UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

   X    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2013

____  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from   to  

COMMISSION FILE NUMBER 1-5735

PROVIDENT COMMUNITY BANCSHARES, INC.

(Exact name of registrant as specified in its Charter)

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

2700 Celanese Road, Rock Hill, South Carolina 29732

(Address of Principal Executive Offices)

(803) 325-9400

(Registrant’s telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

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

Yes  X     No __

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes  X     No __

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

Large accelerated filer o	Accelerated filer o
Non-accelerated filer o	Smaller Reporting Company ■

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.) 

Yes __    No  X 

The Corporation had 1,790,599 shares, $0.01 par value, of common stock issued and outstanding as of August 9, 2013.

PROVIDENT COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES

INDEX

Part I.	Financial Information	Page
	Item 1.  Financial Statements
	Consolidated Balance Sheets as of June 30, 2013
	and December 31, 2012	3
	Consolidated Statements of Income (Loss) for the three and six
	months ended June 30, 2013 and 2012	4
	Consolidated Statements of Comprehensive Income (Loss)
	for the six months ended June 30, 2013 and 2012	5
	Consolidated Statements of Cash Flows for the six
	months ended June 30, 2013 and 2012	6
	Consolidated Statements of Changes in Shareholders’ Equity
	for the six months ended June 30, 2013 and 2012	7
	Notes to Consolidated Financial Statements	8
	Item 2. Management’s Discussion and Analysis of
	Financial Condition and Results of Operations	27
	Item 3. Quantitative and Qualitative Disclosures
	about Market Risk	50
	Item 4. Controls and Procedures	50
Part II.	Other Information
	Item 1.   Legal Proceedings	50
	Item 1A. Risk Factors	50
	Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds	50
	Item 3.   Defaults Upon Senior Securities	51
	Item 4.   Mine Safety Disclosures	51
	Item 5.   Other Information	51
	Item 6.   Exhibits	51
	Signatures	52

Part 1.    Financial Information
PROVIDENT COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
June 30, 2013 and December 31, 2012
	June 30,			December 31,
ASSETS	2013			2012
	(Unaudited)			(Audited)
	(DOLLARS IN THOUSANDS)
Cash and due from banks	$	4,254		$	6,230
Interest earning balances with the Federal Reserve		4,251			2,531
Federal funds sold		8,470			20,298
Cash and cash equivalents		16,975			29,059
Investment and mortgage-backed securities-available for sale		180,408			169,214
Loans, net of unearned fees		124,400			127,781
Allowance for loan losses (ALL)		(4,312	)		(4,367	)
Loans, net of ALL		120,088			123,414
Other real estate owned (OREO)		5,182			9,174
Office properties and equipment, net		3,252			3,180
Federal Home Loan Bank stock, at cost		2,107			2,253
Federal Reserve Bank stock, at cost		736			771
Accrued interest receivable		1,232			1,248
Cash surrender value of life insurance		8,335			8,210
Other assets		5,733			3,419
TOTAL ASSETS	$	344,048		$	349,942
LIABILITIES
Demand and savings deposits	$	163,868		$	160,314
Time deposits		113,745			117,167
Total deposits		277,613			277,481
Advances from the Federal Home Loan Bank		37,500			37,500
Securities sold under agreements to repurchase		5,449			6,280
Floating rate junior subordinated deferrable interest debentures		12,372			12,372
Accrued interest payable		1,266			1,148
Other liabilities		3,330			2,953
TOTAL LIABILITIES		337,530			337,734
Commitments and contingencies-Note 5
SHAREHOLDERS' EQUITY
Serial preferred stock - $0.01 par value
authorized - 500, 000 shares
issued and outstanding - 9,266 shares
at June 30, 2013 and December 31, 2012		9,263			9,260
Common stock - $0.01 par value,
authorized - 5,000,000 shares,
issued-2,192,958 and outstanding 1,790,599 shares at June 30, 2013
and December 31, 2012, respectively		20			20
Common stock warrant		25			25
Additional paid-in capital		12,919			12,919
Accumulated other comprehensive loss		(4,541	)		(527	)
Retained deficit, substantially restricted		(4,868	)		(3,189	)
Treasury stock, at cost		(6,300	)		(6,300	)
TOTAL SHAREHOLDERS' EQUITY		6,518			12,208
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY	$	344,048		$	349,942
See notes to consolidated financial statements.

3

PROVIDENT COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (LOSS)
Three and Six Months Ended June 30, 2013 and 2012 (unaudited)
	Three Months Ended						Six Months Ended
	June 30,			June 30,			June 30,			June 30,
	2013			2012			2013			2012
	(DOLLARS IN THOUSANDS EXCEPT PER SHARE)						(DOLLARS IN THOUSANDS EXCEPT PER SHARE)
Interest Income:
Loans	$	1,526		$	1,805		$	3,042		$	3,781
Deposits and federal funds sold		3			5			7			8
Interest on mortgage-backed securities		259			337			462			766
Interest and dividends on investment securities		721			646			1,375			1,244
Total interest income		2,509			2,793			4,886			5,799
Interest Expense:
Deposit accounts		257			340			535			718
Floating rate junior subordinated deferrable interest debentures		63			70			127			141
Advances from the FHLB and other borrowings		370			569			735			1,175
Total interest expense		690			979			1,397			2,034
Net Interest Income		1,819			1,814			3,489			3,765
Provision for loan losses		500			195			500			630
Net interest income after
provision for loan losses		1,319			1,619			2,989			3,135
Non-Interest Income:
Fees for financial services		652			653			1,285			1,265
Other fees, net		5			5			9			10
Net gain on sale of investments		24			286			24			525
Total non-interest income		681			944			1,318			1,800
Non-Interest Expense:
Compensation and employee benefits		1,195			1,037			2,289			2,126
Occupancy and equipment		664			674			1,291			1,280
Deposit insurance premiums		193			211			385			394
Professional services		170			192			335			355
Advertising and public relations		9			14			17			25
OREO and loan operations		711			(65	)		888			76
Items processing		64			69			127			137
Telephone		48			53			90			89
Other		237			223			476			382
Total non-interest expense		3,291			2,408			5,898			4,864
Net (loss) income before income taxes		(1,291	)		155			(1,591	)		71
Expense for income taxes		42			12			85			12
Net (loss) income		(1,333	)		143			(1,676	)		59
Accretion of preferred stock to redemption value and preferred dividends accrued		119			119			235			237
Net (loss) income to common shareholders	$	(1,452	)	$	24		$	(1,911	)	$	(178	)
Net (loss) income per common share (basic)	$	(0.81	)	$	0.01		$	(1.07	)	$	(0.10	)
Net (loss) income per common share (diluted)	$	(0.81	)	$	0.01		$	(1.07	)	$	(0.10	)
Weighted average number of common shares outstanding
Basic		1,790,599			1,790,599			1,790,599			1,790,599
Diluted		1,790,599			1,790,599			1,790,599			1,790,599
See notes to consolidated financial statements.

4

PROVIDENT COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
Three and Six Months Ended June 30, 2013 and 2012 (unaudited)
	Three Months Ended						Six Months Ended
	June 30,			June 30,			June 30,			June 30,
	2013			2012			2013			2012
	(DOLLARS IN THOUSANDS)						(DOLLARS IN THOUSANDS)
Net (loss) income	$	(1,333	)	$	143		$	(1,676	)	$	59
Unrealized gain (loss) from'available for sale securities:
Amounts reclassified from accumulated other comprehensive income (loss):
Unrealized holding gain (loss) arising during the period, pretax		(5,706	)		655			(6,213	)		(618	)
Tax expense (benefit)		1,940			(223	)		2,176			211
Reclassification adjustment for realized gain (loss) in net income (loss)		36			433			35			795
Tax expense (benefit)		(12	)		(147	)		(12	)		(270	)
Other comprehensive income (loss)		(3,742	)		718			(4,014	)		118
Comprehensive (loss) income	$	(5,075	)	$	861		$	(5,690	)	$	177

5

PROVIDENT COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended June 30, 2013 and 2012 (unaudited)
	Six Months Ended
	June 30,			June 30,
	2013			2012
	(IN THOUSANDS)
OPERATING ACTIVITIES:
Net (loss) income	$	(1,676	)	$	59
Adjustments to reconcile net income (loss) to
net cash (used for) provided by operating activities:
Provision for loan losses		500			630
Amortization of securities		569			543
Depreciation expense		164			182
Recognition of deferred income, net of costs		(15	)		(127	)
Deferral of fee income, net of costs		55			129
Gain on investment transactions		(24	)		(525	)
Loss (gain) on OREO sales		258			(97	)
OREO impairment		750			119
Changes in operating assets and liabilities:
Decrease in accrued interest receivable		16			220
Increase in cash surrender value of life insurance		(125	)		(143	)
(Increase) decrease in other assets		(2,314	)		126
Increase in other liabilities		377			208
Increase in accrued interest payable		118			108
Net cash (used for) provided by operating activities		(1,347	)		1,432
INVESTING ACTIVITIES:
Purchase of AFS securities		(91,000	)		(107,426	)
Proceeds from sales of AFS securities		1,774			24,448
Maturities of AFS securities		66,550			86,954
Principal repayment on mortgage-backed securities AFS		6,923			8,598
Net decrease in loans		1,669			12,840
Redemption of FHLB/FRB stock		181			208
Proceeds from sales of OREO, net of costs and improvements		4,101			826
Purchase of office properties and equipment		(236	)		(64	)
Net cash (used) provided by investing activities		(10,038	)		26,384
FINANCING ACTIVITIES:
Decrease in other borrowings		(831	)		(4,429	)
Increase (decrease) in deposit accounts		132			(1,974	)
Net cash used for financing activities		(699	)		(6,403	)
NET INCREASE (DECREASE) IN CASH
AND CASH EQUIVALENTS		(12,084	)		21,413
CASH AND CASH EQUIVALENTS
AT BEGINNING OF PERIOD		29,059			23,893
CASH AND CASH EQUIVALENTS
AT END OF PERIOD	$	16,975		$	45,306
SUPPLEMENTAL DISCLOSURES:
Cash paid for:
Income taxes	$	--		$	--
Interest		1,279			1,926
Non-cash transactions:
Loans foreclosed	$	1,117		$	2,090
Unrealized gain (loss) on securities available for sale, net of income tax		(4,014	)		444
See notes to consolidated financial statements.

