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Beach First National Bancshares 10-Q 2007

Documents found in this filing:

  1. 10-Q
  2. Graphic
  3. Graphic
  4. Ex-31
  5. Ex-31
  6. Ex-32
  7. Ex-32

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
  For the quarterly period ended:   June 30, 2007

TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
  For the transition period from ___________ to _____________

Commission file number:   000-22503

BEACH FIRST NATIONAL BANCSHARES, INC.
(Exact name of registrant as specified in its charter)

               South Carolina                                   57-1030117               
(State of Incorporation)     (I.R.S. Employer Identification No.)

3751 Grissom Parkway, Suite 100, Myrtle Beach, South Carolina 29577
(Address of principal executive offices)

(843) 626-2265
(Issuer's telephone number)

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 of 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was requited to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes        No   

Indicate by check mark whether the registrant is a large accelerated file, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.
                                   Large accelerated filer                           Accelerated filer                      Non-accelerated filer   

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

State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date: On July 31, 2007, 4,836,916 shares of the issuer's common stock, par value $1.00 per share, were issued and outstanding.


Beach First National Bancshares, Inc. and Subsidiaries

INDEX

PART I - FINANCIAL INFORMATION      Page No.
        
Item 1. Financial Statements (Unaudited)       
        
             Condensed Consolidated Balance Sheets - June 30, 2007, June 30, 2006 and December 31, 2006    3  
        
             Condensed Consolidated Statements of Income -       
                 Six months ended June 30, 2007 and 2006      
                Three months ended June 30, 2007 and 2006    4  
        
             Consolidated Statements of Shareholders’ Equity and Comprehensive Income –       
                 Six months ended June 30, 2007 and 2006    5  
        
             Consolidated Condensed Statements of Cash Flows - Six months ended June 30, 2007 and 2006    6  
        
             Notes to Condensed Financial Statements   7-8  
        
Item 2. Management’s Discussion and Analysis and Results of Operation   9-21
        
Item 3. Quantitative and Qualitative Disclosures about Market Risk    22  
        
Item 4. Controls and Procedures    22  
        
PART II - OTHER INFORMATION       
        
Item 1. Legal Proceedings    22  
        
Item 1A. Risk Factors    22  
        
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds    22  
        
Item 3. Defaults Upon Senior Securities    23  
        
Item 4. Submission of Matters to a Vote of Security Holders    23  
        
Item 5. Other Information    23  
        
Item 6. Exhibits    23  


2


Item 1.   Financial Statements.

Beach First National Bancshares, Inc. and Subsidiaries
Consolidated Condensed Balance Sheets

June 30, December 31,
2007 2006 2006
(unaudited) (unaudited) (audited)
          ASSETS                
Cash and due from banks   $ 6,592,898   $ 7,656,305   $ 5,198,945  
Federal funds sold and short-term investments    26,072,380    1,140,600    14,010,667  
Investment securities available for sale    69,656,885    55,981,528    68,474,531  
Loans, net    438,976,611    371,267,988    392,848,582  
Mortgage loans held for sale    12,073,613    4,057,820    12,478,222  
Federal Reserve Bank stock    984,000    984,000    984,000  
Federal Home Loan Bank stock    3,395,300    2,318,100    2,475,600  
Premises and equipment, net    15,320,930    9,573,056    14,344,330  
Cash value of life insurance    3,488,332    3,361,903    3,424,586  
Other assets    7,701,741    5,517,653    5,961,876  



      Total assets   $ 584,262,690   $ 461,858,953   $ 520,201,339  



          LIABILITIES AND SHAREHOLDERS’ EQUITY              
LIABILITIES:              
Deposits              
   Noninterest bearing deposits   $ 37,320,198   $ 32,062,917   $ 37,194,469  
   Interest bearing deposits    420,950,438    338,648,329    379,162,660  



     Total deposits    458,270,636    370,711,246    416,357,129  
Advances from Federal Home Loan Bank    55,000,000    32,500,000    37,500,000  
Other borrowings    7,058,507    4,971,581    7,209,820  
Junior subordinated debentures    10,310,000    10,310,000    10,310,000  
Other liabilities    4,749,438    2,546,114    3,364,811  



     Total liabilities    535,388,581    421,038,941    474,741,760  



SHAREHOLDERS’ EQUITY:              
Common stock, $1 par value; 10,000,000 shares              
   authorized; 4,836,916 issued and outstanding at               
June 30, 2007, 4,761,762 at June 30, 2006, and               
4,768,413 at December 31, 2006    4,836,916    4,761,762    4,768,413  
Paid-in capital    29,050,951    28,631,156    28,657,576  
Retained earnings    16,017,612    9,145,965    12,706,795  
Accumulated other comprehensive loss    (1,031,370 )  (1,718,871 )  (673,205 )



     Total shareholders' equity    48,874,109    40,820,012    45,459,579  



      Total liabilities and shareholders' equity   $ 584,262,690   $ 461,858,953   $ 520,201,339  



        The accompanying notes are an integral part of these consolidated condensed financial statements.



3


Beach First National Bancshares, Inc. and Subsidiaries
Consolidated Statements of Income

(Unaudited)

Six Months Ended Three Months Ended
June 30, June 30,
2007 2006 2007 2006
INTEREST INCOME                    
   Interest and fees on loans   $ 20,056,229   $ 14,623,038   $ 10,339,772   $ 7,799,168  
   Investment securities    1,849,572    1,262,116    944,729    679,972  
   Fed funds sold    138,378    226,075    69,351    81,022  
    Other    11,860    10,910    5,960    5,653  




          Total interest income    22,056,039    16,122,139    11,359,812    8,565,815  
                   
INTEREST EXPENSE                  
   Deposits    9,199,762    5,850,959    4,732,477    3,154,070  
   Advances from the FHLB and federal funds purchased    970,787    687,414    541,971    345,525  
   Junior subordinated debentures    639,985    366,827    321,605    189,580  




          Total interest expense    10,810,534    6,905,200    5,596,053    3,689,175  
          Net interest income    11,245,505    9,216,939    5,763,759    4,876,640  
                   
PROVISION FOR POSSIBLE LOAN                  
   LOSSES    722,000    1,187,400    370,800    665,200  




          Net interest income after provision                  
             for possible loan losses    10,523,505    8,029,539    5,392,959    4,211,440  




NONINTEREST INCOME                  
   Service fees on deposit accounts    278,023    261,948    142,535    133,982  
   Gain on sale of loan    -    60,392    -    38,133  
   Gain on sale of fixed asset    4,780    -    930    -  
   Income from cash value life insurance    74,416    70,526    37,657    35,676  
   Income from mortgage operations    3,287,803    120,874    1,514,605    54,489  
   Other income    842,240    759,026    457,434    698,967  




         Total noninterest income    4,487,262    1,272,766    2,153,161    961,247  




NONINTEREST EXPENSES                  
   Salaries and wages    4,347,295    2,489,799    2,014,864    1,466,316  
   Employee benefits    807,422    433,710    406,516    199,403  
   Supplies and printing    93,086    59,361    41,903    30,922  
   Advertising and public relations    317,052    172,783    173,446    89,268  
   Professional fees    272,824    269,176    144,836    191,654  
   Depreciation and amortization    522,961    250,125    207,222    119,723  
   Occupancy    865,545    405,889    416,926    216,405  
   Data processing fees    353,062    246,776    181,605    129,807  
   Other operating expenses    2,289,544    859,209    1,322,819    505,538  




          Total noninterest expenses    9,868,791    5,186,828    4,910,137    2,949,036  




          Income before income taxes    5,141,976    4,115,477    2,635,983    2,223,651  
                   
INCOME TAX EXPENSE    1,831,159    1,480,579    937,550    800,560  




          Net income   $ 3,310,817   $ 2,634,898   $ 1,698,433   $ 1,423,091  




BASIC NET INCOME PER COMMON SHARE   $ .69   $ .55   $ .35   $ .30  




DILUTED NET INCOME PER COMMON SHARE   $ .67   $ .54   $ .34   $ .29  




        Weighted average common shares outstanding - basic    4,793,924    4,759,970    4,818,556    4,761,758  
        Weighted average common shares outstanding - diluted    4,949,533    4,870,177    4,967,124    4,874,842  

The accompanying notes are an integral part of these consolidated condensed financial statements.


