**Exhibit 13**

 

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Beach First National Bank (logo)

2007 Annual Report

Beach First National Bancshares, Inc.

 

 

 

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*Beach First National Bank Board of Directors*

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* *

Frontrow from left to right are:  Gary Austin,Katie Huntley, Ray Cleary, Walt Standish, Leigh Meese, and Julien Springs.  Back row from left to right are:  Joe Jarrett, Jimmy Yahnis, Tom Fulmer, BartBuie, Sammy Spann, Rick Seagroves, Dicke Lester, Mike Harrington, Don Smith,Bert Anderson, and Larkin Spivey.

 

 

 

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BeachFirst National Bancshares logo

 

AboutBeach First

 

BeachFirst National Bancshares, Inc. is the parent company of Beach FirstNational Bank, headquartered in Myrtle Beach, South Carolina. Beach First wasorganized in 1996 to meet the financial needs of consumers and small-to-mid-sizedbusinesses, and today serves the Grand Strand and Hilton Head Island markets,with six banking offices. A seventh office will open in Myrtle Beach early inthe second quarter 2008. The bank’s mortgage lending division is a nationwidelender with offices in the Carolinas and the mid-Atlantic states. The company’sstock trades on the NASDAQ Global Market® under the symbol BFNB and its websiteis beachfirst.com.

 

Insidethe Report

 

| To  Our Shareholders and Friends                                                          | 2                 |   |
|-------------------------------------------------------------------------------------------|-------------------|--------|
| Banking  on Relationships                                                                 | 4                 |   |
| How  We Make Banking Easy...Every Day                                                     | 6                 |   |
| Management’s  Discussion and Analysis                                                | 8                 |   |
| Report  on Management’s Assessment of Internal Control Over Financial Reporting      | 24                |   |
| Report  of Independent Registered Public Accounting Firm                                  | 24                |   |
| Consolidated  Balance Sheets                                                              | 26                |   |
| Consolidated  Statements of Income                                                        | 27                |   |
| Consolidated  Statements of Changes in Shareholders’ Equity and Comprehensive Income | 28                |   |
| Consolidated  Statements of Cash Flows                                                    | 29                |   |
| Notes                                                                                     | 30                |   |
| Corporate  Information                                                                    | 51                |   |
| Officers                                                                                  | 52                |   |
| Directors                                                                                 | Inside Back Cover |   |

 

Headquarters

 

3751Grissom Parkway, Suite 100

MyrtleBeach, SC 29577

843.626.2265

843.916.7818(Fax)

 

SelectedFinancial Highlights

 
| ** **                             | ** ** | **2007** | ** ** | **2006** | ** ** | **% Change** | ** ** |
|----------------------------------------|------------|----------|------------|----------|------------|--------------|------------|
| *Earnings (in thousands)*              | * *   | * * | * *   | * * | * *   | * *     | * *   |
| Net Income                             |       | $        | 5,877      |     | 6,196      |         | (5.1       | )% |
| Net Income per share — basic      |       | 1.22     |       | 1.30     |       | (6.1         | )%         |
| Net Income per share — diluted    |       | 1.18     |       | 1.27     |       | (7.1         | )%         |
| Book Value per share                   |       | 10.85    |       | 9.53     |       | 13.9         | %          |
|                                   |       |     |       |     |       |         |       |
| *Earnings Breakdown (in  thousands)*   | * *   | * * | * *   | * * | * *   | * *     | * *   |
| Total Interest Income                  |       | $        | 45,107     |     | 36,487     |         | 23.62      | % |
| Total Interest Expense                 |       | 22,482   |       | 16,029   |       | 40.26        | %          |
| Net Interest Income                    |       | 22,625   |       | 20,458   |       | 10.59        | %          |
| Total Noninterest Income               |       | 7,578    |       | 3,990    |       | 89.92        | %          |
| Total Noninterest Expense              |       | 18,933   |       | 12,576   |       | 50.55        | %          |
| * *                               | * *   | * * | * *   | * * | * *   | * *     | * *   |
| *Year End Balances (in  thousands)*    | * *   | * * | * *   | * * | * *   | * *     | * *   |
| Total Assets                           |       | $        | 605,988    |     | 520,201    |         | 16.49      | % |
| Loans, net of unearned income          |       | 503,433  |       | 411,215  |       | 22.43        | %          |
| Deposits                               |       | 464,198  |       | 416,357  |       | 11.49        | %          |
| Shareholders’ Equity              |       | 52,578   |       | 45,460   |       | 15.66        | %          |
|                                   |       |     |       |     |       |         |       |
| *Selected Ratios*                      | * *   | * * | * *   | * * | * *   | * *     | * *   |
| Allowance for loan loss to total loans |       | 1.36     | %          | 1.43     | %          | (4.90        | )%         |
| Return on average assets               |       | 1.04     | %          | 1.33     | %          | (21.80       | )%         |
| Return on average equity               |       | 12.01    | %          | 14.53    | %          | (17.34       | )%         |
| Average equity to average assets       |       | 8.67     | %          | 9.18     | %          | (5.55        | )%         |

 

 

 

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Graphs

TotalAssets ($ millions)

NetIncome ($ millions)

TotalLoans ($ millions)

TotalDeposits ($ millions)

 

 

 

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**To OurShareholders and Friends**

 

BeachFirst has held its own in a challenging financial environment. During the year,we continued to build brand awareness for our bank in the markets we serve, weabsorbed much of the cost of the relocation to our new Grissom Parkwayheadquarters, and we managed through the issues created by a slowing economy. Iam pleased to share our results for 2007 and our plans for the future.

 

**EarningsUpdate**

 

Netincome decreased 5.15% in 2007, totaling $5.88 million.  This decrease was due in part to slowergrowth in net interest income and an increase in noninterest expense.  Return on average equity was 12.01% for theyear and return on average assets was 1.04%.

 

Totalassets grew to $606.0 million, an increase of 16.5%, and total deposits grew11.5% to $464.2 million. Total loans grew to $509.9 million, an increase of24.0%.  The net interest margin declinedto 4.20%, due in part to three rate cuts in the last four months of 2007 thattotaled a 1% reduction in the Prime lending rate. These rate cuts immediatelyimpacted loan pricing, but deposit rates have not declined as much or asquickly, which has put pressure on the net interest margin. Two additional ratecuts in January 2008, totaling another 1.25% reduction in the Primelending rate, will keep pressure on the net interest margin throughout 2008.

 

Asloan demand has remained robust along the Grand Strand and in Hilton HeadIsland, finding cost effective and efficient ways to fund deposit growth isimperative to maintain balance sheet health. We intend to achieve this goal byusing technology to expand the variety of services available.  This expansion will be a priority for ourbank in 2008.

 

**StockUpdate**

 

Ourmanagement is disappointed in the performance of our common stock during2007.  In December 2007, our boardof directors authorized the holding company to repurchase up to $2 million ofour common stock from the open market, representing approximately 2.5% of theshares outstanding.  This repurchaseprogram is intended to reduce the number of shares available on the market,which will increase the percentage of ownership of the remaining outstandingshares.  Our board considered otherinvestment opportunities and determined that repurchasing our shares representsthe best long-term option for our shareholders. At its recent market levels, we believe our stock is an excellentinvestment.

 

Forfurther updates and to enroll in email notification of news and events, Iinvite you to visit the Investor Relations page of our website atbeachfirst.com.

 

**Strengthin Location and Presence**

 

BeachFirst is fortunate to have its primary locations in a rapidly growing part ofthe country. Projections for the next 25 to 30 years indicate that SouthCarolina’s population will grow 30%, with Horry, Georgetown, and Beaufortcounties having double digit growth. We are located in desirable areas wherepeople want to live and where businesses want to work, and we stand ready tomeet their financial needs.

 

InDecember, Beach First marked its first year in its new headquarters at 3751Grissom Parkway in Myrtle Beach.  The newbuilding greatly expanded our presence in the Myrtle Beach community and gaveus a prominent location in a dynamic part of the city.  We are easily accessible from points north,south, east, and west, and extend a warm welcome to all we serve.

 

Earlyin the second quarter of 2008, we will open our seventh office at 73rdAvenue North in Myrtle Beach.  This newoffice will be in the heart of prime residential and professional areas.   Renovations to the building are on scheduleand we are on track for an April grand opening. We also completed a 1,400square foot expansion of our successful North Myrtle Beach office in November 2007to better serve the needs of our growing customer base in this market. We arepleased to have locations in areas poised for additional growth and areexploring other attractive locations along coastal South Carolina.

 

Ourmortgage lending offices are concentrated primarily in the Carolinas andmid-Atlantic states in areas that are seeing dynamic growth. Despite thecurrent difficulties in the mortgage markets, our mortgage lending divisionremains strong.

 

Problemshave formed nationally within the subprime lending market where loans were madeto borrowers who did not qualify for the best rates. Beach First is not in thebusiness of making subprime loans. The ensuing credit crunch which occurredwhen subprime borrowers could not make their payments, along with the declineboth in home sales and property values, has been felt by mortgage lendersthroughout the country. Our mortgage lending division shares Beach First’scommitment to credit quality and customer service.  We have a talented group of originators, allof whom have the customer’s best interest at heart. To bolster mortgage loanactivity, we are focusing on products that customers will find useful in thecurrent environment, including refinances 

 

 

 

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andreverse mortgages. Another key to increasing originations will be to captureadditional mortgage business through an employee referral program.

 

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Wehave been using Jack Henry and Associates’ (JHA) 20/20 core processing systemsince October 2002 when our asset size was a little over $100 million.Today, with assets greater than $600 million and growing, it is apparent that20/20 is at its maximum capacity. To ensure that we are prepared for futuregrowth and expansion, we are upgrading to JHA’s Silverlake software.  The conversion to the new software will takeplace in April and will greatly enhance customer service capabilitiesgoing forward.

 

**TechnologyExpands Menu of Services**

 

Advancesin technology are continuing to change the banking landscape, closing distancesand eliminating barriers like never before.

 

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Latein 2007, we introduced a new service that is redefining the way deposits aremade.  Known as the *EDGE*,which is short for *Easy Deposits GatheredElectronically*, this new service essentially brings the bank rightto the customer’s storefront or office. Using a table top scanner and softwareprovided by the bank that is hooked to a Windows®-based personal computer,business customers can deposit paper checks of all types electronically. Theneed to rush a deposit to the bank to ensure posting by a certain time iseliminated.

 

The*EDGE*has**allowedus to expand our geographic footprint without adding more bricks and mortar.Once the scanner and software are installed, it makes no difference if thecustomer is based across the street or across the county.  The*EDGE* makes itso that location no longer is an issue for business customers who want to workwith Beach First.

 

Wehave also recently implemented a Remote Deposit Capture program in ourbranches, eliminating the 2 p.m. cutoff and giving both the business andpersonal customer greater flexibility. With these programs, we are making it easier than ever for the customerto do business with Beach First.

 

**CommunityInvolvement**

 

Communityinvolvement has always been a standard in the history of Beach First. In 2007we continued our support of many important endeavors. We produced our seventhannual Children’s Art Calendar to the delight of parents, students, andcustomers alike. More than 1,000 children from eight different elementaryschools along the Grand Strand and Hilton Head Island participated in thisproject. In addition to our support of the arts, we partnered with the WaccamawCommunity Foundation, setting up an endowment that will grow over the years tohelp fund our future charitable activities. In November 2007, we supportedthe work of Greenkeepers, a local organization whose mission is to protect,preserve, and beautify green space. The group arranged for the planting oftrees along Grissom Parkway, where Beach First Center, an environmentallyfriendly building, is located. The bank was also honored by the City of MyrtleBeach Community Appearance Board on Arbor Day for its landscaping at thisoffice. We are glad to be able to give back to the communities where we areproud to make our living.

 

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**2008 andBeyond**

 

Whilewe expect market conditions to remain unsettled in 2008, Beach First willrespond to the challenges ahead with courage, innovation, and strength. We area strong bank, built to weather uncertainties, and we remain poised to takeadvantage of opportunities as economic conditions improve.

 

Asalways, we appreciate your investment in our company, and we hope to see you atour 2008 Annual Meeting of Shareholders on Monday, April 21 at 2 p.m.at the Myrtle Beach Convention Center.

 

| /s/  Walter E. Standish, III      |   |
|----------------------------------------|--------|
|                                   |   |
| Walter  E. Standish, III          |   |
| President  and Chief Executive Officer |   |

 

 

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**Bankingon relationships that put our customers at ease.**

 

Inan age when nearly every part of our lives seems so much more hectic anddemanding, Beach First believes that a bank can make things a lot lesscomplicated for its customers.

 

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Printadvertising for 2008 continues to reinforce our branding strategy built aroundmaking banking easy for Beach First customers.

 

Infact, it’s a philosophy we believe in so strongly that we made it part of a newbranding strategy launched in 2007.  Witha brand platform built around “Banking Should Always be this Easy,” our goalwas to fittingly describe an attitude that pervades everything we do to serveour clients.

 

It’sa simple, assuring message that clearly differentiates us from our competition.And from all accounts, one that truly resonates with customers throughout theGrand Strand and Hilton Head markets. On numerous occasions, for example,customers have commented on how much they share our view that “a bank at thebeach should feel like, well, a bank at the beach,” as our broadcast copyaffirms. And that they really feel we follow through on “making life easier forour customers,” as stated in our print ads.

 

We’vealso taken steps to ensure that “easy banking” is much more than an externalmessage — but one that it is in tune with our internal culture as well. Withthe implementation of our “Action Steps of Easy,” we identify thirteen corevalues that every member of our organization can put into practice every day tohelp us further enhance our corporate image.

 

 

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Asour campaign rolls forward in 2008, our goal is to continue sharing theextraordinary features and benefits of Beach First — and building even strongerand more satisfying relationships with our customers.

 

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Oursmall business direct mail campaign features testimonials from actual BeachFirst customers who have experienced our “less complicated” style of doingbusiness.

 

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Withtheir engaging look, feel, tone, and message, our television spots continue toplay a key role in differentiating Beach First from our competition.

 

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Ournew and improved Web site is easy to navigate and provides quick access to ourNetTeller internet banking service.

 

**TheAction Steps of Easy**

 

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·                  Learn your job and never stop learning

 

·                  Build relationships by caring about people

 

·                  Do the job right the first time

 

·                  Respect the time of others

 

·                  Embrace technology

 

·                  Be friendly

 

·                  Smile often

 

·                  Be a good listener

 

·                  Act with courtesy

 

·                  Offer to help

 

·                  Work together

 

·                  Go the extra mile

 

·                  Recognize problems early and seek resolution

 

 

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**How WeMake Banking Easy...Every Day**

 

*Over theyears, Beach First has built its reputation on providing superior customerservice. From finding the best possible financial solutions to making thebanking process simple and easy — Beach First’s commitment to customers runsdeep. Below, four Beach First bankers share their thoughts on how they makebanking easy for their customers.*

 

**CharlesW. Fisher, III**

**RelationshipManager**

**GrandStrand**

 

Acareer banker with more than 21 years of experience, Charles Fisher understandswhat it takes to make banking easy. “It’s all about listening, exploring, andfinding solutions that work,” he says.

 

“Oneof my customers is a contractor who is away from his office most of the time,managing job sites for clients. The office manager runs the business day today, and is often hard pressed to find the time for the trip to the bank,” Charlessays. “The daily transaction includes depositing a large number of checks,transferring funds to cover payroll, and moving excess cash in the checkingaccount. In addition, many of their employees work at job sites in nearbycounties, requiring reimbursement for gasoline and other purchases. Processingtheir expense reports is another frequent and time consuming task.”

 

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“Aftertalking with the office manager, I knew we could streamline their banking andmake the entire back room more efficient,” Charles recalls. Working withmembers of Beach First’s team, Charles introduced the customer to CashManagement Services. A package combining an operating account, a zero balanceaccount, an investment sweep account, and line curtailment, ensured that fundswould be moved automatically to cover payroll, excess funds were invested yetavailable when needed, and excess interest did not accrue on their loans.

 

Eventhe daily deposit became easy when Charles called in Debbie Myers, Beach First’sbusiness services manager, who set the customer up on the bank’s remote depositcapture product, known as the*EDGE (Easy Deposits MadeElectronically).*“By using the *EDGE*, theoffice manager made deposits right from the office, eliminating thetime-consuming trip to the bank.  We alsoenrolled them in our corporate credit card program. Employees use the cards topay for gasoline and incidentals while traveling on business, and expensereports are down to once a month, which really helps their bookkeeping area,”Charles says.

 

“Whenthe banker understands the challenges and accomplishments of the customer,everyone wins,” Charles says. “By having a dialogue with the customer to reviewall the potential avenues to meet his goals, we make the banking experienceeasy.”

 

**BarbaraAbrams**

**BranchManager**

**MyrtleBeach**

 

Inher 38 years in banking, Barbara Abrams has had the opportunity to work withgenerations of customers in Myrtle Beach, with one goal in mind — finding thebest solutions for their financial needs. “If you can do that, you will makebanking easy for the customer,” she says.

 

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“Ihave a customer who was managing a restaurant when we first met, and I helpedhim with his personal banking. He confided that one of his dreams was to openhis own car lot. He had worked in the business, liked it, and knew he couldmake a go of it. At the time, however, he couldn’t afford a fleet of cars,”Barbara recalls. “We suggested that he start with one car and work from there.Beach First made the loan that gave him his start in the business, and onevehicle at a time, we helped him get where he wanted to be. Today he is thesuccessful owner of several automotive businesses.”

 

“Iserve as a sounding board for my customers, listening to their needs, askingquestions, and then providing them with options. I’ve found that an informedcustomer is better prepared to make wise financial decisions. We take the guesswork out of the process and explain regulations and requirements in a way thatis clear and sensible to the customer. It’s not about fitting the customer tothe product we have, but working with customers to build the package ofservices that’s right for them,” Barbara says.

 

 

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“Whenyou call any of us at Beach First, you won’t get a voice mail system that leadsyou in a circle,” she says. “You will hear a live person on the other end ofthe phone, ready to help. It’s easy to talk to us. When you work with people’sfinances, you are touching their lives. It has to be personal.”

 

**CollierSchettig**

**RelationshipManager**

**SouthStrand**

 

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Asthe son of small business owners, Collier Schettig learned first hand just howimportant attentive service is to the customer. If you can provide a high level of dependable service, you will make thecustomer’s life a lot easier.

 

Recently,Collier worked on a large, government-guaranteed loan for a local restaurant. “Alot of banks won’t do this type of loan because of the amount of work and timeinvolved. This was a diverse, complex credit that took about four months tocomplete.  Our job was to see the bigpicture and then figure out how to get all the individual pieces in the rightorder,” he says.

 

“Ikept the customer informed every step of the way, providing updates, helpingwith paperwork, and taking documents to the customer and to the attorneys andaccountants involved. We wanted to be sure we did everything right the firsttime, so strong communication was very important to ensuring the process wentsmoothly,” Collier says.

 

“Mostcustomers have a vision for their project, and turn to their loan officer tosee if that vision is viable.  I need tomake sure that they’ve thought the project through and will have what they needto succeed.  When you do your job well,you become a trusted member of the customer’s team and they rely on yourexpertise to see them through the process,” Collier says.

 

“Youmay be able to get the same types of products at different banks, but serviceis the one way you can stand out from the competition,” Collier says. “If youmake banking easy for your customers every time, you will have customers forlife.”

 

**MichelleWilson**

**MortgageBanker**

**HiltonHead Island**

 

MichelleWilson knows that buying a home and applying for a mortgage loan are some ofthe biggest financial decisions a customer will ever make. There’s a dauntingamount of paperwork to complete and many procedures to follow. But Michelle hasfound ways to make it easy.

 

“Thebest thing we can do is to be available for the customer throughout the entireprocess,” Michelle says. “Just the other day, I had a customer call withquestions regarding their escrow account. I contacted the insurance agent ontheir behalf, and then called the investor with the updated information on theinsurance coverage.  It only took me afew minutes, and it put my customer’s mind at ease.”

 

“Makingthings easy for the customer is vitally important because most of my businesscomes from customers I’ve helped in the past or referrals from thosecustomers.  Because I’ve made it easy,they remember me and will call when they need another loan,” she says.

 

“Libby[mortgage loan assistant Libby Johnson] and I work with mortgages every day andknow the process inside and out. But the customer doesn’t, so if we can guidethem through it, they appreciate it. We can be trusted to do what’s best forthe customer, provide competitive rates, and keep it simple,” Michelle says.

 

“Nothingis more satisfying than helping a customer finance their home, whether it’s aprimary residence, a second home, or an investment property. The transaction isimportant to the customer, and helping them achieve their goals is verysatisfying to me,” she says.

 

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LibbyJohnson and Michelle Wilson are committed to handling all their customers’mortgage needs before, during and after the closing.

 

 

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**Management’sDiscussion and Analysis**

 

Thissection discusses the financial position, results of operation, and certainrisk factors of the Company and its primary subsidiary, Beach First NationalBank, during the periods included in the accompanying financial statements andshould be read in conjunction with the financial statements, the related notes,and the other statistical information included in this report.

 

Thisreport, including without limitation the letter to shareholders and otherinformation above, contains “forward-looking statements” relating to futureeconomic performance, plans and objectives of management for future operations,and projections of revenues and other financial items that are based on thebeliefs of management, as well as assumptions made by and information currentlyavailable to management. The words “may,” “will,” “anticipate,” “should,” “would,”“believe,” “contemplate,” “expect,” “estimate,” “continue,” and “intend,” aswell as other similar words and expressions of the future, are intended toidentify forward-looking statements. The actual results may differ materiallyfrom the results discussed in the forward-looking statements, and operatingperformance each quarter is subject to various risks and uncertainties that arediscussed in detail in the filings with the Securities and Exchange Commission,including, without limitation:

 

**·******significant increases incompetitive pressure in the banking and financial services industries;

 

**·******changes in the interestrate environment which could reduce anticipated or actual margins;

 

**·******changes in politicalconditions or the legislative or regulatory environment;

 

**·******general economicconditions, either nationally or regionally and especially in our primaryservice area, becoming less favorable than expected resulting in, among otherthings, a deterioration in credit quality;

 

·changesoccurring in business conditions and inflation;

 

·changes in technology;

 

·the level of allowance for loan losses;

 

·the rate of delinquencies and amounts of charge-offs;

 

·the rates of loan growth;

 

·adverse changes in asset quality and resulting creditrisk-related losses and expenses;

 

·changes in monetary and tax policies;

 

·loss of consumer confidence and economic disruptionsresulting from terrorist activities;

 

·changes in the securities markets;

 

·other risks and uncertainties detailed from time to time inour filings with the Securities and Exchange Commission; and

 

·natural disasters, such as a hurricane or flooding in ourfootprint.

 

**Overview**

 

BeachFirst National Bancshares, Inc. (the “Company”) is the parent company ofBeach First National Bank, (the “Bank”), a wholly owned subsidiary, and BeachFirst National Trust (the “Trust”) and Beach First National Trust II (the “TrustII”), both of which are non-consolidated subsidiaries. The Company also owns66% of BFNM Building, LLC, which is a limited liability corporation formedsolely for the construction of a corporate office building that houses the mainoffice for the Bank. The trusts were established exclusively for the issuanceof junior subordinated debt which was used to capitalize the Bank.  The Company’s primary business activities areconducted by the Bank. The Company commenced operations on September 23,1996 and completed its eleventh full year of operations on December 31,2007. From the outset, the Company focused on serving the banking needs ofsmall businesses and individuals, and emphasized local management andownership.

 

TheBank’s primary market areas are located along the coastal regions of SouthCarolina and predominately center on the Metro regions of Myrtle Beach andHilton Head Island, South Carolina. The Bank currently operates from sixbanking locations with a seventh scheduled to open in early 2008. In additionto the main office in Myrtle Beach, there are five branches. The Bank openedthe Surfside branch in June 2001, the North Myrtle Beach branch in November 2002,the Hilton Head Island branch in February 2003, the Litchfield/PawleysIsland area of the Grand Strand branch in 2004, and the branch on the south endof Hilton Head Island in January 2005. All branches are full service.

 

InJune 2006, the Bank added a mortgage division that originates and sellsmortgages to investors. At December 31, 2007, the division had six loanproduction offices in South Carolina, North Carolina, and Virginia.  The South Carolina office in Little Riverincludes the mortgage operations staff. The North Carolina offices are inRaleigh and Gastonia, and the three offices in Virginia are located in Burke,Fredericksburg, and Sterling.

 

 

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OnJune 14, 2005, the Company closed the sale of 1,150,000 shares of commonstock at $18.75 per share.  The netproceeds from the offering were approximately $20 million after deductingunderwriting discounts and expenses. The net proceeds were used for generalcorporate purposes, which included, among other things, providing additionalcapital to the Bank to support its asset growth.

 

Thefollowing table sets forth selected measures of our financial performance forthe periods indicated:

 
| ** **      | ** ** | **For the Years Ended December 31,** | ** **  |
|-----------------|------------|-------------------------------------------|-------------|
| ** **      | ** ** | **2007**                                  | ** **  | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **      | ** ** | ** **                                | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net Income      |       | $                                         | 5,876,630   |   | $ | 6,195,728 |   | $ | 3,359,643 |   | $ | 1,435,922 |   | $ | 1,008,931 |   |
| Total Assets    |       | $                                         | 605,988,418 |   | $ | 520,201,339 |   | $ | 397,389,234 |   | $ | 242,091,345 |   | $ | 165,093,036 |   |
| Total Loans (1) |       | $                                         | 509,908,135 |   | $ | 411,214,856 |   | $ | 311,788,722 |   | $ | 191,481,765 |   | $ | 135,612,193 |   |
| Total Deposits  |       | $                                         | 464,198,345 |   | $ | 416,357,129 |   | $ | 310,894,210 |   | $ | 203,168,958 |   | $ | 138,099,566 |   |
| Total Capital   |       | $                                         | 52,578,050  |   | $ | 45,459,579 |   | $ | 39,125,413 |   | $ | 14,732,893 |   | $ | 13,555,619 |   |

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(1)          Includes mortgage loans heldfor sale and deferred fees.

 

Thefollowing discussion describes the Company’s results of operations for 2007 ascompared to 2006 and 2006 compared to 2005 and also analyzes our financialcondition as of December 31, 2007 as compared to December 31,2006.  Like most community banks, theBank derives most of its income from interest on loans and investments.  The primary sources of funding are depositsand advances from the Federal Home Loan Bank (FHLB), on which interest ispaid.  Consequently, one of the keymeasures of success is the amount of net interest income, or the differencebetween the income on interest-earning assets, such as loans and investments,and the expense on interest-bearing liabilities, such as deposits and advancesfrom FHLB.  Another key measure is thespread between the yield earned on interest-earning assets and the yield oninterest-bearing liabilities.

 

Tablesare included to explain the Company’s performance. The “Average Balances,Income and Expenses, and Rates” table shows the average balance during 2007,2006, and 2005 of each category of assets and liabilities, as well as the yieldearned or the rate paid with respect to each category.  The Company’s loans typically provide higherinterest yields than do other types of interest earning assets, which is whyloans are a substantial percentage of its earning assets.  Similarly, the “Analysis of Changes in NetInterest Income” table demonstrates the impact of changing interest rates andchanging volume of assets and liabilities during the years shown.  The sensitivity of the various categories ofassets and liabilities to changes in interest rates are included in an “InterestSensitivity Analysis Table”.  Othertables provide details about investment securities, loans, deposits, and otherborrowings.

 

Thereare risks inherent in all loans so an allowance for loan losses is establishedto absorb probable losses on existing loans that may become uncollectible.  The Company established and maintains thisallowance by charging a provision for loan losses against operating earnings.  In the “Loans and Allowance for Loan Losses”sections there is a detailed discussion of the process, as well as severaltables describing the allowance for loan losses and the allocation of theallowance among various loan categories.

 

Inaddition to earning interest on loans and investments, income is earned throughfees and other expenses charged to customers. The various components of noninterest income, as well as noninterestexpense, are detailed in the “Noninterest Income and Expense” section.

 

TheCompany has identified significant factors that may affect its financialposition and operating results during the periods included in the accompanyingfinancial statements.  Managementencourages everyone to read this discussion and analysis in conjunction withthe financial statements, the related notes, and the other statisticalinformation included in this report.

 

**CriticalAccounting Policies**

 

TheCompany has adopted various accounting policies which govern the application ofaccounting principles generally accepted in the United States in thepreparation of its financial statements. Significant accounting policies are described in Note 1 of the Notes toConsolidated Financial Statements.

 

Certainaccounting policies involve significant judgments and assumptions by managementwhich have a material impact on the carrying value of certain assets andliabilities.  Management considers suchaccounting policies to be critical.  Thejudgments and assumptions used are based on historical experience and otherfactors, which are believed to be reasonable under the circumstances.  Because of the nature of the judgments andassumptions, actual results could differ from these judgments and estimates.  These differences could have a materialimpact on the carrying values of assets and liabilities and the Company’sresults of operations.