6

PROVIDENT COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Six Months Ended June 30, 2013 and 2012 (Unaudited)
													Retained			Accumulated
											Additional		Earnings,			Other			Treasury			Total
	Preferred Stock				Common Stock						Paid-in		Substantially			Comprehensive			Stock			Shareholders'
	Shares		Amount		Shares		Amount		Warrants		Capital		Restricted			Loss			at Cost			Equity
	(Dollars in Thousands, Except Share Data)
BALANCE AT DECEMBER 31, 2011		9,266	$	9,255		1,790,599	$	20	$	25	$	12,919	$	(3,062	)	$	(387	)	$	(6,300	)	$	12,470
Net income														59									59
Comprehensive loss																	118						118
Accretion of Preferred Stock to redemption value				3										(3	)								--
BALANCE AT JUNE 30, 2012		9,266	$	9,258		1,790,599	$	20	$	25	$	12,919	$	(3,006	)	$	(269	)	$	(6,300	)	$	12,647
BALANCE AT DECEMBER 31, 2012		9,266	$	9,260		1,790,599	$	20	$	25	$	12,919	$	(3,189	)	$	(527	)	$	(6,300	)	$	12,208
Net loss														(1,676	)								(1,676	)
Comprehensive loss																	(4,014	)					(4,014	)
Accretion of Preferred Stock to redemption value				3										(3	)								--
BALANCE AT JUNE 30, 2013		9,266	$	9,263		1,790,599	$	20	$	25	$	12,919	$	(4,868	)	$	(4,541	)	$	(6,300	)	$	6,518
See notes to consolidated financial statements

7

PROVIDENT COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

1.           Presentation of Consolidated Financial Statements

The accompanying unaudited consolidated financial statements of Provident Community Bancshares, Inc. (the “Corporation”) and Provident Community Bank, N.A. (the “Bank”) were prepared in accordance with instructions for Form 10-Q and, therefore, do not include all disclosures necessary for a complete presentation of the consolidated financial condition, results of operations, and cash flows in conformity with accounting principles generally accepted in the United States of America. However, all adjustments which are, in the opinion of management, necessary for the fair presentation of the interim consolidated financial statements have been included. All such adjustments are of a normal and recurring nature. The results of operations for the three and six months ended June 30, 2013 are not necessarily indicative of the results which may be expected for the entire calendar year or for any other period. This quarterly report should be read in conjunction with the Corporation’s annual report on Form 10-K for the year ended December 31, 2012. Certain amounts in the prior year’s financial statements have been reclassified to conform to current year classifications.

Recently Issued Accounting Standards

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

The Comprehensive Income topic of the Accounting Standards Codification (“ASC”) was amended in June 2011. The amendment eliminated the option to present other comprehensive income as a part of the statement of changes in stockholders’ equity and required consecutive presentation of the statement of net income and other comprehensive income. The amendments were applicable to the Corporation January 1, 2012 and have been applied retrospectively.  In December 2011, the topic was further amended to defer the effective date of presenting reclassification adjustments from other comprehensive income to net income on the face of the financial statements while the Financial Accounting Standards Board (“FASB”) redeliberated the presentation requirements for the reclassification adjustments. In February 2013, the FASB further amended the Comprehensive Income topic clarifying the conclusions from such redeliberations. Specifically, the amendments do not change the current requirements for reporting net income or other comprehensive income in financial statements. However, the amendments do require an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, in certain circumstances an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income.  The amendments were effective for the Corporation on a prospective basis for reporting periods beginning after December 15, 2012. These amendments did not have a material effect on the Corporation’s financial statements.

In February, 2013, the FASB amended the Liabilities topic to address obligations resulting from joint and several liability arrangements.  The guidance addresses recognition of financial commitments arising from joint and several liability arrangements.  Specifically, the amendments require recognition of financial commitments arising from loans, contracts, and legal rulings if the Corporation can be held liable for the entire claim.  The amendments will be effective for the Corporation for reporting periods beginning after December 15, 2013.  The Corporation does not expect these amendments to have a material effect on its financial statements.

On April 22, 2013, the FASB issued guidance addressing application of the liquidation basis of accounting.  The guidance is intended to clarify when an entity should apply the liquidation basis of accounting.  In addition, the guidance provides principles for the recognition and measurement of assets and liabilities and requirements for financial statements prepared using the liquidation basis of accounting.  The amendments will be effective for entities that determine liquidation is imminent during annual reporting periods beginning after December 15, 2013, and interim reporting periods therein and those requirements should be applied prospectively from the day that liquidation becomes imminent.  Early adoption is permitted.  The Corporation does not expect these amendments to have any effect on its financial statements.

8

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

2. Income (Loss) Per Common Share

Basic income (loss) per common share amounts for the three and six months ended June 30, 2013 and 2012 were computed based on the weighted average number of common shares outstanding during the period. Diluted income (loss) per share adjusts for the dilutive effect of outstanding common stock options and warrants during the periods utilizing the treasury stock method. There were no common stock equivalents included in the diluted loss per share calculation for the three and six months ended June 30, 2013 and 2012 as all outstanding options and warrants had a higher average exercise price than the average market price and were therefore anti-dilutive. Anti-dilutive common stock equivalents that were excluded in the diluted loss per common share calculation for the three and six months ended June 30, 2013 and 2012 were 235,380.

3. Assets Pledged

Approximately $58.9 million and $62.7 million of debt securities at June 30, 2013 and December 31, 2012, respectively, were pledged by the Bank as collateral to secure deposits of the State of South Carolina, and Union, Laurens and York counties along with additional borrowings and repurchase agreements. The Bank pledges as collateral for Federal Home Loan Bank (the “FHLB”) advances commercial and residential real estate mortgage loans under a collateral agreement with the FHLB whereby the Bank maintains, free of other encumbrances, qualifying mortgages (as defined) with unpaid principal balances equal to, when discounted at 75% of the unpaid principal balances, 100% of total advances. As part of the total assets pledged, the Bank will also pledge securities to cover additional advances from the FHLB that exceed the qualifying mortgages balance along with security repurchase lines with various brokerage houses.

9

4. Loans, net

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

	June 30,			December 31,
	2013			2012
Mortgage loans:
Fixed-rate residential	$	5,740		$	6,329
Adjustable-rate residential		3,230			3,376
Commercial real estate		74,383			75,210
Construction		414			59
Total mortgage loans		83,767			84,974
Commercial nonreal estate		9,120			9,024
Consumer loans:
Home equity		13,045			14,063
Consumer and installment		17,100			19,468
Consumer lines of credit		267			267
Total consumer loans		30,412			33,798
Total loans		123,299			127,796
Adjustments:
Unamortized loan discount		(169	)		(181	)
Loans in process		1,141			--
Allowance for loan losses		(4,312	)		(4,367	)
Net deferred loan origination costs		129			166
Total, net	$	120,088		$	123,414
Weighted-average interest rate of loans		4.90	%		5.15	%

Information about impaired loans for the periods ended June 30, 2013 and December 31, 2012 is as follows (in thousands):

	June 30,		December 31,
	2013		2012
Loans receivable for which there is a related allowance for credit losses determined in accordance with ASC 310-10/Statement No. 114	$	4,944	$	5,339
Other impaired loans		15,755		20,508
Total impaired loans	$	20,699	$	25,847
Average monthly balance of impaired loans	$	19,161	$	29,171
Specific allowance for credit losses	$	2,135	$	2,385

10

Impaired Loans

For the Periods Ended June 30, 2013 and December 31, 2012

(in thousands)

June 30, 2013	Unpaid Principal Balance		Recorded Investment		Related Allowance		Average Recorded Investment
With no related allowance recorded:
Commercial
Commercial real estate	$	9,929	$	8,499	$	--	$	9,214
Commercial non real estate		2,353		2,002		--		2,178
Consumer
Consumer – other		3,989		3,036		--		3,513
Consumer - home equity		689		646		--		667
Residential real estate
1-4 Family		1,773		1,572		--		1,672
With a related allowance recorded:
Commercial
Commercial real estate	$	5,597	$	3,340	$	1,273	$	4,468
Commercial non real estate		112		95		47		104
Consumer
Consumer – other		1,778		1,509		815		1,644
Residential real estate
1-4 Family		--		--		--		--
Total:	$	26,220	$	20,699	$	2,135	$	23,460
Commercial		17,991		13,936		1,320		15,964
Consumer		6,456		5,191		815		5,824
Residential		1,773		1,572		--		1,672

11

December 31, 2012	Unpaid Principal Balance		Recorded Investment		Related Allowance		Average Recorded Investment
With no related allowance recorded:
Commercial
Commercial real estate	$	14,778	$	13,273	$	--	$	14,025
Commercial non real estate		2,004		1,680		--		1,842
Consumer
Consumer - other		4,611		3,696		--		4,154
Consumer - home equity		566		536		--		551
Residential real estate
1-4 Family		1,448		1,323		--		1,385
With a related allowance recorded:
Commercial
Commercial real estate	$	5,622	$	3,388	$	1,260	$	4,505
Commercial non real estate		206		189		49		198
Consumer
Consumer – other		1,363		1,354		962		1,358
Residential real estate
1-4 Family		416		408		114		412
Total:	$	31,014	$	25,847	$	2,385	$	28,430
Commercial		22,610		18,530		1,309		20,570
Consumer		6,540		5,586		962		6,063
Residential		1,864		1,731		114		1,797

12

Loans Receivable on Nonaccrual Status

As of June 30, 2013 and December 31, 2012

(in thousands)

	June 30,		December 31,
	2013		2012
Commercial
Commercial real estate	$	6,878	$	8,734
Commercial non real estate		917		835
Consumer
Consumer – other		2,733		2,287
Consumer – automobile		7		19
Consumer – home equity		440		329
Residential real estate
1-4 family		1,228		970
Total	$	12,203	$	13,174

Allowance for Loan Losses and Recorded Investment in Loans Receivable

(in thousands)

			Commercial
	Commercial		Real Estate			Consumer			Residential			Total
June 30, 2013
Allowance for loan losses:
Beginning balance	$	1,040	$	1,675		$	1,301		$	351		$	4,367
Charge-offs		--		(299	)		(337	)		(15	)		(651	)
Recoveries		3		65			22			5			95
Provisions		--		400			204			(104	)		500
Ending balance	$	1,043	$	1,841		$	1,190		$	238		$	4,312
Loans receivable:
Ending balances:
Individually evaluated for impairment	$	2,097	$	11,839		$	5,191		$	1,572		$	20,699
Allowance for loan losses		47		1,273			815			--			2,135
Collectively evaluated for impairment  imprimpairment	$	7,023	$	62,544		$	25,221		$	7,812		$	102,518
Allowance for loan losses		996		568			375			238			2,177
Ending balance	$	9,120	$	74,383		$	30,412		$	9,384		$	123,217
Total allowance for loan losses	$	1,043	$	1,841		$	1,190		$	238		$	4,312

13

				Commercial
	Commercial			Real Estate			Consumer			Residential			Total
December 31, 2012
Allowance for loan losses:
Beginning balance	$	1,887		$	1,920		$	484		$	258		$	4,549
Charge-offs		(118	)		(339	)		(576	)		(8	)		(1,041	)
Recoveries		52			94			5			4			155
Provisions		(781	)		--			1,388			97			704
Ending Balance	$	1,040		$	1,675		$	1,301		$	351		$	4,367
Loans receivable:
Ending balances:
Individually evaluated for impairment	$	1,869		$	16,661		$	5,586		$	1,731		$	25,847
Allowance for loan losses		49			1,260			962			114			2,385
Collectively evaluated for impairment  imprimpairment	$	7,155		$	58,549		$	28,212		$	8,033		$	101,949
Allowance for loan losses		991			415			339			237			1,982
Ending balance	$	9,024		$	75,210		$	33,798		$	9,764		$	127,796
Total allowance for loan losses	$	1,040		$	1,675		$	1,301		$	351		$	4,367

14

Credit Quality Indicators

As of June 30, 2013 and December 31, 2012

(in thousands)

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

Commercial Credit Exposure (1)

Credit Risk Profile by Creditworthiness Category

	Commercial non real estate				Commercial real estate
	June 30,		December 31,		June 30,		December 31,
	2013		2012		2013		2012
Grade 1 Superior quality	$	53	$	58	$	--	$	--
Grade 2 Good quality		--		--		--		--
Grade 3 Satisfactory		215		209		6,565		7,238
Grade 4 Acceptable		3,379		4,148		25,928		24,844
Grade 5 Watch		2,631		2,433		27,316		23,762
Grade 6 Special mention		1,165		1,125		3,930		6,860
Grade 7 Substandard		1,582		957		9,394		11,256
Grade 8 Doubtful		95		94		1,250		1,250
Total	$	9,120	$	9,024	$	74,383	$	75,210

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

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

Consumer Credit Exposure (1)

Credit Risk Profile by Internally Assigned Grade

	Residential				Consumer
	June30,		December 31,		June 30,		December 31,
	2013		2012		2013		2012
Grade:
Pass	$	7,619	$	7,905	$	25,470	$	27,976
Special mention		383		732		791		1,366
Substandard		1,382		1,127		4,151		4,456
Total	$	9,384	$	9,764	$	30,412	$	33,798

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

Consumer Credit Exposure (1)

Credit Risk Profile Based on Payment Activity

													Residential real estate
	Other				Consumer automobile				Home equity				1-4 family
	June 30,		December 31,		June 30,		December 31,		June 30,		December 31,		June 30,		December 31,
	2013		2012		2013		2012		2013		2012		2013		2012
Performing	$	13,843	$	16,676	$	784	$	753	$	12,605	$	13,734	$	8,156	$	8,794
Nonperforming		2,733		2,287		7		19		440		329		1,228		970
Total	$	16,576	$	18,963	$	791	$	772	$	13,045	$	14,063	$	9,384	$	9,764

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

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Loans graded one through five are considered “pass” credits.  As of June 30, 2013, approximately 80% of the loan portfolio was considered pass credits.  For loans to qualify for these grades, they must be performing relatively close to expectations, with no significant departures from the intended source and timing of repayment.