4


Beach First National Bancshares, Inc. and Subsidiaries
Consolidated Condensed Statements of Changes in Shareholders’ Equity and Comprehensive Income
(Unaudited)

Accumulated
Other Total
Common Stock Paid-in Retained Comprehensive Shareholders’
Shares Amount Capital Earnings Income Equity
 
BALANCE, DECEMBER 31, 2005      3,169,958   $ 3,169,958   $ 30,157,843   $ 6,513,582   $ (715,970 ) $ 39,125,413  
   Net income    -    -    -    2,634,898    -    2,634,898  
Other comprehensive income, net of taxes:                          
  Unrealized loss on investment securities    -    -    -    -    (1,002,901 )  (1,002,901 )
  Plus Reclassification adjustments for gains                          
    included in net income    -    -    -    -    -    -  

  Comprehensive income    -    -    -    -    -    1,631,997  
   Exercise of stock options    6,924    6,924    58,193    -    -    65,117  
   Stock dividend in the form of a 3 for 2 split    1,584,880    1,584,880    (1,584,880 )  (2,515 )  -    (2,515 )






    BALANCE, JUNE 30, 2006    4,761,762   $ 4,761,762   $ 28,631,156   $ 9,145,965   $ (1,718,871 ) $ 40,820,012  








Accumulated
Other Total
Common Stock Paid-in Retained Comprehensive Shareholders’
Shares Amount Capital Earnings Income Equity
 
BALANCE, DECEMBER 31, 2006      4,768,413   $ 4,768,413   $ 28,657,576   $ 12,706,795   $ (673,205 ) $ 45,459,579  
   Net income    -    -    -    3,310,817    -    3,310,817  
Other comprehensive income, net of taxes:                          
  Unrealized loss on investment securities    -    -    -    -    (570,694 )  (570,694 )
  Unrealized gain on interest rate swap    -    -    -    -    212,529    212,529  
  Plus Reclassification adjustments for gains                          
    included in net income    -    -    -    -    -    -  

  Comprehensive income    -    -    -    -    -    2,952,652  
   Exercise of stock options    68,503    68,503    393,375    -    -    461,878  






BALANCE, JUNE 30, 2007    4,836,916   $ 4,836,916   $ 29,050,951   $ 16,017,612   $ (1,031,370 ) $ 48,874,109  






The accompanying notes are an integral part of these consolidated condensed financial statements.





5


Beach First National Bancshares, Inc. and Subsidiaries
Consolidated Condensed Statements of Cash Flows

Six Months Ended
June 30,
2007 2006
(unaudited) (unaudited)
OPERATING ACTIVITIES            
   Net income   $ 3,310,817   $ 2,634,898  
   Adjustments to reconcile net income to net cash provided by (used in)          
operating activities:          
        Proceeds from sale of mortgages held for sale    158,623,684    -  
        Disbursements for mortgages held for sale    (158,552,816 )  -  
        Deferred income taxes    616,493    (747,736 )
        Provisions for loan losses    722,000    1,187,400  
        Depreciation and amortization    522,961    250,125  
        Accretion of deferred loan fees    677,847    32,448  
        Discount accretion and premium amortization    85,822    33,096  
        (Gain) loss on sale of property and equipment    22,773    (581,711 )
        Increase in other assets    (1,913,593 )  (589,611 )
        Increase in other liabilities    1,233,313    990,512  
        Loss on sale of other real estate owned    60,497    -  


           Net cash provided by (used in) operating activities    5,409,798    3,209,421  


INVESTING ACTIVITIES          
   Purchase of investment securities    (1,182,354 )  (13,558,295 )
   Purchase of Federal Home Loan Bank stockb    (919,700 )  (306,700 )
   Purchase of Federal Reserve stock    -    (450,000 )
   Decrease (increase) in Federal funds sold    (12,061,713 )  24,380,471  
   Increase in loans, net    (48,687,115 )  (69,121,221 )
   Purchase of premises and equipment    (976,599 )  (2,568,963 )
   Purchase of life insurance contracts    (63,749 )  (60,486 )


        Net cash used in investing activities    (63,891,230 )  (61,685,194 )
           
FINANCING ACTIVITIES          
    Advances from Federal Home Loan Bank    17,500,000    (1,500,000 )
    Net increase in deposits    41,913,507    59,817,036  
    Exercise of stock options    461,878    62,602  
    Proceeds from other borrowings    -    3,467,572  


          Net cash provided by financing activities    59,875,385    61,847,210  


          Net increase in cash and cash equivalents    1,393,953    3,371,437  
           
CASH AND DUE FROM BANKS, BEGINNING OF PERIOD   $ 5,198,945   $ 4,284,868  


CASH AND DUE FROM BANKS, END OF PERIOD   $ 6,592,898   $ 7,656,305  


CASH PAID FOR          
   Income taxes   $ 1,831,159   $ 1,480,579  


   Interest   $ 10,810,534   $ 6,905,200  


The accompanying notes are an integral part of these consolidated financial statements.




6


Beach First National Bancshares, Inc.
Notes to Consolidated Condensed Financial Statements (Unaudited)

1.   Basis of Presentation

        The accompanying consolidated condensed financial statements for Beach First National Bancshares, Inc. (“Company”) were prepared in accordance with instructions for Form 10-Q and, therefore, do not include all disclosures necessary for a complete presentation of financial condition, results of operations, and cash flows in conformity with generally accepted accounting principles. All adjustments, consisting only of normal recurring accruals, which are, in the opinion of management, necessary for fair presentation of the interim consolidated financial statements have been included. The results of operations for the six month period ended June 30, 2007 are not necessarily indicative of the results that may be expected for the entire year. These consolidated financial statements do not include all disclosures required by generally accepted accounting principles and should be read in conjunction with the Company’s audited consolidated financial statements and related notes for the year ended December 31, 2006.

2.   Principles of Consolidation

        The accompanying consolidated condensed financial statements include the accounts of the Company and its subsidiaries, Beach First National Bank and BFNM Building, LLC (“LLC”) (See Note 4 “Investment in LLC” below). The Company also owns two grantor trusts, Beach First National Trust I and Beach First National Trust II. All significant inter-company items and transactions have been eliminated in consolidation. In accordance with current accounting guidance, the financial statements of the trusts have not been included in the Company’s financial statements.

3.   Earnings Per Share

        The Company calculates earnings per share in accordance with Statement of Financial Accounting Standard No. 128, “Earnings Per Share” (“SFAS 128”). SFAS 128 specifies the computation, presentation, and disclosure requirements for earnings per share (EPS) for entities with publicly held common stock or potential common stock such as options, warrants, convertible securities, or contingent stock agreements if those securities trade in a public market.

        This standard specifies computation and presentation requirements for both basic EPS and, for entities with complex capital structures, diluted EPS. Basic earnings per share are computed by dividing net income by the weighted average common shares outstanding. Diluted earnings per share is similar to the computation of basic earnings per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if the dilutive potential common shares had been issued. The dilutive effect of options outstanding under the Company’s stock option plan is reflected in diluted earnings per share by application of the treasury stock method.

RECONCILIATION OF THE NUMERATORS AND DENOMINATORS OF THE BASIC AND DILUTED EPS COMPUTATIONS:

 For the Six Months Ended  For the Year Ended
2007 2006 2006
Basic earnings per share:                
Net income available to common shareholders   $ 3,310,817   $ 2,634,898   $ 6,195,728  



Average common shares outstanding - basic    4,793,924    4,759,970    4,764,072  



Basic earnings per share   $ 0.69   $ 0.55   $ 1.30  



Diluted earnings per share:              
Net income available to common shareholders   $ 3,310,817   $ 2,634,898   $ 6,195,728  



Average common shares outstanding - basic    4,793,924    4,759,970    4,764,072  
Incremental shares from assumed conversion              
   of stock options    155,609    110,207    110,490  



Average common shares outstanding - diluted    4,949,533    4,870,177    4,874,562  



Diluted earnings per share   $ 0.67   $ 0.54   $ 1.27  




7


For the Three Months Ended For the Year Ended
2007 2006 2006
Basic earnings per share:                
Net income available to common shareholders   $ 1,698,433   $ 1,423,091   $ 6,195,728  



Average common shares outstanding - basic    4,818,556    4,761,758    4,764,072  



Basic earnings per share   $ 0.35   $ 0.30   $ 1.30  



Diluted earnings per share:              
Net income available to common shareholders   $ 1,698,433   $ 1,423,091   $ 6,195,728  



