BANK OF SOUTH CAROLINA CORP - Annual Report: 2012 (Form 10-K)

U.S. SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

For the fiscal year ended December 31, 2012

For the transition period from __________ to __________

Commission file number: 0-27702

BANK OF SOUTH CAROLINA CORPORATION

(Exact name of registrant as specified in its charter)

Issuer's telephone number:   (843) 724-1500

Securities registered under Section 12(b) of the Exchange Act:

Common Stock

(Title of Class)

Securities registered under Section 12(g) of the Exchange Act: NONE

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

£ Yes  S No

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

£ Yes  S No

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes S   No £

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, 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 a shorter period that the registrant was required to submit and post such files).

Yes S   No £

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.

Large accelerated filer  £    Accelerated Filer £    Non-accelerated filer   £    Smaller reporting Company  S

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

Aggregate market value of the voting stock held by non-affiliates, computed by reference to the closing price of such stock on June 30, 2012 was: $50,153,576

As of March 1, 2013, the Registrant has outstanding 4,446,239 shares of common stock.

BANK OF SOUTH CAROLINA CORPORATION

AND SUBSIDIARY

Table of Contents

PART I

Item 1.  Business

General

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 its four banking house locations.  The four banking house locations include: 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 Company (“BKSC”) is publicly traded on the National Association of Securities Dealers Automated Quotations (NASDAQ), and is under the reporting authority of the Securities and Exchange Commission (“SEC”).  All of the Company’s electronic filings with the SEC, including its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and other documents filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, are accessible at no cost on the Bank’s website, www.banksc.com, through the “Investor Relations” link. The Company’s filings are also available through the SEC’s web site at www.sec.gov or by calling 1-800-SEC-0330.

Location and Service Area

The Bank serves Berkeley, Charleston and Dorchester counties (the “Tri-County Area”) as an independent, community oriented commercial bank concentrating on individuals and small and medium-sized businesses desiring a high level of personalized services.  The principal components of the economy within the Company’s service area are service industries, manufacturing, medical, government and wholesale and retail trade.  Like other areas in the United States, the Company’s market area has experienced extreme volatility and disruption for more than 4 years.  The operations of the Company have been impacted by prevailing economic conditions, competition and the monetary, fiscal, and regulatory policies of governmental agencies.  Nonetheless, the Tri-County Area is expected to rebound and grow significantly in the next few years, as a result of new industry led by Boeing locating a production line of its 787 airplanes and Clemson establishing a Wind Turbine Drivetrain Test Facility in Charleston, SC.  In addition, Charleston has become one of the top 10 fastest growing cities in the US for software and Internet technology.  Charleston was also voted the top US city by “Conde Nast.”

Banking Services

The Bank offers a full range of deposit services that are typically available in most banks and thrift institutions, including checking accounts, NOW Accounts, savings accounts and other time deposits of various types, ranging from daily Money Market Accounts to longer-term Certificates of Deposit.  In addition, the Bank offers certain retirement account services, such as Individual Retirement Accounts (“IRAs”).  All deposit accounts are insured by the Federal Deposit Insurance Corporation (“FDIC”) up to the maximum amount allowed by law, $250,000, subject to aggregate rules and limits.  In addition as a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act, as of July 21, 2011, deposit institutions may now pay interest on business demand accounts.

The Bank also offers a full range of commercial and personal loans.  Commercial loans include both secured and unsecured loans for working capital (including inventory and receivables), business expansion (including acquisition of real estate and improvements) and purchase of machinery and equipment.  The Bank originates, processes and closes mortgage loans and sells (each individually) to investors on a list preapproved by the Board.  The Bank’s lending activities are subject to a variety of lending limits imposed by Federal law.  While differing limits apply in certain circumstances based on the type of loan or the nature of the borrower, the direct, indirect and related credit to a single borrowing entity is limited to 10% of the Bank’s unimpaired capital and surplus and up to 15% if approved in advance by the Board of Directors.  All loans made to any Director of the Bank must be approved by the Board of Directors and made on terms not more favorable than would be available to a person not affiliated with the Bank.  This also applies to executive officers who may only apply for overdraft protection.

Other services offered by the Bank include internet banking (for individuals and businesses) including online bill pay, and remote deposit capture, allowing businesses to make deposits from its place of business.  Credit cards are offered through a correspondent banking service, including MasterCard ™ and Visa ™.  The Bank does not have a proprietary automated teller machine but participates in a national ATM network through the Visa Debit Card Program.  This service is called "Check Card" by the Bank and also offers purchases by the cardholder where Visa debit cards are accepted worldwide using a direct charge to their checking account. Other services offered, but not limited to, include safe deposit boxes, letters of credit, travelers checks, direct deposit of payroll, social security and dividend payments and automatic payment of insurance premiums and mortgage loans.    The Bank offers a fee based courier service and ACH origination service as part of its deposit services for commercial customers.

Competition

The financial services industry is highly competitive.  The Bank faces competition in attracting deposits and originating loans based upon a variety of factors including:

Direct competition for deposits and loans principally comes from local and national financial institutions as well as consumer and commercial finance companies, insurance companies, brokerage firms, some of which are not subject to the same degree of regulation and restrictions as the Bank.  Many of these competitors have substantially greater resources and lending limits than the Bank has and offer certain services, such as trust and international banking services, which the Bank is not providing.  The Bank does, however, provide a means for clearing international checks and drafts through a correspondent bank.

Employees

At December 31, 2012, the Bank employed 78 people, with 2 individuals considered part time employees, none of whom are subject to a collective bargaining agreement.  The Bank provides a variety of benefit programs including an Employee Stock Ownership Plan and Trust, health, life, disability and other insurance. Management believes its relationship with its employees is excellent.

SUPERVISION AND REGULATION

Both the Company and the Bank are subject to extensive state and federal banking laws and regulations that impose specific requirements or restrictions on and provide for general regulatory oversight of virtually all aspects of operations.  Changes in applicable laws or regulations may have a material effect on the Company’s business.

Dodd-Frank Act

On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) was signed into law.  The Dodd-Frank Act is expected to result in dramatic changes across the financial regulatory system, some of which become effective immediately and others that will not become effective until various future dates.  Implementation of the Dodd-Frank Act will require many new rules to be made by various federal regulatory agencies over the next several years.  Uncertainty remains until final rulemaking is complete as to the ultimate impact of the Dodd-Frank Act, which could have an adverse impact on both the financial services industry as a whole and on the Company’s business, results of operations, and financial condition.

Bank Holding Company Act

The Company is a one bank holding company under the federal Bank Holding Company Act of 1956, as amended (the “Bank Holding Company Act”).  As a result, the Company is primarily subject to the supervision, examination and reporting requirements of the Board of Governors of the Federal Reserve (the “Federal Reserve”) under the Bank Holding Company Act and its regulations promulgated thereunder.  Moreover, as a bank holding company located in South Carolina, the Company is also subject to the regulations of the South Carolina State Board of Financial Institutions.

Capital Requirements

The Federal Reserve Board imposes certain capital requirements on the Bank Holding Company under the Bank Holding Company Act, including a minimum leverage ratio and minimum ratio of “qualifying” capital to risk-weighted assets.  These requirements are essentially the same as those that apply to the Bank and are described under “Regulatory Capital Requirements” in the notes to the financial statements.  The ability of the Company to pay dividends depends on the Bank’s ability to pay dividends to the Company, which is subject to regulatory restrictions as described below in “Dividends”.