Loans with a credit grade of six are not considered classified; however they are categorized as a special mention or watch list credit. This classification is utilized by us when we have an initial concern about the financial health of a borrower. These loans are designated as such in order to be monitored more closely than other credits in our portfolio. We then gather current financial information about the borrower and evaluate our current risk in the credit. We will then either reclassify the loan as “substandard” or back to its original risk rating after a review of the information. There are times when we may leave the loan on the watch list, if, in management’s opinion, there are risks that cannot be fully evaluated without the passage of time, and we determine to review the loan on a more regular basis. Loans on the watch list are not considered problem loans until they are determined by management to be classified as substandard. As of June 30, 2013, we had loans totaling $6.3 million rated as Special Mention.

Loans graded seven or greater are considered classified credits. Loans classified as substandard are inadequately protected by the current sound worth and paying capacity of the borrower or of the collateral pledged. The loan has well-defined weaknesses that jeopardize the liquidation value and has the distinct possibility that the Corporation will sustain some loss if the deficiencies are not corrected. Loans classified as doubtful have the weaknesses of Substandard but have additional factors that make collection or liquidation in full highly questionable and improbable. At June 30, 2013, classified loans totaled $17.9 million, with all but one loan being collateralized by real estate. This compares to classified loans of $19.1 million at December 31, 2012. Classified credits are evaluated for impairment on a quarterly basis.

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The following are past due loans for the Corporation’s loans receivable for the periods ended June 30, 2013 and December 31, 2012 (in thousands).

					Greater
	30 -59 Days		60 - 89 Days		Than		Total Past				Total Loans
	Past Due		Past Due		90 Days		Due		Current		Receivable
June 30, 2013
Commercial:
Commercial non real estate	$	75	$	64	$	854	$	993	$	8,127	$	9,120
Commercial real estate		931		1,459		4,536		6,926		67,457		74,383
Consumer:
Consumer – other		635		322		1,161		2,118		14,458		16,576
Consumer – automobile		2		3		2		7		784		791
Consumer – home equity		148		--		163		311		12,734		13,045
Residential 1-4 family		156		162		278		596		8,788		9,384
Total	$	1,947	$	2,010	$	6,994	$	10,951	$	112,348	$	123,299

December 31, 2012
Commercial:
Commercial non real estate	$	146	$	110	$	646	$	902	$	8,122	$	9,024
Commercial real estate		2,525		482		6,047		9,054		66,156		75,210
Consumer:
Consumer – other		638		419		1,045		2,102		16,861		18,963
Consumer – automobile		11		5		3		19		753		772
Consumer – home equity		157		7		168		332		13,731		14,063
Residential 1-4 family		259		406		970		1,635		8,129		9,764
Total	$	3,736	$	1,429	$	8,879		14,044	$	113,752	$	127,796

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Troubled Debt Restructurings

As a result of adopting the amendments in ASU 2011-02, the Corporation reassessed all restructurings that occurred on or after the beginning of the fiscal year of adoption (January 1, 2011) to determine whether they were considered troubled debt restructurings (TDRs) under the amended guidance. The Corporation identified as TDRs certain loans for which the allowance for loan losses had previously been measured under a general allowance methodology. Upon identifying those loans as TDRs, the Corporation identified them as impaired under the guidance in ASC 310-10-35. The amendments in ASU 2011-02 require prospective application of the impairment measurement guidance in ASC 310-10-35 for those loans newly identified as impaired. At June 30, 2013, the recorded investment in loans for which the allowance was previously measured under a general allowance methodology and are now impaired under ASC 310-10-35 was $3.9 million, and the allowance for loan losses associated with those loans, on the basis of a current evaluation of loss was $238,000. The following are loan modifications for the Corporation’s loans receivable for the three and six month periods ended June 30, 2013.

	Three Months Ended June 30, 2013					Six Months Ended June 30, 2013
		Pre		Post			Pre		Post
		Modification		Modification			Modification		Modification
	Number	Outstanding		Outstanding		Number	Outstanding		Outstanding
Troubled Debt Restructurings	of New	Recorded		Recorded		of New	Recorded		Recorded
Added during current period	Contracts	Investment		Investment		Contracts	Investment		Investment
	(in thousands)					(in thousands)
Commercial:
Commercial non real estate	-	$	--	$	--	--	$	--	$	--
Commercial real estate	2		326		326	2		326		326
Consumer:
Consumer – other	2		261		261	3		346		341
Residential 1-4 family	1		49		49	1		49		49
Total	5	$	636	$	636	6	$	721	$	716
	Three Months Ended June 30, 2013					Six Months Ended June 30, 2013
		Post					Post
		Modification					Modification
	Number	Outstanding		Defaulted		Number	Outstanding		Defaulted
Troubled Debt Restructurings	of New	Recorded		Recorded		of New	Recorded		Recorded
Defaulted during the period	Contracts	Investment		Investment		Contracts	Investment		Investment
Added since last twelve months	(in thousands)
Commercial:
Commercial non real estate	--	$	--	$	--	--	$	--	$	--
Commercial real estate	--		--		--	--		--		--
Consumer:
Consumer – other	2		187		187	2		187		187
Total	2	$	187	$	187	2	$	187	$	187

During the six months ended June 30, 2013, the Corporation modified 6 loans that were considered to be troubled debt restructurings. We extended the terms for 6 of these loans and the interest rate was lowered for 2 of these loans. During the six months ended June 30, 2013, the Corporation had 2 loans default that had previously been restructured. A default occurs when a loan does not perform as agreed under the new terms to the point it becomes 90 days or more past due.

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5. Contingencies and loan commitments

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

The Corporation’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is represented by the contractual amount of those instruments. The Corporation uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. Total credit exposure at June 30, 2013 related to these items is summarized below:

Loan Commitments:	Contract Amount
Unused portions of loans and credit lines	$	14,076,000

Loan commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Loan commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained upon extension of credit is based on management’s credit evaluation of the counter party. Collateral held is primarily residential and commercial property. Total loan commitments outstanding at June 30, 2013 consisted of fixed and adjustable rate loans at rates ranging from 4.5% to 6.5%.

6. Fixed/Floating Rate Junior Subordinated Deferrable Interest Debentures

On July 18, 2006, the Corporation sponsored the creation of Provident Community Bancshares Capital Trust I (“Capital Trust I”). The Corporation is the owner of all of the common securities of Capital Trust I.  On July 21, 2006, Capital Trust I issued $4,000,000 in the form of floating/fixed rate capital securities through a pooled trust preferred securities offering.  The proceeds from this issuance, along with the Corporation’s $124,000 capital contribution for Capital Trust I’s common securities, were used to acquire $4,124,000 aggregate principal amount of the Corporation’s floating rate junior subordinated deferrable interest debentures due October 1, 2036 (the “Debentures”), which constitute the sole asset of Capital Trust I. The interest rate on the Debentures and the capital securities is variable and adjustable quarterly at 1.74% over the three-month LIBOR. The Corporation has, through the Trust Agreement establishing Capital Trust I, the Guarantee Agreement, the notes and the related Debenture, taken together, fully irrevocably and unconditionally guaranteed all of the Capital Trust I obligations under the capital securities.

On November 28, 2006, the Corporation sponsored the creation of Provident Community Bancshares Capital Trust II (“Capital Trust II”). The Corporation is the owner of all of the common securities of Capital Trust II. On December 15, 2006, Capital Trust II issued $8,000,000 in the form of floating rate capital securities through a pooled trust preferred securities offering. The proceeds of Capital Trust II were utilized for the redemption of Union Financial Bancshares Statutory Trust (the “Trust”) issued on December 18, 2001. The proceeds from this issuance, along with the Corporation’s $247,000 capital contribution for Capital Trust’s II common securities, were used to acquire $8,247,000 aggregate principal amount of the Corporation’s floating rate junior subordinated deferrable interest debentures due March 1, 2037 (the “Debentures”), which constitute the sole asset of  Capital Trust II.  The interest rate on the Debentures and the capital securities is variable and adjustable quarterly at 1.74% over the three-month LIBOR. The Corporation has, through the Trust agreement establishing Capital Trust II, the Guarantee Agreement, the notes and the related Debenture, taken together, fully irrevocably and unconditionally guaranteed all of Capital Trust II obligations under the capital securities.

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The Corporation exercised its right on July 22, 2010 to defer the payment of interest on its outstanding subordinated debentures for an indefinite period (which can be no longer than 20 consecutive quarterly periods). Further, pursuant to a written agreement between the Corporation and the Federal Reserve, the Corporation cannot pay any dividends on its subordinated debentures without the prior written consent of the Federal Reserve Bank. This and any future deferred distributions will continue to accrue interest at a current rate of  LIBOR+1.74% for the $4.0 million of trust preferred securities issued in July 2006 and at a current rate of LIBOR+1.74% for the $8.0 million of trust preferred securities issued in December 2006. Distributions on the trust preferred securities are cumulative. Therefore, in accordance with generally accepted accounting principles, the Corporation will continue to accrue the monthly cost of the trust preferred securities as it has since issuance. Total interest deferred to date is $1.1 million.

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

	Amount Outstanding at June 30,
Name	2013		2012		Rate			Maturity	Distribution Payment Frequency
Provident Community Bancshares Capital Trust I	$	4,000,000	$	4,000,000		2.02	%	October 1, 2036	Quarterly
Provident Community  Bancshares Capital Trust II		8,000,000		8,000,000		2.02	%	March 1, 2037	Quarterly
Total	$	12,000,000	$	12,000,000

The above debentures are subject to redemption at par at the option of the Corporation, subject to prior regulatory approval, in whole or in part on any interest payment date.

7. Fair Value of Financial Instruments

The Corporation utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Effective January 1, 2008, the Corporation adopted FASB 157 (ASC 820-10-15), Fair Value Measurements, which provides a framework for measuring and disclosing fair value under generally accepted accounting principles. This standard requires disclosures about the fair value of assets and liabilities recognized in the balance sheet in periods subsequent to initial recognition, whether the measurements are made on a recurring basis (for example, available-for-sale investment  securities) or on a nonrecurring basis (for example, impaired loans).