Average common shares outstanding - basic    4,818,556    4,761,758    4,764,072  
Incremental shares from assumed conversion              
   of stock options    148,568    113,084    110,490  



Average common shares outstanding - diluted    4,967,124    4,874,842    4,874,562  



Diluted earnings per share   $ 0.34   $ 0.29   $ 1.27  



4.   Investment in LLC

        The LLC is in partnership with our legal counsel, Nelson Mullins Riley & Scarborough LLP, for purposes of acquiring a parcel of land and constructing an office building on the property. The Company owns two-thirds of the LLC and Nelson Mullins Riley & Scarborough owns the remaining one-third. The building is a three-story, 46,066 square foot office building located on 3.5 acres at the southwest corner of Robert Grissom Parkway and 38th Avenue North in Myrtle Beach, South Carolina. The Company moved its main office to this location in December 2006. Nelson Mullins Riley & Scarborough LLP also relocated its Myrtle Beach legal office to the building in December 2006. The LLC purchased the land for approximately $1.8 million and financed the construction project through a third-party lender with each of the owners being responsible for their respective interests in the project. The total land and construction project cost approximately $7.0 million, exclusive of tenant improvements. The Company leases two-thirds of the building (approximately 30,000 square feet) from the LLC. Because the Company only occupies approximately 12,500 square feet of space, it intends to lease the other 17,500 square feet of its portion to outside tenants. Nelson Mullins Riley & Scarborough also leases one-third of the building from the LLC. As of June 30, 2007, 4,700 square feet of the 17,500 available have been leased.

        Upon completion of construction, the construction financing note from the third-party lender was converted to a term loan payable by the LLC to the third-party bank and is secured by the building. The loan requires 107 installments of principal and interest based on a fifteen year amortization, with all remaining principal and interest due on June 15, 2015. The interest rate on the term loan is variable based on one-month LIBOR plus 1.40%. As a result of the interest rate SWAP discussed below, the LLC has converted this variable rate to a fixed rate of 6.02%. The outstanding balance on the term loan at June 30, 2007 is $7.1 million and is shown as other borrowings in the accompanying balance sheet.

5.   Interest Rate SWAP – Derivative Financial Instrument

        The LLC entered into an interest rate swap agreement as a risk management tool to hedge the interest rate risk associated with the variable rate building loan discussed above. This swap instrument is a derivative financial instrument designated as a cash flow hedge and is accounted for in accordance with the provisions of Statement of Financial Accounting Standard No. 133 (“SFAS 133”). Under the swap, the LLC pays a fixed rate of 4.62% and receives interest payments that vary based on LIBOR. Through the swap, the LLC has converted the building loan to a fixed effective rate of 6.02%.

        In accordance with SFAS 133, the LLC has formally documented the relationship between the building loan and the swap, as well as the risk-management objective and strategy for undertaking the hedge transaction. In connection with this process, the LLC has determined that the swap is highly effective as a cash flow hedge and the entire fair value



8


of the swap was initially recorded in other comprehensive income. Under SFAS 133, any material ineffectiveness must be reclassified to earnings. During the formal documentation process, the LLC also determined that no hedge ineffectiveness is anticipated because the terms of the swap so closely match the terms of the building loan.

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

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

        This report contains “forward-looking statements” relating to, without limitation, future economic performance, plans and objectives of management for future operations, and projections of revenues and other financial items that are based on the beliefs of management, as well as assumptions made by and information currently available to management. The words “may,” “will,” “anticipate,” “should,” “would,” “believe,” “contemplate,” “expect,” “estimate,” “continue,” “may,” and “intend,” as well as other similar words and expressions of the future, are intended to identify forward-looking statements. Our actual results may differ materially from the results discussed in the forward-looking statements, and our operating performance each quarter is subject to various risks and uncertainties including, without limitation those described in detail in our Annual Report on Form 10-KSB for the year ended December 31, 2006 under the heading “Risk Fact ors” with the Securities and Exchange Commission and the following:

  significant increases in competitive pressure in the banking and financial services industries;
  changes in the interest rate environment which could reduce anticipated or actual margins;
  changes in political conditions or the legislative or regulatory environment;
  general economic conditions, either nationally or regionally and especially in our primary service area, becoming less favorable than expected resulting in, among other things, a deterioration in credit quality;
  changes occurring in business conditions and inflation;
  changes in management;
  changes in technology;
  changes in deposit flows;
  the level of allowance for loan loss;
  the rate of delinquencies and amounts of charge-offs;
  the rates of loan growth;
  adverse changes in asset quality and resulting credit risk-related losses and expenses;
  changes in monetary and tax policies;
  loss of consumer confidence and economic disruptions resulting from terrorist activities;
  changes in the securities markets; and
  other risks and uncertainties detailed from time to time in our filings with the Securities and Exchange Commission.

We undertake no obligation to publicly update or otherwise revise any forward-looking statements, whether as a result of new information, future events, or otherwise.

Critical Accounting Policies

        We have adopted various accounting policies that govern the application of accounting principles generally accepted in the United States and with general practices within the banking industry in the preparation of our consolidated financial statements. Our significant accounting policies are described in the footnotes to our audited consolidated financial statements as of December 31, 2006 as filed in our 2006 Annual Report on Form 10-K.

        Certain accounting policies involve significant judgments and assumptions by management which have a material impact on the carrying value of certain assets and liabilities. We consider such accounting policies to be critical accounting policies. The judgments and assumptions we use 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 we



9


make, actual results could differ from these judgments and estimates. These differences could have a material impact on our carrying values of assets and liabilities and our results of operations.

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

Overview

        The following discussion describes our results of operations for the quarter ended June 30, 2007 as compared to the quarter ended June 30, 2006, as well as results for the six months ended June 30, 2007 and 2006, and also analyzes our financial condition as of June 30, 2007 as compared to December 31, 2006. Like most community banks, we derive most of our income from interest we receive on our loans and investments. Our primary source of funds for making these loans and investments is our deposits, on which we pay interest. Consequently, one of the key measures of our success is our amount of net interest income, or the difference between the income on our interest-earning assets, such as loans and investments, and the expense on our interest-bearing liabilities, such as deposits. Another key measure is the spread between the yield we earn on these interest-earning assets and the rate we pay on our interest-bearing liabilities.

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

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

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

Results of Operations

Earnings Review

        Our net income was $3.3 million, or $.67 per diluted common share, for the six months ended June 30, 2007 as compared to net income of $2.6 million, or $.54 per diluted common share, for the six months ended June 30, 2006. Our net income was $1.7 million, or $.34 per diluted common share, for the three months ended June 30, 2007 as compared to net income of $1.4 million, or $.29 per diluted common share, for the same period of 2006. The increase in net income reflects the bank’s continued growth, as average earning assets increased to $521.5 million during the first six months of 2007 from $413.0 million during the same period of 2006. The return on average assets for the six month period ended June 30, 2007 was 1.20% compared to 1.22% for the same period 2006. The return on average equity was 14.12% for the six month period ended June 30, 2007 versus 12.88% 2006.

Net Interest Income

        Our primary source of revenue is net interest income, which represents the difference between the income on interest-earning assets and expense on interest-bearing liabilities. During the first six months of 2007, net interest



10


income increased 22.0% to $11.2 million from $9.2 million for the same period of 2006. For the three months ended June 30, 2007, net interest income increased 18.2% to $5.8 million from $4.9 million during the comparable period of 2006. The growth in net interest income during the six month period ended June 30, 2007 resulted from an increase of $5.9 million in interest income, partially offset by an increase in interest expense of $3.9 million. Our net interest income is determined by the level of our earning assets and the management of our net interest margin. The continued growth of our loan portfolio is the primary driver of the increase in net interest income. Average total loans increased from $348.5 million in the first six months of 2006 to $442.2 million in the same period in 2007. In addition, average securities increased to $73.4 million in the first six months of 2007 compared to $54.3 million for the first six months of 2006.

        Net interest spread, the difference between the rate we earn on interest-earning assets and the rate we pay on interest-bearing liabilities, was 3.80% in the first six months of 2007 compared to 3.95% during the same period of 2006. The net interest margin was 4.35% for the six month period ended June 30, 2007 compared to 4.50% for the same period of 2006. The decline in the net interest spread and the net interest margin are due to the rising interest rate environment and the increased competition in our markets for deposits. Despite this decline, we have maintained a solid net interest margin.

