The following is our discussion and analysis of certain significant factors that have affected our financial position and operating results and those of our subsidiaries, Lowcountry National Bank and First National Bank of Nassau County, during the periods included in the accompanying financial statements. This commentary should be read in conjunction with the financial statements and the related notes and the other statistical information included in this report.

This report contains "forward-looking statements" relating to, without limitation, future economic performance, plans and objectives of management for future operations, and projections of revenues and other financial items that are based on the beliefs of management, as well as assumptions made by and information currently available to management. The words "may," "will," "anticipate," "should," "would," "believe," "contemplate," "expect," "estimate," "continue," and "intend," as well as other similar words and expressions of the future, are intended to identify forward-looking statements. Our actual results may differ materially from the results discussed in the forward-looking statements, and our operating performance each quarter is subject to various risks and uncertainties that are discussed in detail in our filings with the Securities and Exchange Commission, including, without limitation:

·

significant increases in competitive pressure in the banking and financial services industries;

·

changes in the interest rate environment which could reduce anticipated or actual margins;

·

changes in political conditions or the legislative or regulatory environment;

·

general economic conditions, either nationally or regionally and especially in our primary service area, becoming less favorable than expected resulting in, among other things, a deterioration in credit quality;

·

changes occurring in business conditions and inflation;

·

changes in technology;

·

the level of allowance for loan loss;

·

the rate of delinquencies and amounts of charge-offs;

·

the rates of loan growth;

·

adverse changes in asset quality and resulting credit risk-related losses and expenses;

·

changes in monetary and tax policies;

·

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

·

changes in the securities markets; and

·

other risks and uncertainties detailed from time to time in our filings with the Securities and Exchange Commission.

Overview

The following discussion describes our results of operations for the quarter ended March 31, 2009 as compared to the quarter ended March 31, 2008 and also analyzes our financial condition as of March 31, 2009 as compared to December 31, 2008. Like most community banks, we derive most of our income from interest we receive on our loans and investments. Our primary source of funds for making these loans and investments is our deposits, on which we pay interest. Consequently, one of the key measures of our success is our amount of net interest income, or the difference between the income on our interest-earning assets, such as loans and investments, and the expense on our interest-bearing liabilities, such as deposits. Another key measure is the spread between the yield we earn on these interest-earning assets and the rate we pay on our interest-bearing liabilities.

Of course, there are risks inherent in all loans, so we maintain an allowance for loan losses to absorb possible losses on existing loans that may become uncollectible. We establish and maintain this allowance by charging a provision for loan losses against our operating income. In the following section we have included a detailed discussion of this process.

In addition to earning interest on our loans and investments, we earn income through fees and other expenses we charge to our customers. We describe the various components of this non-interest income, as well as our non-interest expense, in the following discussion.

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

Critical Accounting Policies

We have adopted various accounting policies which govern the application of accounting principles generally accepted in the United States of America in the preparation of our financial statements. Our significant accounting policies are described in the footnotes to the consolidated financial statements at December 31, 2008, as filed on our annual report on Form 10-K. Certain accounting policies involve significant judgments and assumptions by us which have a material impact on the carrying value of certain assets and liabilities. We consider these accounting policies to be critical accounting policies. The judgments and assumptions we use are based on historical experience and other factors, which we believe to be reasonable under the circumstances. Because of the nature of the judgments and assumptions we make, actual results could differ from these judgments and estimates which could have a material impact on our carrying values of assets and liabilities and our results of operations.

We believe the allowance for loan losses is a critical accounting policy that requires the most significant judgments and estimates used in preparation of our consolidated financial statements. Some of the more critical judgments supporting the amount of our allowance for loan losses include judgments about the credit worthiness of borrowers, the estimated value of the underlying collateral, the assumptions about cash flow, determination of loss factors for estimating credit losses, the impact of current events, and conditions, and other factors impacting the level of probable inherent losses. Under different conditions or using different assumptions, the actual amount of credit losses incurred by us may be different from management's estimates provided in our consolidated financial statements. Refer to the portion of this discussion that addresses our allowance for loan losses for a description of our processes and methodology for determining our allowance for loan losses.