 

 

9

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Theallowance for loan losses is a critical accounting policy that requires themost significant judgment and estimates used in preparation of the consolidatedfinancial statements.  Some of the morecritical judgments supporting the amount of allowance for loan losses includejudgments about the credit worthiness of borrowers, the estimated value of theunderlying collateral, the assumptions about cash flow, determination of lossfactors 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 differentassumptions, the actual amount of credit losses incurred may be different frommanagement’s estimates provided in the consolidated financial statements.  Refer to the portion of this discussion thataddresses the allowance for loan losses for a more complete discussion of theCompany’s processes and methodology for determining its allowance for loanlosses.

 

**Analysisof the Fiscal Years Ended December 31, 2007 and 2006 and 2005**

 

**EarningsReview**

 

Overview.  For the year ended December 31, 2007,the Company’s net income was $5.9 million, or $1.18 per diluted common share,as compared to $6.2 million, or $1.27 per diluted common share, for the yearended December 31, 2006, and $3.4 million, or $0.83 per diluted commonshare, for the year ended December 31, 2005.  All per share data for all periods has beenadjusted to reflect the 3-for-2 stock split in 2006.  The slower net interest income growth and theincrease in noninterest expense contributed to the decline in the current year’searnings. Return on average assets and return on average shareholders’ equityare key measures of earnings performance. Return on average assets for 2007 was 1.04% compared to 1.33% in 2006and 1.08% in 2005.  Return on averageshareholders’ equity for 2007 was 12.01% verses 14.53% in 2006 and 11.37% in2005.  The equity to assets ratio was8.68% in 2007, 8.74% in 2006 and 9.48% in 2005.

 

TheCompany had total assets of $606.0 million at December 31, 2007, anincrease of 16.5% from $520.2 million at December 31, 2006.  Total deposits increased to $464.2 million atDecember 31, 2007, up 11.5% from $416.4 million at December 31, 2006.

 

Overthe past eighteen months, real estate values have stagnated or been fallingnationwide, and the default rates on mortgage loans have risen.  There has been a resulting disruption insecondary markets for mortgages, especially in non-conforming loanproducts.  The Federal Reserve Bank hasreduced short-term rates to stimulate the economy.  The Company has been affected by these eventsin such areas as  mortgage banking; landacquisition, development and construction lending, and consumer lending.  The Company has seen a moderate rise indelinquencies and non-performing loans during 2007, and it continues to monitorits portfolio of real estate loans closely. In the current economic, credit and market environment, there can be noassurance that the Company’s portfolio will continue to perform at currentlevels.

 

(graph)

 

**NetInterest Income**

 

*General.* The Company’s primary source ofrevenue is net interest income, which represents the difference between theincome on interest-earning assets and expense on interest-bearingliabilities.  The Company’s net interestincome increased $2.1 million, or 10.6%, to $22.6 million in 2007 from $20.5million in 2006.  Net interest incomeincreased $6.8 million in 2006 from $13.7 million in 2005.  The level of net interest income isdetermined by the level of earning assets and the management of the netinterest margin.  The continued growth ofour loan portfolio is the primary driver of the increase in net interestincome.  Average total loans increasedfrom $372.8 million in 2006 to $458.7 million in 2007.  In addition, average securities increased to$73.4 million in 2007 compared to $60.2 million in 2006.

 

Netinterest spread, the difference between the rate earned on interest-earningassets and the rate paid on interest-bearing liabilities, was 3.63% for theyear ended December 31, 2007, compared to 4.06% for the year ended December 31,2006, and 4.13% for the year ended December 31, 2005.  The net interest margin, which is netinterest income divided by average interest-earning assets, was 4.20% for theyear ended December 31, 2007, 4.62% for the year ended December 31,2006, and 4.60% for the year ended December 31, 2005.

 

*AverageBalances, Income and Expenses and Rates.* The following tables set forth, for theperiods indicated, information related to our average balance sheet and averageyields on assets and average rates paid on liabilities.  The yield or rates were derived by dividingincome or expense by the average balance of the corresponding assets or liabilities.  The average balances are calculated from thedaily balances from the periods indicated.

 

10

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** **

** **

 
| ** **                                                                 | ** ** | **Average  Balances, Income and Expenses, and Rates** | ** **  |
|----------------------------------------------------------------------------|------------|-------------------------------------------------------|-------------|
| ** **                                                                 | ** ** | **For the  years ended December 31,**            | ** **  |
| ** **                                                                 | ** ** | **2007**                                              | ** **  | **2006** | ** ** | **2005** | ** ** |
| ** **                                                                 | ** ** | **Average**                                           | ** **  | **Income/Expense** | ** ** | **Yield/** | ** ** | **Average** | ** ** | **Income/** | ** ** | **Yield/** | ** ** | **Average** | ** ** | **Income/** | ** ** | **Yield/** | ** ** |
| ** **                                                                 | ** ** | **Balance**                                           | ** **  | **Expense** | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Expense** | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Expense** | ** ** | **Rate** | ** ** |
|                                                                       |       |                                                  |        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Federal funds  sold, short term investments and trust preferred securities |       | $                                                     | 6,290,203   |   | $ | 319,985 |   | 5.09 | % | $ | 10,246,774 |   | $ | 485,515 |   | 4.74 | % | $ | 4,568,208 |   | $ | 140,922 |   | 3.08 | % |
|                                                                       |       |                                                  |        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Investment securities                                                      |       | 73,409,038                                            |        | 3,722,477 |   | 5.07 | % | 60,213,573 |   | 2,909,457 |   | 4.83 | % | 42,624,049 |   | 1,841,034 |   | 4.31 | % |
| Loans (1)                                                                  |       | 458,703,105                                           |        | 41,064,557 |   | 8.95 | % | 372,791,961 |   | 33,091,838 |   | 8.88 | % | 251,305,542 |   | 18,938,675 |   | 7.54 | % |
| Total earning  assets                                                      |       | $                                                     | 538,402,346 |   | $ | 45,107,019 |   | 8.38 | % | $ | 443,252,308 |   | $ | 36,486,810 |   | 8.23 | % | $ | 298,497,799 |   | $ | 20,920,631 |   | 7.01 | % |
| * *                                                                   | * *   | * *                                              | * *    | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * |
| Cash & Due from Banks                                             |       | 6,320,502                                             |        |   |   |   |   | 5,947,556 |   |   |   |   |   | 5,367,687 |   |   |   |   |   |
| Other Assets                                                               |       | 19,474,074                                            |        |   |   |   |   | 15,399,446 |   |   |   |   |   | 8,022,006 |   |   |   |   |   |
|                                                                       |       |                                                  |        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total Assets                                                               |       | $                                                     | 564,196,922 |   |   |   |   |   | $ | 464,599,310 |   |   |   |   |   | $ | 311,887,492 |   |   |   |   |   |
| * *                                                                   | * *   | * *                                              | * *    | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * |
| Interest-bearing deposits                                                  |       |                                                  |        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|  IBCA                                                                 |       | 19,486,521                                            |        | 117,264 |   | 0.60 | % | 21,514,975 |   | 233,353 |   | 1.08 | % | 17,236,509 |   | 95,647 |   | 0.55 | % |
|  MMA                                                                  |       | 106,912,339                                           |        | 4,320,864 |   | 4.04 | % | 85,981,147 |   | 2,980,274 |   | 3.47 | % | 75,683,962 |   | 1,838,868 |   | 2.43 | % |
|  Savings                                                              |       | 2,829,492                                             |        | 38,711 |   | 1.37 | % | 3,265,767 |   | 45,840 |   | 1.40 | % | 3,586,695 |   | 39,133 |   | 1.09 | % |
|  CDs < $100,000                                                    |       | 153,730,655                                           |        | 7,982,414 |   | 5.19 | % | 122,929,041 |   | 5,796,688 |   | 4.72 | % | 58,899,483 |   | 1,947,919 |   | 3.31 | % |
|  CDs > $100,000                                                    |       | 111,858,527                                           |        | 5,886,342 |   | 5.26 | % | 92,326,041 |   | 4,324,574 |   | 4.68 | % | 56,464,039 |   | 1,825,888 |   | 3.23 | % |
|  IRA                                                                  |       | 9,256,635                                             |        | 456,461 |   | 4.93 | % | 7,614,029 |   | 330,483 |   | 4.34 | % | 4,978,161 |   | 165,436 |   | 3.32 | % |
| Total interest-                                                            |       |                                                  |        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| bearing deposits                                                           |       | $                                                     | 404,074,169 |   | $ | 18,802,056 |   | 4.65 | % | $ | 333,631,000 |   | $ | 13,711,212 |   | 4.11 | % | $ | 216,848,849 |   | $ | 5,912,891 |   | 2.73 | % |
|                                                                       |       |                                                  |        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Other borrowings                                                           |       | 69,671,556                                            |        | 3,679,917 |   | 5.28 | % | 50,490,882 |   | 2,318,026 |   | 4.59 | % | 33,244,233 |   | 1,276,021 |   | 3.84 | % |
| Total interest- bearing  liabilities                                       |       | $                                                     | 473,745,725 |   | $ | 22,481,973 |   | 4.75 | % | $ | 384,121,882 |   | $ | 16,029,238 |   | 4.17 | % | $ | 250,093,082 |   | $ | 7,188,912 |   | 2.87 | % |
|                                                                       |       |                                                  |        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Demand Deposits                                                            |       | 36,102,497                                            |        |   |   |   |   | 33,421,935 |   |   |   |   |   | 31,113,839 |   |   |   |   |   |
| Other Liabilities                                                          |       | 5,416,265                                             |        |   |   |   |   | 4,402,565 |   |   |   |   |   | 1,127,407 |   |   |   |   |   |
|                                                                       |       |                                                  |        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total Liabilities                                                          |       | $                                                     | 515,264,487 |   |   |   |   |   | $ | 421,946,382 |   |   |   |   |   | $ | 282,334,328 |   |   |   |   |   |
|                                                                       |       |                                                  |        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Equity Capital                                                             |       | 48,932,435                                            |        |   |   |   |   | 42,652,928 |   |   |   |   |   | 29,553,164 |   |   |   |   |   |
|                                                                       |       |                                                  |        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total Liabilities and Equity                                               |       | $                                                     | 564,196,922 |   |   |   |   |   | $ | 464,599,310 |   |   |   |   |   | $ | 311,887,492 |   |   |   |   |   |
|                                                                       |       |                                                  |        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest spread                                                        |       |                                                  |        |   |   | 3.63 | % |   |   |   |   | 4.06 | % |   |   |   |   | 4.14 | % |
| Net interest income/margin                                                 |       |                                                  |        | $ | 22,625,046 |   | 4.20 | % |   |   | $ | 20,457,572 |   | 4.62 | % |   |   | $ | 13,731,719 |   | 4.60 | % |

----

(1) Theeffect of loans in nonaccrual status and fees collected is not significant tothe computations.  All loans and depositsare domestic. Includes mortgage loans held for sale.

 

*Analysisof Changes in Net Interest Income.* The following tables set forth the impact ofthe varying levels of earning assets and interest-bearing liabilities and theapplicable rates have had on changes in net interest income for the periodspresented. The change in net interest income from 2006 to 2007 is primarily dueto the increases in volume of both loans and deposits and changes in averageinterest rates.

 

** **

 
| ** **                                                                    | ** ** | **Analysis  of Changes in Net Interest Income** | ** ** |
|-------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                                    | ** ** | **For the  years ended December 31,**      | ** ** |
| ** **                                                                    | ** ** | **2007 versus 2006**                            | ** ** | **2006 versus 2005** | ** ** |
| ** **                                                                    | ** ** | **Volume (1)**                                  | ** ** | **Rate (1)** | ** ** | **Net Change** | ** ** | **Volume (1)** | ** ** | **Rate (1)** | ** ** | **Net change** | ** ** |
| Federal funds  sold and short term investments and trust preferred securities |       | $                                               | (201,272   | ) | $ | 28,509 |   | $ | (172,763 | ) | $ | 273,071 |   | $ | 76,034 |   | $ | 349,105 |   |
| Investment securities                                                         |       | 669,125                                         |       | 155,633 |   | 824,758 |   | 846,479 |   | 212,927 |   | 1,059,406 |   |
| Loans                                                                         |       | 7,691,038                                       |       | 277,176 |   | 7,968,214 |   | 10,785,523 |   | 3,372,145 |   | 14,157,668 |   |
| Total earning  assets                                                         |       | 8,158,891                                       |       | 461,318 |   | 8,620,209 |   | 11,905,073 |   | 3,661,106 |   | 15,566,179 |   |
| Interest-bearing deposits                                                     |       | 3,277,805                                       |       | 1,813,039 |   | 5,090,844 |   | 4,799,389 |   | 2,998,932 |   | 7,798,321 |   |
| Other borrowings                                                              |       | 1,013,086                                       |       | 348,805 |   | 1,361,891 |   | 791,790 |   | 250,215 |   | 1,042,005 |   |
| Total  interest-bearing liabilities                                           |       | 4,290,891                                       |       | 2,161,844 |   | 6,452,735 |   | 5,591,179 |   | 3,249,147 |   | 8,840,326 |   |
| Net interest income                                                           |       | $                                               | 3,868,000  |   | $ | (1,700,526 | ) | $ | 2,167,474 |   | $ | 6,313,894 |   | $ | 411,959 |   | $ | 6,725,853 |   |

----

(1) Volume-ratechanges have been allocated to each category proportionately based on thepercentage of the total change.

 

11

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*InterestRate Sensitivity. *A significantportion of the Company’s assets and liabilities are monetary in nature, andconsequently are very sensitive to changes in interest rates.  This interest rate risk is the Company’sprimary market risk exposure, and it can have a significant effect on the netinterest income and cash flows.  Theexposure to market risk is monitored on a regular basis and is managed by thepricing and maturity of assets and liabilities to diminish the potentialadverse impact that changes in interest rates could have on the net interestincome.

 

Netinterest income is also affected by other significant factors, includingchanges in the volume and mix of interest-earning assets and interest-bearingliabilities.  The Company performsasset/liability modeling to assess the impact of varying interest rates and theimpact that balance sheet mix assumptions will have on net interest income.  Interest rate sensitivity is managed byrepricing assets or liabilities, selling securities available-for-sale,replacing an asset or liability at maturity, or adjusting the interest rateduring the life of an asset or liability. Managing the amount of assets and liabilities that reprice in the sametime interval helps to hedge risks and minimize the impact on net interestincome in rising or falling interest rates. The Company evaluates interest sensitivity risk and then formulatesguidelines regarding asset generation and repricing, funding sources and pricing,and off-balance sheet commitments in order to decrease interest ratesensitivity risk.

 

Thefollowing table summarizes the amounts of interest-earning assets andinterest-bearing liabilities outstanding at December 31, 2007 that areexpected to mature, prepay, or reprice in each of the future time periodsshown.  Except as stated in the followingtables, the Company determines the amount of assets or liabilities that matureor reprice during a particular period in accordance with the contractual termsof the asset or liability.  The Companyincludes adjustable rate loans in the period in which interest rates are nextscheduled to adjust rather than in the period in which they are due, andincludes fixed rate loans in the periods in which the Company anticipates theywill be repaid based on scheduled maturities. Savings accounts and interest-bearing demand accounts (interest bearingchecking and money market deposit accounts), which are generally subject toimmediate withdrawal, are in the “Three Months or Less” category, althoughhistorical experience has proven these deposits to be more stable over thecourse of a year.

 

### ** **

### ** **

 
| ** **                                         | ** ** | **Interest  Sensitivity Analysis** | ** **  |
|----------------------------------------------------|------------|------------------------------------|-------------|
| ** **                                         | ** ** | **December 31,  2007**        | ** **  |
| ** **                                         | ** ** | **Within three Months**            | ** **  | **After three but  within twelve months** | ** ** | **After one but  within five years** | ** ** | **After five years** | ** ** | **Total** | ** ** |
| **Assets**                                         | ** ** | ** **                         | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Earning assets:                                    |       |                               |        |   |   |   |   |   |   |   |   |
| Federal funds  sold and short term investments     |       | $                                  | 566,044     |   | — |   | — |   | — |   | $ | 566,044 |   |
| Investments,  including FHLB,FRB, & Trust |       | 999,800                            |        | 376,870 |   | 20,917,957 |   | 48,072,666 |   | 70,367,293 |   |
| Gross loans (1)                                    |       | 293,600,287                        |        | 82,389,406 |   | 111,940,729 |   | 22,403,468 |   | 510,333,890 |   |
| Total earning  assets                              |       | $                                  | 295,166,131 |   | $ | 82,766,276 |   | $ | 132,858,686 |   | $ | 70,476,134 |   | $ | 581,267,227 |   |
| **Liabilities**                                    | ** ** | ** **                         | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest-bearing liabilities                       |       |                               |        |   |   |   |   |   |   |   |   |
| Money market and  interest checking                |       | 124,198,908                        |        | — |   | — |   | — |   | 124,198,908 |   |
| Regular savings  deposits                          |       | 2,988,881                          |        | — |   | — |   | — |   | 2,988,881 |   |
| Time deposits                                      |       | 91,596,216                         |        | 173,445,216 |   | 38,727,575 |   | 102,613 |   | 303,871,620 |   |
| FHLB advances                                      |       | —                             |        | — |   | 32,500,000 |   | 22,500,000 |   | 55,000,000 |   |
| Other borrowings                                   |       | 11,461,859                         |        | 246,643 |   | 1,842,037 |   | 4,737,609 |   | 18,288,148 |   |
| Junior  subordinated debentures                    |       | —                             |        | — |   | — |   | 10,310,000 |   | 10,310,000 |   |
| Total  interest-bearing liabilities                |       | $                                  | 230,245,864 |   | $ | 173,691,859 |   | $ | 73,069,612 |   | $ | 37,650,222 |   | $ | 514,657,557 |   |
| Period gap                                         |       | $                                  | 64,920,267  |   | $ | (90,925,583 | ) | $ | 59,789,074 |   | $ | 32,825,912 |   | $ | 66,609,670 |   |
| Cumulative gap                                     |       | $                                  | 64,920,267  |   | $ | (26,005,316 | ) | $ | 33,783,758 |   | $ | 66,609,670 |   |   |   |
| Ratio of  cumulative gap to total earning assets   |       | 11.16                              | %           | (4.47 | )% | 5.81 | % | 11.46 | % | 11.46 | % |

----

(1) Unearned fees and unamortized loan origination costs totaling $425,755 areexcluded from the above analysis. Mortgage loans held for sale are included.

 

**Allowancefor Loan Losses**

 

Theallowance for loan losses was established through a provision for loan lossescharged to expense on the statement of income. The allowance for loan losses represents an amount which managementbelieves will be adequate to absorb probable losses on existing loans that maybecome uncollectible.  Management’sjudgment as to the adequacy of the allowance for loan losses is based on anumber of assumptions about future events, which are believed to be reasonable,but which may or may not prove to be accurate. The evaluation of the allowance is segregated into general

 

12

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allocationsand specific allocations.  For generalallocations, the portfolio is segregated into risk-similar segments for whichhistorical loss ratios are calculated and adjusted for identified trends orchanges 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 beadjusted for other risk factors.  Toallow for modeling error, a range of probable loss ratios is then derived foreach segment.  The resulting percentagesare then applied to the dollar amounts of the loans in each segment to arriveat each segment’s range of probable loss levels.  Certain nonperforming loans are individuallyassessed for impairment under SFAS No. 114 and assigned specificallocations.  Other identified high-riskloans or credit relationships based on internal risk ratings are alsoindividually assessed and assigned specific allocations.

 

Thegeneral allocation also includes a component for probable losses inherent inthe portfolio, based on management’s analysis that is not fully capturedelsewhere in the allowance.  Thiscomponent serves to address the inherent estimation and imprecision risk in themethodology as well as address management’s evaluation of various factors orconditions not otherwise directly measured in the evaluation of the general andspecific allocations.  Such factorsinclude the current general economic and business conditions; geographic,collateral, or other concentrations of credit; system, procedural, policy, orunderwriting changes; experience of the lending staff; entry into new marketsor new product offerings; and results from internal and external portfolioexaminations.

 

Theamount of the allowance is based on the existing circumstances each time it isevaluated.  The Company chargesrecognized losses and adds subsequent recoveries back to the allowance for loanlosses.  There can be no assurance thatcharge-offs of loans in future periods will not exceed the allowance for loanlosses as estimated at any point in time or that provisions for loan losseswill not be significant to a particular accounting period.

 

Theallocation of the allowance to the respective loan segments is an approximationand not necessarily indicative of future losses or future allocations.  The entire allowance is available to absorblosses occurring in the overall loan portfolio. In addition, the allowance is subject to examination and adequacy testingby regulatory agencies, which may consider such factors as the methodology usedto determine adequacy and the size of the allowance relative to that of peerinstitutions, and other adequacy tests. Such regulatory agencies could require the Company to adjust theallowance based on information available to them at the time of theirexamination.

 

AtDecember 31, 2007, the allowance for loan losses was $6.9 million, or1.36% of outstanding total loans, compared to an allowance for loan losses of$5.9 million, or 1.43% of outstanding total loans, at December 31,2006.  This increase is due to growth inthe loan portfolio and needs based on ongoing evaluations of credits.

 

**Provisionfor Loan Losses**

 

Anallowance for loan losses is established through a provision for loan losses onthe statement of income.  Managementreviews the loan portfolio periodically to evaluate outstanding loans, measurethe performance of the portfolio, and the adequacy of the allowance for loanlosses.  The provision for loan losses was$2.0 million for 2007, $2.2 million for 2006, and $2.2 million for 2005. Theprovision was the result of management’s assessment of the adequacy of thereserve for possible loan losses given the size, mix, and quality of thecurrent loan portfolio.  Please see thediscussion under “Allowance for Loan Losses” for a description of the factorsconsidered in determining the amount of the provision expensed each period.

 

(graph)

 

**NonperformingAssets**

 

TheCompany discontinues accrual of interest on a loan when collection of interestfrom the borrower is doubtful. Management takes into account factors such as the borrower’s financialcondition, economic and business conditions, and the results of its previouscollection efforts.  Generally, adelinquent loan is placed in nonaccrual status when the loan becomes 90 days ormore past due.  When a loan is placed onnonaccrual status, all interest which has been accrued but not paid is reversedand it is deducted from earnings.  Noadditional interest is accrued on the loan balance until management concludesthe collection of both principal and interest is reasonably certain.  At December 31, 2007, there were noloans accruing interest which were 90 days or more past due, and there were norestructured loans.

 

13

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| ** **                                                           | ** ** | **Nonperforming  Assets**                  | ** ** |
|----------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                           | ** ** | **(Dollars  in Thousands)**                | ** ** |
| ** **                                                           | ** ** | **For the  years ended December 31,** | ** ** |
| **Nonaccrual loans**                                                 | ** ** | **2007**                                   | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Commercial                                                           |       | $                                          | 110        |   | $ | — |   | $ | 85 |   | $ | — |   | $ | 198 |   |
| Real estate — construction                                      |       | 1,460                                      |       | 938 |   | 193 |   | — |   | — |   |
| Real estate — mortgage                                          |       | 1,321                                      |       | 661 |   | 795 |   | 70 |   | 168 |   |
| Consumer                                                             |       | 12                                         |       | 26 |   | 38 |   | 7 |   | — |   |
| Total                                                                |       | $2,903                                     |       | $1,625 |   | $1,111 |   | $77 |   | $366 |   |
| **Accruing loans which are contractually past due  90 days or more** | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Commercial                                                           |       | —                                     |       | — |   | — |   | — |   | — |   |
| Real estate — construction                                      |       | —                                     |       | — |   | — |   | — |   | — |   |
| Real estate — mortgage                                          |       | —                                     |       | — |   | — |   | — |   | — |   |
| Consumer                                                             |       | —                                     |       | — |   | — |   | 1 |   | — |   |
| Total                                                                |       | $                                          | —     |   | $ | — |   | $ | — |   | $ | 1 |   | $ | — |   |
| Total nonperforming loans                                            |       | $                                          | 2,903      |   | $ | 1,625 |   | $ | 1,111 |   | $ | 78 |   | $ | 366 |   |
| Other real estate owned                                              |       | 15                                         |       | 15 |   | 63 |   | — |   | — |   |
| Total nonperforming assets                                           |       | $                                          | 2,918      |   | $ | 1,640 |   | $ | 1,174 |   | $ | 78 |   | $ | 366 |   |
| Total nonperforming loans to total loans                             |       | 0.57                                       | %          | 0.40 | % | 0.36 | % | 0.04 | % | 0.27 | % |
| Total nonperforming loans to total assets                            |       | 0.48                                       | %          | 0.31 | % | 0.28 | % | 0.03 | % | 0.22 | % |
| Total nonperforming assets to total assets                           |       | 0.48                                       | %          | 0.32 | % | 0.30 | % | 0.03 | % | 0.22 | % |
|                                                                      |            |                                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Therewere thirteen nonaccrual loans totaling $2.9 million at December 31,2007.  Two of the nonaccrual loanstotaled $1.9 million.  The larger of thetwo nonaccrual loans, at $1.5 million, was a commercial construction loansecured by a first real estate mortgage. The other large nonaccrual loan was aconsumer real estate loan secured by a first real estate mortgage. Interestincome that would have been received for the years ended December 31, 2007and 2006 had nonaccrual loans been current in accordance with their originalterms amounted to $259,958 and $145,626 respectively.  Real estate acquired through foreclosuretotaled $15,000 at December 31, 2007, $15,000 at December 31, 2006,and $62,967 at December 31, 2005. The Company did not have any real estate acquired through foreclosureduring the periods ended December 31, 2004 and 2003.

 

Loansthat are current as to principal and interest are not included in ournonperforming assets categories. However, management will classify a current loan as a potential problemloan if there is serious doubt about the borrower’s future performance underthe terms of the loan contract. Management considers the level of potential problem loans in determiningthe adequacy of the allowance for loan losses. At December 31, 2007,classified loans totaled $10.3 million (substandard $5.2 million and specialmention $5.1 million).  Substandardassets consist primarily of thirty-seven loans with the largest amount to anyone borrower being $1.2 million.  Thespecial mention loans consist of seventeen loans with the largest amount to anyone borrower being $2.4 million.   At December 31,2006, classified loans totaled $3.0 million (substandard $3.0 million andspecial mention $11,410).  Substandardassets consist primarily of thirty-four loans with the largest amount to anyone borrower being $655,310.  The specialmention loans consist of one loan to one borrower in the amount of$11,410.  At December 31, 2005,classified loans totaled $3.3 million, with $3.3 million classified substandardand $423,600 classified special mention. The following table sets forth certain information with respect to theallowance for loan losses and the composition of charge-offs and recoveries forthe years ended December 31, 2007 to December 31, 2003.

 

 

14

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| ** **                                       | ** ** | **Allowance  for Loan Losses**            | ** ** |
|--------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                       | ** ** | **(Dollars  in Thousands)**               | ** ** |
| ** **                                       | ** ** | **For the years ended December 31,** | ** ** |
| ** **                                       | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Average total loans outstanding                  |       | $                                         | 458,703    |   | $ | 372,792 |   | $ | 251,306 |   | $ | 159,321 |   | $ | 116,469 |   |
| Total loans outstanding at period end            |       | $                                         | 509,908    |   | $ | 411,215 |   | $ | 311,789 |   | $ | 191,482 |   | $ | 135,612 |   |
| Total nonperforming loans                        |       | $                                         | 2,903      |   | $ | 1,625 |   | $ | 1,111 |   | $ | 77 |   | $ | 366 |   |
| Above includes mortgage  loans held for sale     |       |                                      |       |   |   |   |   |   |   |   |   |
| Beginning balance of allowance                   |       | $                                         | 5,888      |   | $ | 4,364 |   | $ | 2,422 |   | $ | 1,760 |   | $ | 1,276 |   |
| Loans charged-off:                               |       |                                      |       |   |   |   |   |   |   |   |   |
| Real Estate                                      |       | 294                                       |       | 307 |   | 16 |   | 126 |   | 62 |   |
| Commercial                                       |       | 577                                       |       | 384 |   | 200 |   | 530 |   | 184 |   |
| Consumer                                         |       | 114                                       |       | 101 |   | 64 |   | 27 |   | 2 |   |
| Total loans charged-off                          |       | 985                                       |       | 792 |   | 280 |   | 683 |   | 248 |   |
| Recoveries:                                      |       |                                      |       |   |   |   |   |   |   |   |   |
| Real Estate                                      |       | 9                                         |       | 128 |   | — |   | — |   | 18 |   |
| Commercial                                       |       | 7                                         |       | 5 |   | 28 |   | — |   | — |   |
| Consumer                                         |       | 21                                        |       | 9 |   | 10 |   | — |   | 1 |   |
| Total recoveries                                 |       | 37                                        |       | 142 |   | 38 |   | 5 |   | 19 |   |
| Net loans charged-off                            |       | 948                                       |       | 650 |   | 242 |   | 678 |   | 229 |   |
| Transfer to mortgage recourse reserve            |       | 50                                        |       | — |   | — |   | — |   | — |   |
| Provision for loan losses                        |       | 2,046                                     |       | 2,174 |   | 2,184 |   | 1,340 |   | 713 |   |
| Balance at period end                            |       | $                                         | 6,936      |   | $ | 5,888 |   | $ | 4,364 |   | $ | 2,422 |   | $ | 1,760 |   |
| Net charge-offs to average loans                 |       | 0.21                                      | %          | 0.17 | % | 0.10 | % | 0.43 | % | 0.20 | % |
| Allowance as a percent of total loans            |       | 1.36                                      | %          | 1.43 | % | 1.40 | % | 1.26 | % | 1.30 | % |
| Nonperforming loans as a percentage of allowance |       | 41.85                                     | %          | 27.59 | % | 25.46 | % | 3.18 | % | 20.80 | % |

 

Thefollowing table sets forth the breakdown of the allowance for loan losses byloan category and the percentage of loans in each category to total loans forthe periods indicated.  The allowance canbe allocated by category only on an approximate basis.  The allocation of the allowance to eachcategory is not necessarily indicative of further losses and does not restrictthe use of the allowance to absorb losses in any category.