Provision for Loan Losses

        We have established an allowance for loan losses through a provision for loan losses charged as an expense on our statement of income. We review our loan portfolio periodically to evaluate our outstanding loans and to measure both the performance of the portfolio and the adequacy of the allowance for loan losses. The provision for loan losses was $722,000 for the first six months of 2007 and $1.2 million for the same period of 2006. The provision for loan losses was $370,800 for the three months ended June 30, 2007 and $665,200 for the same period in 2006. The decrease in the provision was the result of management’s assessment of the adequacy of the reserve for possible loan losses given the size, mix and quality of the current loan portfolio. Please see the discussion below under “Allowance for Possible Loan Losses” for a description of the factors we considered in determining the amount of the provision we expense each period to maintain this allowance.

Noninterest Income

        Noninterest income increased to $4.5 million for the first six months of 2007 compared to $1.3 million in the same period of 2006. For the three months ended June 30, 2007, noninterest income increased to $2.2 million as compared to $961,247 in 2006. This increase in noninterest income is related to the income from our mortgage operations that we added in June 2006. With the formation of the company’s mortgage operations, all sources of income from this division are included in income from mortgage operations. The four key components of the revenue from mortgage operations are loan referral fees, document preparation fees which includes origination fees, servicing release premiums, and the net gains on the sale of mortgage loans. The following table sets forth information related to the largest component of our noninterest income, income from mortgage operations, for the first six months of 2007 and 2006, as well as, for the three months ended June 30, 2007 and 2006.

For the six months ended     For the three months ended
June 30,     June 30,
2007 2006     2007     2006
Loan referral fees     $ 140,889   $ 120,874   $ 4,094   $ 54,489  
Document preparation fees    1,160,842    20,449    607,958    24,478  
Servicing release premiums    1,417,220    -    782,768    -  
Gain on sale of mortgage loans    494,833    -    69,862    -  

Changes in federal law regarding the oversight of mortgage brokers and lenders could increase our costs of operations and affect our mortgage origination volume which could negatively impact our Noninterest income in the future. Additional information on the expenses associated with the mortgage division can be found below in the “Noninterest Expense” section.



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Noninterest Expense

        Total noninterest expense increased 90.3% to $9.9 million for the six months ended June 30, 2007 from $5.2 million for the same period of 2006 and increased 66.5% to $4.9 million for the three months ended June 30, 2007 from $2.9 million in the same period of 2006.

        Salaries and wages and employee benefits, the largest component of Noninterest expense, increased $2.2 million to $5.2 million for the six months ended June 30, 2007 compared to the same period in 2006, and increased $755,662 to $2.4 million for the quarter ended June 30, 2007 compared to the same period in 2006. Of the increase, $1.7 million is directly related to salary and wages for employees of our mortgage operations and another $304,781 is directly related to employee benefits for our mortgage operations’ employees. All other increases are the result of personnel additions due to the growth of our bank, normal compensation adjustments, and higher costs associated with group benefits.

        We had 180 full-time equivalent employees at June 30, 2007, an increase of 71 as compared to the same period in 2006. At June 30, 2007, 95 of the full-time equivalent employees work within our mortgage operations. As of June 29, 2007, we added 23 employees from our newest mortgage location in Raleigh, NC. Other staffing increases were primarily due to the overall growth of the bank.

        Advertising and public relations costs increased $144,269 to $317,052 for the six months ended June 30, 2007 compared to the same period in 2006, and increased $84,178 to $173,446 for the three months ended June 30, 2007 compared to the same period in 2006. We incurred $27,994 in advertising and public relations costs directly related to our mortgage operations for the six months ended June 30, 2007. These expenses continue to be a major expense item as we develop our presence in new markets. Other increases are related primarily to special promotions, such as newspaper advertisements, to attract deposits in all markets, as well as contracting with a professional advertising agency. Professional fees increased $3,648 for the six months ended June 30, 2007 compared to the same period in 2006, and decreased $46,818 for the three months ended June 30, 2007 compared to the same period in 2006. While there was a decrease for the quarter, as compared to 2006, these fees continue to increase due to our growth, the regulatory fees associated with such growth, and the escalating cost of accounting, auditing, and legal services for a public company. Our expense directly related to Sarbanes-Oxley compliance for the six months ended June 30, 2007 is $49,983. We expect these fees to continue to increase as we formally prepare to meet the requirements of these comprehensive regulations.

        Occupancy expenses increased $459,656 during the six month period ended June 30, 2007 compared to the same period in 2006 and by $200,521 for the three months ended June 30, 2007 compared to the same period in 2006. This increase is related to the addition of the facilities associated with our mortgage operations, as well as the expense related to the new corporate headquarters. Of the increase in occupancy expense, $346,433 is directly related to the mortgage operations. The increase was also the result of increases on lease payments for most of our branch locations. As we continue to expand, we expect that occupancy costs will continue to increase.

        Data processing fees increased during the six months ended June 30, 2007 to $353,062 compared to $246,776 for the same period in 2006. For the three months ended June 30, 2007, data processing costs totaled $181,605 compared to $129,807 for June 30, 2006. Data processing costs are primarily related to the volume of loan and deposit accounts and associated transaction activity. Strong security of data processing and related systems is paramount to our operations. We expanded the security features of our internet banking product, in addition to upgrading all security measures for internal and external systems. We believe our data processing costs are consistent with our expansion.

        Other operating expenses increased 166.5% to $2.3 million during the first six months of 2007 compared to $859,209 for the same period in 2006. Other operating expenses increased 161.7%, or $817,281, for the three months ended June 30, 2007 compared to the same period in 2006. These increases are primarily the result of increased operating expenses related to the growth of the company, along with other expenses associated with the expansion of loans and deposits. The increase in other operating expenses was primarily due to increase in credit and collection expenses related to the mortgage operations, merchant expenses, entertainment expenses, furniture and equipment expenses, and higher travel and lodging expenses.

        Specifically, credit and collection expenses related to mortgage operations increased $800,083 for the first six months of 2007. Credit and collection expenses related to the mortgage division includes the following accounts: credit report fees of $46,002, appraisal fees of $25,070, flood certification fees of $1,990, investor funding fees of $153,120,



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document preparation fees of $39,895, loan referral fees of $31,857, lenders credit fees of $59,286, early payoff fees of $12,899, and brokers fees of $434,867.

        Merchant expenses increased $237,144 due to the expansion of merchant related activity in the first six months of 2007. Entertainment expenses, which include business development, increased $137,313. Of this increase $125,000 is directly related to business development for our mortgage operations. Furniture and equipment increased $67,579, travel expenses increased $39,572, software maintenance expenses increased $31,638 and telephone expenses increased $28,206, collectively totaling 100% of the total increase of $1.4 million.

        The following table presents a comparison of other operating expenses by category containing a balance over $20,000 as of June 30, 2007.

Other Operating Expenses

For the six months ended For the three months ended June 30
June 30, June 30,
2007 2006 2007 2006
 
Telephone     $ 63,562   $ 35,355   $ 31,828   $ 18,264  
Postage and freight    47,318    28,355    24,757    15,330  
Armored Car    42,550    41,082    22,713    21,633  
Credit and collection - mortgage operations    805,235    5,152    424,849    5,152  
Credit and collection - bank    98,104    42,595    52,627    4,735  
Dues and subscriptions    66,244    57,877    32,285    30,060  
Travel    129,404    89,832    53,452    45,450  
Entertainment    187,953    50,640    161,823    36,516  
FDIC insurance    24,378    18,830    12,696    9,987  
Other insurance    25,141    21,472    12,570    10,736  
Debit/ATM    46,024    38,145    24,093    18,712  
Merchant    280,026    42,882    168,197    35,755  
Credit card processing fees    20,752    39,151    12,767    39,151  
Fed charges    20,681    18,674    10,971    9,945  
Software maintenance    56,980    25,342    41,442    13,443  
Director Supplemental Retirement Plan    49,302    88,076    24,662    40,130  
NASDAQ    29,576    12,250    8,182    6,125  
Furniture and equipment    162,000    94,422    96,349    46,649  
Other Operating Expenses    134,314    109,077    106,556    97,765  




                Total   $ 2,289,544   $ 859,209   $ 1,322,819   $ 505,538  




Balance Sheet Review

General

        We had total assets of $584.3 million at June 30, 2007, an increase of 26.5% from $461.9 million at June 30, 2006 and an increase of 12.3% from $520.2 at December 31, 2006. Total assets consisted primarily of $451.1 million in net loans, $74.0 million in investments, $26.1 million in federal funds sold and short-term investments, and $6.6 million in cash and due from banks. Our liabilities at June 30, 2007 totaled $535.4 million, consisting primarily of $458.3 million in deposits, $55.0 million in Federal Home Loan Bank (FHLB) advances, $7.1 million in a note payable, and $10.3 million of junior subordinated debentures. Our total deposits increased to $458.3 million at June 30, 2007, up 23.6% from $370.7 million at June 30, 2006, and up 10.1% from $416.4 million at December 31, 2006. Shareholder’s equity increased $8.1 million to $48,874,109 at June 30, 2007, as compared to $40,820,012 at June 30, 2006, and increased $3.4 million from $45,459,579 at December 31, 2006.