Standards for Safety and Soundness

The Federal Deposit Insurance Act requires the federal banking regulatory agencies to prescribe, by regulation or guideline, operational and managerial standards for all insured depository institutions relating to (1) internal controls, information systems and internal audit systems, (2) loan documentation, (3) credit underwriting, (4) interest rate risk exposure, and  (5) asset growth. The agencies also must prescribe standards for asset quality, earnings, and stock valuation, as well as standards for compensation, fees, and benefits.  The federal banking agencies have adopted regulations and Interagency Guidelines Prescribing Standards for Safety and Soundness to implement these required standards.  These guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired.

Regulatory Examination

All insured institutions must undergo regular on-site examinations by their appropriate banking agency.  The cost of examinations of insured depository institutions and any affiliates may be assessed by the appropriate banking agency against each institution or affiliate as it deems necessary or appropriate.  Insured institutions are required to submit annual reports to the FDIC, their federal regulatory agency, and state supervisor when applicable.  The federal banking regulatory agencies prescribe, by regulation, standards for all insured depository institutions and depository institution holding companies relating, among other things, to the following:

Transactions with Affiliates and Insiders

The Company is subject to certain restrictions on extensions of credit to executive officers, directors, certain principal shareholders, and their related interests.  Such extensions of credit (1) must be made on substantially the same terms, including interest rates, and collateral, as those prevailing at the time for comparable transactions with third parties and (2) must not involve more than the normal risk of repayment or present other unfavorable features.

Dividends

The Company’s principal source of cash flow, including cash flow to pay dividends to its shareholders, is dividends it receives from the Bank.  Statutory and regulatory limitations apply to the Bank’s payment of dividends to the Company.  As a general rule, the amount of a dividend may not exceed, without prior regulatory approval, the sum of net income in the calendar year to date and the retained net earnings of the immediately preceding two calendar years.  A depository institution may not pay any dividend if payment would cause the institution to become undercapitalized or if it already is undercapitalized.

Consumer Protection Regulations

Activities of the Bank are subject to a variety of statutes and regulations designed to protect consumers.  Interest and other charges collected for the Bank are subject to state usury laws and federal laws concerning interest rates.  The Bank’s loan operations are also subject to federal laws applicable to credit transactions such as:

The deposit operations of the Bank also are subject to:

Enforcement Powers

The Company, including its management and employees, are subject to potential civil and criminal penalties for violations of law, regulations or written orders of a government agency.  These practices can include the failure of an institution to timely file required reports or the filing of false or misleading information or the submission of inaccurate reports.  Civil penalties may be as high as $1 million a day for such violations.  Criminal penalties for some financial institution crimes have been increased to twenty years.  In addition, regulators are provided with greater flexibility to commence enforcement actions against the Company.

Anti-Money Laundering

The Company must maintain anti-money laundering programs that include (1) established internal policies, procedures, and controls, (2) a designated compliance officer, (3) an ongoing employee training program and, (4) testing of the program by an independent audit function.  The Company is prohibited from entering into specified financial transactions and account relationships and must meet enhanced standards for due diligence and “knowing your customer” in dealing with foreign financial institutions and foreign customers.  In addition, the Company must take reasonable steps to conduct enhanced scrutiny of account relationships to guard against money laundering and to report any suspicious transactions.

USA Patriot Act/Bank Secrecy Act

The Company must maintain a Bank Secrecy Act Program that includes (1) established internal policies, procedures, and controls, (2) a designated compliance officer, (3) an ongoing employee training program and, (4) testing of the program by an independent audit function.  The USA Patriot Act amended in part the Bank Secrecy Act and provides for the facilitation of information sharing among governmental entities and the Company for the purpose of combating terrorism and money laundering by enhancing anti-money laundering and financial transparency laws, as well as enhanced information collection tools and enforcement mechanics for the US government.  These provisions include (1) requiring standards for verifying customer identification at account opening, (2) rules to promote cooperation among financial institutions, regulators, and law enforcement entities in identifying parties that may be involved in terrorism or money laundering, and (3) filing suspicious activity reports if the Company believes a customer may be violating US laws and regulations.

Privacy and Credit Reporting

The Company is required to disclose its policies for collecting and protecting confidential information.  Customers generally may prevent the Company from sharing nonpublic personal information with nonaffiliated third parties except under narrow circumstances, such as the processing of transactions requested by the consumer.

Check 21

The Check Clearing For the 21st Century Act gives “substitute checks,” such as a digital image of a check and copies made from that image, the same legal standing as the original paper check.  The following are some of the major provisions:

Item 1A. Risk Factors

Not applicable

Item 1B. Unresolved Staff Comments

None

Item 2.  Properties

The Company’s headquarters is located at 256 Meeting Street in downtown Charleston, South Carolina.  This site is also the location of the main office of its subsidiary, The Bank of South Carolina.  In addition to the Meeting Street location, the Bank operates from three additional locations: 100 North Main Street, Summerville, SC, 1337 Chuck Dawley Boulevard, Mount Pleasant, SC, and 2027 Sam Rittenberg Boulevard, Charleston, SC.  The Bank’s mortgage department is located at 1071 Morrison Drive, Charleston, SC.  The Company owns the 2027 Sam Rittenberg Boulevard location which also houses the Operations Department of the Bank.  All other locations are leased. The owned location is not encumbered and all of the leases have renewal options.  Each of the banking locations are suitable and adequate for banking operations.

Item 3.  Legal Proceedings

On February 3, 2012 the Company was served with pleadings with respect to a South Carolina State Supreme Court Case for the “unauthorized practice of the law” arising from the modifications of real estate loans.  The South Carolina State Supreme Court heard this case on June 19, 2012 and expects to render a decision in the near future.  At this time it is impossible to predict the outcome/results of a final order. Any financial claim is not estimable currently.

In the opinion of management, there are no other legal proceedings pending other than routine litigation incidental to its business involving amounts which are not material to the financial condition of the Company or the Bank.

Item 4. Mine Safety Disclosures

Not applicable

PART II

Item 5.  Market for the Company's Common Equity, Related Stockholder Matters and Issuers Purchases of Equity Securities

There were issued and outstanding 4,446,239 shares of the 12,000,000 authorized shares of common stock of the Company at the close of the Company's fiscal year ended December 31, 2012.  The common stock of the Company is traded on The NASDAQ Capital Market under the trading symbol “BKSC”.

The following table sets forth the high and low sales price information as reported by NASDAQ in 2012, 2011 and 2010. All information has been adjusted for a 10% stock dividend declared on August 26, 2010.

As of January 1, 2013, there were approximately 1,200 shareholders of record with shares held by individuals and in nominee names, and on March 1, 2013, the market price for the common stock of the Company was $11.83

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.

At its December, 1995 Board Meeting, the Board of Directors authorized the repurchase of up to 128,108 shares of its common stock on the open market. At its October, 1999 Board meeting, the Board of Directors authorized the repurchase of up to 41,593 shares of its common stock on the open market and again at its September, 2001 Board meeting, the Board of Directors authorized the repurchase of up to 49,912 shares of its common stock on the open market.  As of the date of this report, 219,451 shares have been repurchased by the Company with 162 shares remaining that are authorized to be repurchased.  At the Annual Meeting April, 2007, the shareholders’ voted to increase the number of authorized shares from 6,000,000 to 12,000,000.  As of March 1, 2013, there were 4,665,690 shares of common stock issued and 4,446,239 shares of common stock outstanding.