Results of Operations

Net Interest Income

The Bank's net interest income is determined by the level of our earning assets, primarily loans outstanding, and the management of our net interest margin. For the quarter ended March 31, 2009, net interest income totaled $2,434,000 as compared to $2,643,000 for the quarter ended March 31, 2008 for a decrease of $209,000. On a consecutive quarter basis, however, net interest income was up by $231,000, or 10%, from the $2,203,000 earned during the quarter ended December 31, 2008.

Total interest income decreased by $1,114,000, or 17%, to $5,451,000 for the three months ended March 31, 2009 compared to $6,565,000 for the three months ended March 31, 2008. This decline in interest income was due to the combination of an increase in non-performing loans and the declining interest rate environment which more than offset the positive impact of an increase in the overall level of the Bank's earning assets.

Interest income not recognized on non-accruing loans during the quarter ended March 31, 2009 was $405,000, an increase of $315,000 from the $90,000 of interest income not recognized during the same quarter in 2008. On a consecutive quarter basis, interest income not recognized on non-accruing loans increased $37,000 from $368,000 during the quarter ended December 31, 2008.

The impact of the interest rate environment is seen in the Prime interest rate that declined from an average rate of 6.23% during the three month period ended March 31, 2008 to just 3.25% for the same three month period in 2009. This 298 basis point decline in the average Prime interest rate had an extremely negative impact on the yield earned by the Bank on that portion of the loan portfolio that carry rates based on the Prime interest rate index. At March 31, 2009 and 2008 the Bank held $153,565,000 and $171,650,000, respectively, in loans carrying rates based on the Prime interest rate index.

The negative impact of increased non performing loans and decreased rates was partially offset by the positive impact of growth in average interest earning assets, which increased to an average balance of $445,928,000 during the quarter ended March 31, 2009, up by $39,231,000, or 10%, from the average balance during the quarter ended March 31, 2008. This growth was largely the result of increases in the Bank's portfolio of residential mortgage loans and mortgage loans available for sale. The overall impact of these several factors was a decrease of interest and fees on loans by $958,000, or 18%, to $4,450,000 in the three months ended March 31, 2009 from $5,408,000 in the three months ended March 31, 2008. On a consecutive quarter basis, interest and fees on loans decreased by $156,000, or 3%, from $4,606,000 earned during the quarter ended December 31, 2008.

Total interest expense decreased by $906,000, or 23%, to $3,017,000 for the three months ended March 31, 2009 compared to $3,923,000 for the same period in 2008. On a consecutive quarter basis, total interest expense decreased by $346,000, or 10%, from $3,363,000 expensed during the quarter ended December 31, 2008.

The net interest margin is a performance metric that reports how successful the Bank's investment decisions have been relative to its funding choices. It is calculated by dividing the annualized net interest income by the balance of the average earning assets for the period. The net interest margin realized on earning assets declined by 40 basis points to 2.21% for the three months ended March 31, 2009 when compared to the 2.61% net interest margin earned during the same three months in 2008. However, on a consecutive quarter basis, the net interest margin improved by 19 basis points from 2.02% during the quarter ended December 31, 2008.

The net interest rate spread is the difference between the average yield earned by the Bank on loans, investment securities and other earning assets, and the rate paid by the Bank on interest bearing deposits and other borrowings. The net interest rate spread declined by 18 basis points to 1.97% for the three months ended March 31, 2009 compared to the 2.15% net interest rate spread earned during the same three months in 2008. However, on a consecutive quarter basis, the net interest rate spread improved by 37 basis points from 1.60% during the quarter ended December 31, 2008.

Interest Rate Sensitivity and Asset Liability Management

Interest rate sensitivity measures the timing and magnitude of the repricing of assets compared with the repricing of liabilities and is an important part of asset/liability management of a financial institution. The objective of interest rate sensitivity management is to generate stable growth in net interest income, and to control the risks associated with interest rate movements. Management constantly reviews interest rate risk exposure and the expected interest rate environment so that adjustments in interest rate sensitivity can be timely made. Since the assets and liabilities of the Company are primarily monetary in nature (payable in fixed, determinable amounts), the performance of the Company is affected more by changes in interest rates than by inflation. Interest rates generally increase as the rate of inflation increases, but the magnitude of the change in rates may not be the same.

