROLINA CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
   
Three Months Ended
 
   
March 31,
 
   
2011
   
2010
 
Interest and fee income
           
Interest and fees on loans
  $ 2,616,584     $ 2,671,441  
Interest and dividends on investment securities
    321,555       366,947  
Other interest income
    10,565       1,066  
Total interest and fee income
    2,948,704       3,039,454  
                 
Interest expense
               
Interest on deposits
    235,938       285,439  
Interest on short-term borrowings
    -       7,365  
Total interest expense
    235,938       292,804  
                 
Net interest income
    2,712,766       2,746,650  
Provision for loan losses
    120,000       120,000  
Net interest income after provision for  loan  losses
    2,592,766       2,626,650  
                 
Other income
               
Service charges, fees and commissions
    245,887       248,281  
Mortgage banking income
    178,263       166,878  
Other non-interest income
    5,177       5,594  
Total other income
    429,327       420,753  
                 
Other expense
               
Salaries and employee benefits
    1,170,400       1,166,856  
Net occupancy expense
    334,478       310,586  
Other operating expenses
    591,558       508,224  
Total other expense
    2,096,436       1,985,666  
                 
Income before income tax expense
    925,657       1,061,737  
Income tax expense
    276,289       334,870  
Net income
  $ 649,368     $ 726,867  
                 
Basic earnings per share
  $ 0.14     $ 0.16  
Diluted earnings per share
  $ 0.14     $ 0.16  
                 
Weighted average shares outstanding
               
Basic
    4,430,705       4,403,201  
Diluted
    4,437,570       4,403,201  
                 
Cash Dividend Per Share
  $ 0.10     $ 0.10  
 
All share and per share data have been restated to reflect a 10% stock dividend declared on August 26, 2010.

See accompanying notes to consolidated financial statements
 
 
4

 
 
BANK OF SOUTH CAROLINA CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME (UNAUDITED)
FOR THREE MONTHS ENDED MARCH 31, 2011 AND 2010

   
Common Stock
   
Additional
Paid In Capital
   
Retained
Earnings
   
Treasury
Stock
   
Accumulated Other Comprehensive Income
   
Total
 
                                     
December 31, 2009
  $ -     $ 23,511,560     $ 4,968,336     $ (1,692,964 )   $ 780,265     $ 27,567,197  
                                                 
Comprehensive income:
                                               
                                                 
Net income
    -       -       726,867       -       -       726,867  
                                                 
Net unrealized gain on securities (net of tax effect of $6,833)
    -       -       -       -       11,637       11,637  
                                                 
Comprehensive income
    -       -       -       -       -       738,504  
                                                 
Stock-based compensation expense
    -       11,800       -       -       -       11,800  
                                                 
Cash dividends ($0.10 per common share)
    -       -       (400,291 )     -       -       (400,291 )
                                                 
March 31, 2010
  $ -     $ 23,523,360     $ 5,294,912     $ (1,692,964 )   $ 791,902     $ 27,917,210  
                                                 
December 31, 2010
  $ -     $ 28,202,939     $ 2,167,927     $ (1,902,439 )   $ 250,455     $ 28,718,882  
                                                 
Comprehensive income:
                                               
                                                 
Net income
    -       -       649,368       -       -       649,368  
                                                 
Net unrealized gain on securities (net of tax effect of $177,549)
    -       -       -       -       388,928       388,928  
                                                 
Total comprehensive income
    -       -       -       -       -       1,038,296  
                                                 
Exercise of stock options
    -       14,850       -       -       -       14,850  
                                                 
Stock-based compensation expense
    -       10,678       -       -       -       10,678  
                                                 
Cash dividends ($0.10 per common share)
    -       -       (443,169 )     -       -       (443,169 )
                                                 
March 31, 2011
  $ -     $ 28,228,467     $ 2,374,126     $ (1,902,439 )   $ 639,383     $ 29,339,537  
 
See accompanying notes to consolidated financial statements.
 
 
5

 
 
BANK OF SOUTH CAROLINA CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
 
   
Three months Ended
March 31,
 
   
2011
   
2010
 
Cash flows from operating activities:
           
Net income
  $ 649,368     $ 726,867  
Adjustments to reconcile net income to net cash provided (used) by operating activities:
               
Depreciation
    86,987       63,489  
Provision for loan losses
    120,000       120,000  
Stock-based compensation expense
    10,678       11,800  
Net (accretion) and amortization of unearned discounts and premiums on investments
    (25,435 )     13,093  
Origination of mortgage loans held for sale
    (12,315,707 )     (14,048,052 )
Proceeds from sale of mortgage loans held for sale
    16,104,796       14,685,806  
(Increase) decrease in accrued interest receivable and other assets
    (59,099 )     106,699  
Increase in accrued interest payable and other liabilities
    153,650       336,952  
                 
Net cash provided by operating activities
    4,725,238       2,016,654  
                 
Cash flows from investing activities:
               
Purchase of investment securities available for sale
    (15,206,250 )     -  
Maturities of investment securities available for sale
    6,160,000       -  
Net decrease in loans
    2,994,633       2,416,933  
Purchase of premises and equipment
    (56,560 )     (10,953 )
Proceeds from the sale of other real estate owned
    -       65,000  
                 
Net cash (used) provided by investing activities
    (6,108,177 )     2,470,980  
                 
Cash flows from financing activities:
               
Net increase in deposit accounts
    17,736,879       4,083,694  
Net decrease in short-term borrowings
    (353,065 )     (214,486 )
Stock options exercised
    14,850       -  
                 
Net cash provided by financing activities
    17,398,664       3,869,208  
                 
Net increase in cash and cash equivalents
    16,015,725       8,356,842  
Cash and cash equivalents, beginning of period
    24,430,785       9,582,502  
                 
Cash and cash equivalents, end of period
  $ 40,446,510     $ 17,939,344  
                 
Supplemental disclosure of cash flow data:
               
Cash paid during the period for:
               
Interest
  $ 216,240     $ 273,555  
Income taxes
  $ 139,111     $ 52,146  
                 
Supplemental disclosure for non-cash investing and financing activity:
               
Change in dividends payable
  $ 443,169     $ 400,291  
Transfer of loans to other real estate owned
  $ -     $ 65,000  
Change in unrealized losses on available for sale securities
  $ 388,928     $ 11,637  
 
See accompanying notes to consolidated financial statements.
 
 
6

 
 
BANK OF SOUTH CAROLINA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2011

NOTE 1:  Basis of Presentation
 
The Bank of South Carolina (the “Bank”) was organized on October 22, 1986 and opened for business as a state-chartered financial institution on February 26, 1987, in Charleston, South Carolina.  The Bank was reorganized into a wholly-owned subsidiary of Bank of South Carolina Corporation (the “Company”), effective April 17, 1995.  At the time of the reorganization, each outstanding share of the Bank was exchanged for two shares of Bank of South Carolina Corporation Stock.  The Company operates as a commercial bank from four banking houses located at: 256 Meeting Street, Charleston, SC, 100 North Main Street, Summerville, SC, 1337 Chuck Dawley Boulevard, Mt. Pleasant, SC and 2027 Sam Rittenberg Boulevard, Charleston, SC.

The consolidated financial statements in this report are unaudited, except for the December 31, 2010 consolidated balance sheet.  All adjustments consisting of normal recurring accruals which are, in the opinion of management, necessary for fair presentation of the interim consolidated financial statements have been included and fairly and accurately present the financial position, results of operations and cash flows of the Company.  The results of operations for the three months ended March 31, 2011, are not necessarily indicative of the results which may be expected for the entire year.

The preparation of the consolidated financial statements is in conformity with accounting principles generally accepted in the United States of America (GAAP) which requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements.  In addition, they affect the reported amounts of income and expense during the reporting period.  Actual results could differ from these estimates and assumptions.

In preparing these financial statements, the Company has evaluated events and transactions for potential recognition or disclosure through the date the financial statements were available to be issued.

NOTE 2:  Investment Securities
 
The Company classifies investments into three categories as follows:  (1) Held to Maturity - debt securities that the Company has the positive intent and ability to hold to maturity, which are reported at amortized cost, adjusted for the amortization of any related premiums or the accretion of any related discounts into interest income using a methodology which approximates a level yield of interest over the estimated remaining period until maturity; (2) Trading - debt and equity securities that are bought and held principally for the purpose of selling them in the near term, which are reported at fair value, with unrealized gains and losses included in earnings; and (3) Available for Sale - debt and equity securities that may be sold under certain conditions, which are reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of shareholders' equity, net of income taxes.  Unrealized losses on securities due to fluctuations in fair value are recognized when it is determined that an other than temporary decline in value has occurred. Realized gains or losses on the sale of investments are recognized on a specific identification, trade date basis.  All securities were classified as available for sale for the three months ended March 31, 2011 and 2010.  The Company does not have any mortgage- backed securities nor has it ever invested in mortgage-backed securities.

 
7

 

NOTE 3: Stock Based Compensation
 
The shareholders of the Company voted at the Company’s Annual Meeting, April 13, 2010, to approve the 2010 Omnibus Stock Incentive Plan, including 330,000 shares (adjusted for a 10% stock dividend declared on August 26, 2010) reserved under the plan (copy of the plan was filed with 2010 Proxy Statement).  This plan is intended to assist the Company in recruiting and retaining employees with ability and initiative by enabling employees to participate in its future success and to associate their interest with those of the Company and its shareholders.  Under the Omnibus Stock Incentive Plan, options are periodically granted to employees at a price not less than 100% of the fair market value of the shares at the date of the grant. All employees are eligible to participate in this plan if the Executive Committee, in its sole discretion, determines that such person has contributed or can be expected to contribute to the profits or growth of the Company or its subsidiary.  Options may be exercised in whole at any time or in part from time to time at such times and in compliance with such requirements as the Executive Committee shall determine. The maximum period in which an Option may be exercised is determined at the date of grant and shall not exceed 10 years from the date of grant.