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Investment Securities

        At June 30, 2007, investment securities totaled $74.0 million and averaged $73.4 million during the first six months of 2007. Total investment securities averaged $54.3 million during the first six months of 2006 and totaled $59.3 million at June 30, 2006. Total investment securities averaged $60.2 million for the year ended December 31, 2006 and totaled $71.9 million at December 31, 2006. At June 30, 2007, investment securities represented 12.7% of total assets compared to 12.8% at June 30, 2006. All investment securities are classified as available-for-sale and are recorded at fair value. At June 30, 2007, our total investment securities portfolio had a book value of $75.9 million and a fair market value of $74.0 million for a gross unrealized net loss of $1.9 million. We primarily invest in U.S. Government Sponsored Enterprises and Federal Agency securities.

        At June 30, 2007 short-term investments totaled $26.1 million, compared to $1.1 million at June 30, 2006 and $14.0 million at December 31, 2006. These funds are one source of our bank’s liquidity and are generally invested in an earning capacity on an overnight or short-term basis. This increase in short-term investments is primarily due to lower loan demand during this quarter.

Loans

        Since loans typically provide higher yields than other types of earning assets, a substantial percentage of our earning assets are invested in our loan portfolio. As of June 30, 2007, loans represented 82.1% of total earning assets compared to 86.3% at June 30, 2006 and 84.2% at December 31, 2006. At June 30, 2007 net loans (total loans less the allowance for loan losses) totaled $451.1 million, an increase of $75.7 million from June 30, 2006 and of $45.7 million from December 31, 2006. Average total loans increased from $348.5 million, with a yield of 8.46%, in the first six months of 2006 to $442.2 million, with a yield of 9.15%, during the same in 2007. Average total loans were $372.8 million with a yield of 8.88% at December 31, 2006. The interest rates charged on loans vary with the degree of risk and the maturity and amount of the loan. Competitive pressures, money market rates, availability of funds and government regulations also influence interest rates.

The following table shows the composition of the loan portfolio by category at June 30, 2007, June 30, 2006, and December 31, 2006.

Composition of Loan Portfolio

June 30, 2007 June 30, 2006 December 31, 2006
Percent Percent Percent
Amount of Total Amount of Total Amount of Total
 
Commercial     $ 52,597,017    11.5 % $ 44,969,584    11.8 %  43,974,792    10.7 %
Real estate - construction    41,964,309    9.2 %  37,284,803    9.8 %  44,032,693    10.7 %
Real estate - mortgage (1)    354,742,057    77.5 %  290,450,214    76.2 %  315,689,304    76.7 %
Consumer    8,357,160    1.8 %  8,276,060    2.2 %  7,784,157    1.9 %






        Loans, gross    457,660,543    100.0 %  380,980,661    100.0 %  411,480,946    100.0 %






Unearned loan fees and costs, net    (278,513 )      (325,462 )      (266,090 )    

Allowance for possible loan losses    (6,331,806 )      (5,329,391 )      (5,888,052 )    



        Loans, net   $ 451,050,224       $ 375,325,808       $ 405,326,804      



        (1)   Includes mortgage loans held for sale

        Mortgage loans were the principal component of our loan portfolio at June 30, 2007, June 30, 2006 and December 31, 2006, which represented 77.5%, 76.2% and 76.7% of the portfolio, respectively. In the context of this discussion, a “real estate mortgage loan” is defined as any loan, other than loans for construction purposes, secured by real estate, regardless of the purpose of the loan. We follow the common practice of financial institutions in our market area of obtaining a security interest in real estate whenever possible, in addition to any other available collateral. The security interest in the collateral is taken to reinforce the likelihood of the ultimate repayment of the loan and tends to increase the



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magnitude of the real estate loan portfolio component. Generally, we limit the loan-to-value ratio to 80%. Because of our relatively small size and the short period of time our loan portfolio has existed, the current portfolio mix may not be indicative of the on-going mix. We will attempt to maintain a relatively diversified loan portfolio to help reduce the risk inherent in concentrations of collateral.

Allowance for Possible Loan Losses

        We have established an allowance for loan losses through a provision for loan losses charged to expense on our statement of income. The allowance for loan losses represents an amount which we believe will be adequate to absorb probable losses on existing loans that may become uncollectible. Our judgment as to the adequacy of the allowance for loan losses is based on a number of assumptions about future events, which we believe to be reasonable, but which may or may not prove to be accurate. The evaluation of the allowance is segregated into general allocations and specific allocations. For general allocations, the portfolio is segregated into risk-similar segments for which historical loss ratios are calculated and adjusted for identified trends or changes in current portfolio characteristics. Historical loss ratios are calculated by product type for consumer loans (installment and revolving), mortgage loans, and commercial loans and may be adjusted for other risk factors. To allow for modeling error, a range of probable loss ratios is then derived for each segment. The resulting percentages are then applied to the dollar amounts of the loans in each segment to arrive at each segment’s range of probable loss levels. Certain nonperforming loans are individually assessed for impairment under SFAS No. 114 and assigned specific allocations. Other identified high-risk loans or credit relationships based on internal risk ratings are also individually assessed and assigned specific allocations.

        The general allocation also includes a component for probable losses inherent in the portfolio, based on management’s analysis that is not fully captured elsewhere in the allowance. This component serves to address the inherent estimation and imprecision risk in the methodology as well as address management’s evaluation of various factors or conditions not otherwise directly measured in the evaluation of the general and specific allocations. Such factors include the current general economic and business conditions; geographic, collateral, or other concentrations of credit; system, procedural, policy, or underwriting changes; experience of the lending staff; entry into new markets or new product offerings; and results from internal and external portfolio examinations.

        Periodically, we adjust the amount of the allowance based on changing circumstances. We charge recognized losses to the allowance and add subsequent recoveries back to the allowance for loan losses. There can be no assurance that charge-offs of loans in future periods will not exceed the allowance for loan losses as estimated at any point in time or that provisions for loan losses will not be significant to a particular accounting period.

        The allocation of the allowance to the respective loan segments is an approximation and not necessarily indicative of future losses or future allocations. The entire allowance is available to absorb losses occurring in the overall loan portfolio. In addition, the allowance is subject to examination and adequacy testing by regulatory agencies, which may consider such factors as the methodology used to determine adequacy and the size of the allowance relative to that of peer institutions, and other adequacy tests. Such regulatory agencies could require us to adjust the allowance based on information available to them at the time of their examination.

        At June 30, 2007, the allowance for possible loan losses was $6.3 million, or 1.38% of outstanding loans, compared to an allowance for possible loan losses of $5.3 million, or 1.40% of outstanding loans, at June 30, 2006 and an allowance for possible loan losses of $5.9 million, or 1.43% of outstanding loans, at December 31, 2006. In the first six months of 2007, we had net charge-offs totaling $178,246. During the same period in 2006, we had net charge-offs totaling $222,296. For the twelve months ended December 31, 2006, we had net charge-offs totaling $650,635. We had non-performing loans totaling $1,431,960 at June 30, 2007, $1,695,566 at June 30, 2006, and $1,625,511 at December 31, 2006. While there can be no assurances, we do not expect significant losses relating to these nonperforming loans because we believe that the collateral supporting these loans is largely sufficient to cover the outstanding loan balances.

        The following table sets forth certain information with respect to our allowance for loan losses and the composition of charge-offs and recoveries for the six months ended June 30, 2007, June 30, 2006, and December 31, 2006.