Net interest income is the primary component of net income for financial institutions. Net interest income is affected by the timing and magnitude of repricing of as well as the mix of interest sensitive and noninterest sensitive assets and liabilities. "Gap" is a static measurement of the difference between the contractual maturities or repricing dates of interest sensitive assets and interest sensitive liabilities within the following twelve months. Gap is an attempt to predict the behavior of the Company's net interest income in general terms during periods of movement in interest rates. In general, if the Company is asset sensitive, more of its interest sensitive assets are expected to reprice within twelve months than its interest sensitive liabilities over the same period. In a rising interest rate environment, assets repricing more quickly are expected to enhance net interest income. Alternatively, decreasing interest rates would be expected to have the opposite effect on net interest income since assets would theoretically be repricing at lower interest rates more quickly than interest sensitive liabilities. Although it can be used as a general predictor, gap as a predictor of movements in net interest income has limitations due to the static nature of its definition and due to its inherent assumption that all assets will reprice immediately and fully at the contractually designated time. At March 31, 2009, the Company, as measured by gap, and adjusted for its expectations of changes in interest bearing categories that might not move completely in tandem with changing interest rates, is asset sensitive when measured at three months and liability sensitive when cumulatively measured at one year. Management has several tools available to it to evaluate and affect interest rate risk, including deposit pricing policies and changes in the mix of various types of assets and liabilities. The Company also forecasts its sensitivity to interest rate changes using modeling software.
For more information on asset-liability management, see the annual report on Form 10-K filed with the Securities and Exchange Commission.

Provision and Allowance for Loan Losses

There are risks inherent in making all loans, including risks with respect to the period of time over which loans may be repaid, risks resulting from changes in economic and industry conditions, risks inherent in dealing with individual borrowers, and, in the case of a collateralized loan, risks resulting from uncertainties about the future value of the collateral. We establish and maintain an allowance for loan losses based on, among other things, historical experience, an evaluation of economic conditions, regular reviews of delinquencies and loan portfolio quality and a number of assumptions about future events which we believe to be reasonable, but which may not prove to be accurate.

The provision for loan losses is the periodic charge to operating earnings that management believes is necessary to maintain the allowance for possible loan losses at an adequate level. The amount of these periodic charges is based on management's analysis of the potential risk in the loan portfolio. This analysis includes, among other things, evaluation of the trends in key loan portfolio metrics as follows:

                   March 31,     December 31,     September 30,    June 30,    March 31,     December 31,     September 30,
(in thousands)        2009           2008             2008           2008         2008           2007             2007
Portfolio loans,
gross              $  305,240   $      304,419   $       310,869   $ 307,861   $  296,497   $      281,291   $       283,438

Loans past due
>30 days
and still
accruing
interest           $    2,782   $        9,765   $         7,322   $   3,417   $    3,841   $        2,099   $         1,352

Loans on non
accrual            $   24,336   $       18,213   $         9,639   $   5,005   $    1,929   $        2,018   $         2,850
(as a % of
 loans, gross)          7.97%            5.98%             3.10%       1.63%        0.65%            0.72%             1.01%

Net loan charge
offs
(recoveries)       $    2,188   $        6,195   $           279   $     (1)   $      170   $           46   $            42
(as a % of
 loans, gross)          0.72%            2.04%             0.09%       0.00%        0.06%            0.02%             0.01%

Portfolio loans, gross addresses the impact on the provision for loan losses from changes in the size and composition of our loan portfolio. We apply various reserve factors to our portfolio based on the risk rated categories of loans because we have had relatively little charge off activity prior to the quarter ended December 31, 2008. We establish various reserve percentages based on the relative inherent risk for a particular loan type and grade. The inherent risk is established based on peer group data, information from regulatory agencies, the experience of the Bank's lending officers, and recent trends in portfolio losses. These reserve factors are continuously evaluated and subject to change depending on trends in national and local economic conditions, the depth of experience of the Bank's lenders, delinquency trends and other factors. While our portfolio size has increased modestly over the last four quarters, there has been a shift in composition from higher risk rated real estate construction loans to comparably lower risk rated owner occupied residential real estate loans.