The options are not transferable except by will or by the laws of descent and distribution. On March 24, 2011, the Executive Committee granted options to purchase 5,000 shares of stock to 1 employee.  Fair value was estimated at the date of grant using the Black-Scholes option pricing model with the following assumptions used for the grant: dividend yield 4.02%, historical volatility 54.43%, risk free interest rate of 3.42%, and an expected life of 10 years.

On April 14, 1998 the Company adopted the 1998 Omnibus Stock Incentive Plan which expired on April 14, 2008.  Options can no longer be granted under the 1998 Plan.  Options granted before April 14, 2008, shall remain valid in accordance with their terms.

The following is a summary of the activity under the 1998 and 2010 Omnibus Stock Incentive Plans for the three months ended March 31, 2011 and the 1998 Omnibus Stock Incentive Plan for the three months ended March 31, 2010.

Three Months Ended March 31, 2011
 
Options
   
Weighted Average Exercise Price
 
             
Balance at January 1, 2011
    88,831     $ 11.51  
Granted
    5,000       11.67  
Exercised
    (1,831 )     8.11  
Balance at March 31, 2011
    92,000     $ 11.59  
 
Three months Ended March 31, 2010
 
Options
   
Weighted Average Exercise Price
 
             
Balance at January 1, 2010
    86,995     $ 10.61  
Exercised
    -       -  
Balance at March 31, 2010
    86,995     $ 10.61  
                 
Options exercisable at March 31, 2011
    11,303     $ 8.11  
      4,870     $ 8.54  
 
All share and per share data have been restated to reflect a 10% stock dividend declared on August 26, 2010.
 
 
8

 
 
NOTE 4:  Shareholders' Equity
 
A regular quarterly cash dividend of $.10 per share was declared on March 24, 2011 for shareholders of record at April 8, 2011, payable April 29, 2011. Income per common share for the three months ended March 31, 2011 and for the three months ended March 31, 2010 was calculated as follows:
 
   
FOR THE THREE MONTHS ENDED
MARCH 31, 2011
 
   
INCOME
(NUMERATOR)
   
SHARES
(DENOMINATOR)
   
PER SHARE
AMOUNT
 
                   
Net income
  $ 649,368              
                     
Basic income available to common shareholders
  $ 649,368       4,430,705     $ .14  
                         
Effect of dilutive options
            6,865          
                         
Diluted income available to common shareholders
  $ 649,368       4,437,570     $ .14  
 
   
FOR THE THREE MONTHS ENDED
MARCH 31, 2010
 
   
INCOME
(NUMERATOR)
   
SHARES
(DENOMINATOR)
   
PER SHARE
AMOUNT
 
                   
Net income
  $ 726,867              
                     
Basic income available to common shareholders
  $ 726,867       4,403,201     $ ..16  
                         
Effect of dilutive options
            -          
                         
Diluted income available to common shareholders
  $ 726,867       4,403,201     $ .16  
 
All share and per share data have been restated to reflect a 10% stock dividend declared on August 26, 2010.

The future payment of cash dividends is subject to the discretion of the Board of Directors and depends upon a number of factors, including future earnings, financial condition, cash requirements, and general business conditions.  Cash dividends when declared, are paid by the Bank to the Company for distribution to shareholders of the Company.  Certain regulatory requirements restrict the amount of dividends which the Bank can pay to the Company.

NOTE 5: Comprehensive Income
 
The Company applies accounting standards which establish guidance for the reporting and display of comprehensive income and its components in a full set of general purpose financial statements.  Comprehensive income consists of net income and net unrealized gains or losses on securities and is presented in the consolidated statements of shareholders’ equity and comprehensive income.

Comprehensive income totaled $1,038,296 at March 31, 2011 and $738,504 at March 31, 2010.

NOTE 6: Fair Value Measurements
 
Effective January 1, 2008, the Company adopted accounting standards which provide a framework for measuring and disclosing fair value under generally accepted accounting principles. The guidance 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).
 
 
9

 

The standard 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. The standard 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 (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access.  Level 1 assets and liabilities include debt and equity securities and derivative contracts that are traded in an active exchange market, as well as US Treasuries and money market funds.
     
Level 2
 
Valuation is based upon quoted prices for similar assets and liabilities in active markets, as well as inputs that are observable for the asset or liability (other than quoted prices), such as interest rates, foreign exchange rates, and yield curves that are observable at commonly quoted intervals.  Level 2 assets and liabilities include debt securities with quoted prices that are traded less frequently than exchange-traded instruments, mortgage-backed securities, municipal bonds, corporate debt securities and derivative contracts whose value is determined using a pricing model with inputs that are observable in the market or can be derived principally from or corroborated by observable market data.  This category generally includes certain derivative contracts and impaired loans.
     
Level 3
 
Valuation is generated from model-based techniques that use at least one significant assumption based on unobservable inputs for the asset or liability, which are typically based on an entity’s own assumptions, as there is little, if any, related market activity.  In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety.  The assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.
 
The following is a description of the valuation methodologies used for assets and liabilities recorded at fair value.

Investment Securities Available for Sale

Investment securities available for sale are recorded at fair value on a recurring basis. At March 31, 2011 and December 31, 2010, the Company’s investment portfolio was comprised of US Treasury Notes, Government Sponsored Enterprises and Municipal Securities. The portfolio did not contain any mortgage-backed securities. Fair value measurement is based upon prices obtained from third party pricing services that use independent pricing models which rely on a variety of factors including reported trades, broker/dealer quotes, benchmark yields, economic and industry events and other relevant market information. As such, these securities are classified as Level 2.
 
 
10

 

Mortgage Loans Held for Sale

The Company originates fixed rate residential loans on a servicing released basis in the secondary market. Loans closed but not yet settled with other investors, are carried in the Company’s loans held for sale portfolio.  These loans are fixed rate residential loans that have been originated in the Company’s name and have closed.  Virtually all of these loans have commitments to be purchased by investors and the majority of these loans were locked in by price with the investors on the same day or shortly thereafter that the loan was locked in with the Company’s customers.  Therefore, these loans present very little market risk for the Company.  The Company usually delivers to, and receives funding from, the investor within 30 days.  Commitments to sell these loans to the investor are considered derivative contracts and are sold to investors on a “best efforts" basis. The Company is not obligated to deliver a loan or pay a penalty if a loan is not delivered to the investor. As a result of the short-term nature of these derivative contracts, the fair value of the mortgage loans held for sale in most cases is the same as the value of the loan amount at its origination.  These loans are classified as Level 2.

Assets and liabilities measured at fair value on a recurring basis at March 31, 2011 and December 31, 2010 are as follows:

   
Quoted Market Price in active markets
(Level 1)
   
Significant Other Observable Inputs
(Level 2)
   
Significant Unobservable Inputs
(Level 3)
   
Balance
at
March 31,
2011
 
US Treasury Note
  $ 21,206,016     $ -     $ -     $ 21,206,016  
Government Sponsored Enterprises
  $ -     $ 3,032,509     $ -     $ 3,032,509  
Municipal Securities
  $ -     $ 24,779,250     $ -     $ 24,779,250  
Mortgage loans to be sold
  $ -     $ 2,119,227     $ -     $ 2,119,227  
Total
  $ 21,206,016     $ 29,930,986     $ -     $ 51,137,002  
 
   
Quoted Market Price in active markets
(Level 1)
   
Significant Other Observable Inputs
(Level 2)
   
Significant Unobservable Inputs
(Level 3)
   
Balance
at
December 31,
2010
 
US Treasury Note
  $ 9,023,437     $ -     $ -     $ 9,023,437  
Government Sponsored Enterprises
  $ -     $ 6,100,545     $ -     $ 6,100,545  
Municipal Securities
  $ -     $ 24,255,631     $ -     $ 24,255,631  
Mortgage loans to be sold
  $ -     $ 5,908,316     $ -     $ 5,908,316  
Total
  $ 9,023,437     $ 36,264,492     $ -     $ 45,287,929  

 
11

 

Other Real Estate Owned (OREO)

Loans, secured by real estate, are adjusted to fair value upon transfer to other real estate owned (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 appraisal, the Company records the OREO as nonrecurring Level 2.  When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the asset as nonrecurring Level 3.

Impaired Loans

The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment in accordance with ASC 310-10, “Accounting by Creditors for Impairment of a Loan”.

In accordance with this standard, the fair value is estimated using one of the following methods: fair value of the collateral less estimated costs to sell, discounted cash flows, or market value of the loan based on similar debt. The fair value of the collateral less estimated costs to sell is the most frequently used method. Typically, the Company reviews the most recent appraisal and if it is over 12 months old will request a new third party appraisal. Depending on the particular circumstances surrounding the loan, including the location of the collateral, the date of the most recent appraisal and the value of the collateral relative to the recorded investment in the loan, management may order an independent appraisal immediately or, in some instances, may elect to perform an internal analysis. Specifically as an example, in situations where the collateral on a nonperforming commercial real estate loan is out of the Company’s primary market area, management would typically order an independent appraisal immediately, at the earlier of the date the loan becomes nonperforming or immediately following the determination that the loan is impaired. However, as a second example, on a nonperforming commercial real estate loan where management is familiar with the property and surrounding areas and where the original appraisal value far exceeds the recorded investment in the loan, management may perform an internal analysis whereby the previous appraisal value would be reviewed and adjusted for recent conditions including recent sales of similar properties in the area and any other relevant economic trends. These valuations are reviewed at a minimum on a quarterly basis.

Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At March 31, 2011 and December 31, 2010, substantially all of the total impaired loans were evaluated based on the fair value of the collateral. In accordance with ASC 820, impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3.

Certain assets and liabilities are measured at fair value on a nonrecurring basis; that is, the instruments are not measured at fair value on an on going basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment).  The following table presents the assets and liabilities carried on the balance sheet by caption and by level within the valuation hierarchy (as described above) as of March 31, 2011 and December 31, 2010 for which a nonrecurring change in fair value has been recorded during the three months ended March 31, 2011 and twelve months ended December 31, 2010.
 
 
12

 
 
   
Quoted Market Price in active markets
(Level 1)
   
Significant Other Observable Inputs
(Level 2)
   
Significant Unobservable Inputs
(Level 3)
   
Balance
at
March 31,
2011
 
Impaired loans
  $ -     $ 4,644,770     $ -     $ 4,644,770  
Other real estate owned
  $ -     $ 659,430     $ -     $ 659,430  
Total
  $ -     $ 5,304,200     $ -     $ 5,304,200  
 
   
Quoted Market Price in active markets
(Level 1)
   
Significant Other Observable Inputs
(Level 2)
   
Significant Unobservable Inputs
(Level 3)
   
Balance
at
December 31,
2010
 
Impaired loans
  $ -     $ 3,559,528     $ -     $ 3,559,528  
Other real estate owned
  $ -     $ 659,492     $ -     $ 659,492  
Total
  $ -     $ 4,219,020     $ -     $ 4,219,020  
 
The Company has no assets or liabilities whose fair values are measured using level 3 inputs.

Accounting standards require disclosure of fair value information about financial instruments whether or not recognized on the balance sheet, for which it is practicable to estimate fair value.   Fair value estimates are made as of a specific point in time based on the characteristics of the financial instruments and the relevant market information.  Where available, quoted market prices are used.  In other cases, fair values are based on estimates using present value or other valuation techniques.  These techniques involve uncertainties and are significantly affected by the assumptions used and the judgments made regarding risk characteristics of various financial instruments, discount rates, prepayments, estimates of future cash flows, future expected loss experience and other factors.  Changes in assumptions could significantly affect these estimates.  Derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, may or may not be realized in an immediate sale of the instrument.

Under the accounting standard, fair value estimates are based on existing financial instruments without attempting to estimate the value of anticipated future business and the value of the assets and liabilities that are not financial instruments.  Accordingly, the aggregate fair value amounts of existing financing instruments do not represent the underlying value of those instruments on the books of the Company.

The following describes the methods and assumptions used by the Company in estimating the fair values of financial instruments:

a.
Cash and due from banks, interest bearing deposits in other banks and federal funds sold
 
The carrying value approximates fair value. All mature within 90 days and do not present unanticipated credit concerns.

b.
Investment securities available for sale
 
The fair value of investment securities is derived from quoted market prices.
 
 
13

 

c.
Loans
 
The carrying values of variable rate consumer and commercial loans and consumer and commercial loans with remaining maturities of three months or less, approximate fair value.  The fair values of fixed rate consumer and commercial loans with maturities greater than three months are determined using a discounted cash flow analysis and assume the rate being offered on these types of loans by the Company at March 31, 2011 and December 31, 2010, approximate market.

The carrying value of mortgage loans held for sale approximates fair value.

For lines of credit, the carrying value approximates fair value.

d.
Deposits
 
The estimated fair value of deposits with no stated maturity is equal to the carrying amount.  The fair value of time deposits is estimated by discounting contractual cash flows, by applying interest rates currently being offered on the deposit products.  The fair value estimates for deposits do not include the benefit that results from the low cost funding provided by the deposit liabilities as compared to the cost of alternative forms of funding (deposit base intangibles).

e.
Short-term borrowings
 
The carrying amount approximates fair value due to the short-term nature of these instruments.

The estimated fair values of the Company's financial instruments at March 31, 2011 and December 31, 2010 are as follows:

   
March 31, 2011
 
   
Carrying
Amount
   
Estimated
Fair Value
 
             
Cash and due from banks
  $ 6,210,726     $ 6,210,726  
Interest bearing deposits in other banks
    8,309       8,309  
Federal funds sold
    34,227,475       34,227,475  
Investments  available for sale
    49,017,775       49,017,775  
Loans (1)
    206,831,723       208,420,615  
Deposits
    268,173,854       268,942,172  
Short-term borrowings
    414,432       414,432  
 
   
December 31, 2010
 
   
Carrying
Amount
   
Estimated
Fair Value
 
             
Cash and due from banks
  $ 5,404,379     $ 5,404,379  
Interest bearing deposits in other banks
    8,302       8,302  
Federal funds sold
    19,018,104       19,018,104  
Investments available for sale
    39,379,613       39,379,613  
Loans (1)
    213,916,674       218,670,423  
Deposits
    250,436,975       250,750,331  
Short-term borrowings
    767,497       767,497  


(1) 
Includes mortgage loans to be sold
 
 
14

 

NOTE 7: Recently Issued Accounting Pronouncements
 
The following is a summary of recent authoritative pronouncements that could impact the accounting, reporting and/or disclosure of financial information by the Company.

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 Company is required to include these disclosures in their interim and annual financial statements.  See the discussion on “Allowance for Loan Losses”.

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 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 will be effective for reporting periods beginning after June 15, 2011.  The Company does not expect this to have an impact on its financial statements.

On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), which significantly changes the regulation of financial institutions and the financial services industry.  The Dodd-Frank Act includes several provisions that will affect how community banks, thrifts, and small bank and thrift holding companies will be regulated in the future.  Among other things, these provisions abolish the Office of Thrift Supervision and transfer its functions to the other federal banking agencies, relax rules regarding interstate branching, allow financial institutions to pay interest on business checking accounts, change the scope of federal deposit insurance coverage, and impose new capital requirements on bank and thrift holding companies.  The Dodd-Frank Act also establishes the Bureau of Consumer Financial Protection as an independent entity within the Federal Reserve, which will be given the authority to promulgate consumer protection regulations applicable to all entities offering consumer financial services or products, including banks.  Additionally, the Dodd-Frank Act includes a series of provisions covering mortgage loan origination standards affecting originator compensation, minimum repayment standards, and pre-payments.  Management is actively reviewing the provisions of the Dodd-Frank Act and assessing its probable impact on the business, financial condition, and results of operations of the Company.
 
In August 2010, two updates were issued to amend various SEC rules and schedules pursuant to Release No. 33-9026: Technical Amendments to Rules, Forms, Schedules and Codification of Financial Reporting Policies and based on the issuance of SEC Staff Accounting Bulletin 112.  The amendments related primarily to business combinations, removed references to “minority interest” and added references to “controlling” and “noncontrolling interests(s)”.  The updates were effective upon issuance but had no impact on the Company’s financial statements.

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 Company for business combinations for which the acquisition date is on or after January 1, 2011, although early adoption is permitted.  The Company does not expect the amendment to have any impact on its financial statements.

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s financial position, results of operations or cash flows.
 
 
15

 
 
NOTE 8: Subsequent Events
 
None

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 available to be issued and no subsequent events have occurred requiring accrual or disclosure.

ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS
OR PLAN OF OPERATION

Management’s discussion and analysis is included to assist shareholders in understanding the Company’s financial condition, results of operations, and cash flow. This discussion should be reviewed in conjunction with the consolidated financial statements (unaudited) and notes included in this report and the supplemental financial data appearing throughout this report.  Since the primary asset of the Company is its wholly-owned subsidiary, most of the discussion and analysis relates to the Bank.

Management’s Discussion and Analysis of Financial Condition and Results of Operations and other portions of this quarterly report contain certain “forward-looking statements” concerning the future operations of the Bank of South Carolina Corporation.  Management desires to take advantage of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1996 and is including this statement for the express purpose of availing the Company of protections of such safe harbor with respect to all “forward-looking statements” contained in this Form 10-Q.  The Company has used “forward-looking statements” to describe future plans and strategies including its expectations of the Company’s future financial results.  The following are cautionary statements. Management’s ability to predict results or the effect of future plans or strategies is inherently uncertain.  A variety of factors may affect the operations, performance, business strategy and results of the Company including, but not limited to the following:

 
·
Risk from changes in economic, monetary policy, and industry conditions
 
 
·
Changes in interest rates, shape of the yield curve, deposit rates, the net interest margin and funding sources
 
 
·
Market risk (including net income at risk analysis and economic value of equity risk analysis) and inflation
 
 
·
Risk inherent in making loans including repayment risks and changes in the value of collateral
 
 
·
Loan growth, the adequacy of the allowance for loan losses, provisions for loan losses, and the assessment of problem loans
 
 
·
Level, composition, and re-pricing characteristics of the securities portfolio
 
 
·
Deposit growth, change in the mix or type of deposit products and services
 
 
·
Continued availability of senior management
 
 
·
Technological changes
 
 
·
Ability to control expenses
 
 
·
Changes in compensation
 
 
·
Risks associated with income taxes including potential for adverse adjustments
 
 
·
Changes in accounting policies and practices
 
 
·
Changes in regulatory actions, including the potential for adverse adjustments
 
 
·
Recently enacted or proposed legislation
 
 
·
Current disarray in the financial service industry.