Fair Value Hierarchy

ASC 820-10-15 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. ASC 820-10-15 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

20

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

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

Investment Securities Available-for-Sale

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

Loans

The Corporation is predominantly an asset based lender with real estate serving as collateral on a substantial majority of loans. The Corporation does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and the related impairment is charged against the allowance or a specific allowance is established. The Corporation performs its allowance for loan and lease losses calculation on a quarterly basis, which also includes an evaluation of all nonperforming loans for further impairment even if a new appraisal is not obtained on a quarterly basis. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Loans which are deemed to be impaired are primarily valued at the fair values of the underlying real estate collateral. Such fair values are obtained using collateral net liquidation value, market value of similar debt, enterprise value, and discounted cash flows. Those impaired loans not requiring a specific allowance represent loans for which the fair value of the expected repayment or collateral meet or exceed the recorded investment in such loans. The Corporation considers all nonaccrual loans and troubled debt restructurings to be impaired. When the fair value of the collateral is based on an observable market price or a current appraised value, the Corporation records the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Corporation records the impaired loans as nonrecurring Level 3. Certain assumptions and unobservable inputs are currently being used by appraisers, therefore qualifying impaired loans as Level 3. Consistent with the regulator’s appraisal guidance dated December 10, 2010, the Corporation has adopted a loan reappraisal policy.  The regulatory guidance states that a bank should establish criteria for assessing whether an existing appraisal or evaluation continues to reflect the market value of the property.  Generally, impaired loans will be evaluated using an existing appraisal if the valuation has been established within the previous twelve months. However, market conditions may dictate an updated appraisal for a lesser timeframe. Factors include deterioration in the credit since origination or changes in market conditions. Changes in market conditions could include material changes in current and projected vacancy, absorption rates, lease terms, rental rates, and sale prices, including concessions and overruns and delays in construction costs.  Fluctuations in discount or direct capitalization rates also are indicators of changing market conditions. In assessing whether changes in market conditions are material, the Bank considers the individual and aggregate effect of these changes on its collateral protection and the risk in its real estate lending program or credit portfolios.

21

Real Estate Acquired Through Foreclosure

Other real estate owned (“OREO”) is adjusted to fair value upon transfer of the loans to OREO. Subsequently, OREO is carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. Certain assumptions and unobservable inputs are currently being used by appraisers, therefore qualifying these assets as Level 3.

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

The following tables present the balances of assets recorded at fair value on a recurring basis by level within the hierarchy as of June 30, 2013 and December 31, 2012 (in thousands).

			Quoted Prices in		Significant Other		Significant
	Total		Active Markets for		Observable		Unobservable
	June 30,		Identical Assets		Inputs		Inputs
	2013		(Level 1)		(Level 2)		(Level 3)
Investment Securities:
Government Sponsored Enterprises	$	121,055	$	121,055	$	--	$	--
Trust Preferred Securities		4,247		--		2,554		1,693
Total Investment Securities		125,302		121,055		2,554		1,693
Mortgage-Backed and       Related Securities		55,106		--		55,106		--
Total	$	180,408	$	121,055	$	57,660	$	1,693

			Quoted Prices in		Significant Other		Significant
	Total		Active Markets for		Observable		Unobservable
	December 31,		Identical Assets		Inputs		Inputs
	2012		(Level 1)		(Level 2)		(Level 3)
Investment Securities:
Government Sponsored Enterprises	$	123,679	$	123,679		--		--
Trust Preferred Securities		4,335		--		2,788		1,547
Total Investment Securities		128,014		123,679		2,788		1,547
Mortgage-Backed and       Related Securities		41,200		--		41,200		--
Total	$	169,214	$	123,679	$	43,988	$	1,547

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The following is a reconciliation of the beginning and ending balances for assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the period ended June 30, 2013.

	Fair Value Measurements Using Significant
	Unobservable Inputs (Level 3)
	(in thousands)
Investment Securities
	Available-for-Sale
Beginning balance at March 31, 2013	$	1,820
Transfers into Level 3		--
Total gains/ (losses) included in:
Net loss		--
Other comprehensive income		(123	)
Purchases, sales, issuances and settlements, net		(4	)
Ending balance at June 30, 2013	$	1,693
	Fair Value Measurements Using Significant
	Unobservable Inputs (Level 3)
	(in thousands)
Investment Securities
	Available-for-Sale
Beginning balance at December 31, 2012	$	1,547
Transfers into Level 3		--
Total gains/ (losses) included in:
Net loss		--
Other comprehensive income		150
Purchases, sales, issuances and settlements, net		(4	)
Ending balance at June 30, 2013	$	1,693

Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis

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

For Level 3 assets and liabilities measured at fair value on a recurring or nonrecurring basis as of June 30, 2013, the significant unobservable inputs used in the fair value measurements were as follows: (in thousands)

	Fair Value at June 30,  2013		Valuation Technique	Significant Unobservable Inputs	General Range Of Significant Unobservable Input Values
Impaired loans	$	18,564	Appraised Value/ Discounted Cash Flows Market Value of Note	Appraisals and/or sales of comparable properties/ Independent quotes		0-25	%
Other  real estate owned		5,182	Appraised Value/ Comparable Sales/ Other Estimates from Independent Sources	Appraisals and/or sales of comparable properties/ Independent quotes		0-40	%
Assets at fair value	$	23,746

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For Level 3 assets and liabilities measured at fair value on a recurring or nonrecurring basis as of December 31, 2012, the significant unobservable inputs used in the fair value measurements were as follows: (in thousands)

	Fair Value at December 31, 2012		Valuation Technique	Significant Unobservable Inputs	General Range Of Significant Unobservable Input Values
Impaired loans	$	23,462	Appraised Value/ Discounted Cash Flows Market Value of Note	Appraisals and/or sales of comparable properties/ Independent quotes		0-25	%
Other real estate owned		9,174	Appraised Value/ Comparable Sales/ Other Estimates from Independent Sources	Appraisals and/or sales of comparable properties/ Independent quotes		0-40	%
Asets at fair value	$	32,636

Level 3 Valuation Methodologies. Following is a description of the unobservable inputs used for Level 3 fair value measurements.

Impaired Loans. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Loans which are deemed to be impaired are primarily valued at the fair values of the underlying real estate collateral. Such fair values are obtained using collateral net liquidation value, market value of similar debt, enterprise value, and discounted cash flows. Those impaired loans not requiring a specific allowance represent loans for which the fair value of the expected repayment or collateral meet or exceed the recorded investment in such loans. The Corporation considers all nonaccrual loans and troubled debt restructurings to be impaired. When the fair value of the collateral is based on an observable market price or a current appraised value, the Corporation records the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Corporation records the impaired loans as nonrecurring Level 3. Certain assumptions and unobservable inputs are currently being used by appraisers, therefore qualifying impaired loans as Level 3. Impaired loan totals represent nonperforming loans for the periods indicated.

OREO is adjusted to fair value upon transfer of the loans to OREO. Subsequently, OREO is carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. Certain assumptions and unobservable inputs are currently being used by appraisers, therefore qualifying these assets as Level 3.

Investment Securities: Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange and U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets. Level 2 securities include mortgage-backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. Securities classified as Level 3 may include asset-backed securities in less liquid markets.

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

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

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

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

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

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

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

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

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

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

Off-balance-sheet instruments - Fair values for off-balance-sheet lending commitments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counter parties’ credit standings.

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The following presents the carrying amount, fair value, and placement in the fair value hierarchy of the Corporation’s financial instruments as of June 30, 2013 and December 31, 2012.  This table excludes financial instruments for which the carrying amount approximates fair value.  For short-term financial assets such as cash and cash equivalents, the carrying amount is a reasonable estimate of fair value due to the relatively short time between the origination of the instrument and its expected realization.  For financial liabilities such as noninterest-bearing demand, interest-bearing demand, and savings deposits, the carrying amount is a reasonable estimate of fair value due to these products having no stated maturity.

					Fair Value Measurements
					Quoted
					Prices in
					Active Markets		Significant
					for Identical		Other		Significant
					Assets or		Observable		Unobservable
	Carrying				Liabilities		Inputs		Inputs
(dollars in thousands)	Amount		Fair Value		(Level 1)		(Level 2)		(Level 3)
June 30, 2013
Financial Instruments - Assets
Loans	$	120,088	$	120,040		--		--	$	120,040
Financial Instruments – Liabilities
Time deposits	$	113,745	$	114,166	$	--	$	114,166	$	--
Securities sold under agreements
to repurchase		5,449		5,449		--		5,449		--
Subordinated debentures		12,372		12,372		--		12,372		--
December 31, 2012
Financial Instruments - Assets
Loans	$	123,414	$	123,553		--		--	$	123,553
Financial Instruments – Liabilities
Time deposits	$	117,167	$	117,723	$	--	$	117,723	$	--
Securities sold under agreements
to repurchase		6,280		6,280		--		6,280		--
Subordinated debentures		12,372		12,372		--		12,372		--

8. Preferred Stock

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

The Corporation may redeem the preferred stock at its liquidation preference plus accrued and unpaid dividends at any time with prior regulatory approval.

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Under the terms of the TARP Preferred Stock, the Corporation is required to pay on a quarterly basis a dividend rate of 5% per year for the first five years, after which the dividend rate automatically increases to 9% per year.  Dividend payments may be deferred, but the dividend is cumulative and failure to pay dividends for six dividend periods may trigger board appointment rights for the holder of the TARP Preferred Stock. The Corporation exercised its right on July 22, 2010 to defer its regular quarterly cash dividend on its TARP Preferred Stock. Total deferred dividends to date are $1.2 million. No action has been taken by the holder of the TARP Preferred Stock regarding board appointments.

9. Subsequent Events

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

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

Critical Accounting Policies

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

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

The Corporation’s critical accounting policies are listed below:

Allowance for Loan Losses

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

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

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

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

Loans are placed on nonaccrual status depending upon the type of loan, the past due status, and the collections activities in progress. Well-secured loans, in the process of collection, remain on an accrual basis until they become 90 days past due. Partially secured loans are written down to the collateral value and placed on nonaccrual status on or before becoming 90 days past due. Unsecured commercial loans are charged off on or before the date they become 90 days past due. Consumer loans are charged off or written down to the fair value of collateral on or before becoming 90 days past due. A past due loan may not be considered impaired if it is expected the delay in payment is minimal. Interest payments are applied to the principal balance on nonaccrual loans.

All interest accrued but not collected for loans that are placed on nonaccrual status or charged off are reversed against interest income.  The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

A loan is considered impaired when, in management’s judgment, based on current information and events, it is probable that the Corporation will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Management determines when loans become impaired through its normal loan administration and review functions. Loans identified as nonaccrual are potentially impaired loans.

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Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired, provided that management expects to collect all amounts due, including interest accrued at the contractual interest rate for the period of delay. Impairment is measured on a loan by loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent. Large groups of smaller balance homogeneous loans are collectively evaluated for loss and a general reserve is established accordingly.

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

Fair Value Measurements

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

Other-Than-Temporary Impairment

The evaluation and recognition of other-than-temporary impairment ("OTTI") on certain investments including our trust preferred securities and other corporate debt security holdings require significant judgment and estimates. Some of the more critical judgments supporting the evaluation of OTTI include projected cash flows including prepayment assumptions, default rates and severities of losses on the underlying collateral within the security.