Loans past due > 30 days and still accruing interest has proven to be a useful leading indicator of directional trends in future loan losses. As the level of this metric rises, expectations are for a comparable increase in loans moving into a non-accrual status and ultimately foreclosure resulting in increased losses. This pattern can be observed in the schedule above where increases in this metric are followed in future quarters with comparable sized increases in the level of loans on non-accrual. For this reason management is encouraged with a 72% decline in loans past due > 30 days and still accruing interest from $9,765,000 at December 31, 2008 to $2,782,000 at March 31, 2009, the lowest level since December 31, 2007. While management does not expect to see a decline in loans on non-accrual of a similar magnitude in the next quarter, we believe this metric is a positive indicator that the weakening trend in loan quality experienced over the previous six fiscal quarters may be reaching a point of stabilization and possible improvement.

Loans on non-accrual is another leading indicator of potential future losses from loans. We typically place loans on non-accrual status when they become 90 days past due. Aside from the interest lost when a loan is placed in non-accrual status, the probability of a loan on non-accrual moving into foreclosure with a potential loss outcome is much increased. As shown in the table above, the level of loans on non-accrual had been relatively stable at approximately $2 million during the second half of 2007 and first quarter of 2008. Beginning with the quarter ended June 30, 2008; this metric began to increase significantly, approximately doubling in each of the remaining three fiscal quarters of 2008. At March 31, 2009 the level of loans on non-accrual had reached $24,336,000, an increase from $18,213,000 at December 31, 2008. The quarterly rate of increase of loans on non accrual since March 31, 2008 has been 159%, 93% and 89% at the end of the second, third and fourth fiscal quarters of 2008, respectively. The rate of increase in the first quarter of 2009 was only 34% reflecting a slowing trend in the growth rate of loans on non-accrual. We believe this slowing in the rate of increase is another positive sign that asset quality degradation may be approaching a point of stabilization.

Net Loan Charge offs or recoveries reflect our practice of charging recognized losses to the allowance and adding subsequent recoveries back to the allowance. During the three months ended March 31, 2009 we recorded charge offs net of recoveries of $2,188,000. This was a significant increase when compared to the $170,000 net charge offs recorded during the quarter ended March 31, 2008, but a 65% reduction from the $6,195,000 in net charge offs recorded in the previous quarter ended December 31, 2008. As previously stated, prior to the final fiscal quarter of 2008 we had very little charge off activity and so we are currently assessing the implications of trends in current period charge off activity on potential future losses. While we are further encouraged by such a significant decline in net charge off levels over consecutive quarters, 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. Thus, there is a risk that substantial additional increases in the allowance for loan losses could be required which would result in a decrease in our net income and possibly our capital.

In addition to considering the metrics described above, we evaluate the collectability of individual loans, the balance of impaired loans, economic conditions that may affect the borrower's ability to repay, the amount and quality of collateral securing the loans and a review of specific problem loans. Based on this process and as shown below, the provision charged to expense was $2,930,000 for the three months ended March 31, 2009, as compared to $122,500 for the three months ended March 31, 2008. On a consecutive quarter basis, this provision level was $3,624,000, or 55%, lower than the $6,554,000 provision charged to expense during the quarter ended December 31, 2008.

                     March 31,    December 31,     September 30,     June 30,     March 31,    December 31,     September 30,
(in thousands)         2009           2008             2008            2008         2008           2007             2007
Provision during
quarter ended       $     2,930   $       6,554   $           250   $      896   $       123   $         114   $           181

Provision added
in
excess of net
charge offs         $       742   $         359   $          (29)   $      897   $      (47)   $          68   $           139

Allowance for
loan losses         $     5,575   $       4,833   $         4,474   $    4,503   $     3,606   $       3,653   $         3,585
(as a % of loans,
gross)                    1.83%           1.59%             1.44%        1.46%         1.22%           1.30%             1.26%

The difference between the amount of the provision for loan losses and net loan charge offs will result in expansion or shrinkage to the level of the allowance for loan losses. As shown above, during the three months ended March 31, 2009 the current provision for loan losses of $2,930,000 exceeded net charge offs against the allowance of $2,188,000 by $742,000. The result was an increase to the allowance for loan losses by $742,000 to a level of $5,575,000, or 1.83% of gross loans outstanding at March 31, 2009, as compared to $4,833,000, or 1.59% of gross loans outstanding at December 31, 2008.