THE BANK OF SOUTH CAROLINA EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST

During 1989, the Board of Directors of the Bank adopted an Employee Stock Ownership Plan and Trust Agreement to provide retirement benefits to eligible employees of the Bank for long and faithful service. An amendment and restatement was made to the Employee Stock Ownership Plan effective January 1, 2007 and approved by the Board of Directors January 18, 2007.  Periodically the Internal Revenue Service “IRS” requires a restatement of a qualified retirement plan to ensure that the plan document includes provisions required by legislative and regulatory changes made since the last restatement.  There have been no substantive changes to the plan.  The Board of Directors approved the restated plan, on January 26, 2012 (incorporated as Exhibit 10.5 in the 2011 10-K). The Plan has been submitted to the IRS for approval and at the time of this filing, the Company has received an acknowledgement letter from the IRS but has not received a determination letter. The Board of Directors of the Bank approved the cash contribution of $285,000 to The Bank of South Carolina Employee Stock Ownership Plan for the fiscal year ended December 31, 2012.  The contribution was made during 2012.

An employee of the Bank who is not a member of an ineligible class of employees is eligible to participate in the plan upon reaching 21 years of age and being credited with one year of service (1,000 hours of service). All employees are eligible employees except for the following ineligible classes of employees:

The employee may enter the Plan on the January 1st that occurs nearest the date on which the employee first satisfies the age and service requirements described above. No contributions by employees are permitted.  The amount and time of contributions are at the sole discretion of the Board of Directors of the Bank. The contribution for all participants is based solely on each participant's respective regular or base salary and wages paid by the Bank including commissions, bonuses and overtime, if any.

A participant becomes vested in the ESOP based upon the employees credited years of service.  The vesting schedule is as follows:

The Bank is the Plan Administrator.  David R. Schools, Fleetwood S. Hassell, Sheryl G. Sharry and Hugh C. Lane, Jr., currently serve as the Plan Administrative Committee and as Trustees for the Plan. The Plan currently owns 269,234 shares of common stock of Bank of South Carolina Corporation.

Item 6.    Selected Financial Data

Consolidated Financial Highlights

All share and per share data have been restated to reflect a 10% stock dividend declared on August 26, 2010.

The following tables, as well as the previously presented consolidated financial highlights, set forth certain selected financial information concerning the Company and its wholly owned subsidiary.  The information was derived from audited consolidated financial statements.  The information should be read in conjunction with “Management's Discussion and Analysis of Financial Condition and Results of Operations”, which follows, and the audited consolidated financial statements and notes which are presented elsewhere in this report.

All share and per share data have been restated to reflect a 10% stock dividend declared on August 26, 2010.

Management’s discussion and analysis is included to assist the Shareholder in understanding the Company’s financial condition, results of operations, and cash flow.  This discussion should be reviewed in conjunction with the audited consolidated financial statements and accompanying notes presented in Item 8 of 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.

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This report, including information included or incorporated by reference in this document, contains statements which constitute “forward looking statements” within the meaning of Section 27A of the Securities Act of 1934.  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-K. Forward looking statements may relate to, among other matters, the financial condition, results of operations, plans, objectives, future performance, and business of the Company.  Forward-looking statements are based on many assumptions and estimates and are not guarantees of future performance.  Actual results may differ materially from those anticipated in any forward-looking statements.  The words “may,” “would,” “could,” “should,” “will,” “expect,” “anticipate,” “predict,” “project,”, “potential,” “continue,” “assume,” “believe,” “intend,” “plan,” “forecast,” “goal,” and “estimate,” as well as similar expressions, are meant to identify such forward-looking statements.  Potential risks and uncertainties that could cause our actual results to differ materially from those anticipated in our forward-looking statements include, without limitations, those described under the heading “Risk Factors” in this Annual Report on Form 10-K for the year ended December 31, 2012 as filed with the Securities and Exchange Commission (the SEC”) and the following:

These risks are exacerbated by the developments over the last four years in national and international financial markets, and management is unable to predict what effect continued uncertainty in market conditions will have on the Company.  There can be no assurance that the unprecedented developments experienced over the last four years will not materially and adversely affect the Company’s business, financial condition and results of operations.

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 $325.4 million in assets as of December 31, 2012 and net income of $992,173 and $3,666,828, respectively, for the three and twelve months ended December 31, 2012.  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, attention to detail to foster long standing relationships.

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.  Consequently, 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 rate 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”.

In addition to earning interest on loans and investments, the Company also earns income through fees and other expenses it charges to the customer.  The following discussion includes various components of this non-interest income and non-interest expenses.  The discussion and analysis also identifies significant factors that have affected the Company’s financial position and operating results as of December 31, 2012 as compared to December 31, 2011 and December 31, 2011 as compared to December 31, 2010, and should be read in conjunction with the financial statements and the related notes included in this report.  In addition, a number of tables have been included to assist in the discussion.

CRITICAL ACCOUNTING POLICIES

The Company has adopted various accounting policies that govern the application of 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 set forth in the notes to the Company’s consolidated financial statements in this report.

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 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 policy 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”.

COMPARISON OF THE YEAR ENDED DECEMBER 31, 2012 TO DECEMBER 31, 2011

Net income increased $477,510 or 14.97% to $3,666,828 or basic and diluted earnings per share of $.82 and $.82, respectively, for the year ended December 31, 2012 from $3,189,318 or basic and diluted earnings per share of $.72 and $.72, respectively for the year ended December 31, 2011.  This increase was primarily due to an increase in mortgage banking income and a decrease in the cost of funds.  Historically low interest rates helped to increase the volume of mortgage loan originations.  In addition, the Company’s market area of Berkeley, Charleston and Dorchester counties saw an increase in home sales during the year ended December 31, 2012.  Mortgage loan originations increased $48,649,766 or 81.02% to $108,699,648 for the year ended December 31, 2012, from $60,049,882 for the year ended December 31, 2011.

The cost of funds decreased as a result of lower rates paid on interest bearing deposits coupled with a decrease in interest bearing deposits and an increase in non-interest bearing deposits.   Interest bearing deposits decreased $23,283,733 or 10.08% to $207,626,168 for the year ended December 31, 2012.  The cost associated with these deposits decreased $322,409 or 41.44% to $455,619 for the year ended December 31, 2012. On February 7, 2012, the Company was notified by a large depositor that it would begin to withdraw its deposits by the end of that month.  This depositor was a company that was started in Charleston, SC and was purchased by an out-of-state company in 2007. The deposits remained with the Bank with the understanding that these deposits would eventually be moved. The balance of the deposits, all of which were interest bearing, at December 31, 2011 was $32,462,427 with $546,000 remaining at December 31, 2012.  Non-interest bearing accounts increased $13,230,061 or 18.84% to $83,447,675 for the year ended December 31, 2012.  The Company had a strong increase in the number of small business accounts, due to its business development efforts.  The Dodd-Frank Act included a provision which required the Federal Deposit Insurance Corporation (FDIC) to provide unlimited federal deposit insurance for non-interest bearing demand accounts. This provision expired on December 31, 2012 but the Company has not experienced any impact from the expiration of this provision.

Net interest income increased $507,664 or 4.42% to $12,007,240 for the year ended December 31, 2012 from $11,499,576 for the year ended December 31, 2011.  Net interest income is a primary source of revenue.  Net interest income is the difference between income earned on assets and interest paid on deposits and borrowings used to support such assets.  Net interest income is determined by the rates earned on interest earning assets and the rates paid on interest bearing liabilities, the relative amounts of interest earning assets and interest bearing liabilities, and the degree of mismatch and maturity and repricing characteristics of its interest earning assets and interest bearing liabilities. The increase in net interest income was primarily due to an increase in interest and fees on loans and, as discussed above, a decrease in the cost of funds.