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Allowance for Loan Losses

Six months ended June 30, December 31,
2007 2006 2006
 
Average total loans outstanding     $ 442,197,589   $ 348,469,042   $ 372,791,961  
Total loans outstanding at period end    457,382,031    380,655,199    411,214,857  
Total nonperforming loans    1,431,960    1,695,566    1,625,511  
               
Beginning balance of allowance   $ 5,888,052   $ 4,364,287   $ 4,364,287  
               
Loans charged off    (185,241 )  (232,116 )  (792,188 )
Total recoveries    6,995    9,820    141,553  



Net loans charged off    (178,246 )  (222,296 )  (650,635 )
               
Provision for loan losses    622,000    1,187,400    2,174,400  



Balance at period end   $ 6,331,806   $ 5,329,391   $ 5,888,052  



Net charge-offs to average total loans    0.04 %  0.06 %  0.17 %
Allowance as a percent of total loans    1.38 %  1.40 %  1.43 %
Nonperforming loans as a percentage of total loans    0.31 %  0.45 %  0.40 %
Nonperforming loans as a percentage of allowance    22.62 %  31.82 %  27.59 %

        The following table sets forth the breakdown of the allowance for loan losses by loan category and the percentage of loans in each category to gross loans as of June 30, 2007. We believe that the allowance can be allocated by category only on an approximate basis. The allocation of the allowance to each category is not necessarily indicative of further losses and does not restrict the use of the allowance to absorb losses in any category.

As of June 30, 2007
Commercial     $ 1,119,997    11.49 %
Real estate - construction    585,331    9.17  
Real estate - mortgage    3,914,387    77.51  
Consumer    143,783    1.83  
Unallocated    568,308    -  


       Total allowance for loan losses   $ 6,331,806    100.0 %


Nonperforming Assets

        We discontinue accrual of interest on a loan when we conclude it is doubtful that we will be able to collect interest from the borrower. We reach this conclusion by taking into account factors such as the borrower’s financial condition, economic and business conditions, and the results of our previous collection efforts. Generally, we will place a delinquent loan in nonaccrual status when the loan becomes 90 days or more past due. When we place a loan in nonaccrual status, we reverse all interest which has been accrued on the loan but remains unpaid and we deduct this interest from earnings as a reduction of reported interest income. We do not accrue any additional interest on the loan balance until we conclude the collection of both principal and interest is reasonably certain. At June 30, 2007, there were no loans accruing interest which were 90 days or more past due and we had no restructured loans.

Deposits

        Total deposits were $458.3 million and represented 78.4% of total assets at June 30, 2007. Average total deposits were $433.4 million and average interest-bearing deposits were $398.8 million for the six months ended June 30, 2007. Average total deposits were $340.2 million and average interest-bearing deposits were $308.8 million in the



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same period of 2006. Average total deposits were $367.1 million and average interest-bearing deposits were $333.6 million at December 31, 2006.

        The following table sets forth our deposits by category as of June 30, 2007, June 30, 2006, and December 31, 2006.

Deposits

June 30, 2007 June 30, 2006 December 31, 2006
Percent of Percent of Percent of
Amount Deposits Amount Deposits Amount Deposits
 
Demand deposit accounts     $ 37,320,198    8.1 % $ 32,062,917    8.7 % $ 37,194,469    8.9 %
Interest bearing checking accounts    22,228,924    4.9 %  25,538,773    6.9 %  21,336,836    5.1 %
Money market accounts    109,117,393    23.8 %  86,333,302    23.3 %  103,056,865    24.8 %
Savings accounts    2,528,859    0.6 %  3,052,057    0.8 %  3,303,763    0.8 %
Time deposits less than $100,000    170,679,000    37.2 %  127,147,486    34.3 %  154,191,755    37.0 %
Time deposits of $100,000 or over    116,396,262    25.4 %  96,576,711    26.0 %  97,273,441    23.4 %






     Total deposits   $ 458,270,636    100.0 % $ 370,711,246    100.0 % $ 416,357,129    100.0 %






        Deposit growth was attributable to internal growth and the generation of new deposit accounts due primarily to special promotions and increased advertising. Demand deposit accounts increased as a result of an expanded focus on demand deposit accounts. Interest bearing checking accounts increased primarily due to a change mandated by the South Carolina Bar Association requiring that all lawyer trust accounts be interest bearing. This created a shift from demand deposit accounts to interest bearing checking accounts.

        Core deposits, which exclude certificates of deposit of $100,000 or more, provide a relatively stable funding source for our loan portfolio and other earning assets. Our core deposits were $341.9 million at June 30, 2007, compared to $274.1 million at June 30, 2006 and $319.1 million at December 31, 2006. Our brokered deposits were $39.6 million as of June 30, 2007, $29.5 million as of June 30, 2006, and $34.6 million as of December 31, 2006. We expect a stable base of deposits to be our primary source of funding to meet both our short-term and long-term liquidity needs. Core deposits as a percentage of total deposits were approximately 74.6% at June 30, 2007, 73.9% at June 30, 2006, and 76.6% at December 31, 2006. Our loan-to-deposit ratio was 98.4% at June 30, 2007 versus 101.2% at June 30, 2006 and 98.8% at December 31, 2006. The average loan-to-deposit ratio was 100.1% during the first six months of 2007, 102.4% during the same period of 2006, and 102.0% for the year ended December 31, 2006.

Advances from Federal Home Loan Bank

        In addition to deposits, we obtained funds from the FHLB to help fund our loan growth. Average borrowings from the FHLB were $43.9 million during the second quarter of 2007 and totaled $55.0 million at June 30, 2007. The following table reflects the current borrowing terms.

FHLB Description Balance      Current Rate    Maturity Date
Fixed Rate Hybrid     $ 5,000,000          4.76%       10/21/2010    
Fixed Rate   $ 10,000,000          5.358%     06/04/2010  
Convertible    7,500,000          4.51%     11/23/2010  
Convertible    5,000,000          3.68%     07/13/2015  
Convertible    5,000,000          4.06%     09/29/2015  
Convertible    5,000,000          4.16%     03/13/2017  
Convertible    7,500,000          4.385%     04/13/2017  
Prime Based Advance    10,000,000          5.41%     09/19/2011  

    $ 55,000,000        



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Junior Subordinated Debentures

        On May 27, 2004 we raised $5.0 million and on March 30, 2005 we raised an additional $5.0 million through the issuance and sale of floating rate trust preferred securities through BFNB Trust I and BFNB Trust II (the “Trusts”). These trust preferred securities are reported on our consolidated balance sheet as junior subordinated debentures. The Trusts loaned these proceeds to our holding company to use for general corporate purposes. Trust preferred securities currently qualify as Tier 1 capital under Federal Reserve Board guidelines.

        Debt issuance costs, net of accumulated amortization, from the junior subordinated debentures totaled $38,561 at June 30, 2007, $45,946 at June 30, 2006, and $41,067 at December 31, 2006. These costs are included in other assets on our consolidated balance sheet. Amortization of debt issuance costs from trust preferred debt totaled $2,086 for the six month period ended June 30, 2007, $2,086 for the six month period ended June 30, 2006, and $4,588 for the year ended December 31, 2006. These costs are reported in other noninterest expense on the consolidated statement of income.

        The trust preferred securities accrue and pay distributions annually at a rate per annum equal to the three month LIBOR plus 270 and 190 basis points, respectively, which was 8.055% and 7.255% at June 30, 2007. The distribution rate payable on these securities is cumulative and payable quarterly in arrears. We have the right, subject to events of default, to defer payments of interest on the trust preferred securities for a period not to exceed 20 consecutive quarterly periods, provided that no extension period may extend beyond the maturity dates of May 27, 2034 and March 30, 2035, respectively. We have no current intention to exercise our right to defer payments of interest on the trust preferred securities. We have the right to redeem the trust preferred securities, in whole or in part, on or after May 27, 2009 and March 30, 2010, respectively. We may also redeem the trust preferred securities prior to such dates upon occurrence of specified conditions and the payment of a redemption premium.