 

** **

 

 
| ** **                      | ** ** | **Allocation  of the Allowance for Loan Losses** | ** ** |
|---------------------------------|------------|--------------------------------------------------|------------|
| ** **                      | ** ** | **For the years ended December 31,**        | ** ** |
| ** **                      | ** ** | **2007**                                         | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|                            |       | **Amount**                                       | ** ** | **%****of Loans** | ** ** | **Amount** | ** ** | **%****of Loans** | ** ** | **Amount** | ** ** | **%****of Loans** | ** ** | **Amount** | ** ** | **% of  Loans** | ** ** | **Amount** | ** ** | **% of  Loans** |   |
| Commercial                      |       | $                                                | 1,228      |   | 11.8 | % | $ | 947 |   | 10.7 | % | $ | 596 |   | 13.5 | % | $ | 437 |   | 17.3 | % | $ | 413 |   | 22.8 | % |
| Real Estate Construction        |       | 1,175                                            |       | 12.5 | % | 761 |   | 10.7 | % | 194 |   | 8.3 | % | 200 |   | 8.5 | % | 61 |   | 6.0 | % |
| Real Estate Mortgage            |       | 4,335                                            |       | 74.0 | % | 3,832 |   | 76.7 | % | 2,023 |   | 75.8 | % | 1,041 |   | 70.5 | % | 706 |   | 66.2 | % |
| Consumer                        |       | 167                                              |       | 1.7 | % | 146 |   | 1.9 | % | 102 |   | 2.4 | % | 128 |   | 3.7 | % | 97 |   | 5.0 | % |
| Unallocated                     |       | 31                                               |       | — |   | 202 |   | — |   | 1,449 |   | — |   | 616 |   | — |   | 483 |   | — |   |
| Total allowance for loan losses |       | $                                                | 6,936      |   | 100.00 | % | $ | 5,888 |   | 100.00 | % | $ | 4,364 |   | 100.0 | % | $ | 2,422 |   | 100.0 | % | $ | 1,760 |   | 100.0 | % |

 

**NoninterestIncome and Expense**

 

*NoninterestIncome.*  Noninterest income increased to$7.6 million for the year ended December 31, 2007, up 92.5% from $3.9million for the year ended December 31, 2006.  Noninterest income increased 252.5% from $1.1million in 2005 to $3.9 million in 2006. The increase in noninterest income is related primarily to the incomefrom our mortgage lending division that we added in June 2006.  Prior to 2006, income from mortgage lendingrepresented referral fees on mortgage loans where the Bank was acting as anagent for a third party originator.  Withthe formation of the Company’s mortgage lending division during the secondquarter of 2006, revenues from mortgage operations

 

 

15

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increaseddramatically. This accounts for the sequential, year over year increases inmortgage production income for each of 2007 and 2006.

 

Otherincome increased 130.2% to $1,265,194 in 2007 from $549,366 in 2006, andincreased 157.1% from $213,775 in 2005. The increase in 2007 relates to lease income on the Company’s newheadquarters building in 2007.  Gain onsale of fixed assets was $6,324, $583,011, and $142 for 2007, 2006, and 2005,respectively.  The increase in 2006 isdue to a one-time gain of $581,711 on the sale of the bank’s former main officein June 2006.  Merchant incomeincreased from $17,806 in 2005 to $164,229 in 2006, and to $665,811 in 2007.The increase in 2006 and 2007 related to the launch of merchant credit cardprocessing and the issuance of credit cards in the bank’s name.  Prior to this issuance, the bank offeredcredit cards through a third party.

 

(graph)

 

*NoninterestExpense.* Noninterestexpense totaled $18.9 million for the year ended December 31, 2007, upfrom $12.5 million for 2006 and $7.5 million for the year ended December 31,2005.  As a percentage of total assets,our total noninterest expenses increased from 1.90% in 2005 to 2.41% in 2006and to 3.12% in 2007.  The increase intotal noninterest expenses and noninterest expenses as a percentage of totalassets relates to 1) the formation of the company’s mortgage division duringthe second quarter of 2006, 2) the launching of merchant credit cardprocessing, and 3) the continued growth of assets as the result of expansion ofthe company’s branch network. 2007 noninterest expenses reflect a full year ofoperation of the mortgage division, while 2006 results reflect less than a fullyear of operation. As a result of organic growth through branch expansion,total assets grew by 16.49% during 2007 and 30.9% during 2006.

 

(graph)

 

Salariesand wages and employee benefits, the largest component of noninterest expense,increased by $2.2 million to $9.4 million during 2007, and by $3.1 million to$7.2 million during 2006.  The principalreason for the increase in 2007 and 2006 is the start-up of the Company’smortgage division during the second quarter of 2006, coupled with headcountincreases related to the growth of the bank, normal compensation adjustments,and higher costs associated with group benefits.

 

TheCompany had 152, 119, and 66 full-time equivalent employees at the end of 2007,2006, and 2005, respectively.  Theincrease during the three year period relates to the start-up of the mortgagelending division during the second quarter of 2006, and, to a lesser extent,the growth in branch and administrative staffing due to the volume increase incore banking functions.

 

Advertisingand public relations expenses were $615,552, $387,056, and $295,509 for 2007,2006, and 2005, respectively.  Theincrease in advertising and public relations expense during the three yearperiod relates to the start-up of the mortgage lending division, specialpromotions to attract deposits in all of the Company’s markets, and the use ofa professional advertising agency commencing in 2006 to develop and promote theCompany’s brand.

 

Professionalfees were $725,122, $311,627 and $327,130 for 2007, 2006, and 2005,respectively.  Professional fees continueto grow due to the growth in size and complexity of the Company, the regulatoryfees associated with such growth, and the escalating cost of accounting,auditing, and legal services related to being a public company, includingexpenses directly related to Sarbanes-Oxley (SOX) compliance.  2007 was the first year management reports onthe Company’s internal control over financial reporting under SOX and itrequired additional work to be performed by the external auditors.

 

Occupancycosts for the year ended December 31, 2007 were $1.7 million, compared to$1.1 million in 2006 and $0.7 million in 2005. The increase during the threeyear period relates to the addition of facilities associated with the mortgageoperations, increases on leases, and the expense associated with the newcorporate headquarters.  As the Companycontinues to expand, occupancy costs will continue to increase.

 

Dataprocessing fees increased in 2007 to $748,446 from $547,747 in 2006 and$455,646 in 2005.  Data processing costsare primarily related to the volume of loan and deposit accounts and associatedtransaction activity. The Company enhanced the security features on internetbanking products in addition to upgrading security measures for internal andexternal systems.  In 2007, the Companysigned an agreement with its existing data processing outsourcer to changeoperating systems in 2008 to expand features and functionality in order toattract and retain customers.

 

Theincrease in mortgage production related expenses during the three year periodrelates primarily to credit and collection charges and other operating expensesin the mortgage operation which was established during the second quarter of2006. The increase in merchant processing expenses relate to the launch ofmerchant credit card processing commencing in 2006.

 

 

16

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Totalother operating expenses increased 45% to $2.7 million in 2007 from $1.8million in 2006.  Total other operatingexpenses increased 75% to $1.8 million in 2006 from $1.1 million in 2005.  The increase during the three year periodrelates to the continued growth of assets as the result of expansion of thecompany’s balance sheet.  The followingtable presents a comparison of other operating expenses by expense category:

 
| ** **                             | ** ** | **For the years ended December 31,** | ** ** |
|----------------------------------------|------------|-------------------------------------------|------------|
| ** **                             | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| Telephone                              |       | $                                         | 144,924    |   | $ | 84,081 |   | $ | 57,138 |   |
| Postage                                |       | 99,733                                    |       | 73,884 |   | 59,651 |   |
| Armored car                            |       | 91,508                                    |       | 86,482 |   | 78,143 |   |
| Credit and collection-bank             |       | 146,073                                   |       | 187,741 |   | 66,973 |   |
| Dues and subscriptions                 |       | 136,788                                   |       | 117,976 |   | 83,733 |   |
| Travel                                 |       | 259,456                                   |       | 189,603 |   | 114,310 |   |
| Entertainment                          |       | 362,261                                   |       | 106,137 |   | 50,940 |   |
| FDIC insurance                         |       | 166,240                                   |       | 41,037 |   | 30,565 |   |
| Other insurance                        |       | 70,542                                    |       | 44,898 |   | 34,916 |   |
| Debit/ATM                              |       | 96,721                                    |       | 77,871 |   | 66,249 |   |
| Credit card processing  fees           |       | 49,794                                    |       | 63,043 |   | — |   |
| Federal Reserve charges                |       | 43,870                                    |       | 38,209 |   | 33,240 |   |
| Software maintenance                   |       | 127,579                                   |       | 61,610 |   | 32,607 |   |
| Director Supplemental  Retirement Plan |       | 118,972                                   |       | 137,289 |   | 78,013 |   |
| NASDAQ                                 |       | 65,940                                    |       | 24,500 |   | 14,292 |   |
| Furniture and equipment                |       | 297,781                                   |       | 427,015 |   | 163,951 |   |
| Other operating expenses               |       | 402,761                                   |       | 86,602 |   | 88,292 |   |
| Total                                  |       | $                                         | 2,680,943  |   | $ | 1,847,978 |   | $ | 1,053,013 |   |

 

*IncomeTaxes.*  Total income tax expenseincluded in the Consolidated Statements of Income was $3.5 million in 2007,$1.8 million in 2006, and $0.8 million in 2005. The Company’s effective tax rates were 36% for 2007, 36% for 2006, and34% for 2005.

 

**FinancialCondition**

 

*General.*  Total assets were $606.0 million at December 31,2007, an increase of 16.5% from $520.2 million at December 31, 2006.  Total assets consisted primarily of $503.0million in net loans, including loans HFS, and $65.6 million ininvestments.  Liabilities at December 31,2007, totaled $553.4 million, consisting primarily of $464.2 million indeposits and $55.0 million in Federal Home Loan Bank (FHLB) advances.  Total deposits increased to $464.2 million atDecember 31, 2007, up 11.5% from $416.4 million at December 31,2006.  Shareholders’ equity increased$7.1 million to $52.6 million at December 31, 2007, as compared to $45.5million at December 31, 2006.

 

*InvestmentSecurities.* Investmentsecurities averaged $69.3 million and $60.2 million for the years ended December 31,2007 and 2006, respectively, representing 12.9% of average earning assets in2007 and 13.6% in 2006.  At December 31,2007, the total portfolio had a book value of $66.1 million, and a market valueof $65.7 million, for an unrealized net loss of $442 thousand.  This compares to a market value of $68.5million at December 31, 2006, and $44.0 million at December 31, 2005.

** **
| ** **                        | ** ** | **Investment  Securities**                | ** ** |
|-----------------------------------|------------|-------------------------------------------|------------|
| ** **                        | ** ** | **For the years ended December 31,** | ** ** |
| ** **                        | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| Government Sponsored  Enterprises |       | $                                         | 64,055,391 |   | $ | 67,578,399 |   | $ | 43,873,698 |   |
| Federal Agencies                  |       | 65,022                                    |       | 80,132 |   | 102,178 |   |
| Other                             |       | 1,557,580                                 |       | 816,000 |   | — |   |
| Total investment  securities      |       | 65,677,993                                |       | 68,474,531 |   | 43,975,876 |   |
| Other                             |       | 4,379,300                                 |       | 3,459,600 |   | 2,545,400 |   |
| Total investments                 |       | $                                         | 70,057,293 |   | $ | 71,934,131 |   | $ | 46,521,276 |   |

 

 

17

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AtDecember 31, 2007, Federal Funds sold and short term investments totaled$566,044 compared with $14.0 million at December 31, 2006.  The funds are generally invested inmaturities of six months or less in federal funds or other financialinstitutions.

 

Contractualmaturities and yields on the investment securities (all available for sale) at December 31,2007 are set forth on the following tables based on market values.  Expected maturities may differ fromcontractual maturities because issuers may have the right to call or prepayobligations with or without call or prepayment penalties.  Investment securities are generally investedin government sponsored enterprises and mortgage backed securities with anaverage life of six years or less.

 
| ** **                       | ** ** | **Investment  Securities Maturity Distribution and Yields** | ** ** |
|----------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                       | ** ** | **December 31, 2007**                                  | ** ** |
| ** **                       | ** ** | **Less than one year**                                      | ** ** | **After one year through five years** | ** ** | **After five years through ten years** | ** ** | **After ten years** | ** ** |
| ** **                       | ** ** | **Amount**                                                  | ** ** | **Yield** | ** ** | **Amount** | ** ** | **Yield** | ** ** | **Amount** | ** ** | **Yield** | ** ** | **Amount** | ** ** | **Yield** | ** ** |
| Government Sponsored Enterprises |       | $                                                           | 1,376,670  |   | 4.55 | % | $ | 20,917,957 |   | 4.56 | % | $ | 15,152,189 |   | 5.26 | % | $ | 26,608,575 |   | 4.95 | % |
| Federal Agencies                 |       | —                                                      |       | — |   | — |   | — |   | — |   | — |   | 65,022 |   | 4.92 | % |
| Other                            |       | —                                                      |       | — |   | — |   | — |   | — |   | — |   | 5,936,880 |   | 6.09 | % |
| Total                            |       | $                                                           | 1,376,670  |   | 4.55 | % | $ | 20,917,957 |   | 4.56 | % | $ | 15,152,189 |   | 5.26 | % | $ | 32,610,477 |   | 5.16 | % |

 

*Loans.*  Loans are the largest component of earningassets and typically provide higher yields than other types of earningassets.  During 2007, loans represented85.2% of average earning assets, representing a small increase from the 84.1%that they represented during 2006.  At December 31,2007, net loans, which are gross loans less the allowance for loan losses anddeferred loan fees plus mortgage loans held for sale (HFS), totaled $503.0million, an increase of $97.6 million, or 24.1%, from December 31,2006.  Average gross loans, including HFSloans, increased 23.0% from $372.8 million with a yield of 8.88% in 2006 to$458.7 million with a yield of 8.95% in 2007. Average gross loans increased from $251.3 million with a yield of 7.54%in 2005.  The increase in yield on loanswas due to the increasing interest rate environment in 2005 and 2006.  Variable rate loans make up approximately 53%of our loan portfolio compared to 47% in fixed rates.  The interest rates charged on loans vary withthe degree of risk and the maturity and amount of the loan.  Competitive pressures, money market rates,availability of funds, and government regulations also influence interestrates.

 

Mortgageloans constitute the principal component of our loan portfolio.  Mortgage loans represented 74.0%, 76.7%, and75.8% of the portfolio at year end 2007, 2006, and 2005, respectively.  In the context of this discussion, a “realestate mortgage loan” is defined as any loan, other than loans for constructionpurposes, secured by real estate, regardless of the purpose of the loan.  We follow the common practice of financialinstitutions of obtaining a security interest in real estate whenever possible,in addition to any other available collateral. The collateral is taken to enhance the likelihood of the ultimaterepayment of the loan and tends to increase the size of our real estate loanportfolio component.  Generally, theCompany limits the loan-to-value ratio to 80%. The Company attempts to maintain a relatively diversified loan portfolioto help reduce the risk inherent in concentrations of collateral.

 

Thefollowing table shows the composition of the loan portfolio, including loansHFS, by category at December 31, for the years indicated.

 

 

18

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| ** **                      | ** ** | **Composition  of Loan Portfolio  (Dollars in Thousands)** | ** ** |
|---------------------------------|------------|------------------------------------------------------------|------------|
| ** **                      | ** ** | **For the years ended December 31,**                  | ** ** |
| ** **                      | ** ** | **2007**                                                   | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                      | ** ** | **Amount**                                                 | ** ** | **% of Total** | ** ** | **Amount** | ** ** | **% of Total** | ** ** | **Amount** | ** ** | **% of Total** | ** ** | **Amount** | ** ** | **% of Total** | ** ** | **Amount** | ** ** | **% of  Total** | ** ** |
| Commercial                      |       | $                                                          | 60,376     |   | 11.8 | % | $ | 43,975 |   | 10.7 | % | $ | 42,183 |   | 13.5 | % | $ | 33,031 |   | 17.2 | % | $ | 30,941 |   | 22.8 | % |
| Real estate — construction |       | 63,988                                                     |       | 12.5 | % | 44,033 |   | 10.7 | % | 25,846 |   | 8.3 | % | 16,255 |   | 8.5 | % | 8,157 |   | 6.0 | % |
| Real estate — mortgage (1) |       | 377,465                                                    |       | 74.0 | % | 315,689 |   | 76.7 | % | 236,539 |   | 75.8 | % | 134,978 |   | 70.4 | % | 89,723 |   | 66.0 | % |
| Consumer                        |       | 8,505                                                      |       | 1.7 | % | 7,784 |   | 1.9 | % | 7,488 |   | 2.4 | % | 7,554 |   | 3.9 | % | 7,066 |   | 5.2 | % |
| Loans, gross                    |       | $                                                          | 510,334    |   | 100.0 | % | $ | 411,481 |   | 100.0 | % | $ | 312,056 |   | 100.0 | % | $ | 191,818 |   | 100.0 | % | $ | 135,887 |   | 100.0 | % |
| Deferred loan fees              |       | (425                                                       | )          |   |   | (266 | ) |   |   | (268 | ) |   |   | (336 | ) |   |   | (275 | ) |   |   |
| Allowance for loan losses       |       | (6,936                                                     | )          |   |   | (5,888 | ) |   |   | (4,364 | ) |   |   | (2,422 | ) |   |   | (1,760 | ) |   |   |
| Loans, net                      |       | $                                                          | 502,973    |   |   |   | $ | 405,327 |   |   |   | $ | 307,424 |   |   |   | $ | 189,060 |   |   |   | $ | 133,852 |   |   |   |

 

----

(1) Includesmortgage loans held for sale.

 

Thefollowing tables set forth the maturity distribution, classified according tosensitivity to changes in interest rates, for selected components of the loanportfolio as of December 31, 2006. The information in this table is based on the contractual maturities ofthe individual loans, including loans which may be subject to renewal at theircontractual maturity.  Renewal of theseloans is subject to review and credit approval, as well as modification ofterms upon their maturity.  Actualrepayments of loans may differ from maturities reflected above becauseborrowers may have the right to prepay obligations with or without prepaymentpenalties.

 
| ** **                     | ** ** | **Loan  Maturity Schedule and Sensitivity to Changes in Interest Rates  (Includes mortgage loans held for sale)** | ** **  |
|--------------------------------|------------|-------------------------------------------------------------------------------------------------------------------|-------------|
| ** **                     | ** ** | **December 31,  2007**                                                                                       | ** **  |
| ** **                     | ** ** | **One year or less**                                                                                              | ** **  | **After one but within  five years** | ** ** | **After five years** | ** ** | **Total** | ** ** |
| Commercial                     |       | $                                                                                                                 | 24,238,209  |   | $ | 21,511,922 |   | $ | 14,625,974 |   | $ | 60,376,105 |   |
| Real estate mortgage           |       | 166,717,355                                                                                                       |        | 166,330,404 |   | 41,786,409 |   | 374,834,168 |   |
| Real estate construction       |       | 34,224,738                                                                                                        |        | 29,763,435 |   | — |   | 63,988,173 |   |
| Consumer                       |       | 3,977,385                                                                                                         |        | 4,328,451 |   | 177,949 |   | 8,483,785 |   |
| Total from maturity  schedules |       | 229,157,687                                                                                                       |        | 221,934,212 |   | 56,590,332 |   | 507,682,231 |   |
| Loans in process               |       | 2,651,659                                                                                                         |        | — |   | — |   | 2,651,659 |   |
| Total                          |       | $                                                                                                                 | 231,809,346 |   | $ | 221,934,212 |   | $ | 56,590,332 |   | $ | 510,333,890 |   |

 

Loansmaturing after one year with fixed interest rates totaled $132,670,919, andvariable interest rates totaled $1,673,278 as of December 31, 2007.

 

**FundingSources**

 

*Depositsand Other Interest-Bearing Liabilities.* Average total deposits were $440.2 million in2007, up 20.0% from $367.0 million in 2006. Average interest-bearing deposits were $404.1 million in 2007, up 53.9%from $333.6 million in 2006.  Theseincreases were primarily a result of the continued expansion of theCompany.  Deposit growth was attributableto internal growth and the generation of new deposit accounts due primarily tospecial promotions and increased advertising. Interest bearing checking accounts increased primarily due to a changemandated in 2005 by the South Carolina Bar Association requiring that alllawyer trust accounts be interest bearing. This created a shift from demand deposit accounts to interest bearingchecking accounts.

 

Coredeposits, which exclude certificates of deposit of $100,000 or more andbrokered deposits, provide a relatively stable funding source for the loanportfolio and other earning assets.  Coredeposits were $275.2 million at December 31, 2007, a slight decrease of3.2% compared to $284.4 million at December 31, 2006.  A stable base of deposits continues to be theCompany’s primary source of funding to meet both short-term and long-termliquidity needs.  Core deposits as apercentage of total deposits were approximately 59.2% at December 31, 2007and 68.3% at December 31,

 

 

19

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2006.  The loan-to-deposit ratio was 108.4% at December 31,2007 versus 97.4% at December 31, 2006. The average loan-to-deposit ratio was 104.2% during 2007 and 101.6%during 2006.

 

Thefollowing table sets forth deposits by category as of December 31, of eachrespective year.

 
| ** **                   | ** ** | **Deposits  by Category  For the years ended December 31,** | ** **  |
|------------------------------|------------|------------------------------------------------------------------|-------------|
| ** **                   | ** ** | **2007**                                                         | ** **  | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                   | ** ** | **Amount**                                                       | ** **  | **% of  Deposits** | ** ** | **Amount** | ** ** | **% of  Deposits** | ** ** | **Amount** | ** ** | **% of  Deposits** | ** ** | **Amount** | ** ** | **% of  Deposits** | ** ** | **Amount** | ** ** | **% of  Deposits** | ** ** |
| Noninterest  bearing demand  |       | $                                                                | 33,138,936  |   | 7.1 | % | $ | 37,194,469 |   | 8.9 | % | $ | 31,152,603 |   | 10.0 | % | $ | 32,540,139 |   | 16.0 | % | $ | 23,454,124 |   | 17.0 | % |
| Interest bearing  demand     |       | 20,377,754                                                       |        | 4.4 | % | 21,336,836 |   | 5.1 | % | 22,235,452 |   | 7.2 | % | 7,770,363 |   | 3.8 | % | 5,024,410 |   | 3.6 | % |
| Money market  accounts       |       | 103,821,154                                                      |        | 22.4 | % | 103,056,865 |   | 24.8 | % | 70,090,021 |   | 22.5 | % | 65,912,428 |   | 32.4 | % | 22,074,665 |   | 16.0 | % |
| Savings accounts             |       | 2,988,881                                                        |        | 0.6 | % | 3,303,763 |   | 0.8 | % | 3,639,178 |   | 1.2 | % | 3,003,904 |   | 1.5 | % | 2,777,278 |   | 2.0 | % |
| Time deposits  < $100,000 |       | 161,038,254                                                      |        | 34.7 | % | 154,191,755 |   | 37.0 | % | 100,390,284 |   | 32.3 | % | 46,751,575 |   | 23.1 | % | 48,988,982 |   | 35.5 | % |
| Time deposits  > $100,000 |       | 142,833,366                                                      |        | 30.8 | % | 97,273,441 |   | 23.4 | % | 83,386,672 |   | 26.8 | % | 47,190,549 |   | 23.2 | % | 35,780,108 |   | 25.9 | % |
| Total deposits               |       | $                                                                | 464,198,345 |   | 100.0 | % | $ | 416,357,129 |   | 100.0 | % | $ | 310,894,210 |   | 100.0 | % | $ | 203,168,958 |   | 100.0 | % | $ | 138,099,567 |   | 100.0 | % |

 

Thefollowing table sets forth deposits by category with the average balance andthe average rate paid for each category. All deposits are domestic.

 
| ** **                 | ** ** | **Average Balances and Rates**            | ** ** |
|----------------------------|------------|-------------------------------------------|------------|
| ** **                 | ** ** | **(Dollars in thousands)**                | ** ** |
| ** **                 | ** ** | **For the years ended December 31,** | ** ** |
| ** **                 | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                 | ** ** | **Amount**                                | ** ** | **Rate** | ** ** | **Amount** | ** ** | **Rate** | ** ** | **Amount** | ** ** | **Rate** | ** ** | **Amount** | ** ** | **Rate** | ** ** | **Amount** | ** ** | **Rate** | ** ** |
| Noninterest bearing demand |       | $                                         | 36,102     |   | — | % | $ | 33,422 |   | — | % | $ | 31,114 |   | — | % | $ | 27,060 |   | — | % | $ | 19,261 |   | — | % |
| Interest bearing demand    |       | 19,487                                    |       | 0.60 | % | 21,515 |   | 1.08 | % | 17,236 |   | 0.55 | % | 6,182 |   | 0.35 | % | 4,869 |   | 0.45 | % |
| Money market accounts      |       | 106,912                                   |       | 4.04 | % | 85,981 |   | 3.47 | % | 75,684 |   | 2.43 | % | 38,956 |   | 1.76 | % | 22,440 |   | 1.40 | % |
| Savings accounts           |       | 2,829                                     |       | 1.37 | % | 3,266 |   | 1.40 | % | 3,587 |   | 1.09 | % | 3,169 |   | 0.80 | % | 3,074 |   | 0.82 | % |
| Time deposits              |       |                                      | 274,847    |   | 5.21 | % |   | 222,869 |   | 4.69 | % |   | 120,342 |   | 3.27 | % |   | 91,396 |   | 2.36 | % |   | 72,088 |   | 2.62 | % |
| Total                      |       | $                                         | 440,177    |   |   |   | $ | 367,053 |   |   |   | $ | 247,963 |   |   |   | $ | 166,763 |   |   |   | $ | 121,732 |   |   |   |

 

 

20

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Asof December 31, 2007, time deposits greater than $100,000 that maturedwithin three months were $56.5 million, those over 3 months through 12 monthswere $76.6 million and time deposits greater than $100,000 that had a maturitygreater than 12 months were $9.7 million.

 

Dueto the seasonal nature of our market areas, deposit growth is strong during thesummer months and loan demand usually reaches its peak during the wintermonths.  Thus, the Company historicallyhas a more favorable liquidity position during the summer months.  To meet loan demand and liquidity needsduring the winter months, the Company typically offers rate specials ondeposits.  Deposit growth during the summermonths is invested in temporary investments and short-term securities.  Additionally, the Company has access to otherfunding sources including federal funds purchased from correspondent banks, aline of credit with the Federal Home Loan Bank (FHLB), and a seasonal line ofcredit with the Federal Reserve Discount Window.

 

*Borrowings.* Total borrowings outstanding at December 31,2007 were $83.5 million, at December 31, 2006 were $55.0 million, and at December 31,2005 were $45.8 million.  Short-termborrowings were $11.3 million at December 31, 2007 and $0.0 at each of December 31,2006 and 2005.  During 2007, averageshort-term borrowings were $3.6 million compared to $5.5 million in 2006 and$0.0 million in 2005.  The maximumoutstanding short-term borrowings during any month-end period for 2007, 2006,and 2005 were $13.5 million, $8.9 million and $3.7 million, respectively.  Long-term borrowings aggregated $72.2million, $55.0 million, and $45.8 million at December 31, 2007, 2006, and2005, respectively.  Average long-termborrowings were $66.0 million, $49.4 million, and $33.2 million for 2007, 2006,and 2005, respectively.  At December 31,2007, the borrowings included $55.0 million of advances from the FHLB, $10.3million of junior subordinated debentures, and $7.0 million of indebtedness onthe main office building.  At December 31,2006, there was $37.5 million of FHLB advances, $10.3 million of juniorsubordinated debentures, and $7.2 million of indebtedness on our main officebuilding.  At December 31, 2005,there was $34.0 million of FHLB advances, $10.3 million of junior subordinateddebentures, and $1.5 million of indebtedness on our main office building.  Funds were obtained from the FHLB to fundloan growth.  For more information onborrowings, refer to Notes 8 and 9 of the Notes to the Consolidated FinancialStatements.