The company experienced a modest increase of $145,218 or 1.33% from interest and fees on loans, and $37,777 or 2.88% increase from interest and dividends on investment securities.  Average loans increased $7,819,484 to $220,780,471 for the year ended December 31, 2012.  A large portion of this increase was primarily due to an increase of $4,725,259 in average mortgage loans to be sold, from $3,164,168 for the year ended December 31, 2011 to $7,889,427 for the year ended December 31, 2012.  The Company had 480 mortgage originations totaling $108,699,648 for the year ended December 31, 2012 as compared to 281 mortgage originations totaling $60,049,882 for the year ended December 31, 2011.  As stated previously, the increase in mortgage originations resulted from the historically low interest rates and an increase in home sales in the Company’s market area.

Average investments increased $5,693,516 to $57,982,652 for the year ended December 31, 2012.  The yield on these investments decreased from 2.50% for the year ended December 31, 2011 to 2.32% for the year ended December 31, 2012.  During 2011, the Company had one US Treasury Note, two Federal Agency Securities and two Municipal Securities mature that were yielding between 5.069% and 3.396%.  The funds from these maturities were re-invested; however, the funds were re-invested at significantly lower interest rates.

The Company maintains an allowance for loan losses (the “allowance”) which is management’s best estimate of probable losses inherent in the outstanding loan portfolio. The allowance is decreased by actual loan charge-offs, net of recoveries, and is increased as necessary by charges to current period operating results through the provision for loan losses. The allowance is based on management’s continuing review and credit risk evaluation of the losses inherent in the loan portfolio. Management takes into consideration many factors such as the balance of impaired loans, the quality, mix and size of the Company’s overall loan portfolio, economic conditions that may affect the borrower’s ability to repay, the amount and quality of collateral securing the loans, the Company’s historical loan loss experience, and a review of specific problem loans. Based on management’s evaluation, the Company recorded a provision for loan losses of $350,000 for the year ended December 31, 2012, a decrease of 27.08% or $130,000 from $480,000 for the year ended December 31, 2011.

The allowance consists of an allocated and unallocated allowance.  The allocated portion is determined by types and ratings of loans within the portfolio.  The unallocated portion of the allowance is established for losses that exist in the remainder of the portfolio and compensates for uncertainty in estimating the loan losses.  The Company had $1,005,141 in unallocated reserves at December 31, 2012 as compared to $558,267 at December 31, 2011.  Management believes this amount is appropriate and properly supported through the environmental factors of its allowance for loan losses.

There can be no assurance that charge-offs of loans in future periods will not exceed the allowance for loan losses as estimated at any point in time or that provisions for loan losses will not be significant to a particular accounting  period.  In addition the allowance is subject to examination and testing for adequacy by regulatory agencies.  Such regulatory agencies could require management to adjust the allowance based on information available to them at the time of their examination.

During 2012, the Company recorded net charge-offs of $24,040 as compared to net charge-offs of $311,703 in 2011. Although uncertainty in the economic outlook still exists, management believes the loss exposure in the portfolio is identified, reserved against and closely monitored to ensure that changes are promptly addressed in the analysis of reserve adequacy.

Impaired loans at December 31, 2012 totaled $11,498,279, an increase of 55.01% over total impaired loans of $7,417,892 at December 31, 2011.  Impaired loans include non-accrual loans of $3,993,816 and five restructured loans (TDR) totaling $1,618,278 at December 31, 2012. In addition, there is one credit totaling $2,623,556 which is entirely secured by a first mortgage, improving the Company’s existing second real estate mortgage secured position and including the existing unsecured debt.  Impaired loans at December 31, 2011 included non-accrual loans of $923,671 and two restructured loans totaling $491,153.  There were no loans over 90 days past due still accruing interest at December 31, 2012 and one loan over 90 days past due that was still accruing interest at December 31, 2011. Comparing the year ended December 31, 2012 and the year ended December 31, 2011, the increase in non-accrual loans was primarily due to the addition of two very well secured first real estate mortgage loans to one borrower which totaled $1,822,592, one secured real estate mortgage totaling $508,651, and three past due loans (greater than 90 days) totaling $743,154.

Non-interest income increased $567,506 or 31.92% to $2,345,463 for the year ended December 31, 2012 from $1,777,957 for the year ended December 31, 2011.  This increase was primarily due to an increase in mortgage banking income offset by a decrease in gains on securities.  Mortgage banking income increased $703,183 or 104.22% to $1,377,888 for the year ended December 31, 2012 from $674,705 for the year ended December 31, 2011.  Mortgage loan originations increased 81.02% or $48,649,766 for the year ended December 31, 2012.  This increase was primarily due to customers taking advantage of the historically low interest rates to refinance and purchase homes.  This increase was offset by a decrease of $124,672 in gains realized on the sale of investment securities in 2011.  There were no sales of investment securities during the year ended December 31, 2012.

Non-interest expense increased $471,359 or 5.71% to $8,731,625 for the year ended December 31, 2012, from $8,260,266 for the year ended December 31, 2011.  This increase was primarily due to increases in salaries and employee benefits, professional legal fees, data processing fees and the Employee Stock Ownership Plan (ESOP) contribution coupled with decreases in fees paid to the FDIC. Wages increased $302,641 or 6.38% from $4,742,772 for the year ended December 31, 2011 to $5,045,413 for the year ended December 31, 2012, as a result of annual merit increases and the hiring of two additional mortgage lenders and an additional loan processor. In addition, at the recommendation of the Compensation Committee, the Board of Directors approved a $10,000 bonus for Executive Officers for the year ending December 31, 2012.  The Board of Directors approved this bonus in appreciation for the outstanding performance of the Bank.  The bonus was paid in December 2012. The cost of providing insurance for employees also increased with the additional employees and a rate increase by the Company’s insurance provider. The cost increased $73,721 from $365,646 for the year ended December 31, 2011 to $439,367 for the year ended December 31, 2012.  Data processing fees increased $113,242 or 25.36% for the year ended December 31, 2012.  This increase was primarily a result of additional customers signing up for eCorp (online banking for businesses) and remote deposit capture. The Company’s data processing fees will continue to increase as additional customers sign up for these products. Professional legal fees increased $50,623 primarily as the result of legal counsel provided on one case, discussed more fully in “Legal Proceedings”.  The contribution to the ESOP increased $45,000 for the year ended December 31, 2012 when compared to the same period in 2011. The company also saw a decrease in fees paid to the FDIC of $54,350 or 24.90% for the year ended December 31, 2012 from $218,315 for the year ended December 31, 2011, as the result of a decrease in the rate used to calculate the assessment.

Income tax expense increased 19.01% to $1,604,250 at December 31, 2012 from $1,347,949 at December 31, 2011. The Company’s effective tax rate was approximately 30.44% for the year ended December 31, 2012 compared to 29.71% for the year ended December 31, 2011.

COMPARISON OF THE YEAR ENDED DECEMBER 31, 2011 TO DECEMBER 31, 2010

Net income increased $78,805 or 2.53% to $3,189,318 for the year ended December 31, 2011 from $3,110,513 for the year ended December 31, 2010.  Basic and diluted earnings per share increased from $.70 for the year ended December 31, 2010 to $.72 for the year ended December 31, 2011.

Net interest income is a primary source of revenue.  Net interest income is the difference between income earned on assets and interest paid on deposits and borrowings used to support such assets.    Net interest income is determined by the rates earned on interest earning assets and the rates paid on interest bearing liabilities, the relative amounts of interest earning assets and interest bearing liabilities, and the degree of mismatch and maturity and repricing characteristics of its interest earning assets and interest bearing liabilities.