Capital Resources

        The Federal Reserve Board and bank regulatory agencies require bank holding companies and financial institutions to maintain capital at adequate levels based on a percentage of assets and off-balance sheet exposures, adjusted for risk weights ranging from 0% to 100%. Under the capital adequacy guidelines, regulatory capital is classified into two tiers. These guidelines require an institution to maintain a certain level of Tier 1 and Tier 2 capital to risk-weighted assets. Tier 1 capital consists of common shareholders’ equity, excluding the unrealized gain or loss on securities available for sale, minus certain intangible assets. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, are multiplied by a risk-weight factor of 0% to 100% based on the risks believed to be inherent in the type of asset. Tier 2 capital consists of Tier 1 capital plus the general reserve for loan losses, subject to certain limitations. We are also required to maintain capital at a minimum level based on total average assets, which is known as the Tier 1 leverage ratio. At both the holding company and bank level, we are subject to various regulatory capital requirements administered by the federal banking agencies. To be considered “well-capitalized,” we must maintain total risk-based capital of at least 10%, Tier 1 capital of at least 6%, and a leverage ratio of at least 5%.

        In October 2006, the Company announced a 3-for-2 stock split effected in the form of a 50% stock dividend to shareholders of record on December 1, 2006. The dividend was paid on December 21, 2006. All earnings per share amounts for all periods have been adjusted to reflect this 3-for-2 split.

        At June 30, 2007, our total shareholders’ equity was $48.9 million ($49.0 million at the bank level). At June 30, 2007, our Tier 1 capital ratio was 13.3% (11.5% at the bank level), our total risk-based capital ratio was 14.7% (12.7% at the bank level), and our Tier 1 leverage ratio was 11.0% (9.08% at the bank level). The bank was considered “well capitalized” and the holding company met or exceeded its applicable regulatory capital requirements.



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Liquidity Management

        Liquidity represents the ability of a company to convert assets into cash or cash equivalents without significant loss, and the ability to raise additional funds by increasing liabilities. Liquidity management involves monitoring our sources and uses of funds in order to meet our day-to-day cash flow requirements while maximizing profits. Liquidity management is made more complicated because different balance sheet components are subject to varying degrees of management control. For example, the timing of maturities of our investment portfolio is fairly predictable and subject to a high degree of control at the time investment decisions are made. However, net deposit inflows and outflows are far less predictable and are not subject to the same degree of control.

        Our primary sources of liquidity are deposits, scheduled repayments on our loans, and interest on and maturities of our investments. We plan to meet our future cash needs through the liquidation of temporary investments and the generation of deposits. All of our securities have been classified as available for sale. Occasionally, we might sell investment securities in connection with the management of our interest sensitivity gap or to manage cash availability. We may also utilize our cash and due from banks, security repurchase agreements, and federal funds sold to meet liquidity requirements as needed. In addition, we have the ability, on a short-term basis, to purchase federal funds from other financial institutions. Presently, we have made arrangements with commercial banks for short-term unsecured advances of up to $21.8 million. We maintain a secured line of credit in the amount of $10.0 million with our primary correspondent. We also have a line of credit with the FHLB to borrow up to 80% of our 1 to 4 family loans, resulting in an availability of funds of $2.4 million at June 30, 2007. The FHLB has approved borrowings up to 15% of the bank’s total assets less advances outstanding. The borrowings are available by pledging additional collateral and purchasing FHLB stock. At June 30, 2007, we had borrowed $55.0 million on this line. We believe that our existing stable base of core deposits, our bond portfolio, borrowings from the FHLB, and short-term federal funds lines will enable us to successfully meet our liquidity needs for the next 12 months.

Interest Rate Sensitivity

        A significant portion of our assets and liabilities are monetary in nature, and consequently they are very sensitive to changes in interest rates. This interest rate risk is our primary market risk exposure, and it can have a significant effect on our net interest income and cash flows. We review our exposure to market risk on a regular basis, and we manage the pricing and maturity of our assets and liabilities to diminish the potential adverse impact that changes in interest rates could have on our net interest income.

        We actively monitor and manage our interest rate risk exposure principally by measuring our interest sensitivity “gap,” which is the positive or negative dollar difference between assets and liabilities that are subject to interest rate repricing within a given period of time. A gap is considered positive when the amount of interest-rate sensitive assets exceeds the amount of interest-rate sensitive liabilities, and it is considered negative when the amount of interest-rate sensitive liabilities exceeds the amount of interest-rate sensitive assets. We generally would benefit from increasing market interest rates when we have an asset-sensitive, or a positive, interest rate gap and we would generally benefit from decreasing market interest rates when we have liability-sensitive, or a negative, interest rate gap. When measured on a “gap” basis, we are liability-sensitive over the cumulative one-year time frame and asset-sensitive after one year as of June 30, 2007. However, our gap analysis is not a precise indicator of our interest sensitivity position. The analysis presents only a static view of the timing of maturities and repricing opportunities, without taking into consideration that changes in interest rates do not affect all assets and liabilities equally. For example, rates paid on a substantial portion of core deposits may change contractually within a relatively short time frame, but we believe those rates are significantly less interest-sensitive than market-based rates such as those paid on noncore deposits.

        Net interest income is also affected by other significant factors, including changes in the volume and mix of interest-earning assets and interest-bearing liabilities. We perform asset/liability modeling to assess the impact of varying interest rates and the impact that balance sheet mix assumptions will have on net interest income. We attempt to manage interest rate sensitivity by repricing assets or liabilities, selling securities available-for-sale, replacing an asset or liability at maturity, or adjusting the interest rate during the life of an asset or liability. Managing the amount of assets and liabilities that reprice in the same time interval helps us to hedge risks and minimize the impact on net interest income of rising or falling interest rates. We evaluate interest sensitivity risk and then formulate guidelines regarding asset generation and repricing, funding sources and pricing, and off-balance sheet commitments in order to decrease interest rate sensitivity risk.



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Off Balance Sheet Risk

        Through the operations of our bank, we have made contractual commitments to extend credit in the ordinary course of our business activities. These commitments are legally binding agreements to lend money to our customers at predetermined interest rates for a specified period of time. We evaluate each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by us upon extension of credit, is based on our credit evaluation of the borrower. Collateral varies but may include accounts receivable, inventory, property, plant and equipment, commercial and residential real estate. We manage the credit risk on these commitments by subjecting them to normal underwriting and risk management processes.

        At June 30, 2007, the bank had issued commitments to extend credit of $39.0 million through various types of lending arrangements, of which $33.5 million was at variable rates. The commitments expire over the next 18 months. Past experience indicates that many of these commitments to extend credit will expire unused. We believe that we have adequate sources of liquidity to fund commitments that are drawn upon by the borrowers.

        In addition to commitments to extend credit, we also issue standby letters of credit which are assurances to a third party that they will not suffer a loss if our customer fails to meet its contractual obligation to the third party. Standby letters of credit totaled $20.0 million at June 30, 2007. Past experience indicates that many of these standby letters of credit will expire unused. However, through our various sources of liquidity, we believe that we will have the necessary resources to meet these obligations should the need arise.

        Except as disclosed in this report, we are not involved in off-balance sheet contractual relationships, unconsolidated related entities that have off-balance sheet arrangements or transactions that could result in liquidity needs or other commitments or significantly impact earnings.

Impact of Inflation

        The effect of relative purchasing power over time due to inflation has not been taken into account in our consolidated financial statements. Rather, our financial statements have been prepared on an historical cost basis in accordance with generally accepted accounting principles.

        Unlike most industrial companies, our assets and liabilities are primarily monetary in nature. Therefore, the effect of changes in interest rates will have a more significant impact on our performance than will the effect of changing prices and inflation in general. In addition, interest rates may generally increase as the rate of inflation increases, although not necessarily in the same magnitude. As discussed previously, we seek to manage the relationships between interest sensitive assets and liabilities in order to protect against wide rate fluctuations, including those resulting from inflation.

Recently Issued Accounting Standards

        The following is a summary of recent authoritative pronouncements that could impact the accounting, reporting, and / or disclosure of financial information by us.

        In September 2006, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements”. SFAS No. 157 provides enhanced guidance for using fair value to measure assets and liabilities. The standard also requires expanded disclosures about the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We do not expect the adoption of Statement 157 to materially impact our consolidated financial statements.

        In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans”, which amends SFAS No. 87 and SFAS No. 106 to require recognition of the overfunded or underfunded status of pension and other postretirement benefit plans on the balance sheet. Under SFAS No. 158, gains and losses, prior service costs and credits, and any remaining transition amounts under SFAS No. 87 and SFAS No. 106



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that have not yet been recognized through net periodic benefit cost will be recognized in accumulated other comprehensive income, net of tax effects, until they are amortized as a component of net periodic cost. The measurement date, the date at which the benefit obligation and plan assets are measured, is required to be the company’s fiscal year end. SFAS No. 158 is effective for publicly-held companies for fiscal years ending after December 15, 2006, except for the measurement date provisions, which are effective for fiscal years ending after December 15, 2008. We do not have a defined benefit pension plan. Therefore, SFAS No. 158 will not impact our consolidated financial statements.