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Income Taxes

Some of the more critical judgments supporting the deferred tax asset amount include judgments about the recovery of these accrued tax benefits.  Deferred income tax assets are recorded to reflect the tax effect of the difference between the book and tax basis of assets and liabilities. These differences result in future deductible amounts that are dependent on the generation of future taxable income through operations or the execution of tax planning strategies. Due to the doubt of our ability to utilize the portion of the deferred tax asset that is not able to be offset against net operating loss carry backs and reversals of future taxable temporary differences projected to occur, management established a valuation allowance of $8.0 million to reduce the recorded deferred tax asset to a net realizable value.

Forward Looking Statements

Management’s discussion and analysis of financial condition and results of operations and other portions of this Form 10-Q may contain certain “forward-looking statements” concerning the future operations, plans or strategies of the Corporation and the Bank. These forward-looking statements are generally identified by the use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project,” or similar expressions. Management intends to take advantage of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and is including this statement for the express purpose of availing the Corporation of the protections of such safe harbor with respect to all forward-looking statements contained in this report. Management’s ability to predict results or the effect of future plans or strategies is inherently uncertain. Factors which could affect actual results include interest rate trends, the general economic climate in the Corporation’s and the Bank’s market area and the country as a whole, real estate values in the Bank’s market area, the ability of the Corporation and the Bank to control costs and expenses, competitive products and pricing and the demand for such products, loan delinquency rates, the quality and composition of the loan and investment portfolios, changes in accounting principles and guidelines and changes in federal and state laws and regulations. The Corporation provides greater detail regarding some of these factors in its Form 10-K for the year ended December 31, 2012, including in the Risk Factors section of that report, and in its other SEC reports. These factors should be considered in evaluating the forward-looking statements, and undue reliance should not be placed on such statements.

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

Financial Condition

Assets

Assets decreased $5.9 million, or 1.7%, to $344.0 million at June 30, 2013 from $349.9 million at December 31, 2012. The decrease in assets was due primarily to the reduction in cash and cash equivalents, loans and other real estate owned, offset by an increase in securities. Net loans decreased $3.3 million from December 31, 2012 to June 30, 2013, due primarily to a significant reduction in loan demand as a result of economic conditions in South Carolina and more stringent underwriting standards. Investment securities at June 30, 2013 increased $11.2 million, or 6.6%, to $180.4 million from $169.2 million at December 31, 2012, primarily due to a increase in mortgage-backed securities, offset by a decrease in securities of government sponsored enterprises. Federal funds sold at June 30, 2013 decreased $11.8 million to $8.5 million from $20.3 million at December 31, 2012 as such funds were used to purchase mortgage-backed securities.

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The Corporation uses the investment securities portfolio for several purposes. It serves as a vehicle to manage interest rate and prepayment risk, to generate interest and dividend income from investment of funds, to provide liquidity to meet funding requirements, and to provide collateral for pledges on public funds and FHLB borrowings. The average yield on investments at June 30, 2013 was 2.11% compared to 1.90% at December 31, 2012.

The carrying values of the investment securities at June 30, 2013 and December 31, 2012 and percentage of each category to total investments are as follows: (dollars in thousands)

	June 30, 2013					December 31, 2012
Available for sale:	Fair Value		Percent of Portfolio			Fair Value		Percent of Portfolio
Investment Securities:
Government Sponsored Enterprises	$	121,055		67.10	%	$	123,679		73.09	%
Trust Preferred Securities		4,247		2.35			4,335		2.56
Total Investment Securities		125,302		69.45			128,014		75.65
Mortgage-Backed Securities		55,106		30.55			41,200		24.35
Total	$	180,408		100.00	%	$	169,214		100.00	%

The Corporation accounts for investment securities in accordance with FASB ASC Topic 320: Investments in Debt and Equity Securities. In accordance with FASB ASC Topic 320, debt securities that the Corporation has the positive intent and ability to hold to maturity are classified as “held to maturity” securities and reported at amortized cost. Debt and equity securities that are bought and held principally for the purpose of selling in the near term are classified as “trading” securities and reported at fair value, with unrealized gains and losses included in earnings.  Debt and equity securities not classified as either held to maturity or trading securities are classified as “available for sale” securities and reported at fair value with unrealized gains and losses excluded from earnings and reported as a separate component of shareholders’ equity. All securities were classified as available for sale at June 30, 2013.

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

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

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

	As of June 30, 2013
	Amortized		Gross Unrealized					Fair
	Cost		Gains		Losses			Value
Investment Securities:
Government Sponsored Enterprises	$	124,617	$	77	$	(3,639	)	$	121,055
Trust Preferred Securities		5,825		5		(1,583	)		4,247
Total Investment Securities		130,442		82		(5,222	)		125,302
Mortgage-Backed Securities:
Fannie Mae		28,336		37		(1,534	)		26,839
Ginnie Mae		15,585		11		(246	)		15,350
Freddie Mac		12,738		36		(141	)		12,633
Collateralized Mortgage Obligations		294		--		(10	)		284
Total Mortgage-Backed Securities		56,953		84		(1,931	)		55,106
Total Available for Sale	$	187,395	$	166	$	(7,153	)	$	180,408

	As of December 31, 2012
	Amortized		Gross Unrealized					Fair
	Cost		Gains		Losses			Value
Investment Securities:
Government Sponsored Enterprises	$	123,381	$	324	$	(26	)	$	123,679
Trust Preferred Securities		5,828		--		(1,493	)		4,335
Total Investment Securities		129,209		324		(1,519	)		128,014
Mortgage-Backed Securities:
Fannie Mae		11,950		72		(20	)		12,002
Ginnie Mae		16,726		101		(72	)		16,755
Freddie Mac		11,822		297		(--	)		12,119
Collateralized Mortgage Obligations		317		7		(--	)		324
Total Mortgage-Backed Securities		40,815		477		(92	)		41,200
Total Available for Sale	$	170,024	$	801	$	(1,611	)	$	169,214

The maturities of securities at June 30, 2013 are as follows (in thousands):

	Available for Sale
	Amortized Cost		Fair Value
Due in one year or less	$	4	$	4
Due after one year through five years		3		3
Due after five years through ten years		41,817		39,926
Due after ten years		145,571		140,475
Total Investment and Mortgage-Backed Securities	$	187,395	$	180,408

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The following table shows gross unrealized losses and fair value, aggregated by investment category, and length of time that individual securities have been in a continuous unrealized loss position at June 30, 2013 (in thousands).

	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Available for Sale
Government Sponsored Enterprises	$	118,675	$	3,639	$	–	$	–	$	118,675	$	3,639
Trust Preferred Securities		–		–		3,081		1,583		3,081		1,583
Mortgage-Backed
Securities		42,646		1,898		1,802		33		44,448		1,931
Total	$	161,321	$	5,537	$	4,883	$	1,616	$	166,204	$	7,153

The following table shows gross unrealized losses and fair value, aggregated by investment category, and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2012 (in thousands).

	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Available for Sale
Government Sponsored Enterprises	$	19,337	$	26	$	–	$	–	$	19,337	$	26
Trust Preferred Securities		–		–		4,335		1,493		4,335		1,493
Mortgage-Backed
Securities		8,665		79		2,149		13		10,814		92
Total	$	28,002	$	105	$	6,484	$	1,506	$	34,486	$	1,611

Management reviews securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. The Corporation reviews several items in determining whether its trust preferred securities are other than temporarily impaired.  These items include a valuation of the securities; an analysis of cash flows following the guidance in ASC 320-10-35 to measure credit loss for OTTI purposes; a stress analysis; a summary of deferrals and defaults of the individual issues in the pool; and information regarding the issuers in the pool.  A detailed description of each of these items of evidence is provided below.

Valuation of Securities – The first item reviewed is the fair market value of the security.  If the security is in an unrealized loss position, the Corporation proceeds to analyze the security for OTTI.  The pricing of securities is performed by a third party and is considered Level III pricing.

Cash flow analysis – A cash flow analysis following the guidance in ASC 320-10-35 is the primary evidence utilized in determining whether there is a credit-related issue with respect to the security. The basic methodology is to calculate the present value of the cash flows using a current effective yield. This calculation uses assumptions for default rates, prepayment speeds and discount rates. We have used 0% as assumed prepayment rates, default rates ranging from 1.2% to 3.6% and discount rates ranging from 100 basis points to 300 basis points. In conjunction with the process of determining the key assumptions, the Corporation also reviews the key financial information on the underlying issuers that are the collateral for the investment securities. The results of these analyses are used to determine estimates of default rates and also to provide additional information for consideration in determining the reasonableness of assumed prepayment rates. ASC 320-10-35 is used to measure credit loss for OTTI purposes. The change in the expected cash flows is reviewed to determine if OTTI should be recorded. The result calculated for the current quarter is then compared to the previous quarter's book value to determine if the change is “adverse.” The credit component of any impairment should be the difference between the book value and the projected present value for the current quarter.

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The analysis is based on cash flows and utilizes a number of assumptions relating to credit and prepayment.  There are 9 scenarios available within three deal cash flow assumption categories (prepays constant, no prepays, prepays constant utilizing select years and defaults over 5 years and constant thereafter).  Each of these scenarios includes different prepayment assumptions and defaults at various levels in addition to projection of recoveries, if applicable, with a two-year lag.  Scenarios in each category range from a base to worse case in addition to two analyses that project defaults over the course of the following year on a quarterly basis and annually thereafter.

Stress Analysis– The Corporation obtains a stress analysis report of each security.  This report provides a snapshot of the immediate deferrals/defaults that a given pool and tranche/class can withstand before causing either a break in yield or temporary interest shortfall position.  There are various assumptions utilized in this report with respect to prepayments, deferrals/defaults, and recovery rates.

● Break in Yield – This is the level of deferrals/defaults the tranche could experience before the tranche would not receive all of its contractual cash flows (principal and interest) by maturity (not just a temporary interest shortfall but an actual loss in yield on the investment).  In other words, a break in yield occurs when the magnitude of the deferrals/defaults has depleted the entire credit enhancement (excess interest and over-collateralization) beneath the given tranche.

● Temporary Interest Shortfall– A temporary interest shortfall is caused by an amount of deferrals/defaults high enough such that there is insufficient cash flow available to pay current interest on the given tranche or by breaching the principal coverage test of the tranche immediately senior to the given tranche.  Principal coverage tests are set up to protect the Senior and Mezzanine Notes from credit events, providing the most credit protection to the Class A-1 Senior Notes, then to the Class A-2 Senior Notes, then to the Class B notes and so on. Cash flow is diverted from the lowest tranches first then from the successively higher tranches as necessary.

The existence of a break in yield or a temporary interest shortfall is an initial indication that OTTI may exist.

Deferral/Default Summary – The Corporation reviews a report that contains current information for individual issues to determine the extent of deferrals and/or defaults, the status of any issuers in the pool, and the impact to the tranche owned by the Corporation. This report lists the issue (i.e., the pool/deal), the amount of deferrals/defaults related to the issue, the issuer that has deferred/defaulted, and the percentage of total current collateral this represents.  Additionally, the report provides the status of the amount in question (i.e. whether it is cured, purchased, in default, or deferred), the projected senior and mezzanine note status for the next payment date, the projected income note status for the next payment date and the next bond payment date. The Corporation compares the information in this report to the assumptions used in the cash flow analysis to ensure that deferral and defaults are correctly reflected in the cash flow analysis.