 

**JuniorSubordinated Debt**

 

Theaverage and period end balances of the junior subordinated debt totaled $10.3million in both 2007 and 2006.  Themaximum amount outstanding during any month-end period at December 31,2007 was $10.3 million with an average rate of 7.78%. At December 31,2006, the maximum outstanding during any month-end period was $10.3 millionwith an average rate of 7.49%.

 

Thetrust preferred securities accrue and pay distributions annually at a rate perannum equal to the three month LIBOR plus 270 and 190 basis points,respectively, which was 7.85% and 7.59% at December 31, 2007.  The distribution rate payable on thesesecurities is cumulative and payable quarterly in arrears.  The Company has the right, subject to eventsof default, to defer payments of interest on the trust preferred securities fora period not to exceed 20 consecutive quarterly periods, provided that noextension period may extend beyond the maturity dates of May 27, 2034 and March 30,2035, respectively.  The Company has nocurrent intention to exercise its right to defer payments of interest on thetrust preferred securities.  The Companyhas the right to redeem the trust preferred securities, in whole or in part, onor after May 27, 2009 and March 30, 2010, respectively.  The trust preferred securities can beredeemed prior to such dates upon occurrence of specified conditions and thepayment of a redemption premium.

 

Debtissuance costs, net of accumulated amortization, from the junior subordinateddebentures totaled $33,943 at December 31, 2007, $41,067 at December 31,2006, and $45,740 at December 31, 2005. These costs are included in other assets on the Consolidated BalanceSheets.  Amortization of debt issuancecosts from trust preferred debt totaled $5,005 during 2007, $4,588 during 2006,and $3,962 during 2005, and is reported in noninterest expenses on theConsolidated Statements of Income.

 

**CapitalStandards and Regulatory Matters**

 

TheFederal Reserve Board and bank regulatory agencies require bank holding companiesand financial institutions to maintain capital at adequate levels based on apercentage of assets and off-balance sheet exposures, adjusted for risk weightsranging from 0% to 100%.  Under thecapital adequacy guidelines, regulatory capital is classified into twotiers.  These guidelines require aninstitution to maintain a certain level of Tier 1 and Tier 2 capital torisk-weighted assets.  Tier 1 capitalconsists of common shareholders’ equity, excluding the unrealized gain or losson securities available for sale, minus certain intangible assets.  In determining the amount of risk-weightedassets, all assets, including certain off-balance sheet assets, are multipliedby a risk-weight factor of 0% to 100% based on the risks believed to beinherent in the type of asset.  Tier 2capital consists of Tier 1 capital plus the general reserve for loan losses,subject to certain limitations.  TheCompany is also required to maintain capital at a minimum level based on totalaverage assets, which is known as the Tier 1 leverage ratio.  The Company and the Bank are subject tovarious regulatory capital requirements administered by the federal bankingagencies.  To be considered “well-capitalized,”total risk-based capital must be at least 10%, Tier 1 capital of at least 6%,and a leverage ratio of at least 5%.

 

 

21

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OnJune 14, 2005, the Company closed the sale of 1,150,000 shares of ourcommon stock at $18.75 per share in underwritten offering managed by Sandler O’Neill &Partners, L.P.  The Company received netproceeds from the offering of approximately $20 million after deductingunderwriting discounts and expenses.  Thenet proceeds were used for general corporate purposes, which included, amongother things, providing additional capital to the Bank to support its growth.

 

(graph)

 

AtDecember 31, 2007, total shareholders’ equity was $52.6 million ($53.0million at the Bank level).  At December 31,2007, the Company’s Tier 1 capital ratio was 12.7% (10.9% at the Bank), thetotal risk-based capital ratio was 14.0% (12.2% at the Bank), and the Tier 1leverage ratio was 11.2% (9.2% at the Bank). The Bank was considered “well-capitalized” and the Company met orexceeded its applicable regulatory capital requirements.

 

**LiquidityManagement**

 

Liquidityrepresents the ability of a company to convert assets into cash or cashequivalents without significant loss, and the ability to raise additional fundsby increasing liabilities.  Liquiditymanagement involves monitoring sources and uses of funds in order to meetday-to-day cash flow requirements while maximizing profits.  Liquidity management is made more complicatedbecause different balance sheet components are subject to varying degrees ofmanagement control.  For example, thetiming of maturities of the investment portfolio is fairly predictable andsubject to a high degree of control at the time investment decisions aremade.  However, net deposit inflows andoutflows are far less predictable and are not subject to the same degree ofcontrol.

 

TheCompany’s primary sources of liquidity are deposits, scheduled repayments onits loans, unused borrowing lines, and interest on and maturities of ourinvestments.  The Company meets futurecash needs through the liquidation of temporary investments and the generationof deposits.  All securities have beenclassified as available for sale. Occasionally, the Company may sell investment securities in connectionwith the management of its interest sensitivity gap or to manage itsliquidity.  The Company has the ability,on a short-term basis, to purchase federal funds from other financialinstitutions.  Arrangements are in placefor $18.8 million in short-term unsecured advances, $13.0 million securedadvances, and a line of credit with the FHLB to borrow up to 80% of our 1 to 4family loans, resulting in an availability of funds of $7.7 million at December 31,2007.  The FHLB has approved borrowingsup to 15% of the Bank’s total assets less advances outstanding.  The borrowings are available by pledgingadditional collateral and purchasing FHLB stock.  At December 31, 2007, FHLB borrowingstotaled $55.0 million.  The Companybelieves the liquidity needs for the next twelve months can be met by theexisting stable base of core deposits, the bond portfolio, loan maturities,borrowings from the FHLB, and short-term credit lines.

 

**InterestRate Sensitivity**

 

Asignificant portion of the Company’s assets and liabilities are monetary innature, and consequently are very sensitive to changes in interest rates.  This interest rate risk is the Company’sprimary market risk exposure, and it can have a significant effect on the netinterest income and cash flows.  TheCompany reviews exposure to market risk on a regular basis, and manages thepricing and maturity of assets and liabilities to diminish the potentialadverse impact that changes in interest rates could have on net interestincome.

 

TheCompany actively monitors and manages interest rate risk exposure principallyby measuring the interest sensitivity “gap,” which is the positive or negativedollar difference between assets and liabilities that are subject to interestrate repricing within a given period of time. A gap is considered positive when the amount of interest-rate sensitiveassets exceeds the amount of interest-rate sensitive liabilities, and it isconsidered negative when the amount of interest-rate sensitive liabilitiesexceeds the amount of interest-rate sensitive assets.  An asset sensitive position, or a positive, interestrate gap, would generally benefit from increasing market interest rates.  A liability-sensitive, or a negative,interest rate gap would generally benefit from decreasing market interestrates.  When measured on a “gap” basis,the Company is asset-sensitive in the one-three month and liability-sensitiveover the cumulative one-year time frame as of December 31, 2007.  However, the gap analysis is not a preciseindicator of the Company’s interest sensitivity position.  The analysis presents only a static view ofthe timing of maturities and repricing opportunities, without taking intoconsideration that changes in interest rates do not affect all assets andliabilities equally.  For example, ratespaid on a substantial portion of core deposits may change contractually withina relatively short time frame, but we believe those rates are significantlyless interest-sensitive than market-based rates such as those paid on non-coredeposits.

 

Netinterest income is also affected by other factors, including how quicklyinterest rates change and changes in the volume and mix of interest-earningassets and interest-bearing liabilities. The Company performs asset/liability modeling to assess the impact ofvarying interest rates and the impact that balance sheet mix assumptions willhave on net interest income.  The Companyattempts to manage interest rate sensitivity by matching maturities of assetsand liabilities, repricing assets or liabilities, selling securities available-for-sale,or adjusting the interest rate paid or received during the life of an asset orliability.  Actively managing the amountof assets and liabilities that reprice in the same time interval helps tominimize the impact on net interest income in a rising or falling interestrates environment.  

 

 

22

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TheCompany evaluates its interest sensitivity risk and formulates guidelinesregarding asset generation, liquidity, funding sources, and off-balance sheetcommitments in order to decrease interest rate sensitivity risk.

 

**Off-BalanceSheet Risk**

 

TheBank makes contractual commitments to extend credit in the ordinary course ofits business activities.  Thesecommitments are legally binding agreements to lend money to customers atpredetermined interest rates for a specified period of time.  Each customer’s credit worthiness isevaluated on a case-by-case basis.  Theamount of collateral obtained, if deemed necessary upon the extension ofcredit, is based on the credit evaluation of the borrower.  Collateral varies but may include accountsreceivable, inventory, property, plant and equipment, commercial andresidential real estate.  The Bankmanages the credit risk on commitments by subjecting them to normal underwritingand risk management processes.

 

AtDecember 31, 2007, the Bank had issued commitments to extend credit of$48.3 million through various types of lending arrangements.  The commitments expire over the next 18months.  Past experience indicates thatmany of these commitments to extend credit will expire unused.  The Company believes adequate sources ofliquidity are available to fund commitments that are drawn upon by theborrowers.

 

Inaddition to commitments to extend credit, the Bank also issue standby lettersof credit which are assurances to a third party that they will not suffer aloss if the customer fails to meet its contractual obligation to the thirdparty.  Standby letters of credit totaled$13.2 million at December 31, 2007. Past experience indicates that many of these standby letters of creditwill expire unused.  The Company believesadequate sources of liquidity are available to fund these obligations, ifnecessary.

 

Exceptas disclosed in this report, The Company is not involved in off-balance sheetcontractual relationships, unconsolidated related entities with off-balancesheet arrangements, or transactions that could result in liquidity needs orother commitments or significantly impact earnings.

 

**Impactof Inflation**

 

Theeffect of relative purchasing power over time due to inflation has not beentaken into account in the consolidated financial statements.  Rather, the financial statements have beenprepared on an historical cost basis in accordance with generally acceptedaccounting principles.

 

TheCompany’s and the Bank’s assets and liabilities, unlike most companies, areprimarily monetary in nature.  Therefore,interest rates have a more significant impact on its performance than do theeffects of changes in the general rate of inflation and changes in prices.  In addition, interest rates do notnecessarily move with the same magnitude as the prices of goods andservices.  As discussed previously, theCompany seeks to manage the relationships between interest sensitive assets andliabilities in order to protect against wide rate fluctuations, including thoseresulting from inflation.

 

 

23

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**Reporton Management’s Assessment of Internal Control Over Financial Reporting**

 

BeachFirst National Bancshares, Inc. is responsible for the preparation,integrity, and fair presentation of the financial statements included in thisannual report. The financial statements and notes have been prepared inconformity with United States generally accepted accounting principles andnecessarily include some amounts that are based on management’s best estimatesand judgments.

 

Asmanagement of Beach First National Bancshares, Inc., we are responsiblefor establishing and maintaining effective internal control over financialreporting that is designed to produce reliable financial statements inconformity with United States generally accepted accounting principles. Thesystem of internal control over financial reporting as it relates to thefinancial statements is evaluated for effectiveness by management and testedfor reliability through a program of internal audits. Actions are taken tocorrect potential deficiencies as they are identified. Any system of internalcontrol, no matter how well designed, has inherent limitations, including thepossibility that a control can be circumvented or overridden and misstatementsdue to error or fraud may occur and not be detected. Also, because of changesin conditions, internal control effectiveness may vary over time. Accordingly,even an effective system of internal control will provide only reasonableassurance with respect to financial statement preparation.

 

Managementassessed the system of internal control over financial reporting as of December 31,2007, in relation to criteria for effective internal control over financialreporting as described in “Internal Control—Integrated Framework,” issued bythe Committee of Sponsoring Organizations of the Treadway Commission. Based onthis assessment, management concludes that, as of December 31, 2007, itssystem of internal control over financial reporting is effective and meets thecriteria of the “Internal Control—Integrated Framework.”  Elliott Davis LLC, independent registeredpublic accounting firm, has issued an attestation report on the effectivenessof internal control over financial reporting.

 

 
| /s/ Walt Standish             |   | /s/ Gary S. Austin            |
|-------------------------------|--------|-------------------------------|
| Walter  E. Standish, III |   | Gary  S. Austin               |
| President  and                |   | Executive  Vice President and |
| Chief  Executive Officer      |   | Chief  Financial Officer      |
|                          |   |                          |
| Myrtle  Beach, South Carolina |   |                          |
| March 11,  2008          |   |                          |

 

**Reportof Independent Registered Public Accounting Firm**

 

Boardof Directors

BeachFirst National Bancshares, Inc.

MyrtleBeach, South Carolina

 

Wehave audited Beach First National Bancshares, Inc. (the Company) andSubsidiaries’ internal control over financial reporting as of December 31,2007, based on criteria established in “Internal Control—Integrated Framework”,issued by the Committee of Sponsoring Organizations of the Treadway Commission(COSO).  The Company’s management isresponsible for maintaining effective internal control over financial reportingand for its assessment of the effectiveness of internal control over financialreporting included in the accompanying Report on Management’s Assessment ofInternal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internalcontrol over financial reporting based on our audit.

 

Weconducted our audit in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtainreasonable assurance about whether effective internal control over financialreporting was maintained in all material respects. Our audit included obtainingan understanding of internal control over financial reporting, assessing therisk that a material weakness exists, and testing and evaluating the design andoperating effectiveness of internal control based on the assessed risk.  Our audit also included performing such otherprocedures as we considered necessary in the circumstances.  We believe that our audit provides areasonable basis for our opinion.

 

Acompany’s internal control over financial reporting is a process designed toprovide reasonable assurance regarding the reliability of financial reportingand the preparation of financial statements for external purposes in accordancewith generally accepted accounting principles. A company’s internal control over financial reporting includes thosepolicies and procedures that (1) pertain to the maintenance of recordsthat, in reasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the company; (2) provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accountingprinciples, andthat receipts and expenditures of the company are being made only in accordancewith authorizations of management and directors of the company; and (3) providereasonable assurance regarding prevention or timely detection of unauthorizedacquisition, use, or disposition of the company’s assets that could have amaterial effect on the financial statements.

 

 

24

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Becauseof its inherent limitations, internal control over financial reporting may notprevent or detect misstatements.  Also,projections of any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies or procedures maydeteriorate.

 

Inour opinion, Beach First National Bancshares, Inc. and Subsidiariesmaintained, in all material respects, effective internal control over financialreporting as of December 31, 2007, based on criteria established in “InternalControl—Integrated Framework”, issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO).We have also audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the consolidated balance sheets of Beach First NationalBancshares, Inc. and Subsidiaries as of December 31, 2007 and 2006,and the related consolidated statements of income, changes in shareholders’equity and comprehensive income and cash flows for each of the three years inthe period ended December 31, 2007 and our report dated March 11,2008 expressed an unqualified opinion.

 

 

 
| /s/  Elliott Davis, LLC   |   |
|---------------------------|--------|
| Elliott  Davis, LLC       |
| Columbia,  South Carolina |
| March 11,  2008      |

 

 

**Reportof Independent Registered Public Accounting Firm**

 

Boardof Directors

BeachFirst National Bancshares, Inc.

MyrtleBeach, South Carolina

 

Wehave audited the consolidated balance sheets of Beach First National Bancshares, Inc.(the Company) and Subsidiaries as of December 31, 2007 and 2006, and therelated consolidated statements of income, changes in shareholders’ equity andcomprehensive income and cash flows for each of the three years in the periodended December 31, 2007.  Thesefinancial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinionon these financial statements based on our audits.

 

Weconducted our audits in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtainreasonable assurance about whether the financial statements are free ofmaterial misstatement.  An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements.  An audit alsoincludes assessing the accounting principles used and significant estimatesmade by management, as well as evaluating the overall financial statementpresentation.  We believe that our auditsprovide a reasonable basis for our opinion.

 

Inour opinion, the consolidated financial statements referred to above presentfairly, in all material respects, the financial position of Beach FirstNational Bancshares, Inc. and Subsidiaries as of December 31, 2007and 2006, and the results of their operations and their cash flows for each ofthe three years in the period ended December 31, 2007, in conformity withU.S. generally accepted accounting principles.

 

Wealso have audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), Beach First National Bancshares, Inc.and Subsidiaries’ internal control over financial reporting as of December 31,2007, based on criteria established in “Internal Control—Integrated Framework”,issued by the Committee of Sponsoring Organizations of the Treadway Commission(COSO) and our report dated March 11, 2008 expressed an unqualifiedopinion on the effectiveness of Beach First National Bancshares, Inc. andSubsidiaries’ internal control over financial reporting.

 

 
| /s/  Elliott Davis, LLC   |   |
|---------------------------|--------|
| Elliott  Davis, LLC       |
| Columbia,  South Carolina |
| March 11,  2008      |

 

 

25

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**BeachFirst National Bancshares, Inc. and Subsidiaries**

**ConsolidatedBalance Sheets**

 
| ** **                                                                                                                                                            | ** ** | **December 31,** | ** **      |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|-----------------|
| ** **                                                                                                                                                            | ** ** | **2007**              | ** **      | **2006** | ** ** |
| **Assets**                                                                                                                                                            |       |                  |            |   |   |
| Cash and due from banks                                                                                                                                               |       | $                     | 4,992,634       |   | $ | 5,198,945 |   |
| Federal funds sold and short term investments                                                                                                                         |       | 566,044               |            | 14,010,667 |   |
| Investment securities                                                                                                                                                 |       | 65,677,993            |            | 68,474,531 |   |
| Loans, net                                                                                                                                                            |       | 496,496,900           |            | 392,848,582 |   |
| Mortgage loans held for sale                                                                                                                                          |       | 6,475,619             |            | 12,478,222 |   |
| Federal Reserve Bank stock                                                                                                                                            |       | 984,000               |            | 984,000 |   |
| Federal Home Loan Bank stock                                                                                                                                          |       | 3,395,300             |            | 2,475,600 |   |
| Property and equipment, net                                                                                                                                           |       | 15,746,143            |            | 14,344,330 |   |
| Cash value of life insurance                                                                                                                                          |       | 3,554,807             |            | 3,424,586 |   |
| Investment in BFNB Trusts                                                                                                                                             |       | 310,000               |            | 310,000 |   |
| Other assets                                                                                                                                                          |       | 7,788,978             |            | 5,651,876 |   |
| Total assets                                                                                                                                                          | ** ** | **$**                 | **605,988,418** | ** ** | **$** | **520,201,339** | ** ** |
|                                                                                                                                                                  |       |                  |            |   |   |
| **Liabilities and shareholders’  equity**                                                                                                                        |       |                  |            |   |   |
| **Liabilities**                                                                                                                                                       |       |                  |            |   |   |
| Deposits                                                                                                                                                              |       |                  |            |   |   |
| Noninterest bearing                                                                                                                                                   |       | $                     | 33,138,936      |   | $ | 37,194,469 |   |
| Interest bearing                                                                                                                                                      |       | 431,059,409           |            | 379,162,660 |   |
| Total deposits                                                                                                                                                        |       | 464,198,345           |            | 416,357,129 |   |
|                                                                                                                                                                  |       |                  |            |   |   |
| Advances from Federal Home  Loan Bank                                                                                                                                 |       | 55,000,000            |            | 37,500,000 |   |
| Federal funds purchased  and other borrowings                                                                                                                         |       | 18,288,148            |            | 7,209,820 |   |
| Junior subordinated  debentures                                                                                                                                       |       | 10,310,000            |            | 10,310,000 |   |
| Other liabilities                                                                                                                                                     |       | 5,613,875             |            | 3,364,811 |   |
| Total liabilities                                                                                                                                                     |       | 553,410,368           |            | 474,741,760 |   |
|                                                                                                                                                                  |       |                  |            |   |   |
| **Commitments and contingencies**                                                                                                                                     |       |                  |            |   |   |
|                                                                                                                                                                  |       |                  |            |   |   |
| **Shareholders’ equity**                                                                                                                                         |       |                  |            |   |   |
| Common stock, $1 par value, 10,000,000 shares authorized, 4,845,018  shares issued and outstanding at December 31, 2007 and 4,768,413 at  December 31, 2006 |       | 4,845,018             |            | 4,768,413 |   |
| Paid-in capital                                                                                                                                                       |       | 29,494,912            |            | 28,657,576 |   |
| Retained earnings                                                                                                                                                     |       | 18,583,425            |            | 12,706,795 |   |
| Accumulated other  comprehensive loss                                                                                                                                 |       | (345,305              | )               | (673,205 | ) |
|                                                                                                                                                                  |       |                  |            |   |   |
| Total shareholders’ equity                                                                                                                                       |       | 52,578,050            |            | 45,459,579 |   |
|                                                                                                                                                                  |       |                  |            |   |   |
| Total liabilities and shareholders’ equity                                                                                                                       | ** ** | **$**                 | **605,988,418** | ** ** | **$** | **520,201,339** | ** ** |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

 

26

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**BeachFirst National Bancshares, Inc. and Subsidiaries**

**ConsolidatedStatements of Income**

 
| ** **                                                       | ** ** | **For the years ended December 31,** | ** **    |
|------------------------------------------------------------------|------------|-------------------------------------------|---------------|
| ** **                                                       | ** ** | **2007**                                  | ** **    | **2006** | ** ** | **2005** | ** ** |
| **Interest income**                                              |       |                                      |          |   |   |   |   |
| Loans and fees on loans                                          |       | $                                         | 41,064,557    |   | $ | 33,091,838 |   | $ | 18,938,675 |   |
| Investment securities                                            |       | 3,698,507                                 |          | 2,886,528 |   | 1,825,174 |   |
| Federal funds sold and short term investments                    |       | 319,985                                   |          | 485,515 |   | 140,922 |   |
| Other                                                            |       | 23,970                                    |          | 22,929 |   | 15,860 |   |
| Total interest income                                            |       | 45,107,019                                |          | 36,486,810 |   | 20,920,631 |   |
|                                                             |       |                                      |          |   |   |   |   |
| **Interest expense**                                             |       |                                      |          |   |   |   |   |
| Deposits                                                         |       | 18,802,056                                |          | 13,711,212 |   | 5,912,891 |   |
| Advances from FHLB, federal funds purchased and other borrowings |       | 2,877,462                                 |          | 1,546,286 |   | 747,209 |   |
| Junior subordinated debentures                                   |       | 802,455                                   |          | 771,740 |   | 528,812 |   |
| Total interest expense                                           |       | 22,481,973                                |          | 16,029,238 |   | 7,188,912 |   |
| Net interest income                                              |       | 22,625,046                                |          | 20,457,572 |   | 13,731,719 |   |
|                                                             |       |                                      |          |   |   |   |   |
| **Provision for loan losses**                                    |       | 2,045,600                                 |          | 2,174,400 |   | 2,184,000 |   |
| Net interest income after provision for loan losses              |       | 20,579,446                                |          | 18,283,172 |   | 11,547,719 |   |
|                                                             |       |                                      |          |   |   |   |   |
| **Noninterest income**                                           |       |                                      |          |   |   |   |   |
| Service fees on deposit accounts                                 |       | 568,760                                   |          | 514,285 |   | 549,689 |   |
| Mortgage production related income                               |       | 4,911,705                                 |          | 2,039,829 |   | 249,757 |   |
| Merchant income                                                  |       | 665,811                                   |          | 164,229 |   | 17,806 |   |
| Gain on sale of investment securities                            |       | 7,904                                     |          | (57,276 | ) | (3,935 | ) |
| Income from cash value life insurance                            |       | 152,086                                   |          | 143,717 |   | 89,809 |   |
| Gain on sale of fixed assets                                     |       | 6,324                                     |          | 583,011 |   | 142 |   |
| Other income                                                     |       | 1,265,194                                 |          | 549,566 |   | 213,755 |   |
| Total noninterest income                                         |       | 7,577,784                                 |          | 3,937,361 |   | 1,117,023 |   |
|                                                             |       |                                      |          |   |   |   |   |
| **Noninterest expenses**                                         |       |                                      |          |   |   |   |   |
| Salaries and wages                                               |       | 7,760,272                                 |          | 6,018,633 |   | 3,371,922 |   |
| Employee benefits                                                |       | 1,646,093                                 |          | 1,138,653 |   | 675,496 |   |
| Supplies and printing                                            |       | 199,977                                   |          | 126,705 |   | 101,889 |   |
| Advertising and public relations                                 |       | 615,552                                   |          | 387,056 |   | 295,509 |   |
| Professional fees                                                |       | 725,122                                   |          | 311,627 |   | 327,130 |   |
| Depreciation and amortization                                    |       | 1,060,255                                 |          | 518,551 |   | 539,406 |   |
| Occupancy                                                        |       | 1,719,491                                 |          | 1,065,091 |   | 724,313 |   |
| Data processing fees                                             |       | 748,446                                   |          | 547,747 |   | 455,646 |   |
| Mortgage production related expense                              |       | 1,153,246                                 |          | 392,762 |   | — |   |
| Merchant processing                                              |       | 623,947                                   |          | 167,866 |   | — |   |
| Other operating expenses                                         |       | 2,680,943                                 |          | 1,847,978 |   | 1,053,013 |   |
| Total noninterest expenses.                                      |       | 18,933,344                                |          | 12,522,669 |   | 7,544,324 |   |
| Income before income taxes.                                      |       | 9,223,886                                 |          | 9,697,864 |   | 5,120,418 |   |
|                                                             |       |                                      |          |   |   |   |   |
| **Income tax expense**                                           |       | 3,347,256                                 |          | 3,502,136 |   | 1,760,775 |   |
| Net income                                                       | ** ** | **$**                                     | **5,876,630** | ** ** | **$** | **6,195,728** | ** ** | **$** | **3,359,643** | ** ** |
|                                                             |       |                                      |          |   |   |   |   |
| **Basic net income per common  share**                           | ** ** | **$**                                     | **1.22**      | ** ** | **$** | **1.30** | ** ** | **$** | **0.85** | ** ** |
|                                                             |       |                                      |          |   |   |   |   |
| **Diluted net income per common  share**                         | ** ** | **$**                                     | **1.18**      | ** ** | **$** | **1.27** | ** ** | **$** | **0.83** | ** ** |
|                                                             |       |                                      |          |   |   |   |   |
| Weighted average common  shares outstanding:                     |       |                                      |          |   |   |   |   |
| Basic                                                            | ** ** | **4,817,911**                             | ** **    | **4,764,072** | ** ** | **3,975,864** | ** ** |
| Diluted                                                          | ** ** | **4,977,067**                             | ** **    | **4,874,562** | ** ** | **4,059,865** | ** ** |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

 

27

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**BeachFirst National Bancshares, Inc. and Subsidiaries**