 
16

 
 
All forward-looking statements in this report are based on information available to the Company as of the date of this report.  Although Management believes that the expectations reflected in the forward-looking statements are reasonable, Management cannot guarantee that these expectations will be achieved.  The Company will undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made to reflect the occurrence of unanticipated events.  In addition, certain statements in future filings by the Company with the SEC, in press releases, and in oral and written statements made by or with the approval of the Company, which are not statements of historical fact, constitute forward looking statements.

Overview
 
Bank of South Carolina Corporation (the Company) is a financial institution holding company headquartered in Charleston, South Carolina, with $299.1 million in assets as of March 31, 2011 and net income of $649,368 for the three months ended March 31, 2011.  The Company offers a broad range of financial services through its wholly-owned subsidiary, The Bank of South Carolina (the Bank). The Bank is a state-chartered commercial bank which operates principally in the Charleston, Dorchester and Berkeley counties of South Carolina.  The Bank’s original and current concept is to be a full service financial institution specializing in personal service, responsiveness, and attention to detail to foster long standing relationships.

The following is a discussion of the Company’s financial condition as of March 31, 2011 as compared to December 31, 2010 and the results of operations for the three months ended March 31, 2011 as compared to the three months ended March 31, 2010.  The discussion and analysis identifies significant factors that have affected the Company’s financial position and operating results and should be read in conjunction with the financial statements and the related notes included in this report.

The Company derives most of its income from interest on loans and investments (interest bearing assets).  The primary source of funding for making these loans and investments is the Company’s interest and non-interest bearing deposits. One of the key measures of the Company’s success is the amount of net interest income, or the difference between the income on its interest earning assets, such as loans and investments, and the expense on its interest bearing liabilities, such as deposits.  Another key measure is the spread between the yield the Company earns on these interest bearing assets and the yield the Company pays on its interest-bearing liabilities.

There are risks inherent in all loans; therefore, the Company maintains an allowance for loan losses to absorb estimated losses on existing loans that may become uncollectible. The Company established and maintains this allowance based on a methodology representing the lending environment it operates within. For a detailed discussion on the allowance for loan losses see “Provision for Loan Losses”.

The Company’s results of operations depend not only on the level of its net interest income from loans and investments, but also on its non-interest income and its operating expenses.  Net interest income depends upon the volumes, rates and mix associated with interest earning assets and interest bearing liabilities which result in the net interest spread.  The Company’s net interest spread for the three months ended March 31, 2011 was 3.82% compared to 4.18% for the three months ended March 31, 2010.

Non-interest income includes fees and other expenses charged to customers.  A more detailed discussion of interest income, non-interest income and operating expenses follows.

For three months ended March 31, 2011, the Bank has paid $425,000 to the Company for dividend payments.

 
17

 

CRITICAL ACCOUNTING POLICIES
 
The Company has adopted various accounting policies that govern the application principles generally accepted in the United States and with general practices within the banking industry in the preparation of its financial statements.  The Company’s significant accounting policies are described in the footnotes to its unaudited consolidated financial statements as of March 31, 2011 and its notes included in the consolidated financial statements in its 2010 Annual Report on Form 10-K as filed with the SEC.

Certain accounting policies involve significant judgments and assumptions by the Company that have a material impact on the carrying value of certain assets and liabilities.  The Company considers these accounting policies to be critical accounting policies.  The judgment and assumptions the Company uses are based on historical experience and other factors, which the Company believes to be reasonable under the circumstances.  Because of the number of the judgments and assumptions the Company makes, actual results could differ from these judgments and estimates that could have a material impact on the carrying values of its assets and liabilities and its results of operations.

The Company considers its policies regarding the allowance for loan losses to be its most subjective accounting policy due to the significant degree of Management judgment.  The Company has developed what it believes to be appropriate policies and procedures for assessing the adequacy of the allowance for loan losses, recognizing that this process requires a number of assumptions and estimates with respect to its loan portfolio. The Company’s assessments may be impacted in future periods by changes in economic conditions, the impact of regulatory examinations and the discovery of information with respect to borrowers which were not known by Management at the time of the issuance of the consolidated financial statements. For additional discussion concerning the Company’s allowance for loan losses and related matters, see “Allowance for Loan Losses.”

BALANCE SHEET
 
LOANS
 
The Company focuses its lending activities on small and middle market businesses, professionals and individuals in its geographic markets.  At March 31, 2011 outstanding loans (plus deferred loan fees of $23,692) totaled $206,855,415 which equaled 77.13% of total deposits and 69.15% of total assets.    Substantially all loans were to borrowers located in the Company’s market areas in the counties of Charleston, Dorchester and Berkeley in South Carolina.
 
Because lending activities comprise such a significant source of revenue, the Company’s main objective is to adhere to sound lending practices.  The Loan Committee of the Board of Directors meets monthly to evaluate the adequacy of the Allowance for Loan Losses and to review all loans resulting in credit exposure of $10,000.

The breakdown of total loans by type and the respective percentage of total loans are as follows:

   
March 31,
   
December 31,
 
   
2011
   
2010
   
2010
 
Commercial loans
  $ 50,459,661     $ 47,710,071     $ 50,601,639  
Commercial real estate
    105,619,466       111,002,283       108,004,910  
Residential mortgage
    15,720,208       18,986,636       16,071,839  
Consumer loans
    5,382,125       5,159,686       5,361,197  
Personal banklines
    27,307,356       28,225,043       27,734,166  
Other
    223,680       247,944       234,607  
                         
Total
    204,712,496       211,331,663       208,008,358  
Deferred loan fees (net)
    23,692       (856 )     17,306  
Allowance for loan losses
    (2,763,745 )     (3,077,261 )     (2,938,588 )
                         
Loans, net
  $ 201,972,443     $ 208,253,546     $ 205,087,076  

 
18

 

 
 
March 31,
   
December 31,
 
Percentage of Loans
 
2011
   
2010
   
2010
 
Commercial loans
    24.65 %     22.58 %     24.33 %
Commercial real estate
    51.59 %     52.53 %     51.92 %
Residential mortgage
    7.68 %     8.98 %     7.73 %
Consumer loans
    2.63 %     2.44 %     2.58 %
Personal banklines
    13.34 %     13.36 %     13.33 %
Other
    .11 %     .11 %     0.11 %
Total
    100.00 %     100.00 %     100.00 %

As the result of the recessionary economic conditions which began in the latter half of 2007, the Company has experienced a decrease in loan demand as shown in the table above.  Loans have decreased 1.58% or approximately $3,289,476 from March 31, 2010 to March 31, 2011.

INVESTMENT SECURITIES AVAILABLE FOR SALE
 
The Company 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.  Investments are classified into three categories (1) Held to Maturity (2) Trading and (3) Available for Sale. Management believes that maintaining its securities in the Available for Sale category provides greater flexibility in the management of the overall investment portfolio.  The average yield on investments at March 31, 2011 was 2.63% compared to 3.90% at December 31, 2010.  The amortized cost of the investments available for sale at March 31, 2011 and December 31, 2010 and percentage of each category to total investments are as follows:

INVESTMENT PORTFOLIO
 
   
March 31,
2011
   
December 31,
2010
 
US Treasury Notes
  $ 21,247,394     $ 9,055,078  
Government-Sponsored Enterprises
    3,006,709       6,013,897  
Municipal Securities
    23,748,779       23,913,091  
    $ 48,002,882     $ 38,982,066  
                 
US Treasury Note
    44.26 %     .03 %
Government-Sponsored Enterprises
    6.27 %     20.09 %
Municipal Securities
    49.47 %     79.88 %
      100.00 %     100.00 %
 
All investment securities were classified as Available for Sale (debt and equity securities that may be sold under certain conditions), at March 31, 2011 and December 31, 2010.  The securities were reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of shareholders' equity, net of income taxes.  Unrealized losses on securities due to fluctuations in fair value are recognized when it is determined that an other than temporary decline in value has occurred. Gains or losses on the sale of securities are recognized on a specific identification, trade date basis.
 
 
19

 

The amortized cost and fair value of investment securities available for sale are summarized as follows as of March 31, 2011 and December 31, 2010:

   
March 31, 2011
 
   
AMORTIZED
COST
   
GROSS
UNREALIZED
GAINS
   
GROSS
UNREALIZED
LOSSES
   
ESTIMATED
FAIR
VALUE
 
                         
U.S. Treasury Note
  $ 21,247,394     $ 12,432     $ 53,810     $ 21,206,016  
Government-Sponsored Enterprises
    3,006,709       25,800       -       3,032,509  
Municipal Securities
    23,748,779       1,065,585       35,114       24,779,250  
                                 
Total
  $ 48,002,882     $ 1,103,817     $ 88,924     $ 49,017,775  

   
DECEMBER 31, 2010
 
   
AMORTIZED
COST
   
GROSS
UNREALIZED
GAINS
   
GROSS
UNREALIZED
LOSSES
   
ESTIMATED
FAIR
VALUE
 
                         
U.S. Treasury Notes
  $ 9,055,078     $ 8,784     $ 40,425     $ 9,023,437  
Government-Sponsored Enterprises
    6,013,897       86,648       -       6,100,545  
Municipal Securities
    23,913,091       577,462       234,922       24,255,631  
                                 
Total
  $ 38,982,066     $ 672,894     $ 275,347     $ 39,379,613  

The amortized cost and estimated fair value of investment securities available for sale at March 31, 2011 and December 31, 2010 by contractual maturity are as follows:

March 31, 2011
 
   
AMORTIZED
COST
   
ESTIMATED
FAIR
VALUE
 
             
Due in one year or less
  $ 3,909,720     $ 3,949,331  
Due in one year to five years
    24,915,379       25,099,023  
Due in five years to ten years
    10,172,213       10,804,382  
Due in ten years and over
    9,005,570       9,165,039  
                 