Issuer Lists –A report listing all of the companies in the pool, along with other relevant information such as organization type (mutual vs. stock), primary geographic location (state), rating, issue amount, years in business and principal line of business. The Corporation reviews the issuer lists for the individual pools held by the Corporation to gain better insight as to the underlying companies, the specific credit characteristics of the collateral underlying each individual security, and to determine risks associated with any concentrations with respect to issue amounts or lines of business.

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To determine impairment charges for the Corporation’s collateralized debt obligations (“CDO”), we performed discounted cash flow valuations through a static default model test. The default model used assumed a 3.6% rate, which is three times the historic default rates for all CDO’s, a 0% recovery on all banks in deferral of interest payments and a 0% prepayment rate. Cash flow valuations with a premium mark up of 300 basis points were also used to determine the fair market values of the Corporation’s collateralized debt obligations. All of the Corporation’s pooled trust preferred securities have the same terms, which is that the securities cannot be redeemed for five years and then can be called quarterly thereafter.  All of the securities are past the five-year no-call period. Valuation documentation for the cash flow analysis is provided by an independent third party.

Amounts in the following table are in thousands.

Security Name	Single/ Pooled	Class Tranche	Amortized Cost		Fair Value		Unrealized (Gain)Loss			Credit Portion		Other		YTD OTTI Total
Alesco II	Pooled	B-1	$	1,161	$	1,166	$	(5	)	$	--	$	--	$	--
MM Com III	Pooled	B		511		417		94			--		--		--
PreTSL  IV	Pooled	Mezz		152		110		42			--		--		--
Total			$	1,824	$	1,693	$	131		$	--	$	--	$	--

OTTI-Other Than Temporary Impairment

	Lowest Rating (1)	% of Current  Performing			% Deferrals/ Defaults (2)			High			Low			Discount Margin (3)
Alesco II	C		84.89	%		15.11	%		1.20	%		0.40	%		4.65	%
MM Com III	CC		70.00	%		30.00	%		1.20	%		0.40	%		5.05	%
PreTSL IV	CCC		72.93	%		27.07	%		1.50	%		0.75	%		2.25	%

Notes to table above:

(1) Credit Ratings represent Moody’s and Fitch ratings (S&P does not rate this security).

(2) The ratio represents the amount of specific deferrals/defaults that have occurred, plus those that are known or projected for the following quarters to the total amount of original collateral for a given security. Fewer deferrals/defaults produce a lower ratio.

(3) Fair market value discount margin to LIBOR.

For the period ended June 30, 2013, the Corporation did not experience a credit-related other-than-temporary impairment on the pooled trust preferred securities portfolio but we have recorded a $1.5 million loss cumulatively since 2008 in this portfolio. All of these securities are in the Corporation’s available for sale portfolio. The previous impairment costs were charged to earnings in noninterest income as “Other-than-temporary-impairment write-down on securities”. The total securities impacted by credit-related other-than-temporary impairment have a current carrying value of $1.7 million and represent approximately 0.94% of available for sale securities. The Corporation does not intend to sell these securities and it is more likely than not that the Corporation will not be required to sell these securities before recovery of their amortized cost. Management continues to monitor these securities. The Corporation may conclude in future periods that conditions existing at that time indicate some or all of the securities may be sold or are other-than-temporarily impaired, which would require a charge to earnings in such periods.

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Loans

Net loans decreased to $120.1 million at June 30, 2013 compared to $123.4 million at December 31, 2012. The decrease was due to a significant reduction in loan demand as a result of economic conditions in South Carolina and more conservative underwriting standards. Consumer loans decreased $3.5 million, or 10.3% and commercial loans, primarily lines of credit, and commercial real estate loans decreased $731,000, or 0.9% for the period ended June 30, 2013.

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

	June 30, 2013			December 31, 2012
Nonaccrual loans
Real estate	$	1,228		$	970
Commercial		7,795			9,569
Consumer		3,180			2,635
Total		12,203			13,174
Accruing troubled debt restructurings		676			4,187
Other real estate owned, net		5,182			9,174
Total nonperforming assets	$	18,061		$	26,535
Percentage of nonperforming loans to loans
receivable, net		10.72	%		14.07	%
Percentage of nonperforming assets to total assets		5.25	%		7.58	%
Allowance for loan losses to total
loans outstanding		3.54	%		3.42	%
Allowance for loan losses as a percent of
nonperforming loans		33.48	%		25.15	%
Allowance for loan losses	$	4,312		$	4,367

Nonperforming assets decreased $8.5 million to $18.1 million at June 30, 2013, or 5.3% of total assets, as compared to $26.5 million or 7.6% of total assets at December 31, 2012. These assets are primarily supported by commercial real estate and are currently being carried at management’s best estimate of net realizable value, although further losses may be incurred on loans until the collateral has been acquired and liquidated or other arrangements can be made.

Interest income that would have been recorded for the six months ended June 30, 2013 had nonaccruing loans been current in accordance with their original terms amounted to approximately $461,000.

Management has allocated specific reserves to its nonperforming assets that it believes will offset losses, if any, arising from less than full recovery of the loans from the supporting collateral. Specific reserves for nonperforming loans are allocated to the loan as a write-down after completion of the impairment analysis for all collateral dependent loans. These additional reserves are based on management’s evaluation of a number of factors, including the estimated value of the collateral supporting each of these loans. Management believes that the combination of additional reserves and established impairment of these loans will be adequate to account for the current risk associated with these loans as of June 30, 2013. Management continues to evaluate and assess all nonperforming assets on a regular basis as part of its well-established loan monitoring and review process. At June 30, 2013, criticized and classified loans, which include all nonperforming loans, totaled $22.4 million, compared to $23.9 million at December 31, 2012. Impaired loans totaled $20.7 million at June 30, 2013 compared to $25.8 million at December 31, 2012. The allowance for loan losses was $4.3 million at June 30, 2013. While management uses the best information available to establish the allowance for loan losses, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the valuations. Such adjustments would be made in the relevant period and may be material to the financial statements.

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OREO decreased $4.0 million to $5.2 million at June 30, 2013 from $9.2 million at December 31, 2012, primarily as a result of property sales. OREO is carried at the lower of carrying value or fair value. Fair value  is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. The properties are being actively marketed and maintained with the primary objective of liquidating the collateral at a level which most accurately approximates fair market value and allows recovery of as much of the unpaid balance as possible upon the sale of the properties in a reasonable period of time. The carrying values of these assets are believed to be representative of their fair market value, although the ultimate proceeds from the sale of these assets may not be equal to or greater than the carrying values.

Other real estate owned is summarized as follows (in thousands):

	June 30,			December 31,
	2013			2012
Balance at beginning of period	$	9,174		$	8,398
Foreclosures added during the period		1,117			2,423
Bank assets transferred to OREO		--			1,356
Sales of foreclosed property		(4,359	)		(2,190	)
Provision charged as a write-down		(750	)		(813	)
Balance at the end of period	$	5,182		$	9,174

Liabilities

Total liabilities decreased $204,000 to $337.5 million at June 30, 2013 from $337.7 million at December 31, 2012. Deposits increased $132,000 to $277.6 million at June 30, 2013 from $277.5 million at December 31, 2012 with a $3.5 million increase in demand deposits partially offset by a $3.4 million decrease in time deposits due to the current low interest rate environment. Security agreements to repurchase decreased $831,000 to $5.4 million at June 30, 2013 from $6.3 million at December 31, 2012.

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Deposit accounts were as follows (dollars in thousands):

	June 30, 2013								December 31, 2012
	Rate			Balance		%			Rate			Balance		%
Account Type
NOW accounts:
Commercial noninterest-bearing		--		$	41,668		15.01	%		--		$	38,346		13.82	%
Noncommercial		0.27	%		58,974		21.24	%		0.32	%		63,433		22.86	%
Money market checking accounts		0.19	%		29,829		10.75	%		0.27	%		27,842		10.03	%
Regular savings		0.28	%		33,397		12.03	%		0.33	%		30,693		11.06	%
Total demand and savings deposits		0.19	%		163,868		59.03	%		0.23	%		160,314		57.77	%
Time deposits:
Up to 1.00%					84,388		30.40	%					81,649		29.43	%
1.01 %-2.00%					29,289		10.55	%					35,322		12.73	%
2.01 %- 3.00%					68		0.02	%					150		0.05	%
3.01 %- 4.00%					--		--	%					46		0.02	%
Total time deposits		0.59	%		113,745		40.97	%		0.63	%		117,167		42.23	%
Total deposit accounts		0.36	%	$	277,613		100.00	%		0.40	%	$	277,481		100.00	%

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

	June 30, 2013					December 31, 2012
	Balance		Wtd Avg Rate			Balance		Wtd Avg Rate
Contractual Maturity:
After three but within five years – adjustable rate		24,000		4.10	%		24,000		4.10	%
Greater than five years - adjustable rate		13,500		3.52	%		13,500		3.52	%
Total advances	$	37,500		3.89	%	$	37,500		3.89	%

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

Shareholders’ Equity

Shareholders’ equity decreased $5.7 million, or 46.6%, to $6.5 million at June 30, 2013 from $12.2 million at December 31, 2012 primarily due to a $4.0 million increase in unrealized losses on securities available for sale along with a net operating loss of $1.7 million. The unrealized losses were primarily attributable to changes in interest rates, rather than deterioration in credit quality. The Corporation considers the length of time and extent to which the fair market value of available for sale securities have been less than cost to conclude that such securities are not other-than-temporally impaired.

Liquidity

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

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

At June 30, 2013, the Corporation’s investment in marketable securities totaled $180.4 million, all of which was available for sale. In addition, the Corporation had $8.5 million in federal funds sold at June 30, 2013 compared to $20.3 million at December 31, 2012. Approximately $59.0 million and $62.7 million of debt securities at June 30, 2013 and December 31, 2012, respectively, were pledged by the Corporation as collateral to secure deposits of the State of South Carolina, and Union, Laurens and York counties along with additional borrowings and repurchase agreements.

Outstanding loan commitments (including commitments to fund credit lines) totaled $14.1 million at June 30, 2013. Management of the Corporation anticipates that it will have sufficient funds available to meet its current loan commitments.

The Corporation closely monitors its liquidity position on a daily basis. Time deposits that are scheduled to  mature in one year or less from June 30, 2013, totaled $84.7 million or 30.5% of total deposits. The Corporation relies primarily on competitive rates, customer service, and long-standing relationships with customers to retain deposits. From time to time, the Corporation will also offer special products to its customers to increase retention and to attract new deposits. Based upon the Corporation’s experience with deposit retention and current retention strategies, management believes that, although it is not possible to predict future terms and conditions upon renewal, a significant portion of such deposits will remain with the Corporation. If the Corporation requires funds beyond its ability to generate them internally, additional sources of funds are available through FHLB advances, securities sold under agreements to repurchase and lines of credit. At June 30, 2013, the Corporation had $37.5 million of FHLB borrowings and $5.4 million of securities sold under agreements to repurchase outstanding. At June 30, 2013, the Corporation had unused short-term lines of credit to purchase federal funds from unrelated banks totaling $4.0 million and the ability to borrow an additional $31.3 million from secured borrowing lines. Lines of credit are available on a one-to-ten day basis for general purposes of the Corporation.  All of the lenders have reserved the right to withdraw these lines at their option.