**ConsolidatedStatements of Changes in Shareholders’ Equity and Comprehensive Income (Loss)**

 
| ** **                                                           | ** ** | ** **        | ** ** | ** **  | ** **    | ** **   | ** ** | ** **        | ** ** | **Accumulated**        | ** **     | ** ** | ** ** |
|----------------------------------------------------------------------|------------|-------------------|------------|-------------|---------------|--------------|------------|-------------------|------------|------------------------|----------------|------------|------------|
| ** **                                                           | ** ** | ** **        | ** ** | ** **  | ** **    | ** **   | ** ** | ** **        | ** ** | **Other**              | ** **     | **Total**  | ** ** |
| ** **                                                           | ** ** | **Common  Stock** | ** ** | **Paid-in** | ** **    | **Retained** | ** ** | **Comprehensive** | ** ** | **Shareholders’** | ** **     |
| ** **                                                           | ** ** | **Shares**        | ** ** | **Amount**  | ** **    | **Capital**  | ** ** | **Earnings**      | ** ** | **Income  (Loss)**     | ** **     | **Equity** | ** ** |
| **Balance, December 31, 2004**                                  |       | 2,013,508         |       | $           | 2,013,508     |         | $          | 11,335,982        |       | $                      | 3,153,939      |       | $          | (170,467) |   | $ | 16,332,962 |   |
| Net income                                                           |       | —            |       | —      |          | —       |       | 3,359,643         |       | —                 |           | 3,359,643  |       |
| Other  comprehensive, income, net of taxes:                          |       |              |       |        |          |         |       |              |       |                   |           |       |       |
| Unrealized loss  on investment securities                            |       | —            |       | —      |          | —       |       | —            |       | (548,100               | )              | (548,100   | )          |
| Plus  reclassification adjustments for losses included in net income |       | —            |       | —      |          | —       |       | —            |       | 2,597                  |           | 2,597      |       |
| Comprehensive  income                                                |       | —            |       | —      |          | —       |       | —            |       | —                 |           | 2,814,140  |       |
| Exercise of stock  options                                           |       | 6,450             |       | 6,450       |          | 37,863       |       | —            |       | —                 |           | 44,313     |       |
| Issuance of  common stock                                            |       | 1,150,000         |       | 1,150,000   |          | 18,783,998   |       | —            |       | —                 |           | 19,933,998 |       |
|                                                                 |       |              |       |        |          |         |       |              |       |                   |           |       |       |
| **Balance, December 31, 2005**                                  |       | 3,169,958         |       | 3,169,958   |          | 30,157,843   |       | 6,513,582         |       | (715,970               | )              | 39,125,413 |       |
| Net income                                                           |       | —            |       | —      |          | —       |       | 6,195,728         |       | —                 |           | 6,195,728  |       |
| Other  comprehensive, income, net of taxes:                          |       |              |       |        |          |         |       |              |       |                   |           |       |       |
| Unrealized gain  on investment securities                            |       | —            |       | —      |          | —       |       | —            |       | 6,108                  |           | 6,108      |       |
| Plus reclassification  adjustments for losses included in net income |       | —            |       | —      |          | —       |       | —            |       | 36,657                 |           | 36,657     |       |
| Comprehensive  income                                                |       | —            |       | —      |          | —       |       | —            |       | —                 |           | 6,238,493  |       |
| Exercise of stock  options                                           |       | 13,575            |       | 13,575      |          | 84,613       |       | —            |       |                   |           | 98,188     |       |
| Issuance of  common stock 3-for-2 stock split                        |       | 1,584,880         |       | 1,584,880   |          | (1,584,880   | )          | (2,515            | )          | —                 |           | (2,515     | )          |
|                                                                 |       |              |       |        |          |         |       |              |       |                   |           |       |       |
| **Balance, December 31, 2006**                                  |       | 4,768,413         |       | 4,768,413   |          | 28,657,576   |       | 12,706,795        |       | (673,205               | )              | 45,459,579 |       |
| Net income                                                           |       | —            |       | —      |          | —       |       | 5,876,630         |       | —                 |           | 5,876,630  |       |
| Other  comprehensive, income, net of taxes:                          |       |              |       |        |          |         |       |              |       |                   |           |       |       |
| Unrealized gain  on investment securities                            |       | —            |       | —      |          | —       |       | —            |       | 386,592                |           | 386,592    |       |
| Plus  reclassification adjustments for gains included in net income  |       | —            |       | —      |          | —       |       | —            |       | (5,375                 | )              | (5,375     | )          |
| Unrealized loss  on interest rate swap                               |       | —            |       | —      |          | —       |       | —            |       | (53,317                | )              | (53,317    | )          |
| Comprehensive  income                                                |       |              |       |        |          |         |       |              |       |                   |           | 6,204,530  |       |
| Stock-based  compensation expense                                    |       | —            |       | —      |          | 7,643        |       | —            |       | —                 |           | 7,643      |       |
| Exercise of stock options                                            |       | 76,605            |       | 76,605      |          | 829,693      |       | —            |       | —                 |           | 906,298    |       |
| **Balance, December 31, 2007**                                  | ** ** | **4,845,018**     | ** ** | **$**       | **4,845,018** | ** **   | **$**      | **29,494,912**    | ** ** | **$**                  | **18,583,425** | ** ** | **$**      | **(345,305** | **)** | **$** | **52,578,050** |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

 

28

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**BeachFirst National Bancshares, Inc. and Subsidiaries**

**ConsolidatedStatements of Cash Flows**

 
| ** **                                                                                   | ** ** | **For the years ended December 31,** | ** **     |
|----------------------------------------------------------------------------------------------|------------|-------------------------------------------|----------------|
| ** **                                                                                   | ** ** | **2007**                                  | ** **     | **2006** | ** ** | **2005** | ** ** |
| **Operating activities**                                                                     | ** ** | ** **                                | ** **     | ** ** | ** ** | ** ** | ** ** |
| Net income                                                                                   |       | $                                         | 5,876,630      |   | $ | 6,195,728 |   | $ | 3,359,643 |   |
| Adjustments to  reconcile net income to net cash provided by (used in) operating activities: |       |                                      |           |   |   |   |   |
| Depreciation and  amortization                                                               |       | 1,060,255                                 |           | 518,551 |   | 539,406 |   |
| Proceeds from  sale of mortgages held for sale                                               |       | 231,970,200                               |           | 93,107,365 |   | — |   |
| Disbursements for  mortgages held for sale                                                   |       | (225,967,597                              | )              | (105,251,847 | ) | — |   |
| Discount  accretion and premium amortization                                                 |       | (153,431                                  | )              | (79,569 | ) | (45,404 | ) |
| Deferred income  taxes                                                                       |       | (673,024                                  | )              | (634,250 | ) | 23,781 |   |
| Provision for  loan loss                                                                     |       | 2,045,600                                 |           | 2,124,400 |   | 2,184,000 |   |
| Recourse reserve  provision                                                                  |       | 205,000                                   |           | 50,000 |   | — |   |
| Gain on sale of  property and equipment                                                      |       | (6,324                                    | )              | (583,011 | ) | — |   |
| Loss (gain) on  sale of investment securities                                                |       | (7,904                                    | )              | 57,276 |   | 3,935 |   |
| Investment in  Beach First National Trusts                                                   |       | —                                    |           | — |   | (310,000 | ) |
| Stock based  compensation expense                                                            |       | 7,643                                     |           | — |   | — |   |
| Increase in other  assets                                                                    |       | (1,713,779                                | )              | (1,672,997 | ) | (917,049 | ) |
| Increase in other  liabilities                                                               |       | 1,994,064                                 |           | 1,809,209 |   | 621,177 |   |
| (Gain) loss on  sale of other real estate owned                                              |       | (99,267                                   | )              | 6,031 |   | — |   |
|                                                                                         |       |                                      |           |   |   |   |   |
| Net cash provided  by (used in) operating activities                                         |       | 14,538,066                                |           | (4,353,114 | ) | 5,459,489 |   |
|                                                                                         |       |                                      |           |   |   |   |   |
| **Investing Activities**                                                                     | ** ** | ** **                                | ** **     | ** ** | ** ** | ** ** | ** ** |
| Proceeds from  paydowns of investment securities                                             |       | 4,988,852                                 |           | 4,180,510 |   | — |   |
| Proceeds from  sale of investment securities                                                 |       | 8,623,625                                 |           | 4,473,361 |   | 6,148,824 |   |
| Purchase of  investment securities                                                           |       | (10,077,003                               | )              | (33,065,437 | ) | (14,707,381 | ) |
| Purchase of FHLB  stock                                                                      |       | (919,700                                  | )              | (464,200 | ) | (941,200 | ) |
| Purchase of  Federal Reserve stock                                                           |       | —                                    |           | (450,000 | ) | (225,000 | ) |
| Decrease  (increase) in Federal funds sold and short-term investments                        |       | 13,444,623                                |           | 11,510,404 |   | (25,058,002 | ) |
| Increase in  loans, net                                                                      |       | (107,223,880                              | )              | (88,352,287 | ) | (120,548,509 | ) |
| Purchase of life  insurance contracts                                                        |       | (130,221                                  | )              | (123,169 | ) | — |   |
| Purchase of  property and equipment                                                          |       | (2,462,068                                | )              | (9,107,363 | ) | (2,540,328 | ) |
| Proceeds from  sale of property and equipment                                                |       | 6,324                                     |           | 1,500,000 |   | 10,227 |   |
| Proceeds from  sale of other real estate owned                                               |       | 1,679,229                                 |           | 400,969 |   | — |   |
|                                                                                         |       |                                      |           |   |   |   |   |
| Net cash used by  investing activities                                                       |       | (92,070,219                               | )              | (109,497,212 | ) | (157,861,369 | ) |
|                                                                                         |       |                                      |           |   |   |   |   |
| **Financing activities**                                                                     | ** ** | ** **                                | ** **     | ** ** | ** ** | ** ** | ** ** |
| Repayment of  advances from Federal Home Loan Bank                                           |       | (5,000,000                                | )              | (6,500,000 | ) | (15,000,000 | ) |
| Advances from  Federal Home Loan Bank                                                        |       | 22,500,000                                |           | 10,000,000 |   | 32,500,000 |   |
| Increase  (decrease) in Federal funds purchased                                              |       | 11,382,100                                |           | — |   | — |   |
| Net increase in  deposits                                                                    |       | 47,841,216                                |           | 105,462,919 |   | 107,725,252 |   |
| Advances from  junior subordinated debentures                                                |       | —                                    |           | — |   | 5,155,000 |   |
| Proceeds from  exercise of stock options                                                     |       | 520,733                                   |           | 98,188 |   | 44,313 |   |
| Cash paid in lieu  of fractional shares                                                      |       | —                                    |           | (2,515 | ) | — |   |
| Proceeds from stock  issuance, net                                                           |       | —                                    |           | — |   | 19,933,998 |   |
| Tax benefit of  stock options                                                                |       | 385,565                                   |           | — |   | — |   |
| Proceeds from  other borrowings                                                              |       | —                                    |           | 5,730,991 |   | 1,504,009 |   |
| Repayments of  other borrowings                                                              |       | (303,772                                  | )              | (25,180 | ) | — |   |
|                                                                                         |       |                                      |           |   |   |   |   |
| Net cash provided  by financing activities                                                   |       | 77,325,842                                |           | 114,764,403 |   | 151,862,572 |   |
|                                                                                         |       |                                      |           |   |   |   |   |
| Net (decrease)  increase in cash                                                             |       | (206,311                                  | )              | 914,077 |   | (539,308 | ) |
|                                                                                         |       |                                      |           |   |   |   |   |
| **Cash and cash equivalents at beginning of year**                                           |       | 5,198,945                                 |           | 4,284,868 |   | 4,824,176 |   |
|                                                                                         |       |                                      |           |   |   |   |   |
| **Cash and cash equivalents at end of year**                                                 | ** ** | **$**                                     | **4,992,634**  | ** ** | **$** | **5,198,945** | ** ** | **$** | **4,284,868** | ** ** |
|                                                                                         |       |                                      |           |   |   |   |   |
| **Cash paid for**                                                                            | ** ** | ** **                                | ** **     | ** ** | ** ** | ** ** | ** ** |
| Interest                                                                                     | ** ** | **$**                                     | **22,042,809** | ** ** | **$** | **15,639,904** | ** ** | **$** | **6,709,409** | ** ** |
|                                                                                         |       |                                      |           |   |   |   |   |
| Income taxes                                                                                 | ** ** | **$**                                     | **3,851,653**  | ** ** | **$** | **4,388,302** | ** ** | **$** | **1,281,882** | ** ** |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

29

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**Notes**

 

**NOTE 1 —SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES**

 

BeachFirst National Bancshares, Inc. (the “Company”) is organized under thelaws of the State of South Carolina for the purpose of operating as a bankholding company for Beach First National Bank (the “Bank”), Beach FirstNational Trust (the “Trust”), Beach First National Trust II (the “Trust II”),and BFNM, LLC (the “LLC”).  The Bankprovides full commercial banking services to customers and is subject toregulation by the Office of the Comptroller of the Currency (OCC) and theFederal Deposit Insurance Corporation. The Company is subject to regulation by the Federal Reserve Board.  The Trust and Trust II are special purposesubsidiaries organized for the sole purpose of issuing trust preferredsecurities.

 

In2005, the Company formed a limited liability company with Nelson Mullins Riley &Scarborough, LLP (NMRS) known as BFNM, LLC. The purpose of the LLC was to construct and own an office building inMyrtle Beach, South Carolina.  Thebuilding was completed in 2006.  TheCompany owns two-thirds of the LLC and NMRS owns one-third.

 

**Basis ofpresentation —** The consolidated financial statements include theaccounts of the Company, the Bank, and the LLC. All significant intercompany accounts and transactions have beeneliminated in consolidation.  Theaccounting and reporting policies of the Company conform to accountingprinciples generally accepted in the United States of America and to generalpractices in the banking industry.  Inaccordance with current accounting guidance, the Trust and Trust II have notbeen consolidated in these financial statements.  The Company uses the accrual basis ofaccounting.

 

**Estimates—** The preparation of consolidated financial statements in conformity withaccounting principles generally accepted in the United States of Americarequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities and disclosure of contingent assets andliabilities as of the date of the consolidated financial statements and thereported amount of income and expenses during the reporting periods.  Actual results could differ from thoseestimates.

 

**Concentrationsof credit risk —**Financial instruments, which potentially subject theCompany to concentrations of credit risk, consist principally of loans,investment securities, federal funds sold and amounts due from banks.

 

TheCompany originates consumer, commercial business, commercial real estate,residential mortgage loans and land acquisition and land development loans forpersonal and business purposes. These loans are primarily originated in themarkets we serve.  These markets arecentered in the Myrtle Beach area and Hilton Head, South Carolina but includethe geographical area from Little River, South Carolina to Pawleys Island,South Carolina and Hilton Head and Bluffton in Beaufort County, SouthCarolina.  The mortgage divisionoriginates mortgages in several states and these loans are sold to investors.

 

TheCompany’s loan portfolio is not centered in loans to any single borrower or arelatively small number of borrowers, but it does have a geographicconcentration in real estate. Additionally, management is not aware of any concentrations of loans togroups of borrowers or industries that would be similarly affected by economicconditions except for loans for the acquisition of land and loans for thedevelopment of land and for commercial real estate loans.  The acquisition of land and loans for thedevelopment of land concentration totaled $169.4 million at December 31,2007, representing 322.2% of total capital and 33.7% of net loans.  At December 31, 2006, the concentrationtotaled $120.1 million representing 264.2% of total capital and 29.6% of netloans.  This concentration increased as apercentage of capital and loans in 2007, as compared to 2006.  Investment in second homes, relocation ofretirees to our markets and the steady growth of population to support theservice industries (i.e., heating and cooling, plumbing, janitorial services,pest control, medical, etc.) have contributed to this concentration.

 

Thecommercial real estate loan concentration totaled $149.5 million at December 31,2007, representing 284.4% of total capital and 29.7% of net loans.  At December 31, 2006, the concentrationtotaled $116.7 million, representing 256.7% of total capital and 28.8% of netloans.  This concentration increased as apercentage of capital and loans in 2007, as compared to 2006.  There is a diversified portfolio mix of theseloans. The loans are primarily centered in small business owner occupiedbuildings, retail shops, office buildings, medical offices, warehouses, servicebusinesses, churches, restaurants, convenience stores and tourist relatedbusinesses.

 

Theseloans could be negatively impacted by changes in economic conditions, decliningmarket values, slower absorption of the projects and interest rateincreases.  The Company has notexperienced any significant losses in these areas.  Management continues to implement proceduresto monitor these concentrations and has considered these concentration’s in itsallowance for loan loss analysis.

 

Inaddition to monitoring potential concentrations of loans to particularborrowers or groups of borrowers, industries and geographic regions, managementmonitors exposure to credit risk from concentrations of lending products andpractices.  These loans include those thatsubject borrowers to substantial payment increases (e.g. principal deferralperiods, loans with initial interest-only periods, etc), and loans with highloan-to-value ratios.  Management triesto use its best judgment when evaluating risk and the effect and impact thesefactors may have on the banks loan portfolio. These factors may include national and local economic conditions,concentrations of credit types of loans that carry a higher degree of risk,terms of loans both long-term and interest-only repayment schedules,supervisory loan-to-value 

 

30

----

 

limits,unsecured loan concentrations, nature and mix of the loan portfolio, vacancyrates, collateral types, insurance volatility, real estate markets, entry intonew products and other factors that may be assigned from time to time.

 

Additionally,there are industry practices that could subject the Company to increased creditrisk should economic conditions change over the course of a loan’s life.  For example, the Company makes variable rateloans and fixed rate principal-amortizing loans with maturities prior to theloan being fully paid (i.e. balloon payment loans).  These loans are underwritten and monitored tomanage the associated risks.  Therefore,management believes that these particular practices do not subject the Companyto unusual credit risk.

 

TheCompany’s investment portfolio consists principally of obligations of theUnited States and its agencies or its corporations.  In the opinion of management, there is noconcentration of credit risk in its investment portfolio.  The Company places its deposits andcorrespondent accounts with and sells its federal funds to financialinstitutions.  Management believes creditrisk associated with correspondent accounts is not significant.

 

**Cash andcash equivalents —**For purposes of the statement of cash flows, cash andcash equivalents are defined as those amounts included in the balance sheetcaption “Cash and due from banks”.  Cashand cash equivalents have an original maturity of three months or less.

 

**Investmentsecurities —**The Company accounts for investment securities inaccordance with Statement of Financial Accounting Standards (SFAS) No. 115,“Accounting for Certain Investments in Debt and Equity Securities.”  Gains or losses on the disposition ofsecurities are based on the difference between the net proceeds and theadjusted carrying amount of the securities sold, using the specificidentification method.  Interest incomeis recognized when earned.  SFAS 115requires investments in equity and debt securities to be classified into threecategories:

 

**1.  Available for sale:****** These are securities which are not classifiedas either held to maturity or as trading securities. These securities arereported at fair market value. Unrealized gains and losses are reported, net ofincome taxes, as separate components of shareholders’ equity (accumulated othercomprehensive income).

 

**2. Heldto maturity:****** These are investment securities which theCompany has the ability and intent to hold until maturity.  These securities are stated at cost, adjustedfor amortization of premiums and the accretion of discounts. The Companycurrently has no held to maturity securities.

 

**3.Trading:**  These aresecurities which are bought and held principally for the purpose of selling inthe near future. Trading securities are reported at fair market value, andrelated unrealized gains and losses are recognized in the statement ofincome.  The Company has no tradingsecurities.

 

**Otherinvestments —** The Bank, as a member institution, is required toown certain stock investments in the Federal Home Loan Bank of Atlanta and theFederal Reserve Bank.  The stock isgenerally pledged against any borrowings from these institutions.  No ready market exists for the stocks andthey have no quoted market value. However, redemption of these stocks has historically been at parvalue.  Dividends are recognized whenearned. These non-marketable equity securities have not been evaluated forimpairment.

 

**Loans,interest and fee income on loans —** Loans are stated at theprincipal balance outstanding. Unamortized loan fees and the allowance for loan losses are deductedfrom total loans in the balance sheet. Interest income is recognized over the term of the loan based on theprincipal amount outstanding.

 

Feeson real estate loans are taken into income to the extent they represent thedirect cost of initiating a loan.  Theamount in excess of direct costs is deferred and amortized over the expectedlife of the loan using a method approximating a level yield.

 

Loansare generally placed on non-accrual status when principal or interest becomescontractually ninety days past due, or when payment in full is notanticipated.  When a loan is placed onnon-accrual status, interest accrued but not received is generally reversedagainst interest income.  Ifcollectibility is in doubt, cash receipts on non-accrual loans are not recordedas interest income, but are used to reduce principal.

 

**Allowancefor loan losses —** The provision for loan losses charged to operatingexpenses reflects the amount deemed appropriate by management to establish anadequate allowance to meet the present and foreseeable risk characteristics ofthe current loan portfolio.  Management’sjudgment is based on periodic and regular evaluation of individual loans, theoverall risk characteristics of the various portfolio segments, past experiencewith losses and prevailing and anticipated economic conditions.  Loans which are determined to be uncollectibleare charged against the allowance. Provisions for loan losses and recoveries onloans previously charged off are added to the allowance.  Management considers the year-end allowanceappropriate and adequate to cover probable losses in the loan portfolio;however, management’s judgment is based upon a number of assumptions aboutfuture events, which are believed to be reasonable, but which may or may notprove valid.  Thus, there can be noassurance that charge-offs in future periods will not exceed the allowance forloan losses or that additional increases in the allowance for loan losses willnot be required.

 

TheCompany accounts for impaired loans in accordance with SFAS No. 114, “Accountingby Creditors for Impairment of a Loan”. This standard requires that all lenders value loans at the loan’s fairvalue if it is probable that the lender will be unable to collect all amountsdue according to the terms of the loan agreement.  Fair value may be determined based upon thepresent value of expected cash flows, market price of the loan, if available,or value of the underlying collateral. Expected cash flows are required to be discounted at the loan’seffective interest rate.  SFAS No. 

 

31

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114was amended by SFAS No. 118 to allow a lender to use existing methods forrecognizing interest income on an impaired loan and by requiring additionaldisclosures about how a creditor recognizes interest income on an impairedloan.

 

UnderSFAS No. 114, as amended by SFAS No. 118, when the ultimate collectibilityof an impaired loan’s principal is in doubt, wholly or partially, cash receiptsare applied to principal.  Once thereported principal balance has been reduced to the loan’s estimated netrealized value, future cash receipts are applied to interest income, to theextent that any interest has been foregone. Further cash receipts are recorded as recoveries of any amountspreviously charged off.  When this doubtdoes not exist, cash receipts are applied under the contractual terms of theloan agreement first to interest income then to principal.

 

Aloan is also considered impaired if its terms are modified in a troubled debtrestructuring.  For these accruingimpaired loans, cash receipts are typically applied to principal and interestreceivable in accordance with the terms of the restructured loanagreement.  Interest income is recognizedon these loans using the accrual method of accounting.

 

**Residentialmortgage loans held for sale (HFS) —** The Company’s residentialmortgage lending activities for sale in the secondary market are comprised ofaccepting residential mortgage loan applications and qualifying borrowers tostandards established by investors under pre-existing commitments. Fundedresidential mortgages held temporarily for sale to investors are recorded atthe lower of cost or market value determined on an individual basis usingquoted market prices.  Application andorigination fees collected by the Company are recognized as income upon sale tothe investor.

 

TheCompany issues rate lock commitments to borrowers based on prices quoted bysecondary market investors.  When ratesare locked with borrowers, a sales commitment is immediately entered (on a bestefforts basis) at a specified price with a secondary market investor.  Accordingly, any potential liabilitiesassociated with rate lock commitments are offset by sales commitments toinvestors.

 

**Realestate acquired in settlement of loans —** Real estate acquired throughforeclosure is initially recorded at the lower of cost or estimated fairvalue.  Subsequent to the date ofacquisition, it is carried at the lower of cost or fair value, adjusted for netselling costs.  Fair values of realestate owned are reviewed regularly and writedowns are recorded when it isdetermined that the carrying value of real estate exceeds the fair value lessestimated costs to sell.  Costs relatingto the development and improvement of such property are capitalized, whereasthose costs relating to holding the property are charged to expense.

 

**Propertyand equipment —**Buildings and furniture and equipment are stated atcost, net of accumulated depreciation. Depreciation is computed using the straight-line method over theestimated useful lives of the related assets. Maintenance and repairs are charged to operations, while majorimprovements are capitalized.  Uponretirement, sale or other disposition of property and equipment, the cost andaccumulated depreciation are eliminated from the accounts, and gain or loss isincluded in net income.

 

**Incometaxes —** The consolidated financial statements have been prepared on the accrualbasis.  When income and expenses arerecognized in different periods for financial reporting purposes and forpurposes of computing income taxes currently payable, deferred taxes are providedon such temporary differences.  TheCompany accounts for income taxes in accordance with SFAS No. 109, “Accountingfor Income Taxes”.  Under SFAS No. 109,deferred tax assets and liabilities are recognized for the expected future taxconsequences of events that have been recognized in the consolidated financialstatements or tax return.  Deferred taxassets and liabilities are measured using the enacted tax rates expected toapply to taxable income in the years in which those temporary differences are expectedto be realized or settled.

 

TheCompany adopted FIN 48, “Accounting for Uncertain Income Taxes”, which is aninterpretation of SFAS 109.  FIN 48prescribes a comprehensive model for how companies should recognize, measure,present, and disclose uncertain tax positions. Such positions shall be recognized in the financial statements when itis more likely than not the position will be sustained upon examination of thetaxing authorities.  Upon adoption of FIN48 no changes were required to the Company’s income tax reserves.

 

**Advertisingand public relations expense —** Advertising, promotional andother business development costs are generally expensed as incurred.  External costs incurred in producing mediaadvertising are expensed the first time the advertising takes place.  External costs relating to direct mailingcosts are expensed in the period in which the direct mailings are sent.

 

**Earningsper share —** Basic is computed by dividing net income by theweighted average number of common shares outstanding. Earnings per share —diluted is computed by dividing net income by the weighted average number ofcommon shares outstanding and dilutive common share equivalents using thetreasury stock method.  All share amountshave been adjusted for the 3-for-2 stock split recorded in 2006.  Dilutive common share equivalents includecommon shares issuable upon exercise of outstanding stock options.

 

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| ** **                                                   | ** ** | **For the years ended December 31,** | ** **    |
|--------------------------------------------------------------|------------|-------------------------------------------|---------------|
| ** **                                                   | ** ** | **2007**                                  | ** **    | **2006** | ** ** | **2005** | ** ** |
| **Basic earnings per share:**                                |       |                                      |          |   |   |   |   |
| Net income available to  common shareholders                 | ** ** | **$**                                     | **5,876,630** | ** ** | **$** | **6,195,728** | ** ** | **$** | **3,359,643** | ** ** |
| Average common shares  outstanding — basic              |       | 4,817,911                                 |          | 4,764,072 |   | 3,975,864 |   |
| Basic earnings per share                                     | ** ** | **$**                                     | **1.22**      | ** ** | **$** | **1.30** | ** ** | **$** | **0.85** | ** ** |
| **Diluted earnings per share:**                              |       |                                      |          |   |   |   |   |
| Net income available to  common shareholders                 | ** ** | **$**                                     | **5,876,630** | ** ** | **$** | **6,195,728** | ** ** | **$** | **3,359,643** | ** ** |
| Average common shares  outstanding — basic              |       | 4,817,911                                 |          | 4,764,072 |   | 3,975,864 |   |
| Incremental shares from  assumed conversion of stock options |       | 159,156                                   |          | 110,490 |   | 84,001 |   |
| Average common shares  outstanding — diluted            |       | 4,977,067                                 |          | 4,874,562 |   | 4,059,865 |   |
| Diluted earnings per share                                   | ** ** | **$**                                     | **1.18**      | ** ** | **$** | **1.27** | ** ** | **$** | **0.83** | ** ** |

 

**StockBased Compensation —**The Company has a stock-based employeecompensation plan which is further described in Note 17.  For the year ended December 31, 2005,the Company utilized the intrinsic value method under Accounting PrinciplesBoard Opinion No. 25, “Accounting for Stock Issued to Employees” (asamended) (“APB 25”). Under the intrinsic value method prescribed by APB 25, nocompensation costs were recognized for the Company’s stock options because theoption exercise price in its plans equals the market price on the date of thegrant.

 

EffectiveJanuary 1, 2006, the Company adopted Statement of Financial AccountingStandards (“SFAS”) No. 123 (revised 2004), “Share-Based Payment” (“SFAS No. 123(R)”).SFAS No. 123(R), which requires that the fair value of share-basedpayments to employees, including stock options, be recognized as compensationexpense in the statement of income.

 

InDecember 2005, the Company elected to fully vest all outstanding optionseffective immediately.  The acceleratedvesting was effective as of December 14, 2005.  All of the other terms and conditionsapplicable to the outstanding stock options remained unchanged.   As a result, there is no compensation costattributable to periods after 2005 for options granted in 2005 or earlier,because there is no requisite service period over which the options must beearned.

 

Thefollowing table illustrates the effect on net income and net income per commonshare as if the Company had applied fair value recognition provisions tostock-based compensation in 2007, 2006, and 2005.

 
| ** **                                                                                                                                   | ** ** | **For the years ended December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                                                                   | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net income, as reported                                                                                                                      |       | $                                         | 5,876,630  |   | $ | 6,195,728 |   | $ | 3,359,643 |   |
| Deduct: Total stock-based employee compensation expense determined  under fair value based method for all awards, net of related tax effects |       | (7,643                                    | )          | — |   | (1,256,526 | ) |
| Amount of stock-based compensation included in net income as reported                                                                        |       | 7,643                                     |       | — |   | — |   |
| Pro forma net income                                                                                                                         |       | $                                         | 5,876,630  |   | $ | 6,195,728 |   | $ | 2,103,117 |   |
| Net income per common  share                                                                                                                 |       |                                      |       |   |   |   |   |
| Basic — as reported                                                                                                                     |       | $                                         | 1.22       |   | $ | 1.30 |   | $ | 0.85 |   |
| Basic — pro forma                                                                                                                       |       | $                                         | 1.22       |   | $ | 1.30 |   | $ | 0.53 |   |
| Diluted — as reported                                                                                                                   |       | $                                         | 1.18       |   | $ | 1.27 |   | $ | 0.83 |   |
| Diluted — pro forma                                                                                                                     |       | $                                         | 1.18       |   | $ | 1.27 |   | $ | 0.52 |   |

 

Thedecision to accelerate vesting did not incur recognition of pre-taxcompensation expense by the Company upon the adoption of SFAS 123(R) in2006. The Company believes that the acceleration of vesting stock options meetsthe criteria for variable accounting under FIN No. 44.  Based upon past experience, the Companybelieves the grantees of these stock options will remain as a director oremployee of the Company.