Total
  $ 48,002,882     $ 49,017,775  


December 31, 2010
 
   
AMORTIZED
COST
   
ESTIMATED
FAIR
VALUE
 
             
Due in one year or less
  $ 9,619,604     $ 9,719,581  
Due in one year to five years
    9,465,147       9,608,773  
Due in five years to ten years
    8,832,440       9,137,645  
Due in ten years and over
    11,064,875       10,913,614  
                 
Total
  $ 38,982,066     $ 39,379,613  

 
20

 

MARCH 31, 2011
 
   
Less than 12 months
   
12 months or longer
   
Total
 
Description of Securities
 
Fair
Value
   
Unrealized
Losses
   
Fair Value
   
Unrealized
Losses
   
Fair
Value
   
Unrealized
Losses
 
                                     
U.S. Treasury Notes
  $ 12,193,125     $ 53,810     $ -     $ -     $ 12,193,125     $ 53,810  
Government-Sponsored Enterprises
    -       -       -       -       -       -  
Municipal Securities
     2,577,487       35,114       -       -        2,577,487       35,114  
                                                 
    $ 14,770,612     $ 88,924     $ -     $ -     $ 14,770,612     $ 88,924  
                                                 
 

DECMBER 31, 2010
 
   
Less than 12 months
   
12 months or longer
   
Total
 
Description of Securities
 
Fair
Value
   
Unrealized
 Losses
   
Fair
Value
   
Unrealized
Losses
   
Fair
Value
   
Unrealized
 Losses
 
U.S. Treasury Notes
  $ 6,015,469       40,425     $ -       -     $ 6,015,469     $ 40,425  
Government-Sponsored Enterprises
      -         -         -         -         -         -  
Municipal Securities
    8,468,976       234,922       -       -       8,468,976       234,922  
Total
  $ 14,484,445       275,347     $ -       -     $ 14,484,445     $ 275,347  
 
At March 31, 2011, there were four US Treasury Notes with an unrealized loss of $53,810 and four Municipal Securities with an unrealized loss of $35,114 as compared to two US Treasury Notes with an unrealized loss of $40,425 and fourteen Municipal Securities with an unrealized loss of $234,922, at December 31, 2010.  The investments at March 31, 2011 and December 31, 2010 were not considered other-than-temporarily impaired.  The Company does not intend to sell these investments and therefore it is more likely than not that the Company will not be required to sell these securities before recovery of any amortized cost.  The contractual terms of these investments do not permit the issuer to settle the securities at a price less than the amortized cost of the investment.

 
21

 
 
DEPOSITS
 
Deposits remain the Company’s primary source of funding for loans and investments. Average interest bearing deposits provided funding for 72.61% of average earning assets for the three months ended March 31, 2011, and 71.30% for the twelve months ended December 31, 2010. The Company encounters strong competition from other financial institutions as well as consumer and commercial finance companies, insurance companies and brokerage firms located in the primary service area of the Bank. However, the percentage of funding provided by deposits has remained stable. The breakdown of total deposits by type and the respective percentage of total deposits are as follows:
 
   
March 31,
   
December 31,
 
   
2011
   
2010
   
2010
 
Non-interest bearing demand
    57,417,806       48,062,604       56,884,235  
Interest bearing demand
    54,724,732       52,090,918       50,394,101  
Money market accounts
    80,809,316       66,725,130       68,007,823  
Certificates of deposit $100,000 and over
    45,280,146       38,877,199       45,523,280  
Other time deposits
    17,647,120       16,714,610       17,760,278  
Other savings deposits
    12,294,734       11,450,913       11,867,258  
                         
Total Deposits
    268,173,854       233,921,374       250,436,975  
 
   
March 31,
   
December 31,
 
Percentage of Deposits
 
2011
   
2010
   
2010
 
Non-interest bearing demand
    21.41 %     20.55 %     22.71 %
Interest bearing demand
    20.41 %     22.27 %     20.12 %
Money Market accounts
    30.13 %     28.52 %     27.16 %
Certificates of deposit $100,000 and over
    16.89 %     16.62 %     18.18 %
Other time deposits
    6.58 %     7.15 %     7.09 %
Other savings deposits
    4.58 %     4.89 %     4.74 %
                         
Total Deposits
    100.00 %     100.00 %     100.00 %
 
While deposit fluctuations are normal in the Company’s business, in order to reduce its cost of funds the Company has tried to reduce the amount of its outstanding Certificates of deposit greater than $100,000 as a current business strategy.  Overall deposits have increased 14.64% from March 31, 2010 to March 31, 2011 and 7.08% from December 31, 2010 to March 31, 2011.  This increase is the result of the Company’s business development efforts and the strength of the Bank.
 
 
22

 
 
SHORT-TERM BORROWINGS
 
The Bank has a demand note through the US Treasury, Tax and Loan system with the Federal Reserve Bank of Richmond.  The Bank may borrow up to $1,000,000 at March 31, 2011 and December 31, 2010 under the arrangement at an interest rate set by the Federal Reserve.  The note is secured by Government Sponsored Enterprise Securities with a market value of $1,112,665 at March 31, 2011 and $1,073,450 at December 31, 2010. The amount outstanding under the note totaled $414,432 and $767,497 at March 31, 2011 and December 31, 2010, respectively.  At March 31, 2011 and December 31, 2010, the Company had no outstanding federal funds purchased with the option to borrow up to $26,000,000 on short term lines of credit. The Company has also established a Borrower-In-Custody arrangement with the Federal Reserve.  This arrangement permits the Company to retain possession of loans pledged as collateral to secure advances from the Federal Reserve Discount Window.  The Company established this arrangement as a secondary source of liquidity. As of March 31, 2011 and December 31, 2010 the Company could borrow up to $62,477,724 and $63,389,913, respectively. There have been no borrowings under this arrangement.
 
Comparison of Three Months Ended March 31, 2011 to Three Months Ended March 31, 2010
 
Net income decreased $77,499 or 10.66% to $649,368, or basic and diluted earnings per share of $.14 and $.14, respectively, for the three months ended March 31, 2011, from $726,867, or basic and diluted earnings per share of $.16 and $.16, respectively, for the three months ended March 31, 2010. The decrease in net income between periods is primarily due to an increase in other operating expenses including an increase in overall auditing fees and an increase in data processing fees.  Average earning assets increased $22.1 million for the three months ended March 31, 2011 as compared to the same period in 2010.  Average earning assets were $278.5 million during the three months ended March 31, 2011 as compared to $256.4 million for the three months ended March 31, 2010.  Average loans decreased $8.3 million or 3.84% to $208.9 million for the three months ended March 31, 2011 as compared to $217.2 million for the three months ended March 31, 2010.

Net Interest Income
 
Net interest income, the major component of the Company’s net income, decreased $33,884 or 1.23% to $2,712,766 for the three months ended March 31, 2011, from $2,746,650 for the three months ended March 31, 2010.  This decrease is primarily due to a decrease of $54,857 or 2.05% in interest and fees on loans as well as a decrease of $45,392 in interest and dividends on investment securities.  Average loans decreased $8,344,882 or 3.84% and average investments increased $6,990,038 or 17.23%.  The Company had a $3 million US Treasury Note with a yield of 4.87%, a $3 million Government Sponsored Security with a yield of 5.69%, and a $160 thousand Municipal Security with a yield of 4.38%, mature during the three months ended March 31, 2011.  The Company reinvested in $6 million in US Treasury Notes that are yielding between 1.25% and 1.35%, a significant decrease in the yield on the Company’s investments. The yields on interest earning assets decreased 51 basis points to 4.29% from 4.81%.  The cost of interest bearing liabilities during the three months ended March 31, 2011 was 0.47% as compared to 0.63% for the same period in 2010, a decrease of 16 basis points.  Also contributing to the decline in net interest income was the increase in Federal Funds Sold during the quarter ended March 31, 2011, which averaged $25.7 million at a yield of .17% as compared to $2.3 million at a yield of .19% during the quarter ended March 31, 2010.
 
 
23

 
 
Allowance for Loan Losses
 
The allowance for loan losses represents management’s estimate of probable losses inherent in the loan portfolio.  The adequacy of the allowance for loan losses (the “Allowance”) is reviewed monthly by the Loan Committee and on a quarterly basis by the Board of Directors.  For purposes of this analysis, adequacy is defined as a level sufficient to absorb estimated losses in the loan portfolio as of the balance sheet date presented.  The methodology employed for this analysis was modified in 2007, 2008 and 2010 to better reflect the economic environment and regulatory guidance. The revised methodology is based on a Reserve Model that is comprised of the three components listed below.
 
 
1)
Specific Reserve analysis for impaired loans based on FASB ASC 310-10-35.
 
 
2)
General reserve analysis applying historical loss rates based on FASB ASC 450-20.
 
 
3)
Qualitative or environmental factors.

Loans are reviewed for impairment which is measured in accordance with FASB ASC 310-10-35. Impaired loans can either be secured or unsecured, not including large groups of smaller balance loans that are collectively evaluated.  Impairment is measured by the difference between the loan amount and the present value of the future cash flow discounted at the loan’s effective interest rate, or, alternatively the fair value of the collateral if the loan is collateral dependent.  An impaired loan may not represent an expected loss.

A general reserve analysis is performed on individually reviewed loans, but not impaired loans, and excluded individually reviewed impaired loans, based on FASB ASC 450-20. Historical losses are segregated into risk-similar groups and a loss ratio is determined for each group over a three year period. The three year average loss ratio by type is then used to calculate the estimated loss based on the current balance of each group.  The three year historical loss percentage for the three months ended March 31, 2011 and March 31, 2010 was .34% and .16%, respectively.