From a historical perspective you will note that during the second half of 2007 and first quarter of 2008, while the level of loans on non-accrual was relatively stable, the allowance for loan losses was maintained in the range of 1.2% to 1.3%. Then with the uptick in loans on non accrual during the quarter ended June 30, 2008 it was determined that an increase to the allowance level was appropriate given the projected increased risk of loss, and so the allowance was increased to a range of 1.4% to 1.5% for the second and third fiscal quarters of 2008. The weakening of the loan portfolio performance continued into the final quarter of 2008 with actual loss levels that exceeded projections from earlier in 2008 resulting in the decision to increase the allowance level further, to approximately 1.6%. The most recent quarter ended March 31, 2009 reflects further analysis and projections of potential loan losses in the Bank's existing portfolio and the resultant further increase in the allowance level to in excess of 1.8% of gross loans outstanding.

We believe that the level of the allowance for loan losses at March 31, 2009 will be adequate to absorb probable losses on existing loans that may become uncollectible. Our judgment as to the adequacy of the allowance for loan losses is based upon a number of assumptions about future events, which we believe to be reasonable, but which may or may not prove to be accurate. Our losses will undoubtedly vary from our estimates, and there is a possibility that future charge offs could exceed this allowance level.

Noninterest Income

Noninterest income for the three months ended March 31, 2009 totaled $2,156,000, as compared to $1,078,000 for the three months ended March 31, 2008. The largest increase was in mortgage banking income, which increased $1,906,000 to $2,305,000 for the quarter ended March 31, 2009 compared to $399,000 for the same period of 2008. SBA loan income decreased $93,000 to $43,000 for the first quarter of 2009 compared to $136,000 for the first quarter of 2008. Also, during the first quarter of 2009, we recorded a loss on our investment in common stock of Silverton Financial Services of $507,000. In the first quarter of 2008, sales of securities available for sale contributed a non-recurring gain of $207,000.

Noninterest Expense

Total noninterest expense for the three months ended March 31, 2009 was $4,297,000, as compared to $3,000,000 for the same period in 2008. The largest contributor to this increase was the $1,086,000 in increased noninterest expense, for the same quarters year over year, incurred by the wholesale mortgage banking division. Excluding the impact of the wholesale mortgage banking expenses in both 2009 and 2008, noninterest expense was $2,917,000 and $2,707,000 for the three months ended March 31, 2009 and 2008, respectively, for an increase of $210,000 or 8% from the same period in 2008. Excluding the wholesale mortgage banking division, the community banking divisions experienced a decrease in salaries and benefits of $192,000 during the first quarter of 2009 compared to the same period in 2008. This was more than offset by an increase in FDIC insurance expense of $343,000 during the first quarter 2009 compared to the first quarter 2008.

Wholesale Mortgage Banking Division

The primary source of direct income generated by this division is the gain on sale of mortgage loans which was $2,310,000 for the quarter ended March 31, 2009 compared to $408,000 for the quarter ended March 31, 2008. Attractive mortgage rates caused a surge in mortgage loan refinancing during the first quarter of 2009, leading to above average volume at the wholesale mortgage banking division, and thus, above average gains on sales. The direct noninterest expenses incurred by the wholesale division were $1,380,000 for the first quarter of 2009, an increase of $1,086,000 over the first quarter 2008 expenses of $294,000. The largest contributor to this increase was in salaries and benefits, which were $1,086,000 for first quarter 2009 compared to $157,000 for first quarter 2008.

Beyond the impact of the noninterest income and expense from this division, the Bank earns interest income at the respective note rates on the balance of loans originated by the division from the time the loan is funded until it is sold to a secondary market investor. The average outstanding daily balance of wholesale residential mortgage loans available for sale was $51,031,000 for the three months ended March 31, 2009 and $20,217,000 for the three months ended March 31, 2008. The interest income earned on these loans available for sale was $633,000 and $285,000 during the three months ended March 31, 2009 and 2008, respectively.

Income Taxes

. . .