 

In2007, the Company granted 9,200 stock options. The cost recognized under SFAS 123 (R) was $7,643.

 

 

33

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**Reclassifications—** Certain previously reported amounts have been reclassified to conformto the current year presentation. Such changes had no effect on previouslyreported net income or shareholders’ equity.

 

**RecentlyIssued Accounting Pronouncements —** The following is a summaryof recent authoritative pronouncements:

 

InSeptember 2006, the FASB issued SFAS No. 157, “Fair ValueMeasurements” (“SFAS 157”). SFAS 157 defines fair value, establishes aframework for measuring fair value in generally accepted accounting principles,and expands disclosures about fair value measurements. This standard eliminatesinconsistencies found in various prior pronouncements but does not require anynew fair value measurements. SFAS 157 is effective for the Company on January 1,2008 and will not impact the Company’s accounting measurements but it isexpected to result in additional disclosures.

 

InSeptember 2006, The FASB ratified the consensuses reached by the FASB’sEmerging Issues Task Force (“EITF”) relating to EITF 06-4, “Accounting for theDeferred Compensation and Postretirement Benefit Aspects of EndorsementSplit-Dollar Life Insurance Arrangements” (“EITF 06-4”).  Entities purchase life insurance for variousreasons including protection against loss of key employees and to fundpostretirement benefits. The two most common types of life insurancearrangements are endorsement split dollar life and collateral assignment splitdollar life. EITF 06-4 covers the former and EITF 06-10 (discussed below)covers the latter. EITF 06-4 states that entities with endorsement split-dollarlife insurance arrangements that provide a benefit to an employee that extendsto post retirement periods should recognize a liability for future benefits inaccordance with SFAS No. 106, “Employers’ Accounting for Postretirementearnings or to other components Benefits Other Than Pensions,” (if, insubstance, a postretirement benefit plan exists) or Accounting Principles Board(“APB”) Opinion No. 12, “Omnibus Opinion —1967” (if the arrangement is, insubstance, an individual deferred compensation contract).  Entities should recognize the effects ofapplying this Issue through either (a) a change in accounting principlethrough a cumulative-effect adjustment to equity or net assets in the statementof financial position as of the beginning of the year of adoption or (b) achange in accounting principle through retrospective application to all priorperiods. EITF 06-4 is effective for the Company on January 1, 2008. TheCompany does not believe the adoption of EITF 06-4 will have a material impacton its financial position, results of operations or cash flows.

 

InSeptember 2006, the FASB ratified the consensus reached on EITF 06-5, “Accountingfor Purchases of Life Insurance—Determining the Amount That Could Be Realizedin Accordance with FASB Technical Bulletin No. 85-4, Accounting forPurchases of Life Insurance” (“EITF 06-5”).  EITF 06-5 states that apolicyholder should consider any additional amounts included in the contractualterms of the insurance policy other than the cash surrender value indetermining the amount that could be realized under the insurancecontract.  EITF 06-5 also states that a policyholder should determine theamount that could be realized under the life insurance contract assuming thesurrender of an individual-life by individual-life policy (or certificate bycertificate in a group policy). EITF 06-5 is effective for the Company on January 1,2008.  The Company does not believe the adoption of EITF 06-5 will have amaterial impact on its financial position, results of operations, or cashflows.

 

InMarch 2007, the FASB ratified the consensus reached on EITF 06-10, “Accountingfor Collateral Assignment Split-Dollar Life Insurance Arrangements” (“EITF06-10”). The postretirement aspect of this EITF is substantially similar toEITF 06-4 discussed above and requires that an employer recognize a liabilityfor the postretirement benefit related to a collateral assignment split-dollarlife insurance arrangement in accordance with either FASB Statement No. 106or APB Opinion No. 12, as appropriate, if the employer has agreed tomaintain a life insurance policy during the employee’s retirement or providethe employee with a death benefit based on the substantive agreement with theemployee.  In addition, a consensus wasreached that an employer should recognize and measure an asset based on thenature and substance of the collateral assignment split-dollar life insurancearrangement. EITF 06-10 is effective for the Company on January 1, 2008.The Company does not believe the adoption of EITF 06-10 will have a materialimpact on its financial position, results of operations, or cash flows.

 

InFebruary 2007, the FASB issued SFAS No. 159, “The Fair Value Optionfor Financial Assets and Financial Liabilities — Including an amendment of FASBStatement No. 115” (“SFAS 159”). This statement permits, but does notrequire, entities to measure many financial instruments at fair value. Theobjective is to provide entities with an opportunity to mitigate volatility inreported earnings caused by measuring related assets and liabilitiesdifferently without having to apply complex hedge accounting provisions.Entities electing this option will apply it when the entity first recognizes aneligible instrument and will report unrealized gains and losses on suchinstruments in current earnings.  Thisstatement:  1) applies to all entities,2) specifies certain election dates, 3) can be applied on aninstrument-by-instrument basis with some exceptions, 4) is irrevocable, and 5)applies only to entire instruments. One exception is demand deposit liabilitieswhich are explicitly excluded as qualifying for fair value. With respect toSFAS 115, available-for-sale and held-to-maturity securities at the effectivedate are eligible for the fair value option at that date. If the fair valueoption is elected for those securities at the effective date, cumulativeunrealized gains and losses at that date shall be included in thecumulative-effect adjustment and thereafter, such securities will be accountedfor as trading securities. SFAS 159 is effective for the Company on January 1,2008. The Company is currently analyzing the fair value option that ispermitted, but not required, under SFAS 159.

 

InJune 2007, the FASB ratified the consensus reached by the EITF withrespect to EITF 06-11, “Accounting for Income Tax Benefits of Dividends onShare-Based Payment Awards” (“EITF 06-11”). Under EITF 06-11, a realized incometax benefit from dividends or dividend equivalents that are charged to retainedearnings and are paid to 

 

 

34

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employeesfor equity-classified nonvested equity shares, nonvested equity share units andoutstanding equity share options should be recognized as an increase inadditional paid-in capital.  This EITF isto be applied prospectively to the income tax benefits that result fromdividends on equity-classified employee share-based payment awards that aredeclared beginning in 2008, and interim periods within those fiscal years.  Early application is permitted. The Companydoes not believe the adoption of EITF 06-11 will have a material impact on itsfinancial position, results of operations, or cash flows.

 

InNovember 2007, the Securities and Exchange Commission (“SEC”) issued StaffAccounting Bulletin No. 109, “Written Loan Commitments Recorded at FairValue Through Earnings” (“SAB 109”). SAB 109 expresses the current view of theSEC staff that the expected net future cash flows related to the associatedservicing of the loan should be included in the measurement of all written loancommitments that are accounted for at fair value through earnings.   SEC registrants are expected to apply thisguidance on a prospective basis to derivative loan commitments issued ormodified in the first quarter of 2008 and thereafter. The Company is currentlyanalyzing the impact of this guidance, which relates to the Company’s mortgageloans held for sale.

 

InDecember 2007, the FASB issued SFAS No. 141(R), “BusinessCombinations,” (“SFAS 141(R)”) which replaces SFAS 141. SFAS 141(R) establishesprinciples and requirements for how an acquirer in a business combinationrecognizes and measures in its financial statements the identifiable assetsacquired, the liabilities assumed, and any controlling interest; recognizes andmeasures goodwill acquired in the business combination or a gain from a bargainpurchase; and determines what information to disclose to enable users of thefinancial statements to evaluate the nature and financial effects of thebusiness combination. FAS 141(R) is effective for acquisitions by theCompany taking place on or after January 1, 2009. Early adoption isprohibited. Accordingly, a calendar year-end company is required to record anddisclose business combinations following existing accounting guidance until January 1,2009. The Company will assess the impact of SFAS 141(R) if and when afuture acquisition occurs.

 

InDecember 2007, the FASB issued SFAS No. 160, “NoncontrollingInterests in Consolidated Financial Statements — an amendment of ARB No. 51”(“SFAS 160”). SFAS 160 establishes new accounting and reporting standards forthe noncontrolling interest in a subsidiary and for the deconsolidation of asubsidiary. Before this statement, limited guidance existed for reportingnoncontrolling interests (minority interest). As a result, diversity inpractice exists. In some cases minority interest is reported as a liability andin others it is reported in the mezzanine section between liabilities andequity. Specifically, SFAS 160 requires the recognition of a noncontrollinginterest (minority interest) as equity in the consolidated financialsstatements and separate from the parent’s equity. The amount of net incomeattributable to the noncontrolling interest will be included in consolidatednet income on the face of the income statement. SFAS 160 clarifies that changesin a parent’s ownership interest in a subsidiary that do not result indeconsolidation are equity transactions if the parent retains its controllingfinancial interest. In addition, this statement requires that a parentrecognize gain or loss in net income when a subsidiary is deconsolidated. Suchgain or loss will be measured using the fair value of the noncontrolling equityinvestment on the deconsolidation date. SFAS 160 also includes expandeddisclosure requirements regarding the interests of the parent and itsnoncontrolling interests. SFAS 160 is effective for the Company on January 1,2009. Earlier adoption is prohibited. The Company is currently evaluating the impact, if any, the adoption ofSFAS 160 will have on its consolidated financial statements.

 

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

 

**NOTE 2 —RESTRICTIONS ON CASH AND DUE FROM BANKS**

 

TheBank is required to maintain average reserve balances, computed by applyingprescribed percentages to its various types of deposits, either at the bank or ondeposit with the Federal Reserve Bank. At December 31, 2007 and 2006, these required reserves wereapproximately $1.9 million and $ 2.0 million, respectively.  These balances do not bear interest.

 

**NOTE 3 —INVESTMENT SECURITIES**

 

Theamortized costs and fair values of available for sale investment securities areas follows:

 

 

35

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| ** **                        | ** ** | **December 31, 2007** | ** ** |
|-----------------------------------|------------|----------------------------|------------|
| ** **                        | ** ** | **Amortized**              | ** ** | **Gross Unrealized** | ** ** | **Fair** | ** ** |
| ** **                        | ** ** | **Cost**                   | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
|                              |       |                       |       |   |   |   |   |   |   |
| Government Sponsored  Enterprises |       | $                          | 64,484,602 |   | $ | 259,996 |   | $ | 689,207 |   | $ | 64,055,391 |   |
| Federal Agencies                  |       | 65,023                     |       | 480 |   | 481 |   | 65,022 |   |
| Tax exempt securities             |       | 760,046                    |       | — |   | 12,786 |   | 747,260 |   |
| Corporate                         |       | 810,728                    |       | — |   | 408 |   | 810,320 |   |
|                              |       |                       |       |   |   |   |   |   |   |
| Total securities                  |       | $                          | 66,120,399 |   | $ | 260,476 |   | $ | 702,882 |   | $ | 65,677,993 |   |

 
| ** **                        | ** ** | **December 31, 2006** | ** ** |
|-----------------------------------|------------|----------------------------|------------|
| ** **                        | ** ** | **Amortized**              | ** ** | **Gross Unrealized** | ** ** | **Fair** | ** ** |
| ** **                        | ** ** | **Cost**                   | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
| Government Sponsored  Enterprises |       | $                          | 67,608,363 |   | $ | 130,700 |   | $ | 1,144,546 |   | $ | 66,594,517 |   |
| Federal Agencies                  |       | 1,071,863                  |       | 212 |   | 8,061 |   | 1,064,014 |   |
| Corporate                         |       | 814,312                    |       | 1,688 |   | — |   | 816,000 |   |
|                              |       |                       |       |   |   |   |   |   |   |
| Total securities                  |       | $                          | 69,494,538 |   | $ | 132,600 |   | $ | 1,152,607 |   | $ | 68,474,531 |   |

 

Theamortized costs and fair values of investment securities at December 31,2007, by contractual maturity, are shown in the following chart.  Expected maturities may differ fromcontractual maturities because borrowers may have the right to call or prepayobligations with or without call or prepayment penalties.  Government Sponsored Enterprise securities,which consist of mortgage-backed securities, are presented as a separate linesince pay downs are expected before contractual maturity dates.

 
| ** **                             | ** ** | **Amortized cost** | ** ** | **Fair value** | ** ** |
|----------------------------------------|------------|--------------------|------------|----------------|------------|
| Due within one year                    |       | $                  | 999,800    |           | $          | 999,300 |   |
| Due after one year through  five years |       | 17,912,758         |       | 18,015,099     |       |
| Due after five through ten  years      |       | 9,593,703          |       | 9,725,986      |       |
| Due after ten years                    |       | 1,570,775          |       | 1,557,580      |       |
| Sub-total                              |       | 30,077,036         |       | 30,297,965     |       |
| Government Sponsored  Enterprises      |       | 36,043,363         |       | 35,380,028     |       |
|                                   |       |               |       |           |       |
| Total securities                       |       | $                  | 66,120,399 |           | $          | 65,677,993 |   |

 

Thefollowing table shows gross unrealized losses and fair value, aggregated byinvestment category, and length of time that individual securities have been ina continuous unrealized loss position, at December 31, 2007 and December 31,2006.

 
| ** **                       | ** ** | **December 31, 2007** | ** ** | ** **            | ** ** | ** ** | ** ** |
|----------------------------------|------------|----------------------------|------------|-----------------------|------------|------------|------------|
| ** **                       | ** ** | **Less than 12 months**    | ** ** | **12 months or More** | ** ** | **Total**  | ** ** |
| ** **                       | ** ** | **Fair**                   | ** ** | **Unrealized**        | ** ** | **Fair**   | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| ** **                       | ** ** | **Value**                  | ** ** | **Losses**            | ** ** | **Value**  | ** ** | **Losses** | ** ** | **Value** | ** ** | **Losses** | ** ** |
|                             |       |                       |       |                  |       |       |       |   |   |   |   |   |   |
| Government Sponsored Enterprises |       | $                          | 11,849,251 |                  | $          | 42,735     |       | $ | 22,287,826 |   | $ | 646,472 |   | $ | 34,137,077 |   | $ | 689,207 |   |
| Federal Agencies                 |       | 39,751                     |       | 299                   |       | 12,232     |       | 181 |   | 51,983 |   | 480 |   |
| Tax exempt securities            |       | 747,260                    |       | 12,786                |       | —     |       | — |   | 747,260 |   | 12,786 |   |
| Corporate                        |       | 810,320                    |       | 409                   |       | —     |       | — |   | 810,320 |   | 409 |   |
|                             |       |                       |       |                  |       |       |       |   |   |   |   |   |   |
| Total                            |       | $                          | 13,446,582 |                  | $          | 56,229     |       | $ | 22,300,058 |   | $ | 646,653 |   | $ | 35,746,640 |   | $ | 702,882 |   |

 

 

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| ** **                       | ** ** | **December 31, 2006** | ** ** | ** **            | ** ** | ** ** | ** ** |
|----------------------------------|------------|----------------------------|------------|-----------------------|------------|------------|------------|
| ** **                       | ** ** | **Less than 12 months**    | ** ** | **12 months or More** | ** ** | **Total**  | ** ** |
| ** **                       | ** ** | **Fair**                   | ** ** | **Unrealized**        | ** ** | **Fair**   | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| ** **                       | ** ** | **Value**                  | ** ** | **Losses**            | ** ** | **Value**  | ** ** | **Losses** | ** ** | **Value** | ** ** | **Losses** | ** ** |
|                             |       |                       |       |                  |       |       |       |   |   |   |   |   |   |
| Government Sponsored Enterprises |       | $                          | 13,716,282 |                  | $          | 66,633     |       | $ | 36,594,828 |   | $ | 1,077,912 |   | $ | 50,311,110 |   | $ | 1,144,545 |   |
| Federal Agencies                 |       | 983,881                    |       | 7,540                 |       | 64,578     |       | 521 |   | 1,048,459 |   | 8,061 |   |
| Tax exempt securities            |       | —                     |       | —                |       | —     |       | — |   | — |   | — |   |
| Corporate                        |       | —                     |       | —                |       | —     |       | — |   | — |   | — |   |
|                             |       |                       |       |                  |       |       |       |   |   |   |   |   |   |
| Total                            |       | $                          | 14,700,163 |                  | $          | 74,173     |       | $ | 36,659,406 |   | $ | 1,078,433 |   | $ | 51,359,569 |   | $ | 1,152,606 |   |

 

Securitiesclassified as available-for-sale are recorded at fair market value.  Approximately 92.0% of the unrealized losses,or twenty-seven individual securities, were in a continuous loss position fortwelve months or more.  The Company hasthe ability and intent to hold these securities until such time as the valuerecovers or the securities mature.  TheCompany believes, based on industry analyst reports and credit ratings, thatthe deterioration in value is attributable to changes in market interest ratesand is not in the credit quality of the issuer and, therefore, these losses arenot considered other-than-temporary.

 

Theamortized cost and fair value of securities pledged as collateral for publicfunds and other purposes as of December 31, 2007 and 2006 were $64,549,625and $40,097,490, and $64,120,413 and $37,740,753, respectively.

 

Forthe years ended December 31, 2007, 2006, and 2005, proceeds from sales ofsecurities available for sale amounted to $8,623,625, $4,473,361, and$6,148,824, respectively.  Gross realizedgains amounted to $7,904, $1,007, and $10,195, respectively.  Gross realized losses amounted to $0,$58,283, and $14,130, respectively.

 

**NOTE 4 —LOANS**

 

Thecomposition of net loans by major loan category is presented below:

 
| ** **                      | ** ** | **December 31,** | ** **      |
|---------------------------------|------------|-----------------------|-----------------|
| ** **                      | ** ** | **2007**              | ** **      | **2006** | ** ** |
|                            |       |                  |            |   |   |
| Commercial                      |       | $                     | 60,376,105      |   | $ | 43,974,792 |   |
| Real estate — construction |       | 63,988,173            |            | 44,032,693 |   |
| Real estate — mortgage     |       | 370,989,308           |            | 303,211,082 |   |
| Consumer                        |       | 8,504,685             |            | 7,784,157 |   |
|                            |       |                  |            |   |   |
|                            |       | 503,858,271           |            | 399,002,724 |   |
| Less:                           |       |                  |            |   |   |
| Allowance for loan losses       |       | 6,935,616             |            | 5,888,052 |   |
| Deferred loan fees              |       | 425,755               |            | 266,090 |   |
|                            |       | 7,361,371             |            | 6,154,142 |   |
|                            |       |                  |            |   |   |
| Loans, net                      | ** ** | **$**                 | **496,496,900** | ** ** | **$** | **392,848,582** | ** ** |

 

Impairedloans totaled $5,526,724 and $2,633,702 at December 31, 2007 and 2006,respectively, which had the effect of reducing net income $259,958 in 2007,$145,626 in 2006, and $148,196 in 2005. Included in the allowance for loan losses related to impaired loans at December 31,2007 and 2006, was $1,378,306 and $877,331, respectively.  The average recorded investment in impairedloans for the years ended December 31, 2007 and 2006, was $2,852,830 and$2,528,335, respectively.  Interestincome recognized on impaired loans in fiscal 2007 and 2006 was $324,556 and$78,368 respectively.

 

**NOTE 5 —ALLOWANCE FOR LOAN LOSSES**

 

Theallowance for loan losses is available to absorb future loan charge-offs.  The allowance is increased by provisionscharged to operating expenses and by recoveries of loans which were previouslywritten-off.  The allowance is decreasedby the aggregate loan balances, if any, which were deemed uncollectible duringthe year.

Activitywithin the allowance for loan losses account follows:

 

 

37

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| ** **                                                    | ** ** | **For the years ended December 31,** | ** **    |
|---------------------------------------------------------------|------------|-------------------------------------------|---------------|
| ** **                                                    | ** ** | **2007**                                  | ** **    | **2006** | ** ** | **2005** | ** ** |
| Balance, beginning of year                                    |       | $                                         | 5,888,052     |   | $ | 4,364,287 |   | $ | 2,421,839 |   |
| Mortgage recourse reserve                                     |       | (50,000                                   | )             | — |   | — |   |
| Recoveries of loans  previously charged against the allowance |       | 36,394                                    |          | 141,553 |   | 38,304 |   |
| Provision for loan losses                                     |       | 2,045,600                                 |          | 2,174,400 |   | 2,184,000 |   |
| Loans charged against the  allowance                          |       | (984,430                                  | )             | (792,188 | ) | (279,856 | ) |
|                                                          |       |                                      |          |   |   |   |   |
| Balance, end of year                                          | ** ** | **$**                                     | **6,935,616** | ** ** | **$** | **5,888,052** | ** ** | **$** | **4,364,287** | ** ** |

 

In2006, a retail mortgage recourse reserve of $50,000 was established within theallowance. The reserve was established to provide for situations where theCompany could be required by an investor, in accordance with the salesagreement, to repurchase retail mortgage loans that were previously sold.  For 2007, $50,000 was transferred into a separateliability.  The Company expensed in 2007an additional $205,000 and paid losses of $47,445.  At December 31, 2007, the reserve was$207,555.  Subsequent to year end, theCompany settled all known claims with its largest investor group for $180,000.   In addition the Company eliminated futureconforming loan default claims with our largest investor through the payment ofan additional fee per loan sold.  Withthe disruption occurring in the retail mortgage market, the Company isperiodically reviewing loans sold to ensure the reserve is sufficient.

 

**NOTE 6 —PROPERTY AND EQUIPMENT**

 

Propertyand equipment are stated at cost less accumulated depreciation.  Components of property and equipment includedin the consolidated balance sheets are as follows:

 
| ** **                   | ** ** | **December 31,** | ** **     |
|------------------------------|------------|-----------------------|----------------|
| ** **                   | ** ** | **2007**              | ** **     | **2006** | ** ** |
| Land                         |       | $                     | 1,838,564      |   | $ | 1,838,564 |   |
| Buildings and improvements   |       | 12,895,464            |           | 11,402,529 |   |
| Furniture and equipment      |       | 3,429,624             |           | 2,766,333 |   |
| Software                     |       | 792,167               |           | 674,462 |   |
| Construction in progress     |       | 55,708                |           | 12,434 |   |
|                         |       | 19,011,527            |           | 16,694,322 |   |
| Accumulated depreciation     |       | (3,265,384            | )              | (2,349,992 | ) |
|                         |       |                  |           |   |   |
| Total property and equipment | ** ** | **$**                 | **15,746,143** | ** ** | **$** | **14,344,330** | ** ** |

 

Depreciationexpense for the years ended December 31, 2007, 2006, and 2005 amounted to$1,060,255, $518,551 and $539,406, respectively.  Depreciation is charged to operations overthe estimated useful lives of the assets. The estimated useful lives and methods of depreciation for the principalitems follow:

 

| **Type of Asset**          | ** ** | **Life in Years** | ** ** | **Depreciation Method** |
|----------------------------|------------|-------------------|------------|-------------------------|
|                       |       |              |       |                    |
| Software                   |       | 3 to 5            |       | Straight-line           |
| Furniture and equipment    |       | 5 to 7            |       | Straight-line           |
| Buildings and improvements |       | 5 to 40           |       | Straight-line           |

 

TheBank has entered into non-cancelable operating leases related to land andbuildings.  At December 31, 2007,future minimum payments under non-cancelable operating leases with initial orremaining terms of one year or more are as follows:

 

| 2008       |       | $         | 1,261,159     |
|------------|------------|-----------|---------------|
| 2009       |       | 1,201,687 |
| 2010       |       | 1,157,974 |
| 2011       |       | 1,074,394 |
| 2012       |       | 989,938   |
| Thereafter |       | 3,441,306 |
|       | ** ** | **$**     | **9,126,458** |

 

 

38

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TheBank has entered into eight separate lease agreements for its banking locationsand seven lease agreements for its mortgage production locations.  These lease agreements have various initiallease terms and expire on various dates through 2023.  The lease agreements generally provide thatthe Bank is responsible for ongoing repairs and maintenance, insurance and realestate taxes.  The leases also providefor renewal options and certain scheduled increases in monthly leasepayments.  The future minimum rentalcommitments above include commitments to the Company’s partially-ownedsubsidiary, BFNM, LLC aggregating $478,473 for each of 2008 through 2012.  Total rental expense amounted to $1,245,172,$775,232, and $508,250 for the years ended December 31, 2007, 2006, and2005, respectively.

 

Otherincome for the year ended December 31, 2006 includes a gain on the sale ofa branch location of $583,011.

 

**NOTE 7 —DEPOSITS**

 

Thefollowing is a detail of the deposit accounts:

 
| ** **                         | ** ** | **December 31,** | ** **      |
|------------------------------------|------------|-----------------------|-----------------|
| ** **                         | ** ** | **2007**              | ** **      | **2006** | ** ** |
|                               |       |                  |            |   |   |
| Noninterest bearing                |       | $                     | 33,138,936      |   | $ | 37,194,469 |   |
| Interest bearing:                  |       |                  |            |   |   |
| Interest bearing checking accounts |       | 20,377,754            |            | 21,336,836 |   |
| Money market accounts              |       | 103,821,154           |            | 103,056,865 |   |
| Savings                            |       | 2,988,881             |            | 3,303,763 |   |
| Time, less than $100,000           |       | 161,038,254           |            | 154,191,756 |   |
| Time, $100,000 and over            |       | 142,833,366           |            | 97,273,440 |   |
|                               |       |                  |            |   |   |
| Total deposits                     | ** ** | **$**                 | **464,198,345** | ** ** | **$** | **416,357,129** | ** ** |

 

AtDecember 31, 2007 and 2006, $46,135,000 and $34,644,000, respectively, oftime deposits less than $100,000 consisted of brokered deposits.  Interest expense on time deposits greaterthan $100,000 was $6,071,474 in 2007, $4,446,592 in 2006, and $1,880,101 in2005.

 

 At December 31, 2007, the scheduledmaturities of time deposits are as follows at right:

** **

| 2008       |       | $          | 265,041,431     |       |
|------------|------------|------------|-----------------|------------|
| 2009       |       | 31,728,483 |            |
| 2010       |       | 5,565,772  |            |
| 2011       |       | 1,284,144  |            |
| 2012       |       | 149,177    |            |
| Thereafter |       | 102,613    |            |
|       |       |       |            |
|       | ** ** | **$**      | **303,871,620** | ** ** |

 

**NOTE 8 —ADVANCES FROM FEDERAL HOME LOAN BANK**

 

Advancesfrom the Federal Home Loan Bank (“FHLB”) at December 31 are summarizedbelow:

 
| **FHLB Description** | ** ** | **Current Rate** | ** ** | **Maturity  Date** | ** ** | **Call Date** | ** ** | **2007**   | ** **     | **2006**   | ** ** |
|----------------------|------------|------------------|------------|--------------------|------------|---------------|------------|------------|----------------|------------|------------|
| Fixed Rate           |       | 5.358            | %          | 06/04/2010         |       |          |       | $          | 10,000,000     |       | $          | — |   |
| Convertible          |       | 4.510            | %          | 11/23/2010         |       | 11/24/2008    |       | 7,500,000  |           | 7,500,000  |       |
| Convertible          |       | 3.440            | %          | 03/10/2015         |       |          |       | —     |           | 5,000,000  |       |
| Convertible          |       | 3.680            | %          | 07/13/2015         |       | 07/14/2008    |       | 5,000,000  |           | 5,000,000  |       |
| Convertible          |       | 4.060            | %          | 09/29/2015         |       | 09/29/2009    |       | 5,000,000  |           | 5,000,000  |       |
| Fixed Rate Hybrid    |       | 4.760            | %          | 10/21/2010         |       |          |       | 5,000,000  |           | 5,000,000  |       |
| Convertible          |       | 4.160            | %          | 03/13/2017         |       | 03/13/2009    |       | 5,000,000  |           | —     |       |
| Convertible          |       | 4.385            | %          | 04/13/2017         |       | 04/13/2009    |       | 7,500,000  |           | —     |       |
| Prime Based Advance  |       | 3.160            | %          | 09/19/2011         |       |          |       | 10,000,000 |           | 10,000,000 |       |
|                 | ** ** | ** **       | ** ** | ** **         | ** ** | ** **    | ** ** | **$**      | **55,000,000** | ** ** | **$**      | **37,500,000** | ** ** |

 

Theadvances were collateralized by one to four family residential mortgage loans,government sponsored enterprises securities, and FHLB stock.  Additional borrowings are available bypledging additional collateral and purchasing additional stock in the FHLB.

 

 

39

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**NOTE 9 —OTHER BORROWINGS**

 

InJune 2005, the LLC obtained a loan from a bank for the construction of abuilding that serves as the Company’s corporate office.  The loan proceeds of $7,235,000 were advancedduring construction.  The loan is pricedat LIBOR plus 1.40%, and the amount of the 107 monthly payments of principaland interest are based upon a fifteen year amortization.  All remaining principal and interest is dueon June 15, 2015.  The LLC enteredinto an interest rate swap agreement as a risk management tool to hedge theinterest rate risk of the variable interest rate building loan.  Under the swap agreement, the LLC pays afixed rate of 4.62% and receives interest rate payments equal to LIBOR.  The fixed rate of 4.62% paid under the swapagreement, when added to the loan’s margin above LIBOR of 1.40%, converts thebuilding loan’s interest from a variable rate to a fixed rate of 6.02%.  The outstanding balance on the loan at December 31,2007 was $6,906,048.  The principal dueon the loan is $364,402 in 2008, $345,638 in 2009, $367,355 in 2010, $ 390,394in 2011, and $412,248 in 2012.