Qualitative and environmental factors include external risk factors that Management believes are representative of the overall lending environment of the Bank.  Management believes that the following factors create a more comprehensive system of controls in which the Bank can monitor the quality of the loan portfolio.

 
1)
Portfolio risk
 
 
2)
National and local economic trends and conditions
 
 
3)
Effects of changes in risk selection and underwriting practices
 
 
4)
Experience, ability and depth of lending management staff
 
 
5)
Industry conditions
 
 
6)
Effects of changes in credit concentrations
 
 
7)
Loan and credit administration risk

Portfolio risk includes the levels and trends in delinquencies, impaired loans and changes in the loan rating matrix, trends in volume and terms of loans and overmargined real estate lending. Management is satisfied with the stability of the past due and non-performing loans and believes there has been no decline in the quality of the loan portfolio due to any trend in delinquent or adversely classified loans. Although the aggregate total of classified loans has increased, management is confident in the adequacy of the sources of repayment.  Sizable unsecured principal balances on a non-amortizing basis are monitored.  Within the portfolio risk factor the Company elected to increase the risk percentage for “trends in volume and term of loan”.  In addition the Company elected to increase the risk percentage for “over margined real estate lending risk”.  Although the vast majority of the Company’s real estate loans are underwritten on a cash flow basis, the secondary source of repayment is typically tied to the Company’s ability to realize on the collateral. Given the contraction in real estate values, the Company closely monitors its loan to value.  The Company recently amended its Loan Policy to reduce the collateral advance rate from 85% to 80% on all real estate transactions, with the exception of raw land at 65% and land development at 70%.
 
 
24

 
 
Occasional extensions of credit occur beyond the policy thresholds of the Company’s normal collateral advance margins for real estate lending.  These loans are monitored and the balances reported to the Board every quarter. An excessive level of this practice could result in additional examiner scrutiny, competitive disadvantages and potential losses if forced to convert the collateral. The consideration of overmargined real estate loans directly relates to the capacity of the borrower to repay. Management often requests additional collateral to bring the loan to value ratio within the policy guidelines and also require a strong secondary source of repayment in addition to the primary source of repayment.

Although significantly under the threshold of 100% of capital (currently approximately $29 million), the Company’s list and number of over margined real estate loans currently totals approximately $14.9 million or approximately 7.18% of its loan portfolio.

Management revised the credit rating matrix in order to rate all extensions of credit providing a more specified picture of the risk each loan poses to the quality of the loan portfolio.  There are eight possible ratings based on ten different qualifying characteristics. The ten characteristics are: cash flow, collateral quality, guarantor strength, financial condition, management quality, operating performance, the relevancy of the financial statements, historical loan performance, debt service coverage and the borrower’s leverage. In an effort to place more emphasis on borrower’s cash flow a weighted average method is used to determine the loan grade with cash flow, financial conditions, and debt service coverage being weighted triple and financial statements being weighted double. The matrix is designed to meet management’s standards and expectations of loan quality.  In addition to the rating matrix, the Company rates its credit exposure on the basis of each loan and the quality of each borrower.

National and local economic trends and conditions are constantly changing and results in both positive and negative impact on borrowers.  Most macroeconomic conditions are not controllable by the Company and are incorporated into the qualitative risk factors. Natural and environmental disasters, wars and the recent fallout of the subprime lending market as well as problems in the traditional mortgage market are a few of the trends and conditions that are currently affecting the Company’s national and local economy.  Changes in the national and local economy have impacted borrowers’ ability, in many cases, to repay loans in a timely manner.  On occasion a loan’s primary source of repayment (i.e., personal income, cash flow, or lease income) may be eroded as a result of unemployment, lack of revenues, or the inability of a tenant to make rent payments.

The quality of the Bank’s loan portfolio is contingent upon its risk selection and underwriting practices.  Every credit with over $100,000 in exposure is summarized by the Bank’s Credit Department and reviewed by the Loan Committee on a monthly basis.  The Board of Directors review credits over $500,000 monthly with an annual credit analysis conducted on credits in excess of $350,000 upon the receipt of updated financial information. Prior to any extension of credit, every significant commercial loan goes through sound credit underwriting.  The Credit Department conducts detailed cash flow analysis on each proposal using the most current financial information.  Relevant trends and ratios are evaluated.

The Bank has over 300 years of lending management experience among twelve members of its lending staff.  In addition to the lending staff the Bank has an Advisory Board for each branch comprised of business and community leaders from the specific branch’s market area.  Management meets with these boards quarterly to discuss the trends and conditions in each respective market. Management is aware of the many challenges currently facing the banking industry.  Assessing banks to replenish the insurance fund and its corresponding impact on bank profits, increased regulatory scrutiny in and or on lending practices, and pending changes in deposit and or funding source type and mix, continue to impact the Company’s environment.  As other banks look to increase earnings in the short term, the Company will continue to emphasize the need to maintain its sound lending practices and core deposit growth.

There has been an influx of new banks over the last several years within the Company’s geographic area.  This increase has decreased the local industry’s overall margins as a result of pricing competition.  Management believes that the borrowing base of the Bank is well established and therefore unsound price competition is not necessary.
 
 
25

 
 
The risks associated with the effects of changes in credit concentration include loan concentration, geographic concentration and regulatory concentration.

As of March 31, 2011, there were only four Standard Industrial Code groups that comprised more than three percent of the Bank’s total outstanding loans.  The four groups are activities related to real estate, offices and clinics of doctors, real estate agents and managers, and legal services.

The Company is located along the coast and on an earthquake fault, increasing the chances that a natural disaster may impact the Bank and its borrowers.  The Company has a Disaster Recovery Plan in place; however, the amount of time it would take for its customers to return to normal operations is unknown.

Loan and credit administration risk includes collateral documentation, insurance risk and maintaining financial information risk.

The majority of the Bank’s loan portfolio is collateralized with a variety of its borrower’s assets.  The execution and monitoring of the documentation to properly secure the loan is the responsibility of the Bank’s lenders and Loan Department.  The Bank requires insurance coverage naming the Bank as the mortgagee or loss payee.  Although insurance risk is also considered collateral documentation risk, the actual coverage, amounts of coverage and increased deductibles are important to management.

Risk includes a function of time during which the borrower’s financial condition may change; therefore, keeping financial information up to date is important to the Bank.  The policy of the Bank is that all new loans, regardless of the customer’s history with the Bank, should have updated financial information, as long as exposure is greater than $10,000.  In addition the Company is monitoring appraisals closely as real estate values continue to decline.

The aforementioned changes to the Company’s Allowance for Loan Loss methodology were not made as a result of dramatic or patterned history of loan losses, increases in past due loans, or non-performing assets, but rather because of specific changes in the Company’s lending environment.  These changes precipitated the need for additional reserves in a period of time when the Company’s loan portfolio grew significantly (three months ended March 31, 2010).  Based on the evaluation described above, the Company recorded a provision for loan losses during the three months ended March 31, 2011 and March 31, 2010 of $120,000, respectively. At March 31, 2011 the three year average loss ratios were: .57% Commercial, .48% Consumer, .49% 1-4 Residential, .00% Real Estate Construction and .14% Real Estate Mortgage.  The three year historical loss ratio used at March 31, 2011 was .34% compared to .163% at March 31, 2010.

During the quarter ended March 31, 2011, charge-offs of $303,403 and recoveries of $8,559 were recorded to the allowance resulting in an allowance for loan losses of $2,763,745 or 1.35% of total loans, compared to charge-offs of $71,356 and recoveries of $1,621 resulting in an allowance loan losses of $3,077,261 or 1.46% of total loans at March 31, 2010.

The Bank had impaired loans totaling $4,644,770 as of March 31, 2011, compared to $2,721,896 as of March 31, 2010.  The impaired loans at March 31, 2011 include six non-accrual loans with a combined balance of $1,345,211. Impaired loans at March 31, 2010 included six non-accrual loans with a combined balance of $1,100,852. Included in the impaired loans at March 31, 2011, is one credit totaling $1,023,000 which is secured by a second mortgage. Management does not know of any loans which will not meet their contractual obligations that are not otherwise discussed herein.
 
 
26

 
 
The accrual of interest is generally discontinued on loans, which become 90 days past due as to principal or interest.  The accrual of interest on some loans, however, may continue even though they are 90 days past due if the loans are well secured or in the process of collection and management deems it appropriate.  If non-accrual loans decrease their past due status to less than 30 days for a period of three months, they are reviewed individually by management to determine if they should be returned to accrual status. There were no loans over 90 days past due still accruing interest at March 31, 2011 or March 31, 2010.

Net charge-offs for the three months ended March 31, 2011 were $294,844 compared to net charge-offs of $69,735 for the three months ended March 31, 2010. Uncertainty in the economic outlook still exists, making charge-off levels in future periods less predictable; however, loss exposure in the portfolio is identified, reserved and closely monitored to ensure that changes are promptly addressed in the analysis of reserve adequacy.

The Company had $122,562 unallocated reserves at March 31, 2011 related to other inherent risk in the portfolio compared to unallocated reserves of $694,943 at March 31, 2010. Management believes this amount is appropriate and properly supported through the environmental factors of its Allowance for Loan Losses.    Management believes the allowance for loan losses at March 31, 2011 is adequate to cover estimated losses in the loan portfolio; however, assessing the adequacy of the allowance is a process that requires considerable judgment.  Management's judgments are based on numerous assumptions about current events which it believes to be reasonable, but which may or may not be valid.  Thus there can be no assurance that loan losses in future periods will not exceed the current allowance amount or that future increases in the allowance will not be required.  No assurance can be given that management's ongoing evaluation of the loan portfolio in light of changing economic conditions and other relevant circumstances will not require significant future additions to the allowance, thus adversely affecting the operating results of the Company.