Net interest income increased $399,784 or 3.60% to $11,499,576 for the year ended December 31, 2011 from $11,099,792 for the year ended December 31, 2010. Total interest and fee income increased $111,421 or .92% to $12,277,604 for the year ended December 31, 2011 from $12,166,183 for the year ended December 31, 2010.  A modest increase in loan demand which coupled with the Company’s effort to improve its yield on loans resulted in the increase in interest and fees on loans of $194,208 or 1.82% to $10,887,709 for the year ended December 31, 2011, from $10,693,501 for the year ended December 31, 2010.  Average loans increased $869 with the yield improving from 5.02% at December 31, 2010 to 5.11% at December 31, 2011.  Other interest income increased $67,201 or 518.89% to $80,152 at December 31, 2011 from $12,951 at December 31, 2010.  To improve its yield on daily liquidity, the Company terminated all of its Federal Funds positions, moving this money to deposits with the Federal Reserve as the Company was able to earn .25% (approximately 10 basis points more than the Company was earning on its Federal Funds deposits). Average other interest bearing accounts increased $26,975,490 with a yield of .24%.  The yield on average Federal Funds sold decreased from .19% at December 31, 2010 to .17% at December 31, 2011.  Although average investment securities increased $14,879,062 or 39.77%, interest and dividends on investments decreased $149,988 or 10.28% to $1,309,743 for the year ended December 31, 2011 from $1,459,731 at December 31, 2010.

The Company increased its investment portfolio to enhance income in this low rate environment.  The average yield on the Company’s investment portfolio decreased from 3.90% at December 31, 2010 to 2.50% at December 31, 2011.  The Company had $6 million in Federal Agency Securities and $3 million in US Treasury Notes mature during the year ended December 31, 2011, which were yielding between 4.05% and 5.07%.  The Company sold $18 million in US Treasury Notes during the year ended December 31, 2011 for a gain of $124,672.  The Company reinvested $17 million in Government Sponsored Securities that were yielding between 1.30% and 1.71% and $1 million in Municipal Securities that were yielding between 2.50% and 3.00% at December 31, 2011.  In addition to the above noted investments, the Company also purchased an additional $7.73 million in Municipal Securities which were yielding between .55% and 3.55% at December 31, 2011.  Overall, average interest bearing assets increased $42.6 million to $300.6 million for the year ended December 31, 2011 with a yield of 4.08% from $258.0 million at December 31, 2010 with a yield of 4.71%.

Average interest bearing liabilities increased $32.0 million to $216.3 million for the year ended December 31, 2011 with a yield of .36% from $184.3 million with a yield of .58% for the year ended December 31, 2010 a decrease of 22 basis points.  Because of the Company’s increase in liquidity and the reinvestment of its bond portfolio the Company’s net interest margin fell from 4.30% at December 31, 2010 to 3.83% at December 31, 2011.

Interest expense decreased $288,363 or 27.04% to $778,028 for the year ended December 31, 2011, from $1,006,391 for the year ended December 31, 2010.  On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) was signed into law.  One of the provisions under this law is for the Federal Deposit Insurance Corporation (FDIC) to provide unlimited federal deposit insurance for non-interest-bearing demand transaction accounts.  The Company’s non-interest bearing demand accounts increased $13,333,379 or 23.44% from $56,884,235 at December 31, 2010 to $70,217,614 at December 31, 2011. In addition interest rates remain at historically low rates resulting in lower rates paid on deposits as well as lower rates paid on short term borrowings.

The provision for loan losses is a charge to earnings in a given period to maintain the allowance for loan losses at an adequate level. Provision for loan losses decreased $190,000 or 28.36% to $480,000 for the year ended December 31, 2011 from $670,000 for the year ended December 31, 2010. The allowance for loan losses represents an amount which management believes will be adequate to absorb probable losses on existing loans that may become uncollectible.  Management’s judgment as to the adequacy of the allowance for loan losses is based on numerous assumptions about current events, which management believes to be reasonable, but which may or may not be valid. Management’s determination of the allowance of loan losses is based on evaluations of the collectability of loans, including consideration of factors such as the balance of impaired loans, the quality, mix and size of the Company’s overall loan portfolio, economic conditions that may affect the borrower’s ability to repay, the amount and quality of collateral securing the loans, the Company’s historical loan loss experience, and a review of specific problem loans.  Recognized losses are charged to the allowance with subsequent recoveries added back.

The allowance consists of an allocated and unallocated allowance.  The allocated portion is determined by types and ratings of loans within the portfolio.  The unallocated portion of the allowance is established for losses that exist in the remainder of the portfolio and compensates for uncertainty in estimating the loan losses.  The Company had $558,267 in unallocated reserves at December 31, 2011 as compared to $1,061,859 at December 31, 2010.  Management believes this amount is appropriate and properly supported through the environmental factors of its allowance for loan losses.

There can be no assurance that charge-offs of loans in future periods will not exceed the allowance for loan losses as estimated at any point in time or that provisions for loan losses will not be significant to a particular accounting  period.  In addition the allowance is subject to examination and testing for adequacy by regulatory agencies.  Such regulatory agencies could require management to adjust the allowance based on information available to them at the time of their examination.

During 2011, the Company recorded net charge-offs of $311,703 as compared to net charge-offs of $758,408 in 2010.  Impaired loans at December 31, 2011 totaled $7,417,892 an increase of 108.40% over total impaired loans of $3,559,528 at December 31, 2010.  Impaired loans include non-accrual loans of $923,671 at December 31, 2011 and $945,328 at December 31, 2010, and two restructured loans totaling $491,153 at December 31, 2011.  There was one restructured loan of $153,015 at December 31, 2010.  There was one loan at December 31, 2011 over 90 days past due that was still accruing interest and no loans over 90 days past due that were still accruing interest at December 31, 2010.

Non-interest income decreased $285,740 from $2,063,697 for the year ended December 31, 2010 to $1,777,957 for the year ended December 31, 2011.  This decrease was primarily due to the decrease in mortgage banking income of $329,619 or 32.82%.   Loan origination fees and the service release premiums decreased as the Company originated 61 fewer mortgage loans for the year ended December 31, 2011 as compared to the year ended December 31, 2010.  The Company originated 281 mortgage loans in 2011 compared to 342 in 2010.  Service charges, fees and commissions decreased $83,700 to $946,518 at December 31, 2011 from $1,030,218 at December 31, 2010.  This decrease is primarily due to a decrease in credit card fees.  The Company changed to a merchant service provider that pays on a quarterly basis as compared to a monthly basis in 2010.  In addition, the Company receives a lower rate from the merchant provider.  The merchant service provider assumes all liabilities. Credit card fees decreased $77,127 or 58.47% for the year ended December 31, 2011.  The Company realized a gain of $124,672 on the sale of $18,000,000 in US Treasury Notes in 2011.

Non-interest expenses increased $261,721 or 3.27% to $8,260,266 for the year ended December 31, 2011 from $7,998,545 for the year ended December 31, 2010.  This increase is primarily due to an increase of $174,677 in salaries and employee benefits. Salaries and wages increased due to the hiring of a new commercial loan officer and annual merit increases.  The Company also experienced an increase in other operating expenses with data processing fees increasing $95,524 due to the addition of remote capture and eCorp (online banking for corporations). As additional customers sign up for eCorp and remote deposit capture the Company’s data processing fees increase. Fees paid to the FDIC decreased $115,502 from $333,817 for the year ended December 31, 2010 to $218,315 for the year ended December 31, 2011 due to a decrease in the rate used to calculate the assessment.  The Company also realized a loss of $63,273 on the sale of Other Real Estate Owned for the year ended December 31, 2011, as compared to a loss of $13,347 for the year ended December 31, 2010.