 

**NOTE 10— JUNIOR SUBORDINATED DEBENTURES**

 

OnMay 27, 2004, and March 30, 2005, Beach First National Trusts (the “Trust”)and (“Trust II”), non-consolidated subsidiaries of the Company, issued and soldfloating rate capital securities of the trusts, which are reported on theConsolidated Balance Sheets as junior subordinated debentures.  The junior subordinated debentures areunsecured obligations of the Company and are subordinate and junior in right ofpayment to all present and future senior indebtedness of the Company.  The Company has entered into guarantees,which together with its obligations under the junior subordinated debenturesand the declaration of trusts governing the Trusts, provides full and unconditionalguarantees of the trust preferred securities. Each issuance generated proceeds of $5.0 million. The Trusts loanedthese proceeds to the Company to use for general corporate purposes, primarilyto provide capital to the Bank.  Thedebentures qualify as Tier 1 capital under Federal Reserve Board guidelines.

 

During2007 and 2006, the average junior subordinated debt was $10.3 million.  Total junior subordinated debt outstanding atDecember 31, 2007 and 2006, was $10.3 million and $10.3 million, respectively.The maximum amount outstanding during any month-end period in 2007 was $10.3million with an average rate of 7.78%. The maximum amount outstanding during any month-end period in 2006 was$10.3 million with an average rate of 7.49%.

 

Thetrust preferred securities under Trust and Trust II accrue and paydistributions annually at a rate per annum equal to the three month LIBOR plus270 and 190 basis points, respectively, which was 7.85% and 7.59% at December 31,2007.  The distribution rate payable on these securities is cumulative andpayable quarterly in arrears.  The Company has the right, subject toevents of default, to defer payments of interest on the trust preferredsecurities for a period not to exceed 20 consecutive quarterly periods, providedthat no extension period may extend beyond the maturity dates of May 27,2034 and March 30, 2035, respectively.  The Company has no currentintention to exercise this right to defer payments of interest on the trustpreferred securities.  The Company has the right to redeem the trustpreferred securities, in whole or in part, on or after May 27, 2009 and March 30,2010, respectively.  The Company may also redeem the trust preferredsecurities prior to such dates upon occurrence of specified conditions and thepayment of a redemption premium.

 

Debtissuance costs, net of accumulated amortization, from the junior subordinateddebentures totaled $33,943 and $38,948 at December 31, 2007 and 2006,respectively, and are included in other assets on the Consolidated BalanceSheets.  Amortization of debt issuance costs from trust preferred debttotaled $5,005, $4,588, and $3,962 for the years ended December 31, 2007,2006, and 2005, respectively.

 

 

40

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**NOTE 11— UNUSED LINES OF CREDIT**

 

AtDecember 31, 2007, the Bank had $31.8 million of lines of credit topurchase federal funds from unrelated banks. These lines of credit are available on a one to fourteen day basis forgeneral corporate purposes of the Bank. All of the lenders have reserved the right to withdraw these lines attheir option.

 

AtDecember 31, 2007, the Bank had the ability to borrow an additional $7.7million from the FHLB secured by a blanket lien on one to four family firstmortgage loans.  In addition, U.S.government agency securities with a book value of $6.5 million and a marketvalue of $6.3 million, respectively, are pledged to secure the borrowing. FHLBhas approved borrowings up to 15% of the bank’s total assets less advancesoutstanding.  The borrowings areavailable by pledging collateral and purchasing additional stock in the FHLB.

 

**NOTE 12— COMMITMENTS AND CONTINGENCIES**

 

TheCompany is party to litigation and claims arising in the normal course ofbusiness.  As of December 31, 2007,there is no litigation pending.

 

Referto Note 15 concerning financial instruments with off balance sheet risk.

 

TheCompany currently has two capital projects in process as of December 31,2007.  The first is to implement a newbank software system, and the second project is the build-out of leaseholdimprovements and furniture and equipment for a new branch location.  The estimated cost of these projects is$211,000 and $730,000, respectively.  TheCompany in 2007 has spent $55,700 on the branch and $103,700 on the new banksoftware system.

 

**NOTE 13— INCOME TAXES**

 

Thefollowing summary of the provision for income taxes includes tax deferralswhich arise from temporary differences in the recognition of certain items ofrevenue and expense for tax and financial reporting purposes for the yearsended December 31:

 
| ** **                      | ** ** | **2007**  | ** **    | **2006**   | ** ** | **2005**      | ** ** |
|---------------------------------|------------|-----------|---------------|------------|------------|---------------|------------|
| Income taxes currently  payable |       |      |          |       |       |          |       |
| Federal                         |       | $         | 3,721,922     |       | $          | 3,834,918     |       | $ | 2,251,274 |   |
| State                           |       | 298,358   |          | 301,468    |       | 168,861       |       |
|                            |       |      |          |       |       |          |       |
|                            |       | 4,020,280 |          | 4,136,386  |       | 2,420,135     |       |
|                            |       |      |          |       |       |          |       |
| Deferred taxes                  |       |      |          |       |       |          |       |
| Allowance for loan losses       |       | (373,172  | )             | (537,502   | )          | (617,922      | )          |
| Depreciation                    |       | 60,520    |          | 51,238     |       | (62,418       | )          |
| Loan origination fees           |       | (63,973   | )             | 43,164     |       | (18,752       | )          |
| Deferred compensation           |       | (139,302  | )             | (76,916    | )          | (46,213       | )          |
| Other                           |       | (157,097  | )             | (114,234   | )          | 85,945        |       |
|                            |       |      |          |       |       |          |       |
|                            |       | (673,024  | )             | (634,250   | )          | (659,360      | )          |
|                            |       |      |          |       |       |          |       |
| Income tax expense              | ** ** | **$**     | **3,347,256** | ** ** | **$**      | **3,502,136** | ** ** | **$** | **1,760,775** | ** ** |

 

Theincome tax effect of cumulative temporary differences at December 31, areas follows:

 
| ** **                                | ** ** | **Deferred tax asset (liability)** | ** **    |
|-------------------------------------------|------------|------------------------------------|---------------|
| ** **                                | ** ** | **2007**                           | ** **    | **2006** | ** ** |
| Allowance for loan losses                 |       | $                                  | 2,222,365     |   | $ | 1,827,410 |   |
| Unrealized loss on  investment securities |       | 178,742                            |          | 380,769 |   |
| Depreciation                              |       | (210,205                           | )             | (149,685 | ) |
| Loan origination fees                     |       | 154,018                            |          | 90,046 |   |
| Deferred compensation                     |       | 331,222                            |          | 191,920 |   |
| Oth                                       |       | 176,595                            |          | 41,279 |   |
|                                      |       |                               |          |   |   |
| Net deferred tax asset                    | ** ** | **$**                              | **2,852,737** | ** ** | **$** | **2,381,739** | ** ** |

 

Thenet deferred tax asset is reported in other assets in the Consolidated BalanceSheets at December 31, 2007 and 2006. The recognition of a net deferred tax asset is dependent upon a “morelikely than not” expectation of the realization of the deferred tax asset,based upon the analysis of the available evidence.  A valuation allowance is required tosufficiently reduce the deferred tax asset to the amount that is expected to berealized through future

 

 

41

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realizationof profits on a “more likely than not” basis. The analysis of available evidence is performed on an ongoing basisutilizing the “more likely than not” criteria to determine the amount, if any,of the deferred tax asset to be realized. Adjustments to the valuation allowance are made accordingly.  There can be no assurance that the Companywill recognize additional portions of the deferred tax asset in future periodsor that additional valuation allowances may not be recorded in the futureperiods. As of December 31, 2007 and December 31, 2006, there are novaluation allowances established.

 

Theprovision for income taxes is reconciled to the amount of income tax computedat the federal statutory rate on income before income taxes for the years endedDecember 31, as follows:

 
| ** **                              | ** ** | **2007**   | ** **    | **2006**   | ** ** | **2005**   | ** ** |
|-----------------------------------------|------------|------------|---------------|------------|------------|------------|------------|
| ** **                              | ** ** | **Amount** | ** **    | **%**      | ** ** | **Amount** | ** ** | **%** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Tax expense at statutory  rate          |       | $          | 3,136,121     |       | 34         | %          | $          | 3,297,274 |   | 34 | % | $ | 1,740,942 |   | 34 | % |
| Increase (decrease) in  taxes           |       |       |          |       |       |       |       |   |   |   |   |   |   |
| Resulting from:                         |       |       |          |       |       |       |       |   |   |   |   |   |   |
| State bank tax (net of federal benefit) |       | 196,916    |          | 2          |       | 198,969    |       | 2 |   | 111,448 |   | 2 |   |
| Other                                   |       | 14,219     |          | —     |       | 5,893      |       | — |   | (91,615 | ) | (2 | ) |
|                                    |       |       |          |       |       |       |       |   |   |   |   |   |   |
| Tax provision                           | ** ** | **$**      | **3,347,256** | ** ** | **36**     | **%**      | **$**      | **3,502,136** | ** ** | **36** | **%** | **$** | **1,760,775** | ** ** | **34** | **%** |

 

**NOTE 14— RELATED PARTY TRANSACTIONS**

 

Certaindirectors, executive officers and companies with which they are affiliated, arecustomers of and have banking transactions with the Bank in the ordinary courseof business. These loans were made on substantially the same terms, includinginterest rates and collateral, as those prevailing at the time for comparablearms-length transactions.

 

Asummary of loan transactions with directors, including their affiliates, andexecutive officers follows:

 
| ** **                 | ** ** | **For the years ended December 31,** | ** **     |
|----------------------------|------------|-------------------------------------------|----------------|
| ** **                 | ** ** | **2007**                                  | ** **     | **2006** | ** ** |
| Balance, beginning of year |       | $                                         | 18,976,915     |   | $ | 15,002,485 |   |
| New loans                  |       | 18,128,080                                |           | 17,417,068 |   |
| Less loan payments.        |       | 8,838,454                                 |           | 13,442,638 |   |
|                       |       |                                      |           |   |   |
| Balance, end of year       | ** ** | **$**                                     | **28,266,541** | ** ** | **$** | **18,976,915** | ** ** |

 

Depositsby directors, including their affiliates and executive officers, at December 31,2007 and 2006, totaled $12,494,266 and $19,712,400, respectively.

 

**NOTE 15— FINANCIAL INSTRUMENTS WITH OFF BALANCE SHEET RISK**

 

Inthe ordinary course of business, and to meet the financing needs of itscustomers, the Company is a party to various financial instruments with offbalance sheet risk.  These financialinstruments, which include commitments to extend credit and standby letters ofcredit, involve, to varying degrees, elements of credit and interest rate riskin excess of the amounts recognized in the balance sheets.  The contract amount of those instrumentsreflects the extent of involvement the Company has in particular classes offinancial instruments.

 

TheCompany’s exposure to credit loss in the event of nonperformance by the otherparty to the financial instrument for commitments to extend credit and standbyletters of credit is represented by the contractual amounts of thoseinstruments.

 

TheCompany uses the same credit policies in making commitments and conditionalobligations as it does for on balance sheet instruments.

 

Commitmentsto extend credit are agreements to lend to a customer as long as there is noviolation of any material condition established in the contract.  Commitments generally have fixed expirationdates or other termination clauses and may require the payment of a fee.  At December 31, 2007, unfundedcommitments to extend credit were $48,275,254 of which $5,922,997 were at fixedrates and $42,352,257 were at variable rates. The Company evaluates each customer’s credit worthiness on acase-by-case basis.  The amount ofcollateral obtained, if deemed necessary by the Company upon extension ofcredit, is based on management’s credit evaluation of the borrower.  Collateral varies but may include accountsreceivable, inventory, property, plant and equipment, commercial andresidential real estate.

 

AtDecember 31, 2007, there were commitments totaling $13,531,310 for standbyletters of credit.  The credit riskinvolved in issuing letters of credit is essentially the same as that involvedin extending loan facilities to customers. Collateral varies but may include accounts receivable, inventory,equipment, marketable securities and property. Since most of the letters of credit are expected to expire without beingdrawn upon, they do not necessarily represent future cash requirements.

 

 

42

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** **

**NOTE 16 — EMPLOYEE BENEFIT PLAN**

 

TheCompany sponsors the Beach First National Bank Profit Sharing and 401(k) Planfor the benefit of all eligible employees. The Company contributes to the Plan annually upon approval by the Boardof Directors.  Contributions made to thePlan in 2007 and 2006 amounted to $447,564 and $117,497, respectively.

 

Supplementalbenefits have been approved by the Board of Directors for the directors andcertain executive officers of Beach First National Bank.  These benefits are not qualified under theInternal Revenue Code and they are not funded. However, certain funding is provided informally and indirectly by lifeinsurance policies.  The cash surrendervalue of the life insurance policies are recorded as a separate line item inthe accompanying balances sheets at $3,554,807 and $3,424,586 at December 31,2007 and 2006, respectively.  Incomeearned on these policies is reflected as a separate line item in theConsolidated Statements of Income.  TheCompany recorded expense related to these benefits in 2007, 2006, and 2005 of$310,923, $227,515, and $120,832, respectively.

 

**NOTE 17— STOCK OPTION PLANS**

 

TheCompany sponsors a qualified stock option plan for the benefit of thedirectors, officers, and employees (“Plan”). Under the Plan, options vest on a straight line basis over a five yearperiod and terminate ten years after grant. The shareholders in 2007 approved an 111,224 share increase in optionsavailable under the Plan.  The Plan has718,724 shares available for grant at an option price per share not less thanthe fair market value on the date of grant. As discussed in Note 1, the Company fully vested all options on December 14,2005 that had been granted, including an additional 117,000 options issued todirectors on the same date.  The newgrant of options in 2007 is subject to FAS 123(R) accounting recognitionof pre-tax compensation expense by the Company, which aggregated $7,643 in2007.

 

Thefair value of the option grant is estimated on the date of grant using the Black-Scholesoption pricing model.  For the year endedDecember 31, 2007, options were granted with an expected life of 6.5 yearsbased on the simplified method, risk free rate of 4.97% based on market ratesfor comparable terms, volatility rate of 32.96% based on the Company’s stockhistorical volatility, and an assumed dividend rate of zero.  There were no options granted for the yearended December 31, 2006. For the year ended December 31, 2005, therisk free interest rate used ranged from 4.04% to 4.76%, the expected optionlife was 10 years, volatility ranged from 34.98% to 35.58% and the assumeddividend rate was zero.

 

Asof December 31, 2007, there was $69,186 of total unrecognized compensationcosts related to non-vested options granted under the Plan that is expected tobe recognized over a weighted average period of 2.56 years.

 

Asummary of the status of the plan as of December 31, 2007, 2006, and 2005and changes during the years ended on those dates is presented below, adjustedfor the 3-for-2 stock split in 2006:

 
| ** **                                      | ** ** | **2007**    | ** ** | **2006**                            | ** ** | **2005**    |
|-------------------------------------------------|------------|-------------|------------|-------------------------------------|------------|-------------|
| ** **                                      | ** ** | **Shares**  | ** ** | **Weighted average exercise price** | ** ** | **Shares**  | ** ** | **Weighted  average  exercise price** | ** ** | **Shares** | ** ** | **Weighted  average  exercise price** |
| Outstanding  at beginning of year               |       | 503,479     |       | $                                   | 11.19      |        | 517,054 |   | $ | 11.06 | * * | 346,954 |   | $ | 8.19 |
| Granted                                         |       | 9,200       |       | 19.12                               |       | —      |   | — |   | 184,500 |   | 16.16 |
| Exercised                                       |       | (77,728     | )          | 6.93                                |       | (13,575     | ) | 7.25 |   | (9,675 | ) | 4.58 |
| Forfeited or  expired                           |       | —      |       | —                              |       | —      |   | — |   | (4,725 | ) | — |
| Outstanding  at end of year                     | ** ** | **434,951** | ** ** | **12.11**                           | ** ** | **503,479** | ** ** | **11.19** | ** ** | **517,054** | ** ** | **11.06** |
|                                            |       |        |       |                                |       |        |   |   |   |   |   |   |
| Options  exercisable at year-end                | ** ** | **425,751** | ** ** | **11.96**                           | ** ** | **503,479** | ** ** | **11.19** | ** ** | **517,054** | ** ** | **11.06** |
| Shares  available for grant                     | ** ** | **125,458** | ** ** | ** **                          | ** ** | **23,434**  | ** ** | ** ** | ** ** | **23,434** | ** ** | ** ** |
| Weighted average fair value of options  granted | ** ** | ** **  | ** ** | **$**                               | **8.35**   | ** **  | ** ** | ** ** | **$** | **—** | ** ** | ** ** | ** ** | **$** | **6.06** |

 

Thetotal fair value of shares vested during the years ended December 31,2007, 2006, and 2005 was $0, $0 and $2,030,054, respectively.

 

Thetotal intrinsic value of options exercised during the years ended December 31,2007, 2006 and 2005 was $1,219,177, $256,118 and $158,245, respectively.

 

Asof December 31, 2007, all options outstanding were exercisable, except the9,200 options granted in 2007. The aggregate intrinsic value of all outstandingoptions was $1,715,016, and the weighted average remaining contractual term ofthe options was 6.62 years at December 31, 2007. Vested and non-vestedoptions had remaining contractual lives of 6.55 and 9.57 years, respectively.

 

 

43

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**NOTE 18— SHAREHOLDERS’ EQUITY**

 

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

 

**StockOffering —** On June 14,2005, the Company closed on a secondary stock offering whereby 1,150,000 sharesof the Company’s stock were issued at $18.75 per share.  Net proceeds after deducting underwriterdiscounts and expenses were $19.9 million. Proceeds from the offering were used to support the growth of theCompany.

 

**CashDividends —** There areno current plans to initiate payment of cash dividends and future dividendpolicy will depend on the Company’s earnings, capital requirements, financialcondition and other factors considered relevant by the Company’s Board ofDirectors.  The Bank is restricted in itsability to pay dividends under the national banking laws and regulations of theOffice of the Comptroller of the Currency. OCC prior approval is required if dividends declared in any calendaryear exceed the Bank’s net profit for that year combined with its retained netprofits for the preceding two years.

 

**StockRepurchase Plan —** On December 19,2007, the Company approved a plan to repurchase up to $2 million of its commonstock, representing approximately 2.5% of the shares outstanding.  The timing, price, and quantity of purchasesunder the plan will be at the discretion of management for up to one year andthe plan may be discontinued, suspended or restarted at any time.  No shares were repurchased during 2007.

 

**NOTE 19— REGULATORY MATTERS**

 

TheBank is subject to various regulatory capital requirements administered by thefederal banking agencies.  Failure tomeet minimum capital requirements can initiate certain mandatory, and possibleadditional discretionary actions by regulators that, if undertaken, could havea direct material effect on the Bank’s financial statements.

 

Undercapital adequacy guidelines and the regulatory framework for prompt correctiveaction, the Bank must meet specific capital guidelines that involvequantitative measures of the Bank’s assets, liabilities, and certain offbalance sheet items as calculated under regulatory accounting practices.  The Bank’s capital amounts and classificationare also subject to qualitative judgments by the regulators about components,risk weightings, and other factors.

 

Quantitativemeasures established by regulation to ensure capital adequacy require the Bankto maintain minimum amounts and ratios (set forth in the table below) of totaland Tier 1 capital to risk-weighted assets, and of Tier 1 capital to averageassets.  As of December 31, 2007,the Bank meets all capital adequacy requirements to which it is subject.

 

Asof December 31, 2007, the most recent notification of the Office of theComptroller of the Currency categorized the Bank as well capitalized under theregulatory framework for prompt corrective action.  There are no conditions or events since thatnotification that management believes have changed the institution’s wellcapitalized category.

 

TheCompany’s actual capital amounts and ratios are presented as follows:

 
| ** **                                | ** ** | ** **            | ** ** | ** **  | ** ** | **For capital**       | ** ** | **To be well capitalized  under prompt corrective** |
|-------------------------------------------|------------|-----------------------|------------|-------------|------------|-----------------------|------------|-----------------------------------------------------|
| ** **                                | ** ** | ** **            | ** ** | ** **  | ** ** | **adequacy purposes** | ** ** | **action provisions**                               |
| ** **                                | ** ** | **Actual**            | ** ** | **Minimum** | ** ** | **Minimum**           |
| ** **                                | ** ** | **Amount**            | ** ** | **Ratio**   | ** ** | **Amount**            | ** ** | **Ratio**                                           | ** ** | **Amount** | ** ** | **Ratio** |
| ** **                                | ** ** | **(amounts in $000)** |
| **As of December 31, 2007**          | ** ** | ** **            |
| Total  Capital (to risk weighted assets)  |       | $                     | 69,405     |        | 14.0       | %                     | $          | 39,774                                              |   | 8.0 | % | $ | N/A |   | N/A |
| Tier 1  Capital (to risk weighted assets) |       | 63,180                |       | 12.7        |       | 19,899                |       | 4.0                                                 |   | N/A |   | N/A |
| Tier 1  Capital (to average assets)       |       | 63,180                |       | 11.2        |       | 22,564                |       | 4.0                                                 |   | N/A |   | N/A |
| ** **                                | ** ** | ** **            | ** ** | ** **  | ** ** | ** **            | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** |
| **As of  December 31, 2006**         | ** ** | ** **            | ** ** | ** **  | ** ** | ** **            | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** |
| Total  Capital (to risk weighted assets)  |       | $                     | 61,622     |        | 15.2       | %                     | $          | 32,432                                              |   | 8.0 | % | $ | N/A |   | N/A |
| Tier 1 Capital  (to risk weighted assets) |       | 56,543                |       | 14.0        |       | 16,155                |       | 4.0                                                 |   | N/A |   | N/A |
| Tier 1  Capital (to average assets)       |       | 56,543                |       | 12.2        |       | 18,539                |       | 4.0                                                 |   | N/A |   | N/A |
|                                           |            |                       |            |             |            |                       |            |                                                     |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

TheBank’s actual capital amounts and ratios and minimum regulatory amounts andratios are presented as follows:

 

 

44

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| ** **                                | ** ** | ** **            | ** ** | ** **  | ** ** | **For capital**       | ** ** | **To be well capitalized  under prompt corrective** | ** ** |
|-------------------------------------------|------------|-----------------------|------------|-------------|------------|-----------------------|------------|-----------------------------------------------------|------------|
| ** **                                | ** ** | ** **            | ** ** | ** **  | ** ** | **adequacy purposes** | ** ** | **action provisions**                               | ** ** |
| ** **                                | ** ** | **Actual**            | ** ** | **Minimum** | ** ** | **Minimum**           | ** ** |
| ** **                                | ** ** | **Amount**            | ** ** | **Ratio**   | ** ** | **Amount**            | ** ** | **Ratio**                                           | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| ** **                                | ** ** | **(amounts in $000)** | ** ** |
| **As of  December 31, 2007**         | ** ** | ** **            | ** ** | ** **  | ** ** | ** **            | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total  Capital (to risk weighted assets)  |       | $                     | 59,269     |        | 12.2       | %                     | $          | 38,799                                              |       | 8.0 | % | $ | 48,499 |   | 10.0 | % |
| Tier 1  Capital (to risk weighted assets) |       | 53,179                |       | 10.9        |       | 19,478                |       | 4.0                                                 |       | 29,217 |   | 6.0 |   |
| Tier 1  Capital (to average assets)       |       | 53,179                |       | 9.2         |       | 23,289                |       | 4.0                                                 |       | 29,111 |   | 5.0 |   |
| ** **                                | ** ** | ** **            | ** ** | ** **  | ** ** | ** **            | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| **As of  December 31, 2006**         | ** ** | ** **            | ** ** | ** **  | ** ** | ** **            | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total  Capital (to risk weighted assets)  |       | $                     | 51,497     |        | 13.0       | %                     | $          | 31,690                                              |       | 8.0 | % | $ | 39,613 |   | 10.0 | % |
| Tier 1  Capital (to risk weighted assets) |       | 46,531                |       | 11.7        |       | 15,908                |       | 4.0                                                 |       | 23,862 |   | 6.0 |   |
| Tier 1  Capital (to average assets)       |       | 46,531                |       | 19.3        |       | 20,013                |       | 4.0                                                 |       | 25,016 |   | 5.0 |   |
|                                           |            |                       |            |             |            |                       |            |                                                     |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

**NOTE 20— FAIR VALUE OF FINANCIAL INSTRUMENTS**

 

SFASNo. 107, “Disclosures about Fair Value of Financial Instruments” requiresdisclosure of fair value information, whether or not recognized in the balancesheets, when it is practical to estimate the fair value.  SFAS No. 107 defines a financialinstrument as cash, evidence of an ownership interest in an entity, orcontractual obligations which require the exchange of cash or other financialinstruments. Certain items are specifically excluded from the disclosurerequirements, including the Company’s common stock, premises and equipment andother assets and liabilities.

 

Fairvalue approximates carrying value for the following financial instruments dueto the short-term nature of the instrument: cash and due from banks, federalfunds sold and short term investments, demand deposit accounts, andinterest-bearing accounts with no fixed maturity date.  Securities are valued using quoted marketprices.  Fair value for the Company’soff-balance sheet financial instruments is based on the discounted presentvalue of the estimated future cash flows. Fair value for fixed and variable rate loans maturing after one year isbased on the discounted present value of the estimated future cash flows.  Discount rates used in these computationsapproximate the rates currently offered for similar loans of comparable termsand credit quality.

 

Fairvalue for certificate of deposit accounts are valued by discounting cash flowsat rates currently available on similar account types.  Fair value for advances from the FHLB isbased on discounted cash flows using the Company’s current incrementalborrowing rate.  Fair value for juniorsubordinated debentures approximates their carrying value since the debentureswere issued at a floating rate.  Fairvalue for other borrowings approximates their carrying value since theborrowings bear a floating rate.  Fairvalue of the LIBOR rate swap agreement is valued using a quoted market price.

 

TheCompany has used management’s best estimate of fair value based on the aboveassumptions.  Thus, the fair valuespresented may not be the amounts which could be realized in an immediate saleor settlement of the instrument.  Inaddition, any income taxes or other expenses which would be incurred in anactual sale or settlement are not taken into consideration in the fair valuepresented.