The Allowance is also subject to examination testing by regulatory agencies, which may consider such factors as the methodology used to determine adequacy and the size of the Allowance relative to that of peer institutions, and other adequacy tests.  In addition, such regulatory agencies could require the Company to adjust its allowance based on information available to them at the time of their examination.

The methodology used to determine the reserve for unfunded lending commitments, which is included in other liabilities, is inherently similar to that used to determine the allowance for loan losses adjusted for factors specific to binding commitments, including the probability of funding and historical loss ratio.  During the three months ended March 31, 2011, no entry was made to the allowance for unfunded loans and commitments leaving a balance of $20,825.

The following is a summary of the non-accrual loans as of March 31, 2011.
 
Loans Receivable on Non-Accrual  at March 31, 2011

Commercial
  $ 6,043  
Commercial Real Estate:
       
  Commercial  Real Estate -  Construction
      -  
  Commercial  Real Estate - Other
    838,768  
  Consumer  Real Estate
    500,400  
Total
  $ 1,345,211  
 
 
27

 

The following is a schedule of the Bank’s delinquent loans, excluding mortgage loans held for sale and deferred loan fees, as of March 31, 2011.

March 31, 2011
 
30-59 Days
Past Due
   
60-89 Days
Past Due
   
Greater Than
90 Days
   
Total Past Due
   
Current
   
Total Loans Receivable
   
Recorded Investment > 90 Days and Accruing
 
Commercial
  $ 144,759       57,883       -       202,642       50,253,661       50,456,303       -  
Commercial Real Estate:
                                    4,127,548       4,127,548          
Commercial Real Estate - Other
      1,793,000         322,669         486,390         2,602,059         98,289,860         100,891,919         -  
Consumer:
                                                       
Consumer - Real Estate
            317,500               317,500       43,803,174       44,120,674          
Consumer - Other
    49,337       -               49,337       5,544,382       5,593,719       -  
Total
  $ 1,987,096       698,052       486,390       3,171,538       202,018,625       205,190,163       -  
 
As of March 31, 2011 loans individually evaluated and considered impaired are presented in the following table:

Impaired and Restructured Loans
For the Three Months Ended March 31, 2011
 
   
 
 
Recorded Investment
   
Unpaid Principal Balance
   
Related Allowance
   
Average Recorded Investment
   
Interest Income Recognized
 
With no related allowance recorded:
                             
Commercial
  $ 83,350     $ 6,043     $ -     $ 9,450     $ 34,055  
Commercial Real Estate
    1,997,543       2,021,209       -       2,012,407       354,097  
Consumer Real Estate
    599,786       599,354       -       599,636       133,198  
                                         
Total
  $ 2,680,679     $ 2,626,606     $ -     $ 2,621,493     $ 521,350  
                                         
With an allowance recorded:
                                       
Commercial
  $ 1,211,163     $ 1,205,663     $ 1,205,663     $ 807,846     $ 41,714  
Commercial Real Estate
    126,000       90,959       86,084       87,431       17,702  
Consumer Real Estate
    725,000       721,542       263,215       721,542       250,995  
                                         
Total
  $ 2,062,163     $ 2,018,164     $ 1,554,962     $ 1,616,819     $ 310,411  
 
 
28

 

The following table illustrates credit risks by category and internally assigned grades.
 
March 31, 2011
 
Commercial
   
Commercial
Real Estate
Construction
   
Commercial
Real Estate
Other
   
Residential –
Real Estate
   
Consumer –
Other
 
Pass
  $ 44,066,319     $ 3,652,773     $ 93,582,288       42,333,818       4,941,212  
Watch
    3,121,517       474,775       3,299,525       89,108       313,918  
OAEM
    1,925,601       -       426,124       376,852       230,142  
Sub-Standard
    1,342,866       -       3,583,982       1,320,896       106,824  
Doubtful
    -       -       -       -       1,623  
Loss
    -       -       -       -       -  
                      -       -       -  
Total
  $ 50,456,303     $ 4,127,548     $ 100,891,919       44,120,674       5,593,719  
 
The following table sets forth the changes in the allowance and an allocation of the allowance by loan category.  The allocation of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in Management’s judgment, should be charged-off.  The allowance consists of specific and general components.  The specific component relates to loans that are individually classified as impaired.  The general component covers non-impaired loans and is based on historical loss experience adjusted for current economic factors described above.
 
 
March 31, 2011
 
Commercial
   
Commercial
Real Estate
   
Consumer
   
Residential
   
Finance
Leases
   
Total
   
Unallocated
 
Allowance for Loan Losses
                                         
Beginning Balance
  $ 1,213,865     $ 2,115,641     $ -     $ 230,022     $ -     $ 2,938,588     $ 592,647  
Charge-offs
    -       303,403       -       -       -       303,403          
Recoveries
    3,559       5,000       -       -       -       8,559          
Provisions
    -       120,000       -       -       -       120,000       (470,085 )
Ending Balance
    1,217,424       1,937,238       -       230,022       -       2,763,744       122,562  
Ending Balances:
                                                       
Individually evaluated for impairment
        1,211,706           2,112,168           -           1,320,896           -           4,644,770          
Collectively evaluated for impairment
  $ 49,244,597     $ 102,907,299     $ 5,593,719     $ 42,799,778     $ -     $ 200,545,393     $    
 
 
29

 

Other Income
 
Other income for the three months ended March 31, 2011, increased $8,574 or 2.04% to $429,327 from $420,753 for the three months ended March 31, 2010.  This increase is primarily due to a increase in mortgage banking income of $11,385 or 6.82% to $178,263 for the three months ended March 31, 2011 as compared to $166,878 for the three months ended March 31, 2010. During the three months ended March 31, 2011, the Company originated $12,315,708 in mortgage loans a decrease of $1,732,344 compared to March 31, 2010.  However, the service release premium increased $28,171 to $265,805 for the three months ended March 31, 2011 compared to 2010.  This was offset by an increase in discount points paid of $22,605 to $83,618.  With fewer originations, commissions paid to the mortgage lenders decreased $2,286.

Other Expense
 
Bank overhead increased $110,770 or 5.57% to $2,096,436 for the three months ended March 31, 2011, from $1,985,666 for the three months ended March 31, 2010. Net occupancy expense increased $23,892 or 7.69% to $334,478 for the three months ended March 31, 2011 as compared to $310,586 for the three months ended March 31, 2010.   During 2010 the Company moved its Mortgage Department from its main banking house at 256 Meeting Street to a new office on Morrison Drive in Charleston, SC.  This move resulted in an increase in rental expense of $2,000 a month as well as an increase in utilities. Other operating expenses increased $83,334 or 16.40% to $591,558 for the three months ended March 31, 2011, from $508,224 for the three months ended March 31, 2010.  Data processing fees increased $22,036, due to the addition of remote capture and eCorp (online banking for corporations). The Company saw an increase of $24,174 in audit fees and a decrease in legal fees of $8,941 for the three months ended March 31, 2011 Audit fees increased due to additional audits required with the addition of new products.  Legal fees decreased as a result of fewer billing hours related to foreclosed properties. The other changes in non-interest expense categories reflect normal modest fluctuations between the two periods.

Income Tax Expense
 
For the three months ended March 31, 2011, the Company’s effective tax rate was 29.85% compared to 31.54% during the three months ended March 31, 2010.

Off Balance Sheet Arrangements
 
In the normal course of operations, the Company engages in a variety of financial transactions that, in accordance with generally accepted accounting principles, are not recorded in the financial statements, or are recorded in amounts that differ from the notional amounts.  These transactions involve, to varying degrees, elements of credit, interest rate, and liquidity risk.  Such transactions are used by the Company for general corporate purposes or for customer needs.  Corporate purpose transactions are used to help manage credit, interest rate and liquidity risk or to optimize capital.  Customer transactions are used to manage customer’s requests for funding.

The Company’s off-balance sheet arrangements consist principally of commitments to extend credit described below.  The Company estimates probable losses related to binding unfunded lending commitments and records a reserve for unfunded lending commitment in other liabilities on the consolidated balance sheet.  The balance of the reserve was $20,825 at March 31, 2011 and 2010. The Company had no interests in non-consolidated special purpose entities.

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. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained if deemed necessary by the Company upon extension of credit is based on management's credit evaluation of the borrower.  Collateral held varies, but may include accounts receivable, negotiable instruments, inventory, property, plant and equipment, and real estate.  Commitments to extend credit, including unused lines of credit, amounted to $45,451,474 and $41,352,245 at March 31, 2011 and 2010, respectively.
 
 
30

 
 
Standby letters of credit represent an obligation of the Company to a third party contingent upon the failure of the Company’s customer to perform under the terms of an underlying contract with the third party or obligates the Company to guarantee or stand as surety for the benefit of the third party. The underlying contract may entail either financial or nonfinancial obligations and may involve such things as the shipment of goods, performance of a contract, or repayment of an obligation.  Under the terms of a standby letter, generally drafts will be drawn only when the underlying event fails to occur as intended.  The Company can seek recovery of the amounts paid from the borrower. The majority of these standby letters of credit are unsecured. Commitments under standby letters of credit are usually for one year or less. The maximum potential amount of undiscounted future payments related to standby letters of credit at March 31, 2011 was $532,613 and $521,610 at March 31, 2010.