Income tax expense decreased 2.64% to $1,347,949 at December 31, 2011 from $1,384,431 at December 31, 2010. The Company’s effective tax rate was approximately 29.71% for the year ended December 31, 2011 compared to 30.80% for the year ended December 31, 2010.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

ASSET AND LIABILITY MANAGEMENT

The assets and liabilities of the Company are managed to provide a consistent level of liquidity to accommodate normal fluctuations in loans and deposits. At year end 2012, total assets were $325,410,646 a decrease of 2.58% from year end 2011; total deposits were $291,073,843, a decrease of 3.34% from the end of the previous year.

At December 31, 2012, approximately 98.35% of the Company’s assets were earning assets composed of U.S. Treasury, Government Sponsored Enterprises and Municipal Securities in the amount of $58,514,216, interest bearing deposits in other banks in the amount of $25,903,960 and total loans including mortgage loans held for sale in the amount of $235,608,502.

The yield on a majority of the Company’s earning assets adjusts simultaneously with changes in the general level of interest rates. Some of the Company’s liabilities are issued with fixed terms and can be repriced only at maturity.

MARKET RISK

Market risk is the risk of loss from adverse changes in market prices and rates. For the Company, this risk is constituted primarily of interest rate risk in its lending and investing activities as they relate to their funding by deposit and borrowing activities.

The Bank’s policy is to minimize interest rate risk between interest bearing assets and liabilities at various maturities and to attempt to maintain an asset sensitive position over a 6 month period.  By adhering to this policy, management anticipates that the Bank’s net interest margins will not be materially affected unless there is an extraordinary precipitous drop in interest rates.  The average net interest rate spread for 2012 increased to 3.78% from 3.72% for 2011 and the average net interest margin for 2012 increased to 3.86% from 3.83% for 2011.  Management will continue to monitor its asset sensitive position.

Since the rates on most of the Bank’s interest bearing liabilities can vary on a daily basis, management continues to maintain a loan portfolio priced predominately on a variable rate basis; however, in an effort to protect future earnings in a declining rate environment, the Bank offers certain fixed rates, interest rate floors, and terms primarily associated with real estate transactions. The Bank seeks stable, long-term deposit relationships to fund its loan portfolio.  The Bank does not have any Brokered Deposits or Internet Deposits.

At December 31, 2012, the average maturity of the investment portfolio was 4 years 1.94 months with an average yield of 2.46% compared to 5 years 5.28 months with an average yield of 2.45% at December 31, 2011.  Although there is greater market risk with maturity extension, management feels that the core deposit base minimizes the need to sell securities, and the maturity extension of the investment portfolio improves the yield on the portfolio.

The Company does not take foreign exchange or commodity risks.  In addition the Company does not own mortgage-backed securities, nor does it have any exposure to the sub-prime market or any other distressed debt instruments.

The following table summarizes the Bank’s interest sensitivity position as of December 31, 2012:

LIQUIDITY

Historically, the Company has maintained its liquidity at levels believed by management to be adequate to meet requirements of normal operations, potential deposit outflows and strong loan demand and still allow for optimal investment of funds and return on assets. The following table summarizes future contractual obligations as of December 31, 2012:

The Bank manages its assets and liabilities to ensure that there is sufficient liquidity to enable management to fund deposit withdrawals, loan demand, capital expenditures, reserve requirements, operating expenses, dividends and to manage daily operations on an ongoing basis.  Funds are primarily provided by the Bank through customer's deposits, principal and interest payments on loans, mortgage loan sales, the sale or maturity of securities, temporary investments and earnings.

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, which are not pledged, 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.  Net cash provided by operations and deposits from customers have been the primary sources of liquidity for the Company.  At December 31, 2012, the Bank had unused short-term lines of credit totaling approximately $19 million (which can be withdrawn at the lender's option).  Additional sources of funds available to the Company for additional 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 held for sale.  In March 2012, the Company established a $6 million REPO Line with Raymond James (formally Morgan Keegan).  There have been no borrowings under this agreement. The Company has also 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. At December 31, 2012 the Company could borrow up to $63 million. There have been no borrowings under this arrangement.

Composition of Average Assets

(1) Including mortgage loans held for sale

Average earning assets increased by $10,520,742 from 2011 to 2012. This increase was primarily due to a $7,819,484 increase in average loans, a $5,693,516 increase in average available for sale securities and a $4,585,911 increase in average other short term investments.  The average balance of Federal Funds Sold decreased $7,578,169.

ANALYSIS OF CHANGES IN NET INTEREST INCOME

The following table shows changes in interest income and expense based upon changes in volume and changes in rates:

(1)  Volume/Rate changes have been allocated to each category based on the percentage of each to the total change.

(2)  Including mortgage loans held for sale

YIELDS ON AVERAGE EARNING ASSETS AND RATES ON AVERAGE INTEREST-BEARING LIABILITIES

INVESTMENT PORTFOLIO

The following is a schedule of the Bank’s investment portfolio as of December 31, 2012, December 31, 2011, and December 31, 2010:

The Bank’s investment portfolio had a weighted average yield of 2.46%, 2.45%, and 3.46% for the years ended December 31, 2012, 2011, and 2010, respectively.

At December 31, 2012 there was one Municipal Security with an unrealized loss of $3,592 compared to three Municipal Securities with an unrealized loss of $1,117 at December 31, 2011.  These investments are not considered other-than-temporarily impaired.  The Company has the ability and the intent to hold these investments until a market price recovery or maturity.  The unrealized losses on these investments were caused by interest rate increases.  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.

LOAN PORTFOLIO COMPOSITION

The Company focuses its lending activities on small and middle market businesses, professionals and individuals in its geographic markets.  At December 31, 2012, outstanding loans (plus deferred loan fees of $60,207) totaled $217,128,624, which equaled 74.60% of total deposits and 66.72% of total assets.  Substantially all loans were to borrowers located in the Company’s market area 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.  Every credit with over $100,000 in exposure is summarized by the Company’s Credit Department and reviewed by the Loan Committee on a monthly basis.  The Board of Directors reviews credits over $500,000 monthly with an annual credit analysis conducted on these borrowers 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.

The following is a schedule of the Bank’s loan portfolio, excluding mortgage loans and deferred loan fees, as of December 31, 2012, as compared to December 31, 2011, 2010, 2009 and 2008:

The Bank had no foreign loans or loans to fund leveraged buyouts (LBO’s) during 2012, 2011, 2010, 2009, or 2008.

The following table presents the contractual terms to maturity for loans outstanding at December 31, 2012.  Demand loans, loans having no stated schedule of repayment and no stated maturity, and overdrafts are reported as due in one year or less.  The table does not include an estimate of prepayments, which can significantly affect the average life of loans and may cause the Company’s actual principal experience to differ from that shown.

IMPAIRED LOANS

A loan is impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement and exhibits one or more of the following characteristics:

Impairment loss is measured by:

All loans placed on non-accrual status are classified as impaired.  However, not all impaired loans are on non-accrual status.

The Bank had impaired loans totaling $11,498,279 as of December 31, 2012 compared to $7,417,892, $3,559,528, $2,502,202, and $1,802,291, as of December 31, 2011, 2010, 2009, and 2008, respectively. The impaired loans include non-accrual loans with balances at December 31, 2012, 2011, 2010, 2009, 2008, of $3,993,816, $923,671, $945,328, $627,373, and $75,486, respectively.  The Bank had five restructured loans (“TDR”) in the amount of $1,618,278 at December 31, 2012, two restructured loans in the amount of $491,153 at December 31, 2011, one restructured loan at December 31, 2010 of $153,015, no restructured loans for the years ended December 31, 2009 or 2008, respectively. According to Generally Accepted Accounting Principals (GAAP), the Company is required to account for certain loan modifications or restructuring as a troubled debt restructuring (“TDR”).  In general, the modification or restructuring of a debt is considered a TDR if the Company, for economic or legal reasons related to a borrower’s financial difficulties, grants a concession to the borrower that the Company would not otherwise consider.