Provident Community Bancshares, Inc. is a separate legal entity from the Bank and must provide for its own liquidity. In addition to its operating expenses, Provident Community Bancshares is responsible for paying any dividends declared to its shareholders and paying the obligations on its outstanding debentures and preferred stock. Provident Community Bancshares’ primary source of income is dividends received from the Bank. The dividends that may be paid by the Bank to the Corporation are subject to legal limitations and regulatory capital requirements. The amount of dividends that the Bank may declare and pay to Provident Community Bancshares in any calendar year, without the receipt of prior approval from the Office of the Comptroller of the Currency (“OCC”) cannot exceed retained net income for that year combined with retained net income for the prior two years less any transfers to surplus and capital distributions. Further, the Corporation cannot pay cash dividends on its common stock during any calendar quarter unless full dividends on the Preferred Stock have been paid. However, restrictions currently exist, including within the Consent Order the Bank signed with the OCC on December 21, 2010, that prohibit the Bank from paying cash dividends to the Corporation.  See “Consent Order and Written Agreement”. For the three and six month period ended June 30, 2013, no cash dividends were declared or paid by the Bank or the Corporation. 

The Corporation is exercising its right to defer the regularly scheduled quarterly distribution on its $12.6 million in subordinated debentures related to its two outstanding trust preferred security issuances and its regular quarterly cash dividend on its Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the “TARP Preferred Stock”) issued to the U.S. Treasury Department in connection with the Corporation’s participation in the Treasury’s TARP Capital Purchase Program. Total dividends deferred to date are $1.4 million.

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Capital Management and Regulatory Matters

Dividend Restrictions

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

Capital Guidelines

The Bank and the Corporation are subject to various regulatory capital requirements administered by banking regulators. Failure to meet minimum capital requirements can initiate certain mandatory - and possibly additional discretionary - actions by regulators that, if undertaken, could have a direct material effect on the Corporation’s financial statements. Under capital adequacy guidelines and the regulatory framework for Prompt Corrective Action (“PCA”), the Bank must meet specific capital guidelines that involve quantitative measures of its assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices.  The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. PCA provisions are not applicable to bank holding companies.

Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

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

The Bank is required by the consent order to maintain Tier 1 capital at least equal to 8% of adjusted total assets and total capital of at least 12% of risk-weighted assets. So long as the Bank is subject to the enforcement action executed with the OCC on December 21, 2010, it will not be deemed to be well-capitalized even if it maintains the minimum capital ratios to be well-capitalized under applicable regulations unless it achieves the higher thresholds required by the consent order. At June 30, 2013, the Bank did not meet the higher Tier 1 capital requirements required by the consent order and is evaluating alternatives to increase capital. The Bank’s capital category as of June 30, 2013 is determined solely for the purpose of applying the PCA restrictions and the Bank’s capital category as of June 30, 2013 may not constitute an accurate representation of the Bank’s overall financial condition or prospects.

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

	Minimum Capital Levels
	Actual					Regulatory Minimum					From Consent Order(1)
	Amount		Ratio			Amount		Ratio			Amount		Ratio
Leverage ratio
Corporation	$	13,814		3.95	%	$	13,984		4.00	%	$	n/a		n/a	%
Bank		23,163		6.63			13,970		4.00			27,940		8.00
Tier 1 capital ratio
Corporation		13,814		8.01			6,894		4.00			n/a		n/a
Bank		23,163		13.47			6,880		4.00			n/a		n/a
Total risk-based capital ratio
Corporation		24,305		14.10			13,789		8.00			n/a		n/a
Bank		25,340		14.73			13,760		8.00			20,640		12.00

(1) Minimum capital amounts and ratios presented for the Bank as of June 30, 2013 are the minimum levels set forth in the Consent Order.  No minimum Tier 1 capital to risk-weighted assets ratio was specified in the Consent Order. 

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

The Bank is required to maintain reserves, in the form of cash and balances with the Federal Reserve Bank, against its deposit liabilities. The amounts of such reserves totaled $1.7 million at June 30, 2013.

Consent Order and Written Agreement

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

In addition, the Consent Order required the Bank to develop a three-year capital plan, which includes, among other things, specific plans for maintaining adequate capital, a discussion of the sources and timing of additional capital, as well as contingency plans for alternative sources of capital. The Consent Order also required the Bank to develop a strategic plan covering at least a three-year period, which among other things, included a specific description of the strategic goals and objectives to be achieved, the targeted markets, the specific Bank personnel who are responsible and accountable for the plan, and a description of systems to monitor our progress. On March 19, 2011, the Bank’s Board submitted a written strategic plan and capital plan to the OCC covering a three-year period which included an action plan for increasing the Bank’s capital ratios to the minimums set forth in the Consent Order. The Consent Order also required the Bank to achieve and maintain total capital of at least equal to 12% of risk-weighted assets and Tier 1 capital at least equal to 8% of adjusted total assets. The Bank has been working on efforts to achieve the Tier 1 capital levels imposed under the Consent Order.

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

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

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In response to the Consent Order, the Bank:

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

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

•   Implemented and adhered to a program for the maintenance of an adequate allowance for loan and lease losses that is consistent with OCC requirements; and

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

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

Written Agreement with Federal Reserve Bank

On May 20, 2011, the Corporation entered into a written agreement with the Federal Reserve Bank of Richmond, which, among other things:

● required the Corporation to fully utilize its financial and managerial resources to serve as a source of strength to the Bank;

● prohibited the Company from paying any dividends and taking any dividends representing a reduction in capital from the Bank, in each case without the prior written approval of the Federal Reserve;

● prohibited the Corporation from making any distributions on subordinated debentures or trust preferred securities without the prior written approval of the Federal Reserve; and

● prohibited the Corporation from incurring, increasing or guaranteeing any debt or redeeming any shares of its common stock, in each case without the prior written approval of the Federal Reserve.

Off-Balance Sheet Risk

In the normal course of operations, the Corporation engages in a variety of financial transactions that, in accordance with generally accepted accounting principles are not recorded in its financial statements. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are used primarily to manage customers’ requests for funding and take the form of legally binding agreements to lend money to customers at predetermined interest rates for a specified period of time. Outstanding loan commitments (including commitments to fund credit lines) totaled $14.1 million at June 30, 2013. Each customer's credit worthiness is evaluated on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Corporation upon extension of credit, is based on the credit evaluation of the borrower. Collateral varies but may include accounts receivable, inventory, property, plant and equipment, commercial and residential real estate. The credit risk on these commitments is managed by subjecting each customer to normal underwriting and risk management processes. For the quarter ended June 30, 2013, the Corporation did not engage in any off-balance sheet transactions reasonably likely to have a material effect on its financial condition, results of operations or cash flows.

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Results of operations for the three months ended June 30, 2013 and 2012

General

The Corporation recorded a net loss to common shareholders of $1.5 million for the three months ended June 30, 2013 as compared to net income to common shareholders of $24,000 for the same period in 2012. The loss in 2013 was primarily due to an increase in the provision for loan losses due to an increase in specific loan reserves and loan write-downs and an increase in noninterest expense, primarily due to increased OREO and loan operation expense. In addition, the gain on the sale of investments for the quarter ended June 30, 2013 was $24,000 compared to $286,000 for the previous year comparable quarter.

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Average Yields and Rates

    (dollars in thousands)

	Three Months Ended June 30,
	2013							2012
	Average Balance		Interest		Average Yield/Cost(2)			Average Balance		Interest		Average Yield/Cost
Interest earning assets:
Loans (1)	$	122,730	$	1,526		4.97	%	$	145,523	$	1,805		4.96	%
Mortgage-backed securities		52,444		259		1.98	%		64,359		337		2.09	%
Investment securities		133,729		721		2.16	%		109,120		646		2.37	%
Deposits and fed funds sold		13,305		3		0.07	%		18,872		5		0.10	%
Total interest earning assets		322,208		2,509		3.11	%		337,874		2,793		3.31	%
Noninterest earning assets		28,326							33,916
Total assets	$	350,534						$	371,790
Interest bearing liabilities:
Deposits	$	238,549		257		0.43	%	$	261,078		340		0.52	%
Floating rate junior subordinated deferrable interest debentures		12,372		63		2.05	%		12,372		70		2.26	%
FHLB advances and other borrowings		42,555		370		3.48	%		60,537		569		3.76	%
Total interest bearing liabilities		293,476		690		0.94	%		333,987		979		1.17	%
Noninterest bearing sources:
Noninterest bearing deposits		41,422							22,084
Noninterest bearing liabilities		4,502							3,916
Total liabilities		339,400							359,987
Shareholders’ equity		11,134							11,803
Total liabilities and shareholders’ equity	$	350,534						$	371,790
Net interest income			$	1,819						$	1,814
Interest rate spread (2)						2.17	%						2.14	%
Impact of noninterest bearing (3) deposits						0.06	%						0.08	%
Net interest margin (4)						2.23	%						2.22	%

(1) Average balance of loans includes nonaccruing loans. Interest income includes deferred loan fees and does not include interest on nonaccrual loans.

(2) Represents difference between weighted average yield on all interest earning assets and weighted average rate on all interest bearing liabilities.

(3) Represents the reduction of noninterest bearing deposits on total deposit funding costs.

(4) Represents net interest income before provision for loan losses as a percentage of average interest earning assets.

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Interest Income

Interest income decreased $284,000, or 10.2%, to $2.5 million for the three months ended June 30, 2013 as compared to the same period in 2012. Interest income on loans decreased by 15.5%, or $279,000, to $1.5 million for the three months ended June 30, 2013 from $1.8 million for the three months ended June 30, 2012, due primarily to lower average balances due to lower demand. Interest on mortgage-backed securities decreased $78,000, or 23.1%, primarily due to lower interest rates and lower average balances. Interest on investment securities increased $75,000 or 11.6%, for the three months ended June 30, 2013 compared to the same period in 2012 due primarily to higher average balances offset by lower interest rates.

Interest Expense

Interest expense decreased $289,000, or 29.5%, to $690,000 for the three months ended June 30, 2013 as compared to $979,000 for the three months ended June 30, 2012. Interest expense on deposit accounts decreased $83,000, or 24.4%, to $257,000 for the three months ended June 30, 2013 from $340,000 during the same period in 2012 due primarily to lower average balances, as a result of reductions in funding needs, and lower average costs due to lower market interest rates and an increase in core deposits. Interest expense on borrowings (including subordinated debentures) decreased $206,000, to $433,000 for the three months ended June 30, 2013 from $639,000 during the same period in 2012 due primarily to lower average balances as a result of the pay-down of $22 million in FHLB advances and lower market interest rates.

Provision for Loan Losses

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

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

Our judgment about the adequacy of the allowance is based upon a number of assumptions about future events, which we believe to be reasonable, but which may not prove to be accurate. Thus, charge-offs in future periods could exceed the allowance for loan losses, or substantial additional increases in the allowance for loan losses could be required. Additions to the allowance for loan losses would result in a decrease of our net income and, possibly, our capital. Based on present information, we believe the allowance for loan losses is adequate at June 30, 2013 to meet presently known and inherent risks in the loan portfolio.

45

During the three months ended June 30, 2013, the provision for loan losses was $500,000 compared to a provision of $195,000 for the same period in the previous year. The increase was due primarily to an increase in loan charge-offs and an increase in specific loan reserves. Specific reserves for nonperforming loans at June 30, 2013 were $2.1 million compared to $692,000 for nonperforming loans at June 30, 2012. The increase in specific reserves was primarily due to additional allocations of $2.0 million to cover TDR concessions. Nonperforming loans decreased $5.0 million from $17.2 million at June 30, 2012 to $12.2 million at June 30, 2013.