        In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities – Including an amendment of SFAS No. 115". This statement permits, but does not require, entities to measure many financial instruments at fair value. The objective is to provide entities with an opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. Entities electing this option will apply it when the entity first recognizes an eligible instrument and will report unrealized gains and losses on such instruments in current earnings. This statement 1) applies to all entities, 2) specifies certain election dates, 3) can be applied on an instrument-by-instrument basis with some exceptions, 4) is irrevocable and 5) applies only to entire instruments. One exception is demand deposit liabilities which are explicitly excluded as qualifying for fair value. With respect to SFAS No. 115, available for sale and held to maturity securities at the effective date are eligible for the fair value option at that date. If the fair value option is elected for those securities at the effective date, cumulative unrealized gains and losses at that date shall be included in the cumulative-effect adjustment and thereafter, such securities will be accounted for as trading securities. SFAS No. 159 will be effective for us on January 1, 2008. Earlier adoption is permitted in 2007 if we also elect to apply the provisions of SFAS No. 157. We did not adopt early SFAS No. 159 and believes that it is unlikely that it will expand its use of fair value accounting upon the January 1, 2008 effective date.

        In September, 2006, The FASB ratified the consensuses reached by the FASB’s Emerging Issues Task Force (“EITF”) relating to EITF No. 06-4 “Accounting for the Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements”. EITF No. 06-4 addresses employer accounting for endorsement split-dollar life insurance arrangements that provide a benefit to an employee that extends to postretirement periods should recognize a liability for future benefits in accordance with SFAS No. 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions”, or Accounting Principles Board (“APB”) Opinion No. 12, “Omnibus Opinion-1967". EITF 06-4 is effective for fiscal years beginning after December 15, 2007. Entities should recognize the effects of applying this Issue through either (a) a change in accounting principle through a cumulative-effect adjustment to retained earnings or to other components of equity or net assets in the statement of financial position as of the beginning of the year of adoption or (b) a change in accounting principle through retrospective application to all prior periods. Based on the results of preliminary analysis, we do not believe that EITF No. 06-4 will have a material impact on our consolidated financial statements.

        In September 2006, the FASB ratified the consensus reached related to EITF No. 06-5, “Accounting for Purchases of Life Insurance – Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4, Accounting for Purchases of Life Insurance.” EITF No. 06-5 states that a policyholder should consider any additional amounts included in the contractual terms of the insurance policy other than the cash surrender value in determining the amount that could be realized under the insurance contract. EITF No. 06-5 also states that a policyholder should determine the amount that could be realized under the life insurance contract assuming the surrender of an individual-life by individual-life policy (or certificate by certificate in a group policy). EITF No. 06-5 is effective for fiscal years beginning after December 15, 2007. Although we do not believe the adoption of EITF No. 06-5 will have a material impact on our consolidated financial statements, management is currently analyzing the impact of adoption.

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

Item 3.   Quantitative and Qualitative Disclosures About Market Risk.

        Market risk is the risk of loss from adverse changes in market prices and rates. Our market risk arises principally from interest rate risk inherent in our lending, deposit, and borrowing activities. Management actively monitors and manages its interest rate risk exposure. In addition to other risks that we manage in the normal course of



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business, such as credit quality and liquidity, management considers interest rate risk to be a significant market risk that could potentially have a material effect on our financial condition and results of operations. The information contained in Item 2 in the section captioned “Interest Rate Sensitivity” is incorporated herein by reference. Other types of market risks, such as foreign currency risk and commodity price risk, do not arise in the normal course of our business activities.

        The primary objective of asset and liability management is to manage interest rate risk and achieve reasonable stability in net interest income throughout interest rate cycles. This is achieved by maintaining the proper balance of rate-sensitive earning assets and rate-sensitive interest-bearing liabilities. The relationship of rate-sensitive earning assets to rate-sensitive interest-bearing liabilities is the principal factor in projecting the effect that fluctuating interest rates will have on future net interest income. Rate-sensitive assets and liabilities are those that can be repriced to current market rates within a relatively short time period. Management monitors the rate sensitivity of earning assets and interest-bearing liabilities over the entire life of these instruments, but places particular emphasis on the next twelve months. At June 30, 2007, on a cumulative basis through 12 months, rate-sensitive liabilities exceeded rate-sensitive assets by $47.6 million. This liability-sensitive position is largely attributable to short-term certificates of deposit, money market accounts and interest bearing checking accounts, which totaled $415.1 million at June 30, 2007.

Item 4.   Controls and Procedures.

        As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as defined in Exchange Act Rule 13a-15(e). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our current disclosure controls and procedures are effective as of June 30, 2007. There have been no significant changes in our internal controls over financial reporting during the fiscal quarter ended June 30, 2007 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

        The design of any system of controls and procedures is based in part upon certain assumptions about the likelihood of future events. There can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.

PART II

OTHER INFORMATION

Item 1.   Legal Proceedings.

        There are no material legal proceedings to which the company or any of its subsidiaries is a party or of which any of their property is the subject.

Item 1A.   Risk Factors.

        There were no material changes from the risk factors presented in our annual report on Form 10-K for the year ended December 31, 2006.

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

        Not applicable.

Item 3.   Defaults Upon Senior Securities.

        Not applicable.



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Item 4.   Submission of Matters to a Vote of Security Holders.

        There was one matter submitted to a vote of security holders during the three months ended June 30, 2007 at our annual meeting of shareholders held on April 18, 2007.

Proposal #1 – Election of Class III Directors

        Our board of directors is divided into three classes with each class to be as nearly equal in number as possible. The three classes of directors have staggered terms, so that the terms of only approximately one-third of the board members will expire at each annual meeting of shareholders. The current Class I directors are Raymond E. Cleary, III, DDS, Joe N. Jarrett, Jr., MD, Richard E. Lester, and Don J. Smith. The current Class II directors are Michael Bert Anderson, O. Bartlett Buie, Michael D. Harrington, Rick H. Seagroves, and Walter E. Standish, III. The current Class III directors are James C. Yahnis, Samuel Robert Spann, Jr., B. Larkin Spivey, Jr., Leigh Ammons Meese, and E. Thomas Fulmer. The Class III directors were up for reelection at this year’s annual meeting held April 18, 2007. Each of the existing Class III directors were re-elected at the annual meeting for a three-year term expiring at the 2010 annual meeting of shareholders. For Mr. Yahnis, 4,183,929 votes were cast in favor of his reelection as director with 40,620 abstained. For Mr. Spann, 4,183,929 votes were cast in favor of his reelection as director with 40,620 abstained. For Mr. Spivey, 4,183,251 votes were cast in favor of his reelection as director with 41,298 abstained. For Ms. Meese, 4,182,651 votes were cast in favor of her reelection as director with 41,898 abstained. For Mr. Fulmer, 4,183,971 votes were cast in favor of his reelection as director with 40,578 abstained. There were no votes cast against any of the five directors. The terms of the Class I directors will expire at the 2008 annual shareholders meeting, and the terms of the Class II directors will expire at the 2009 annual shareholders meeting.

Item 5.   Other Information.

        Not applicable.

Item 6.   Exhibits.

Exhibit          Description

31.1               Rule 13a-14(a) Certification of the Principal Executive Officer.

31.2               Rule 13a-14(a) Certification of the Principal Financial Officer.

32                  Section 1350 Certifications





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SIGNATURES

        In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

BEACH FIRST NATIONAL BANCSHARES, INC.

Date:  August 10, 2007 By:  /s/ Walter E. Standish, III
        Walter E. Standish, III
         President and Chief Executive Officer

Date:  August 10, 2007 By:  /s/ Melissa Downs-High
        Melissa Downs-High
        Interim Chief Financial and Principal Accounting Officer









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INDEX TO EXHIBITS

Exhibit
Number          Description

31.1                 Rule 13a-14(a) Certification of the Principal Executive Officer.

31.2                 Rule 13a-14(a) Certification of the Principal Financial Officer.

32                    Section 1350 Certifications.











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