TROUBLED DEBT RESTRUCTURING

According to GAAP, the Company is required to account for certain loan modifications or restructuring as a troubled debt restructuring (“TDR”).  In general, the modification or restructuring of a debt is considered a TDR if the Company, for economic or legal reasons related to a borrower’s financial difficulties, grant a concession to the borrower that the Company would not otherwise consider.  Three factors must always be present:

All TDR loans must be considered for Impairment and included on  the Bank’s Allowance for Credit Losses.

The Bank had five TDR’s in the amount of $1,618,278 at December 31, 2012, two TDR’s in the amount of $491,153 at December 31, 2011, one TDR loan at December 31, 2010 of $153,015, no TDR’s for the years ended December 31, 2009 or 2008, respectively.

Management does not know of any potential problem loans, which will not meet their contractual obligations that are not otherwise discussed herein.

OTHER REAL ESTATE OWNED

Real estate acquired as a result of foreclosure or by deed-in-lieu of foreclosure is classified as other real estate owned (“OREO”) until it is sold.  When the property is acquired, it is recorded at the lesser of fair value of the property less estimated selling costs or the total loan balance. It is in the Company’s best interest to determine the fair market value by engaging an independent appraisal within 30 days of property being acquired into OREO.  The Company can not hold the property for a period of more than five years.  The Bank will pay property taxes along with insurance expenses until the property is sold.  Other real estate owned at December 31, 2010 was $659,492.  The Company sold its OREO during the year ended December 31, 2011 for a loss of $63,273.  The Company had no OREO at December 31, 2012 or at December 31, 2011.

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 has had various modifications since 2007 to better reflect the economic environment and to implement regulatory guidance. This allowance is validated on a monthly basis by Credit Personnel (who have no lending approval authority nor complete the allowance). The revised methodology is based on a Reserve Model that is comprised of the three components listed below.

Loans are reviewed for impairment on a quarterly basis if any of the following criteria are met:

These loans are measured in accordance with FASB ASC 310-10-35. Impaired loans can either be secured or unsecured, yet does not apply to large groups of smaller balance loans that are collectively evaluated.  Impairment is measured by 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 all loans, excluding impaired loans, based on FASB ASC 450-20.  This includes a pool of loans that are reviewed for impairment but are not found to be impaired. 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 was .211% and .311% at December 31, 2012 and December 31, 2011, respectively.

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

The sum of each component’s analysis results represents the “estimated loss” within the Company’s total portfolio.

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 and impaired loans have increased, management is confident in the sources of repayment and this increase reflects sound credit management. 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 “trend 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 collateral advance rate is 80% on all real estate transactions, with the exception of raw land at 65% and land development at 70%.

Occasionally, the Company extends credit beyond its normal collateral advance margins in real estate lending. Although infrequent, the aggregate of these loans represent a notable part of the Company’s portfolio.  Accordingly these loans are monitored and the balances reported to the Board every quarter. An excessive level of this practice (as a percentage of capital) could result in additional regulatory 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 requires 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 $34 million), the Company’s list and number of over margined real estate loans currently totals approximately $15,287,601 or approximately 6.49% of its loan portfolio at the year ended December 31, 2012 compared to $16,723,105 or approximately 7.56% of the loan portfolio at December 31, 2011.  This decrease is largely due to loans paying down resulting in an acceptable loan to value ratio.  Additionally, the Company has focused on originating loans with acceptable loan to value ratios.

A credit rating matrix is used to rate all extensions of credit and to provide a more specified picture of the risk each loan poses to the quality of the loan portfolio.  There are eight possible ratings used to determine the quality of each loan based on nine different qualifying characteristics: cash flow, collateral quality, guarantor strength, financial condition, management quality, operating performance, the relevancy of the financial statements, historical loan performance, and the borrower’s leverage position. The matrix is designed to meet management’s standards and expectations of loan quality

National and local economic trends and conditions are constantly changing and result 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 Company’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 reviews credits over $500,000 monthly with an annual credit analysis conducted on these borrower’s 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 Company has over 350 years of lending management experience among eleven members of its lending staff. In addition to the lending staff the Company has an Advisory Board for each branch comprised of business and community leaders from the specific branch’s market area.  An additional Advisory Board was created during the year ended December 31, 2012, to support the Company’s business efforts in the North Charleston area of South Carolina.  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.  The assessment of banks to replenish the insurance fund and its corresponding impact on bank profits, increased regulatory scrutiny 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 continues be 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 Company is well established and therefore unsound price competition is not necessary.

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

As of December 31, 2012, there were only four Standard Industrial Code groups that comprised more than 2% 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 Company 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 Company’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 Company’s lenders and Loan Department.  The Company requires insurance coverage naming the Company 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 Company.  The policy of the Company is that all new loans, regardless of the customer’s history with the Company, should have updated financial information. In addition, the Company is monitoring appraisals closely as real estate values continue to fluctuate. .

Based on the evaluation described above, the Company recorded a provision for loan loss of $350,000 for the year ended December 31, 2012 compared to $480,000 for the year ended December 31, 2011.   At December 31, 2012 the three year average loss ratios were: .118% Commercial, .795% Consumer, .520% 1-4 Residential, .000% Real Estate Construction and .112% Real Estate Mortgage. The three year historical loss ratio used at December 31, 2012 was .211% compared to .311% at December 31, 2011.

During the year ended December 31, 2012 charge-offs of $172,288 and recoveries of $148,248 were recorded to the allowance for loan losses, resulting in an allowance for loan losses of $3,432,844 or 1.46% of total loans at December 31, 2012, compared to charge-offs of $383,714 and recoveries of $72,010 resulting in an allowance for loan losses of $3,106,884 or 1.40% of total loans at December 31, 2011.

The Company had impaired loans totaling $11,498,279 as of December 31, 2012 compared to $7,417,892 at December 31, 2011. The impaired loans include non-accrual loans with balances at December 31, 2012, and 2011, of $3,993,816 and $923,671, respectively.  The Bank had five restructured loans (“TDR”) at December 31, 2012 and two restructured loans at December 31, 2011.  According to GAAP, the Company is required to account for certain loan modifications or restructuring as a troubled debt restructuring, when appropriate.  In general, the modification or restructuring of a debt is considered a TDR if the Company, for economic or legal reasons related to a borrower’s financial difficulties, grants a concession to the borrower that the Company would not otherwise consider.  At December 31, 2012 the five restructured loans had an aggregate balance of $1,618,278 compared to the two restructured loans with an aggregate balance of $491,153 at December 31, 2011. Included in the impaired loans at December 31, 2012, is one credit totaling $2,623,556 which is entirely secured by a first mortgage, improving the Company’s existing second real estate mortgage secured position and including the existing unsecured debt.  Management does not know of any loans which will not meet their contractual obligations that are not otherwise discussed herein.

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 6 to 9 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 December 31, 2012 and one loan over 90 days past due still accruing interest as of December 31, 2011.

Net charge-offs for the year ended December 31, 2012, were $24,040 as compared to net charge-offs of $311,704 for the year ended December 31, 2011.  Although uncertainty in the economic outlook still exists, management believes loss exposure in the portfolio is identified, reserved against and closely monitored to ensure that changes are promptly addressed in the analysis of reserve adequacy.