Loan charge-offs and recoveries consisted of the following for the three months ended June 30, 2013 and 2012.

(In thousands)

	Commercial			Consumer			Residential			Total
June 30, 2013
Charge-offs	$	272		$	298		$	16		$	586
Recoveries		(32	)		(21	)		(5	)		(58	)
Net Charge-offs	$	240		$	277		$	11		$	528
	Commercial			Consumer			Residential			Total
June 30, 2012
Charge-offs	$	256		$	188		$	6		$	450
Recoveries		(4	)		(2	)		(1	)		(7	)
Net Charge-offs	$	252		$	186		$	5		$	443

Management believes the specific reserves allocated to these and other nonaccrual loans will offset losses, if any, arising from less than full recovery of the loans from the supporting collateral. Management has sought to provide the amount estimated to be necessary to maintain an allowance for loan losses that is adequate to cover the level of loss that management believes to be inherent in the portfolio as a whole, taking into account the Corporation’s experience, economic conditions and information about borrowers available at the time of the analysis. However, management expects that further deterioration of economic conditions in the Corporation’s market areas is likely in the short-term, especially with respect to real estate related activities and real property values.

Non Interest Income

Total noninterest income decreased $263,000, or 27.9%, to $681,000 for the three months ended June 30, 2013 from $944,000 for the same period in the previous year. The decrease was due primarily to gains on the sale of investments for the current year of $24,000 compared to a gain of $286,000 for the same period in the previous year.

Non Interest Expense

For the three months ended June 30, 2013, total noninterest expense increased $883,000, or 36.7%, to $3.3 million. Compensation and employee benefits increased $158,000, or 15.2%, due primarily to staffing additions for the start up of a new residential mortgage loan department. Deposit insurance premiums expense decreased $18,000, or 8.5%, to $193,000 for the three months ended June 30, 2013 from $211,000 for the same period in 2012, due to a reduction in the deposit base for FDIC premium cost assessments. OREO and loan operations expense increased $776,000, to $711,000 for the three months ended June 30, 2013 from net recoveries of $65,000 for the same period in 2012, due primarily to an increase in write-downs and operating expenses for foreclosed loans. Items processing expense decreased $5,000, or 7.3%, to $64,000 for the three months ended June 30, 2013 from $69,000 for the same period in 2012, due primarily to a reduction in the number of accounts processed. Other expense increased $14,000, or 6.3%, to $237,000 for the three months ended June 30, 2013 from $223,000 for the same period in 2012, due primarily to increases in loan expense due to loan appraisals required for impaired loans.

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Income taxes

Expense for income taxes for the three months ended June 30, 2013 was $42,000 as compared to $12,000 for the same period in 2012. The current period expense is due to amortization of tax credits to the fair market value.

Results of operations for the six months ended June 30, 2013 and 2012

General

The Corporation recorded a net loss to common shareholders of $1.9 million for the six months ended June 30, 2013 as compared to a net loss to common shareholders of $178,000 for the same period in 2012. The increase in loss in 2013 was primarily due to a reduction in net interest income due primarily to lower loan balances due to economic conditions and higher underwriting standards, and an increase in noninterest expense, offset by the reduction of the provision for loan losses for the period ended June 30, 2013, due to a net reduction in loans of $3.3 million. In addition, the gain on the sale of investments was $24,000 for the period ended June 30, 2013 compared to $525,000 for the previous year comparable period.

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Average Yields and Rates

    (dollars in thousands)

	Six Months Ended June 30,
	2013							2012
	Average Balance		Interest		Average Yield/Cost(2)			Average Balance		Interest		Average Yield/Cost
Interest-earning assets:
Loans (1)	$	124,247	$	3,042		4.90	%	$	150,284	$	3,781		5.03	%
Mortgage-backed securities		48,651		462		1.90	%		66,893		766		2.29	%
Investment securities		130,617		1,375		2.11	%		101,726		1,244		2.45	%
Deposits and fed funds sold		19,179		7		0.07	%		20,867		8		0.07	%
Total interest-earning assets		322,694		4,886		3.03	%		339,770		5,799		3.41	%
Non-interest-earning assets		28,246							34,280
Total assets	$	350,940						$	374,050
Interest-bearing liabilities:
Deposits	$	239,898		535		0.45	%	$	262,195		718		0.55	%
Floating rate junior subordinated deferrable interest debentures		12,372		127		2.04	%		12,372		141		2.27	%
FHLB advances and other borrowings		42,543		735		3.46	%		61,997		1,175		3.79	%
Total interest-bearing liabilities		294,813		1,397		0.95	%		336,564		2,034		1.21	%
Non-interest-bearing sources:
Non-interest-bearing deposits		40,208							21,488
Non-interest-bearing liabilities		4,290							3,842
Total liabilities		339,311							361,894
Shareholders’ equity		11,629							12,156
Total liabilities and shareholders’ equity	$	350,940						$	374,050
Net interest income			$	3,489						$	3,765
Interest rate spread (2)						2.08	%						2.20	%
Impact of non-interest-bearing (3) deposits						0.07							0.08
Net interest margin (4)						2.15	%						2.28	%

(1) Average balance of loans includes nonaccruing loans. Interest income includes deferred loan fees and does not include interest on nonaccrual loans.

(2) Represents difference between weighted average yield on all interest earning assets and weighted average rate on all interest bearing liabilities.

(3) Represents the reduction of noninterest bearing deposits on total deposit funding costs.

(4) Represents net interest income before provision for loan losses as a percentage of average interest earning assets.

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Interest Income

Interest income decreased $913,000, or 15.7%, to $4.9 million for the six months ended June 30, 2013 as compared to the same period in 2012. Interest income on loans decreased by 19.6%, or $739,000, to $3.0 million for the six months ended June 30, 2013 from $3.8 million for the six months ended June 30, 2012, due primarily to lower average balance of loans as a result of a decrease in demand. Interest on mortgage-backed securities decreased $304,000, or 39.7%, primarily due to lower interest rates and lower average balances. Interest on investment securities increased $131,000 or 10.5%, for the six months ended June 30, 2013 compared to the same period in 2012 due primarily to higher average balances offset by lower investment yields due to declining market interest rates.

Interest Expense

Interest expense decreased $637,000, or 31.3%, to $1.4 million for the six months ended June 30, 2013 as compared to $2.0 million for the six months ended June 30, 2012. Interest expense on deposit accounts decreased $183,000, or 25.5%, to $535,000 for the six months ended June 30, 2013 from $718,000 during the same period in 2012 due primarily to lower market interest rates and lower average balances as a result of lower funding needs. Interest expense on borrowings (including subordinated debentures) decreased $454,000, or 34.5%, to $862,000 for the six months ended June 30, 2013 as compared to the same period in the previous year due to lower average balances and lower market interest rates.

Provision for Loan Losses

During the six months ended June 30, 2013, the provision for loan losses was $500,000 compared to $630,000 for the same period in the previous year. The decrease in provision in 2013 was a result of a decrease in nonperforming assets of $17.5 million to $18.1 million at June 30, 2013, or 5.3% of total assets, as compared to $35.5 million or 9.6% of total assets at June 30, 2012. During the six months ended June 30, 2013, bad debt charge-offs, net of recoveries, were $556,000 as compared to $603,000 for the same period in the previous year. Offsetting these decreases was an increase in specific reserves on nonperforming loans to $2.1 million for the six months ended June 30, 2013 compared to $692,000 for the same period in the previous year. The increase in specific reserves was primarily due to additional allocations of $2.0 million to cover TDR concessions. The Corporation’s loan loss allowance at June 30, 2013 was approximately 3.5% of the Corporation’s outstanding loan portfolio compared to 3.2% of the Corporation’s outstanding loan portfolio at June 30, 2012.

Non-Interest Income

Total non-interest income decreased $482,000, or 26.8%, to $1.3 million for the six months ended June 30, 2013 from $1.8 million for the same period in the previous year due primarily to lower gain on sale of investment securities. Gain on sale of investments was $24,000 from security sales of $1.7 million for the six months ended June 30, 2013 compared to $525,000 from security sales of $23.9 million for the same period in the previous year. Fees from financial services increased $20,000, or 1.6%, to $1.3 million for the six months ended June 30, 2013 due to higher account charges on deposit accounts.

Non-Interest Expense

For the six months ended June 30, 2013, total non-interest expense increased $1.0 million, or 21.3%, to $5.9 million from $4.9 million for the same period in 2012. Compensation and employee benefits increased $163,000, or 7.7%, due primarily to staffing additions for the start up of a new residential mortgage loan department. Professional services expense decreased $20,000, or 5.6%, to $335,000 for the six months ended June 30, 2013 from $355,000 for the same period in 2012 due primarily to lower legal expense. OREO and loan operations expense increased $812,000, to $888,000 for the six months ended June 30, 2013 from $76,000 for the same period in 2012, due primarily to higher costs associated with loan foreclosures and write-downs required to adjust other real estate owned to fair market value. Items processing expense decreased $10,000, or 7.3%, to $127,000 for the six months ended June 30, 2013 from $137,000 for the same period in 2012, due primarily to lower NOW account balances due to rate reductions. Other expense increased $94,000, or 24.6%, to $476,000 for the six months ended June 30, 2013 from $382,000 for the same period in 2012, due primarily to a higher loan expense as a result of new appraisals for impaired loans.

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Income taxes

Expense for income taxes for the six months ended June 30, 2013 was $85,000 as compared to $12,000 for the same period in 2012. The current period expense is due to amortization of tax credits to the fair market value.

Item 3.  Quantitative and Qualitative Disclosures about Market Risk

Not applicable as the registrant is a smaller reporting company.

Item 4. Controls and Procedures

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

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

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

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

Item 1A. Risk Factors

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2012, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K are not the only risks that we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

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

In May 2005, the Corporation implemented a share repurchase program under which the Board of Directors of the Corporation authorized the repurchase of up to 5% of the outstanding shares or 98,000 shares. The program was expanded by an additional 5%, or 92,000 shares, in August 2006. However, under the written agreement between the Corporation and the Federal Reserve Bank, the Corporation cannot repurchase its shares without the prior written consent of the Federal Reserve Bank. The Corporation did not repurchase any shares during the three months ended June 30, 2013 and 36,034 shares remain under the previously authorized plans.

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Item 3. Defaults upon Senior Securities

	Not applicable.
Item 4.	Mine Safety Disclosures
	Not applicable.
Item 5.	Other Information
	None
Item 6.	Exhibits

31(a)	Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer
31(b)	Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer
32(a)	Chief Executive Officer Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32(b)	Chief Financial Officer Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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Interactive Data File*

The following materials from Provident Community Bancshares, Inc.’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2013 formatted in Extensible Business Reporting Language (XBRL): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income (Loss), (iii) the Consolidated Statement of Comprehensive Income (Loss), (iv) the Consolidated Statements of Cash Flows, (v) the Consolidated Statements of Shareholders’ Equity and (vi) related notes.

*Furnished not filed.

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SIGNATURES

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

PROVIDENT COMMUNITY BANCSHARES, INC.

(Registrant)

Date:           August 14, 2013	By:	/s/ Dwight V. Neese
	Dwight V. Neese, President and
	Chief Executive Officer

Date:           August 14, 2013	By:	/s/ Richard H. Flake
	Richard H. Flake, Executive Vice President
	and Chief Financial Officer

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