The Company originates certain fixed rate residential loans and commits these loans for sale.  The commitments to originate fixed rate residential loans and the sale commitments are freestanding derivative instruments. The fair value of the commitments to originate fixed rate conforming loans was not significant at March 31, 2011. The Company has forward sales commitments, totaling $2.1 million at March 31, 2011, to sell loans held for sale of $2.1 million. The fair value of these commitments was not significant at March 31, 2011.  The Company has no embedded derivative instruments requiring separate accounting treatment.

Liquidity
 
The Company must maintain an adequate liquidity position in order to respond to the short-term demand for funds caused by withdrawals from deposit accounts, extensions of credit and for the payment of operating expenses. Primary liquid assets of the Company are cash and due from banks, federal funds sold, investments available for sale, other short-term investments and mortgage loans held for sale.  The Company’s primary liquid assets accounted for 30.61% and 21.25% of total assets at March 31, 2011 and 2010, respectively. Proper liquidity management is crucial to ensure that the Company is able to take advantage of new business opportunities as well as meet the credit needs of its existing customers.  Investment securities are an important tool in the Company's liquidity management.  Securities classified as available for sale may be sold in response to changes in interest rates and liquidity needs. All of the securities presently owned by the Bank are classified as available for sale. At March 31, 2011, the Bank had short-term lines of credit totaling approximately $26,000,000 (which are withdrawable at the lender's option), with no outstanding balance at March 31, 2011.  Additional sources of funds available to the Bank for liquidity needs include borrowing on a short-term basis from the Federal Reserve System, increasing deposits by raising interest rates paid and selling mortgage loans for sale.  In order to establish a secondary source of liquidity, the Company has established a Borrower-In-Custody arrangement with the Federal Reserve.  This arrangement permits the Company to retain possession of assets pledged as collateral to secure advances from the Federal Reserve Discount Window.  As of March 31, 2011 the Company could borrow up to $62,477,724. There have been no borrowings under this arrangement. In addition, on March 11, 2010 the Company borrowed $7,500,000 from the Federal Reserve Bank’s Term Auction Facility (TAF) at a rate of .50% for a term of 28 days (paid off on April 8, 2010). The Board of Governor’s of the Federal Reserve System established this program to allow depository institutions to place a bid for an advance from its local Federal Reserve Bank at a fixed interest rate determined via centralized single-price auction.  The collateral pledged to secure advances from the Federal Reserve Discount Window, serves as collateral.   This loan was paid off on April 8, 2010.
 
The Company’s core deposits consist of non-interest bearing accounts, NOW accounts, money market accounts, time deposits and savings accounts. The Company closely monitors its reliance on certificates of deposit greater than $100,000 and other large deposits. The Company's management believes its liquidity sources are adequate to meet its operating needs and does not know of any trends, events or uncertainties that may result in a significant adverse effect on the Company's liquidity position. At March 31, 2011 and 2010, the Bank's liquidity ratio was 23.97% and 10.68%, respectively.
 
 
31

 
 
Capital Resources
 
The capital needs of the Company have been met to date through the $10,600,000 in capital raised in the Bank’s initial offering, the retention of earnings less dividends paid and the exercise of stock options for total shareholders' equity at March 31, 2011 of $29,339,537.  The rate of asset growth since the Bank's inception has not negatively impacted this capital base. The risk-based capital guidelines for financial institutions are designed to highlight differences in risk profiles among financial institutions and to account for off balance sheet risk.  The guidelines established require a risk based capital ratio of 8% for bank holding companies and banks.  The risk based capital ratio at March 31, 2011, for the Bank is 13.15% and at March 31, 2010 was 12.76%.  The Company's management does not know of any trends, events or uncertainties that may result in the Company's capital resources materially increasing or decreasing.

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

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios of total and Tier 1 capital to risk-weighted assets and to average assets.  Management believes, as of March 31, 2011, that the Company and the Bank meet all capital adequacy requirements to which they are subject.

At March 31, 2011 and 2010, the Company and the Bank were categorized as “well capitalized” under the regulatory framework for prompt corrective action. To be categorized as “well capitalized” the Company and the Bank must maintain minimum total risk based, Tier 1 risk based and Tier 1 leverage ratios of 10%, 6% and 5%, respectively, and to be categorized as “adequately capitalized,” the Company and the Bank must maintain minimum total risk based, Tier 1 risk based and Tier 1 leverage ratios of 8%, 4% and 4%, respectively. There are no current conditions or events that management believes would change the Company’s or the Bank’s category.
 
ITEM 3
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not required.

ITEM 4
CONTROLS AND PROCEDURES

Evaluation of disclosure controls and procedures and internal controls and procedures for financial reporting
 
An evaluation was carried out under the supervision and with the participation of Bank of South Carolina Corporation’s management, including its Principal Executive Officer and the Chief Financial Officer/ Executive Vice President and Treasurer, of the effectiveness of Bank of South Carolina Corporation’s disclosure controls and procedures as of March 31, 2011.  Based on that evaluation, Bank of South Carolina Corporation’s management, including the Chief Executive Officer and Chief Financial Officer/Executive Vice President and Treasurer, has concluded that Bank of South Carolina Corporation’s disclosure controls and procedures are effective.  During the period ending March 31, 2011, there was no change in Bank of South Carolina Corporation’s internal control over financial reporting that has materially affected or is reasonably likely to materially affect, Bank of South Carolina Corporation’s internal control over financial reporting.
 
 
32

 

The Company established a Disclosure Committee on December 20, 2002. The committee is made up of the President and Chief Executive Officer, Chief Financial Officer/Executive Vice President and Treasurer, Executive Vice President, Vice President (Audit Compliance Officer), Vice President (Accounting), Vice President (Credit Department) and Vice President (Operations and Technology). This Committee meets quarterly to review the 10Q and or the 10K, to assure that the financial statements, Securities and Exchange Commission filings, and all public releases are free of any material misstatements and correctly reflect the financial position, results of operations and cash flows of the Company.  This Committee also assures that the Company is in compliance with the Sarbanes-Oxley Act.

The Disclosure Committee establishes a calendar each year to assure that all filings are reviewed and filed in a proper manner.  The calendar includes the dates of the Disclosure Committee meetings, the dates that the 10Q and or the 10K are sent to its independent accountants and to its independent counsel for review as well as the date for the Audit Committee of the Board of Directors to review the reports.

PART II OTHER INFORMATION

Item 1.  Legal Proceedings
 
The Company and its subsidiary from time to time are involved as plaintiff or defendant in various legal actions incident to its business.  These actions are not believed to be material either individually or collectively to the consolidated financial condition of the Company or its subsidiary.

Item 1A. Risk Factors
 
Not required.

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds
 
None.

Item 3.  Defaults Upon Senior Securities
 
None.

Item 4. Removed and Reserved

Item 5.  Other Information
 
None.

Item 6.  Exhibits

1.
The Consolidated Financial Statements are included in this Form 10-Q and listed on pages as indicated.
 
     
Page
 
(1)
Consolidated Balance Sheets
    3  
(2)
Consolidated Statements of Income for the three months ended March 31, 2011 and 2010
    4  
(3)
Consolidated Statements of Shareholders’ Equity and Comprehensive Income
    5  
(4)
Consolidated Statements of Cash Flows
    6  
(5)
Notes to Consolidated Financial Statements
    7-16  
 
 
33

 
 
2.
Exhibits
     
 
2.0
Plan of Reorganization (Filed with 1995 10-KSB)
     
 
3.0
Articles of Incorporation of the Registrant (Filed with 1995 10-KSB)
     
 
3.1
By-laws of the Registrant (Filed with 1995 10-KSB)
     
 
4.0
2010 Proxy Statement (Filed with 2010 10-K)
     
 
10.0
Lease Agreement for 256 Meeting Street (Filed with 1995 10-KSB)
     
 
10.1
Sublease Agreement for Parking Facilities at 256 Meeting Street (Filed with 1995 10-KSB)
     
 
10.2
Lease Agreement for 100 N. Main Street, Summerville, SC (Filed with 1995 10-KSB)
     
 
10.3
Lease Agreement for 1337 Chuck Dawley Blvd., Mt. Pleasant, SC (Filed with 1995 10-KSB)
     
 
10.4
Lease Agreement for 1071 Morrison Drive, Charleston, SC (Filed with 2010 10K)
     
 
10.5
1998 Omnibus Stock Incentive Plan (Filed with 2008 10K/A)
    2010 Omnibus Stock Incentive Plan (Filed with 2010 Proxy Statement)
     
 
10.6
Employee Stock Ownership Plan (Filed with 2008 10K/A)
     
 
10.7
2010 Omnibus Incentive Stock Option Plan (Filed with 2010 Proxy Statement)
     
 
14.0
Code of Ethics (Filed with 2004 10KSB)
     
 
21.0
List of Subsidiaries of the Registrant (Filed with 1995 10-KSB)
   
The Registrant’ only subsidiary is The Bank of South Carolina (Filed with 1995 10KSB)
     
 
31.1
Certification pursuant to Rule 13a-14(a)/15d-14(a) by Chief Executive Officer
     
 
31.2
Certification pursuant to Section 13a-14(a)/15d-14(a) by Chief Financial Officer
     
 
32.1
Certification pursuant to Section 1350
     
 
32.2
Certification pursuant to Section 1350
 
 
34

 
 
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.
 
 
BANK OF SOUTH CAROLINA CORPORATION
       
May 5, 2011
BY:
/s/ Hugh C. Lane, Jr.  
    Hugh C. Lane, Jr.   
    President and Chief Executive Officer   
 
 
 
BY:
/s/ Sheryl G. Sharry   
    Sheryl G. Sharry   
    Chief Financial Officer   
    Executive Vice President & Treasurer  
 
 
35