The following table represents the net charge-offs by loan type.

The Company had $1,005,141, in unallocated reserves at December 31, 2012 related to other inherent risk in the portfolio compared to unallocated reserves of $558,267 at December 31, 2011. 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 December 31, 2012, 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 following tables present a breakdown of the allowance for loan losses as of December 31, 2012 and 2011, respectively.

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 described above adjusted for factors specific to binding commitments, including the probability of funding and historical loss ratio.   No provision was recorded during the year ended December 31, 2012 or the year ended December 31, 2011, resulting in no change to the balance of $20,825.

DEPOSITS

Certificates of Deposit $100,000 and over increased $2,265,358 or 5.86% for the year ended December 31, 2012, from $38,638,528 at December 31, 2011.  This increase was not the result of special promotions or advertising.

The Bank funds its growth through core deposits and does not rely on Brokered Deposits or Internet Deposits as a source to do so.

SHORT-TERM BORROWINGS

At December 31, 2012, the Company had no outstanding federal funds purchased with the option to borrow $19,000,000 on short term lines of credit. In March 2012, the Company established a $6 million REPO line with Raymond James (formally Morgan Keegan).  There have been no borrowings under this arrangement. The Company has also established a Borrower-In-Custody arrangement with the Federal Reserve as a secondary source of liquidity.  This arrangement permits the Company to retain possession of loans pledged as collateral to secure advances from the Federal Reserve Discount Window.  Under this agreement the Company may borrow up to $62.6 million.  There have been no borrowings under this arrangement.

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 commitments in other liabilities on the consolidated balance sheet. At December 31, 2012 and 2011 the balance of this reserve was $20,825.  At December 31, 2012 and 2011, 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 $51,144,731 and $47,629,822 at December 31, 2012 and 2011 respectively.

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 December 31, 2012 and 2011 was $749,712 and $875,679, respectively.

The Company originates certain fixed rate residential loans and commits these loans for sale.  The commitments to originate fixed rate residential loans and the sales commitments are freestanding derivative instruments. The fair value of these commitments was not significant at December 31, 2012 or December 31,  2011. The Company had forward sales commitments, totaling $18,479,878 at December 31, 2012, to sell loans held for sale of $18,479,878.  At December 31, 2011, the Company had forward sales commitments of $7,578,587. The fair value of these commitments was not significant at December 31, 2012 or 2011. The Company has no embedded derivative instruments requiring separate accounting treatment.

Once the Company sells certain fixed rate residential loans, the loans are no longer reportable on the Company’s balance sheet. With most of these sales, the Company has an obligation to repurchase the loan in the event of a default of principal or interest on the loan. This recourse period ranges from three to six months with unlimited recourse as a result of fraud.  The unpaid principal balance of loans sold with recourse was $36,105,000 at December 31, 2012 and $28,596,000 at December 31, 2011.  For the year ended December 31, 2012 and December 31, 2011 there were no loans repurchased.

EFFECT OF INFLATION AND CHANGING PRICES

The consolidated financial statements have been prepared in accordance with generally accepted accounting principles which require the measurement of financial position and results of operations in terms of historical dollars without consideration of changes in the relative purchasing power over time due to inflation.

Unlike most other industries, the assets and liabilities of financial institutions such as the Company are primarily monetary in nature.  As a result, interest rates generally have a more significant impact on the Company’s performance than do the effects of general levels of inflation and changes in prices.  In addition, interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services.  The Company strives to manage the relationship between interest sensitive assets and liabilities in order to protect against wide interest rate fluctuations, including those resulting from inflation.

CAPITAL RESOURCES

The capital needs of the Company have been met to date through the $10,600,000 in capital raised in the Company’s initial offering, the retention of earnings less dividends paid and the exercise of stock options for a total shareholders’ equity at December 31, 2012, of $33,930,442. The rate of asset growth since the Bank’s inception has not negatively impacted this capital base. The current 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 current guidelines established require a minimum risk-based capital ratio of 8% for bank holding companies and banks. The risk-based capital ratio at December 31, 2012, for the Bank was 13.64% and 13.41% at December 31, 2011. 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.

On June 23, 2011 the Board of Directors voted to file a shelf registration (Form S-3) with the SEC (Securities and Exchange Commission).  This shelf registration statement on Form S-3 provides for the offer and sale from time to time over a three year period, in one or more public offerings, up to $10 million in common stock or debt securities. Specific terms and prices will be determined at the time of each offering under a separate prospectus supplement, which will be filed with the SEC at the time of the offering. The registration statement was filed with the SEC on June 23, 2011. The filing of the shelf registration does not require the Company to issue securities. Although the Company has no current commitments to sell additional stock or securities, the shelf registration will provide the Company with a source of additional capital for acquisitions, capital expenditures, repayment of indebtedness the Company may incur in the future, working capital and other general corporate purposes.

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 current 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.

Current 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 December 31, 2012, that the Company and the Bank meet all capital adequacy requirements to which they are subject.

At December 31, 2012 and 2011, the Company and the Bank are 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.

In June 2012, U.S. banking regulators issued the Basel III Notice of Proposed Rulemaking (NPR) to implement the Basel III regulatory capital reforms from the Basel Committee on Banking Supervision and changes required by the Financial Reform Act.  The Basel III NPR proposes material changes to the deduction of certain assets from capital, new minimum capital ratios and buffer requirements, a Standardized Approach that provides a floor to the calculation of risk-weighted assets, and significant changes to the calculation of credit and counterparty credit risk.

The Basel III NPR addressing standardized risk-weighting of assets would significantly change the risk-weighting of certain assets for almost all U.S. financial institutions beginning in 2015.  To what extent the NPR will be adopted as proposed is not known; however, management estimates that the Company would remain a well-capitalized institution under its interpretation of the proposed increased capital requirements and risk-weighted asset revisions if the proposals had been fully in effect as of December 31, 2012.

Many of the changes to capital deductions are subject to a transition period where the impact is recognized in 20% increments beginning on January 1, 2014 through January 1, 2018.  The majority of the other aspects of the Basel III NPR were proposed to become effective on January 1, 2013.  However, this effective date was postponed in November 2012.  The delay is expected to be a six month time period.  The phase-in period for the new minimum capital requirements and related buffers is proposed to occur between 2013 and 2019.

Preparing for the implementation of the new capital rules is a top strategic priority, and management expects to comply with the final rules when issued and effective.  In the meantime, management intends to continue to build capital through retained earnings, actively managing the Company’s portfolios and implementing other capital related initiatives, including focusing on reducing both higher risk-weighted assets and assets proposed to be deducted from capital under the Basel III NPR.

Please see “Notes to Consolidated Financial Statements” for the Company’s and the Bank’s various capital ratios at December 31, 2012.

Elliott Davis

Report of Independent Registered Public Accounting Firm

The Board of Directors
Bank of South Carolina Corporation and Subsidiary

Charleston, South Carolina

We have audited the accompanying consolidated balance sheets of Bank of South Carolina Corporation and Subsidiary (the “Company”) as of December 31, 2012 and 2011, and the related consolidated statements of operations, comprehensive income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2012. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

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

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Bank of South Carolina Corporation and Subsidiary as of December 31, 2012 and 2011, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2012, in conformity with U.S. generally accepted accounting principles.

Charleston, South Carolina
March 4, 2013

BANK OF SOUTH CAROLINA CORPORATION AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

See accompanying notes to consolidated financial statements.

BANK OF SOUTH CAROLINA CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF OPERATIONS