 

Theestimated fair values of the Company’s financial instruments are as follows:

 

 

45

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| ** **                                    | ** ** | **December 31,** |
|-----------------------------------------------|------------|-----------------------|
| ** **                                    | ** ** | **2007**              | ** ** | **2006** |
| ** **                                    | ** ** | **Carrying  amount**  | ** ** | **Fair  value** | ** ** | **Carrying  amount** | ** ** | **Fair  value** |
| **Financial Assets:**                         | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash and due from banks                       |       | $                     | 4,992,634 |   | $ | 4,992,634 |   | $ | 5,198,945 |   | $ | 5,198,945 |
| Federal funds sold and short term investments |       | 566,044               |   | 566,044 |   | 14,010,667 |   | 14,010,667 |
| Investment securities                         |       | 65,677,993            |   | 65,677,993 |   | 68,474,531 |   | 68,474,531 |
| Loans, net                                    |       | 496,496,900           |   | 499,389,381 |   | 392,848,582 |   | 392,616,778 |
| Mortgage loans held for sale                  |       | 6,475,619             |   | 6,475,619 |   | 12,478,222 |   | 12,478,222 |
| Federal Reserve Bank stock                    |       | 984,000               |   | 984,000 |   | 984,000 |   | 984,000 |
| Federal Home Bank Loan Bank stock             |       | 3,395,300             |   | 3,395,300 |   | 2,475,600 |   | 2,475,600 |
| Trust preferred securities                    |       | 310,000               |   | 310,000 |   | 310,000 |   | 310,000 |
| Cash value of life insurance                  |       | 3,554,807             |   | 3,554,807 |   | 3,424,586 |   | 3,424,586 |
|                                          |       |                  |   |   |   |   |   |   |
| **Financial Liabilities:**                    | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Deposits                                      |       | 464,198,345           |   | 458,851,000 |   | 416,357,129 |   | 412,594,234 |
| Advances from Federal Home Loan Bank          |       | 55,000,000            |   | 57,636,000 |   | 37,500,000 |   | 36,994,000 |
| Federal funds purchased and other borrowings  |       | 18,288,148            |   | 8,288,148 |   | 7,209,820 |   | 7,209,820 |
| Junior subordinated debt                      |       | 10,310,000            |   | 10,310,000 |   | 10,310,000 |   | 10,310,000 |
|                                               |            |                       |  |  |  |  |  |  |  |  |  |  |

 

**NOTE 21 — PARENT COMPANY FINANCIAL INFORMATION**

 

Followingis condensed financial information of Beach First National Bancshares, Inc.(parent company only):

 

**Condensed Balance Sheets**

 

| ** **                                      | ** ** | **December 31,** |
|-------------------------------------------------|------------|-----------------------|
| ** **                                      | ** ** | **2007**              | ** ** | **2006** |
| **Assets**                                      | ** ** | ** **            | ** ** | ** ** |
| Cash                                            |       | $                     | 6,443,711 |   | $ | 9,043,890 |
| Investment in Bank  subsidiary                  |       | 52,887,079            |   | 45,857,311 |
| Investment in Beach First  National Trusts      |       | 310,000               |   | 310,000 |
| Investment in BFNM, LLC                         |       | 3,175,873             |   | 2,861,446 |
| Other assets                                    |       | 110,611               |   | 49,830 |
|                                            |       |                  |   |   |
| Total assets                                    | ** ** | **$**                 | **62,927,274** | ** ** | **$** | **58,122,477** |
| ** **                                      | ** ** | ** **            | ** ** | ** ** |
| **Liabilities and Shareholders’  Equity**  | ** ** | ** **            | ** ** | ** ** |
| Accounts payable                                |       | $                     | (187,877 | ) | $ | 188,836 |
| Due to Bank subsidiary                          |       | 227,101               |   | 2,164,062 |
| Junior subordinated debentures                  |       | 10,310,000            |   | 10,310,000 |
| Shareholders’ equity                       |       | 52,578,050            |   | 45,459,579 |
|                                            |       |                  |   |   |
| Total liabilities and shareholders’ equity | ** ** | **$**                 | **62,927,274** | ** ** | **$** | **58,122,477** |

 

 

46

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**Condensed Statements of Income**

 
| ** **                                                       | ** ** | **For the years ended December 31,** | ** **    |
|------------------------------------------------------------------|------------|-------------------------------------------|---------------|
| ** **                                                       | ** ** | **2007**                                  | ** **    | **2006** | ** ** | **2005** | ** ** |
| ** **                                                       | ** ** | ** **                                | ** **    | ** ** | ** ** | ** ** | ** ** |
| **Income**                                                       |       | $                                         | 665,853       |   | $ | 242,985 |   | $ | 140,365 |   |
| **Expenses**                                                     | ** ** | ** **                                | ** **    | ** ** | ** ** | ** ** | ** ** |
| Interest                                                         |       | 802,455                                   |          | 771,740 |   | 528,812 |   |
| Amortization                                                     |       | 5,005                                     |          | 5,006 |   | 4,379 |   |
| Other expenses                                                   |       | 612,253                                   |          | — |   | — |   |
|                                                             |       |                                      |          |   |   |   |   |
| Total expenses                                                   |       | 1,419,713                                 |          | 776,746 |   | 533,191 |   |
|                                                             |       |                                      |          |   |   |   |   |
| Income before equity in undistributed net income of subsidiaries |       | (753,860                                  | )             | (533,761 | ) | (392,826 | ) |
| Equity in undistributed  net income of subsidiaries              |       | 6,630,490                                 |          | 6,729,489 |   | 3,752,469 |   |
|                                                             |       |                                      |          |   |   |   |   |
| Net income                                                       | ** ** | **$**                                     | **5,876,630** | ** ** | **$** | **6,195,728** | ** ** | **$** | **3,359,643** | ** ** |

** **

**Condensed Statements of Cash Flows**

 
| ** **                                                                                                                                      | ** ** | **For the years ended December 31,** | ** **    |
|-------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|---------------|
| ** **                                                                                                                                      | ** ** | **2007**                                  | ** **    | **2006** | ** ** | **2005** | ** ** |
| **Operating activities**                                                                                                                        | ** ** | ** **                                | ** **    | ** ** | ** ** | ** ** | ** ** |
| Net income                                                                                                                                      |       | $                                         | 5,876,630     |   | $ | 6,195,728 |   | $ | 3,359,643 |   |
| Adjustments to reconcile net income to net cash provided by (used in)  operating activities: Equity in undistributed net income of subsidiaries |       | (6,630,490                                | )             | (6,729,489 | ) | (3,752,469 | ) |
| Amortization                                                                                                                                    |       | 5,005                                     |          | 5,006 |   | 4,628 |   |
| Increase (decrease) in due to Bank                                                                                                              |       | (1,936,961                                | )             | 2,010,879 |   | 588,600 |   |
| (Increase) decrease in other assets                                                                                                             |       | 14,009                                    |          | (200 | ) | (25,401 | ) |
| Increase (decrease) in accounts payable                                                                                                         |       | (376,713                                  | )             | (300,591 | ) | 353,108 |   |
| Stock based compensation expense                                                                                                                |       | 7,643                                     |          | — |   | — |   |
| Net cash provided by (used for) operating activities                                                                                            |       | (3,040,877                                | )             | 1,181,333 |   | 528,109 |   |
|                                                                                                                                            |       |                                      |          |   |   |   |   |
| **Investing activities**                                                                                                                        | ** ** | ** **                                | ** **    | ** ** | ** ** | ** ** | ** ** |
| Additional investment in bank                                                                                                                   |       | —                                    |          | — |   | (19,000,000 | ) |
| Additional investment in BFNM, LLC                                                                                                              |       | (385,806                                  | )             | (958,663 | ) | — |   |
| Investment in Beach First National Trusts                                                                                                       |       | —                                    |          | — |   | (155,000 | ) |
| Proceeds from sale of securities available for sale                                                                                             |       | —                                    |          | — |   | 18,246 |   |
| Purchase of premises and equipment                                                                                                              |       | (79,795                                   | )             | — |   | (607,618 | ) |
|                                                                                                                                            |       |                                      |          |   |   |   |   |
| Net cash used for investing activities                                                                                                          |       | (465,601                                  | )             | (958,663 | ) | (19,744,372 | ) |
| ** **                                                                                                                                      | ** ** | ** **                                | ** **    | ** ** | ** ** | ** ** | ** ** |
| **Financing activities**                                                                                                                        | ** ** | ** **                                | ** **    | ** ** | ** ** | ** ** | ** ** |
| Proceeds from issuance of  junior subordinated debentures                                                                                       |       | —                                    |          | — |   | 5,155,000 |   |
| Proceeds from exercise of  stock options                                                                                                        |       | 520,734                                   |          | 98,188 |   | 44,313 |   |
| Tax benefit of options in  excess of compensation expense                                                                                       |       | 385,565                                   |          | — |   | — |   |
| Cash in lieu of stock  dividend                                                                                                                 |       | —                                    |          | (2,515 | ) | — |   |
| Proceeds from stock  issuance, net                                                                                                              |       | —                                    |          | — |   | 19,933,998 |   |
|                                                                                                                                            |       |                                      |          |   |   |   |   |
| Net cash provided by financing activities                                                                                                       |       | 906,299                                   |          | 95,673 |   | 25,133,311 |   |
|                                                                                                                                            |       |                                      |          |   |   |   |   |
| Net (decrease) increase in cash and cash equivalents                                                                                            |       | (2,600,179                                | )             | 318,343 |   | 5,917,048 |   |
| **CASH AND CASH EQUIVALENTS,  BEGINNING OF YEAR**                                                                                               |       | 9,043,890                                 |          | 8,725,547 |   | 2,808,499 |   |
| **CASH AND CASH EQUIVALENTS, END  OF YEAR**                                                                                                     | ** ** | **$**                                     | **6,443,711** | ** ** | **$** | **9,043,890** | ** ** | **$** | **8,725,547** | ** ** |

 

 

47

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**NOTE 22— QUARTERLY DATA (UNAUDITED)**

 
| ** **                                          | ** ** | **2007**           | ** ** | **2006**           | ** ** |
|-----------------------------------------------------|------------|--------------------|------------|--------------------|------------|
| **(Dollars in thousands except  per share)**        | ** ** | **Fourth Quarter** | ** ** | **Third  Quarter** | ** ** | **Second  Quarter** | ** ** | **First  Quarter** | ** ** | **Fourth  Quarter** | ** ** | **Third  Quarter** | ** ** | **Second  Quarter** | ** ** | **First  Quarter** | ** ** |
|                                                |       |               |       |               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest income                                     |       | $                  | 11,382     |               | $          | 11,669 |   | $ | 11,360 |   | $ | 10,696 |   | $ | 10,668 |   | $ | 9,696 |   | $ | 8,566 |   | $ | 7,556 |   |
| Interest expense                                    |       | 5,829              |       | 5,842              |       | 5,596 |   | 5,214 |   | 4,890 |   | 4,234 |   | 3,689 |   | 3,216 |   |
|                                                |       |               |       |               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest income                                 |       | 5,553              |       | 5,827              |       | 5,764 |   | 5,482 |   | 5,778 |   | 5,462 |   | 4,877 |   | 4,340 |   |
| Provision for loan losses                           |       | 1,095              |       | 279                |       | 321 |   | 351 |   | 396 |   | 591 |   | 665 |   | 522 |   |
|                                                |       |               |       |               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest income after provision for loan losses |       | 4,458              |       | 5,548              |       | 5,443 |   | 5,131 |   | 5,382 |   | 4,871 |   | 4,212 |   | 3,818 |   |
|                                                |       |               |       |               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Noninterest income                                  |       | 1,286              |       | 1,804              |       | 2,153 |   | 2,334 |   | 1,481 |   | 1,237 |   | 961 |   | 312 |   |
| Noninterest expenses                                |       | 4,493              |       | 4,521              |       | 4,960 |   | 4,959 |   | 3,991 |   | 3,398 |   | 2,949 |   | 2,238 |   |
|                                                |       |               |       |               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Income before taxes                                 |       | 1,251              |       | 2,831              |       | 2,636 |   | 2,506 |   | 2,872 |   | 2,710 |   | 2,224 |   | 1,892 |   |
| Income tax expense                                  |       | 507                |       | 1,009              |       | 937 |   | 894 |   | 1,041 |   | 980 |   | 801 |   | 680 |   |
|                                                |       |               |       |               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net Income                                          | ** ** | **$**              | **744**    | ** **         | **$**      | **1,822** | ** ** | **$** | **1,699** | ** ** | **$** | **1,612** | ** ** | **$** | **1,831** | ** ** | **$** | **1,730** | ** ** | **$** | **1,423** | ** ** | **$** | **1,212** | ** ** |
|                                                |       |               |       |               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Earnings per share:                                 |       |               |       |               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                                               |       | $                  | 0.15       |               | $          | 0.38 |   | $ | 0.35 |   | $ | 0.34 |   | $ | 0.41 |   | $ | 0.36 |   | $ | 0.30 |   | $ | 0.26 |   |
| Diluted                                             |       | $                  | 0.15       |               | $          | 0.37 |   | $ | 0.34 |   | $ | 0.33 |   | $ | 0.40 |   | $ | 0.35 |   | $ | 0.29 |   | $ | 0.25 |   |

 

 

48

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** **

**Rule 13a-14(a) Certification of theChief Executive Officer (CEO)**

** **

**I, Walter E. Standish, III, President andCEO, certify that:**

** **

1.  I have reviewed this AnnualReport on Form 10-K of Beach First National Bancshares, Inc.;

 

2.  Based on my knowledge, thisreport does not contain any untrue statement of a material fact or omit tostate a material fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this report;

 

3.  Based on my knowledge, thefinancial statements, and other financial information included in this report,fairly present in all material respects the financial condition, results ofoperations, and cash flows of the registrant as of, and for, the periodspresented in this report;

 

4.  The registrant’s othercertifying officer and I are responsible for establishing and maintainingdisclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and15d-15(e)) and internal control over financial reporting (as defined inExchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant andhave:

 

(a) Designed such disclosure controls and procedures, or causedsuch disclosure controls and procedures to be designed under our supervision,to ensure that material information relating to the registrant, including itsconsolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this report is being prepared;

 

(b) Designed such internal control over financial reporting, orcaused such internal control over financial reporting to be designed under oursupervision, to provide reasonable assurance regarding the reliability offinancial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles;

 

(c) Evaluated the effectiveness of the registrant’s disclosurecontrols and procedures and presented in this report our conclusions about theeffectiveness of the disclosure controls and procedures, as of the end of theperiod covered by this report based on such evaluation; and

 

(d) Disclosed in this report any change in the registrant’sinternal control over financial reporting that occurred during the registrant’smost recent fiscal quarter (the registrant’s fourth fiscal quarter in the caseof an annual report) that has materially affected, or is reasonably likely tomaterially affect, the registrant’s internal control over financial reporting;and

 

5. The registrant’s other certifying officer and I have disclosed,based on our most recent evaluation of internal control over financialreporting, to the registrant’s auditors and the audit committee of registrant’sboard of directors (or persons performing the equivalent functions):

 

(a) All significant deficiencies and material weaknesses in thedesign or operation of internal control over financial reporting which arereasonably likely to adversely affect the registrant’s ability to record,process, summarize, and report financial information; and

 

(b) Any fraud, whether or not material, that involves managementor other employees who have a significant role in the registrant’s internalcontrol over financial reporting.

 

March 11, 2008

 
| /s/ Walt Standish            |   |
|------------------------------|--------|
| Walter E. Standish, III |
| President and                |
| Chief Executive Officer      |

 

49

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** **

**Rule 13a-14(a) Certification of theChief Financial Officer (CFO)**

** **

**I, Gary S. Austin, Executive Vice President andCFO, certify that:**

** **

1.  I have reviewed this AnnualReport on Form 10-K of Beach First National Bancshares, Inc.;

 

2.  Based on my knowledge, thisreport does not contain any untrue statement of a material fact or omit tostate a material fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this report;

 

3.  Based on my knowledge, thefinancial statements, and other financial information included in this report,fairly present in all material respects the financial condition, results ofoperations, and cash flows of the registrant as of, and for, the periodspresented in this report;

 

4.  The registrant’s othercertifying officer and I are responsible for establishing and maintainingdisclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and15d-15(e)) and internal control over financial reporting (as defined inExchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant andhave:

 

(a) Designed such disclosure controls and procedures, or causedsuch disclosure controls and procedures to be designed under our supervision,to ensure that material information relating to the registrant, including itsconsolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this report is being prepared;

 

(b) Designed such internal control over financial reporting, orcaused such internal control over financial reporting to be designed under oursupervision, to provide reasonable assurance regarding the reliability offinancial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles;

 

(c) Evaluated the effectiveness of the registrant’s disclosurecontrols and procedures and presented in this report our conclusions about theeffectiveness of the disclosure controls and procedures, as of the end of theperiod covered by this report based on such evaluation; and

 

(d) Disclosed in this report any change in the registrant’sinternal control over financial reporting that occurred during the registrant’smost recent fiscal quarter (the registrant’s fourth fiscal quarter in the caseof an annual report) that has materially affected, or is reasonably likely tomaterially affect, the registrant’s internal control over financial reporting;and

 

5. The registrant’s other certifying officer and I have disclosed,based on our most recent evaluation of internal control over financialreporting, to the registrant’s auditors and the audit committee of registrant’sboard of directors (or persons performing the equivalent functions):

 

(a) All significant deficiencies and material weaknesses in thedesign or operation of internal control over financial reporting which arereasonably likely to adversely affect the registrant’s ability to record,process, summarize, and report financial information; and

 

(b) Any fraud, whether or not material, that involves managementor other employees who have a significant role in the registrant’s internalcontrol over financial reporting.

 

March 11, 2008

 
| /s/ Gary S. Austin           |   |
|------------------------------|--------|
| Gary S. Austin               |
| Executive Vice President and |
| Chief Financial Officer      |

 

50

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**CorporateInformation**

 

**AnnualMeeting of Shareholders**

 

TheAnnual Meeting of Shareholders of Beach First National Bancshares, Inc.will be held at the Myrtle Beach Convention Center, 2101 Oak Street, MyrtleBeach, South Carolina on Monday, April 21, beginning at 2 p.m.

 

**StockInformation**

 

TheCompany’s stock trades on the NASDAQ Global Market® under the symbol “BFNB”. Asof February 29, 2008, the Company had approximately 3,068 stockholders and4,845,018 shares of common stock outstanding. This includes an estimate of the number of persons or entities who holdstock in nominee or “street name.”  Ourcommon stock can be purchased from any broker licensed to sell or buystock.  You can also learn about BeachFirst National Bancshares via the Internet. You may visit NASDAQ.com, enter “BFNB,” and click on “Info Quotes.”  You may also visit the shareholder relationssection of our website, beachfirst.com, for additional details and companynews.

 

**StockPerformance**

 

****

 

Thechart at right shows the performance of

BeachFirst National Bancshares, Inc. in comparison

tothree indices over the time period from

December 2002until December 2007.

 

(chart)

 

**Registrarand Transfer Agent**

 

FirstCitizens Bank

ShareholderServices-FCC61

P.O. Box29522

Raleigh,NC 27626-0522

Toll-free:  1.877.685.0576

 

**Form 10-K**

 

Copiesof the Company’s Annual Report on Form 10-K for the fiscal year ended December 31,2007, as filed with the Securities and Exchange Commission, will be furnishedat no charge to shareholders upon written request to Gary S. Austin, ExecutiveVice President and Chief Financial Officer, 3751 Robert M. Grissom Parkway, Suite 100,Myrtle Beach, SC 29577, or via e-mail (gaustin@beachfirst.com).

 

**ForwardLooking Statement**

 

Certainstatements in this document contain “forward-looking statements,” such asstatements relating to future plans and expectations.  Such forward-looking statements are subjectto risks and uncertainties, such as a downturn in the economy, greater thanexpected non-interest expenses or excessive loan losses, which could causeactual results to differ materially from future plans and expectationsexpressed or implied by such forward-looking statements. For a more detaileddescription of factors that could cause such differences, please see ourfilings with the SEC.

 

Althoughwe believe that the assumptions underlying the forward-looking statements arereasonable, any of the assumptions could prove to be inaccurate.  Therefore, we can give no assurance that theresults contemplated in the forward-looking statements will be realized.  The inclusion of this forward-lookinginformation should not be construed as a representation by our company or anyperson that future events, plans, or expectations contemplated by our company willbe achieved.  We undertake no obligationto publicly update or revise any forward-looking statements, whether as aresult of new information, future events, or otherwise.

 

51

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**ExecutiveOffice**

 

WaltStandish

M.Katharine Huntley (Katie)

JulienE. Springs

GaryS. Austin

 

AnnNesmith

PatGregory

SharonBurton

 

**Departments**

 

**Accounting**

 

JoeyHousand

 

JasonHucks

DanielleSettles

AllisonStout

 

**DepositOperations**

 

RitaMaxson

 

LorraineBest

MaryKay Flynn

BeverleyHarrison

BradMcNabb

LauraScagliotti

MichelleThomas

 

**BusinessServices**

 

DeborahJ. Myers

 

KristenCurtis

SharynGlass

DreamaS. Osborne

 

**HumanResources**

 

LorieY. Runion

 

AudraBarnett

KimberlyH. Gary

 

**InformationTechnology and Facilities**

 

WilliamE. Hinson

 

SarahCarter

TinaMcInville

HarryMyers

M.Scott Williamson

 

**LoanOperations**

 

LindaS. Dickinson

 

JohnD. Brown, Jr.

KrystalFurlough

SandyGablehouse

VeronicaGilbert

SheilaKing

 

52

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MargieLivingston

LisaNeff

JennieShaw

DaleSullivan

SharonVane

 

**Audit**

 

KimberlyL. Talley

 

**Compliance**

 

SherrySchoolfield

 

KathleenLutes

 

**Security**

 

C.Dale Long

 

**Marketing**

 

BarbaraW. Marshall

 

ChristiWickliffe-Bessinger

 

**Branches**

 

**GrandStrand**

 

**MyrtleBeach Main**

 

BarbaraH. Abrams

 

TheresaBretz

MariaDrummond

KimFullwood

WillGravely

ZellaHenley

LeslieHotzelt

BrigidMcKee

MonicaShinn

 

**CommercialBanking**

 

HarryG. Bates, IV

Charles W. Fisher, III

J. Louis LaBruce

JoshuaC. Wise

 

ZebethFowler

SarahJohnson

Jolene McCune

 

**73rd Avenue North**

 

Rosie Minton

 

SusieBarnhill

JessicaBrown

SusanEccard

 

**NorthStrand**

 

MarcusG. McDowell

 

53

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**NorthMyrtle Beach Office**

 

JohnL. Breeden, III

 

MaryArgondizzo

LisaBell

KathyCrawford

LisaFineran

SandraGore

StephanieRhea

PeggyRoessler

 

**SouthStrand**

 

O.Kendall Buckner

 

**LitchfieldOffice**

 

LynnCarmon

 

CathyBoatman

MarkHawkinson

YolandaRogers

NellieYohe

 

**SurfsideBeach Office**

 

OritPerez

 

CarrieDuran

AlexusGore

KarenHess

ChristineHolmes

ChrisLindamood

TamiMiller

CollierJ. Schettig

 

**HiltonHead Island**

 

PaulR. Walter

 

**TheVillage at Wexford**

 

KimberlyKrivda

 

ShereseBailey

StephanieGreen

LibbyJohnson

RoselynMoultrie

JuanitaStrnad

MichelleWilson

 

**PinelandStation**

 

JamieBloch

MichaelBrown

NatGreen

MabelHerrera

 

54

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**MortgageOffices**

 

**LittleRiver**

 

H.David Stacy

 

PaulAllman

ElizabethAnthony

CarlaCunningham

JulieGilbert

BrendaGose

DonnellaHardee

Alan(Butch) Irby

AmyJack

TinaKosmos

DavidNeff

NancyRutkowski

 

**Gastonia,NC**

 

ChrisNichols

LisaNichols

 

**Raleigh,NC**

 

PaulBengds

MarkBlack

RonnieBotros

WadeBrantley

DavidBrunetz

JasonHarris

AaronLindeen

TonyaMason

DanielNelson

MonicaSmith

LeonTyler

ChristopherWheaton

DennisZullig

 

**Fredericksburg,VA**

 

MichelleHalpin

CaroleMoyer

WendyRichards

ScottSwahl

EladioTavara

PatriciaWells

 

**Burke,VA**

 

DavidBryan

Keith Bryan

Mary De la Vega

Delphia Ferguson

JohnForgrave

GregMeads

DanSlattery

JudithWines

 

**Sterling,VA**

 

JamesBell, Jr.

SusanBrazel

ChandaBreakiron

 

55

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KelliFoster

JamesGbormittah

MarkGriffin

JackiHaynes

JohnHaynes

BrianMatteson

JenniferPerry-Griffin

DerronTapp

DianeWalsh

 

**EqualEmployment Opportunity**

 

BeachFirst is an equal opportunity employer. It is the bank’s policy to grant equalemployment opportunity (EEO) to all qualified persons without regard to race,color, sex, religion, age, national origin, physical or mental disability,veteran’s status, or any other characteristic protected by applicable law (“ProtectedCharacteristics”). The bank provides equal opportunities in employment,promotion, wages, benefits, and all other privileges, terms, and conditions ofemployment.  This policy has the supportof the highest levels of management. Unfavorable speech or actions by employeesregarding the Protected Characteristics of other employees, agents, contractors,vendors, customers, or others having an affiliation with the Bank will not betolerated.  All employees and managersare expected to comply with our equal employment opportunity policy.

 

BeachFirst is a South Carolina Family Friendly Workplace.

 

(graphic)

 

(graphicMember FDIC logo)

 

(graphicEqual Housing Lender logo)

 

56

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**Board ofDirectors**

 

**MichaelBert Anderson**

ManagingOwner

OceanaResorts

 

**ThomasP. Anderson**

ChiefExecutive Officer

MedicalUniversity of South Carolina Foundation

 

**BartBuie**

CertifiedPublic Accountant

BartlettBuie, CPA, P.A.

 

**RaymondE. Cleary, III, DDS**

Chairmanof the Board

BeachFirst National Bancshares, Inc.

Dentist

Glenn’sBay Dentists at Surfside

 

**E.Thomas Fulmer**

Owner

BeachcomberRealty

 

**MichaelD. Harrington**

GeneralContractor

HarringtonConstruction Company, Inc.

 

**Joe N.Jarrett, Jr. MD**

OrthopaedicSurgeon

StrandOrthopaedic Consultants, LLC

 

**RichardE. Lester**

Attorney

Lester &Lester, P.A.

 

**LeighAmmons Meese**

President

SeaMist Resort and Family Kingdom Amusement Park

 

**Rick H.Seagroves**

Owner

SoutheastRestaurant Corporation

 

**Don J.Smith**

President

ColdwellBanker Chicora Real Estate

 

**SamuelR. Spann, Jr.**

President

SpannRoofing and Sheet Metal, Inc.

 

**B.Larkin Spivey, Jr.**

Owner

SpiveyCompany, LLC

 

**WaltStandish**

Presidentand Chief Executive Officer

BeachFirst National Bank

 

**James C.Yahnis**

BeverageWholesaler

TheYahnis Company

 

57

----

 

**BusinessDevelopment Boards**

 

**North Strand**

 

**J. MichaelCampbell**

SalesRepresentative, Blanchard Machinery

 

**Bunkie Ford**

Owner, Ford’s Fuel Service, Inc.,Ford’s Propane, Inc., and Affordable Trailers

 

**Roger P. Roy, Jr.**

Attorney, Cook &Roy, LLC

 

**Linda HopeTaylor**

Owner, Hope Taylor &Co.

 

**MickeyThompson**

Owner, Marine Service Centerof Little River

 

**QuinnThompson**

Owner, Thompson RoofingCompany

 

**Joey Todd**

Owner, Atlantic Heating andCooling

 

**Tina Yates**

Owner, Hoskins Restaurant

 

**South Strand**

 

**Brian J.Brady, CPA, PFS, ChFC**

Lawlor & Brady CPAs,LLC

Lawlor & BradyFinancial Planning, LLC

 

**Tim Conner**

Owner, American AthleticClubs

 

**Allen B.Foxworth**

President,Foxworth Development, Inc.

 

**LauraJackson Hoy**

The Jackson Companies

 

**Frederick C.Parsons, III**

Attorney, Parsons, Ouverson,Stark, Guest, and Neill, PA

 

**Helen Smith**

Project Manager, SE SmithConstruction Co., Inc.

Developer/Owner, The Park atForestbrook and Maddington Place Condos

 

58

----

 

 

**Hilton Head Island**

 

**Paul Cale**

Owner/President,Hilton Head Vacation Rentals

 

**David Howard**

President,Allied Management Group

 

**Mark June, CPA**

ManagingDirector, June & Associates, CPA

 

**Gloria LaCoe**

Realtor,Dunes Marketing

 

**HaleMayer**

Retired

 

**Mary Navis**

President,Billy Wood Appliance

 

**Joe Ryan**

Broker-in-Charge/Owner,

WeichertRealty-Coastal Properties

 

**Dennis Sexton**

President,Dennis Sexton Home Builders

 

**Chuck Slusne**

Owner,Coastal Home & Villa Rentals

 

**JeffWilson**

President,Pinnacle Southeastern, Inc.

 

**PawleysIsland**

 

**VanArrington**

Pastor, My Father’s House

 

**JackieEpperson, M.D.**

Inlet Medical Associates

 

**DonaldGodwin**

Owner, Southern Asphalt

 

**HeywardGulledge**

Investor/Real EstateAppraiser

 

**Lee Hewitt**

Co-Owner,Garden City Realty

 

**Vida Miller**

Owner, Gray Man Gallery, and

South Carolina StateRepresentative

 

 

59

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**FullService Banking Offices**

 

**HiltonHead Island-**

**PinelandStation**

430William Hilton Parkway,

Suite 501

HiltonHead Island, SC 29926

 

**Hilton HeadIsland-**

**TheVillage at Wexford**

1000William Hilton Parkway,

Suite F-4

HiltonHead Island, SC 29928

843.842.3232

 

**MyrtleBeach Main**

3751Grissom Parkway, Suite 100

MyrtleBeach, SC 29577

843.626.2265

 

**NorthMyrtle Beach**

710Highway 17 North

NorthMyrtle Beach, SC 29582

843.663.2265

 

**PawleysIsland**

115Willbrook Blvd., Suite A

PawleysIsland, SC 29585

843.979.5300

 

**Opening April ‘08**

**73rdAvenue**

7202North Kings Highway

MyrtleBeach, SC 29572

843.839.9750

 

**SurfsideBeach**

3064Dick Pond Road

SurfsideBeach, SC 29588

843.294.6000

 

 

60

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**MortgageOffices**

 

**Burke**

9554-FOld Keene Road

Burke,VA 22015

703.564.8019

 

**Fredericksburg**

10500Wakeman Drive, Suite 300

Fredericksburg,VA 22407

800.261.1833

 

**Gastonia**

1519South Marietta Street

Gastonia,SC 28054

704.868.3460

 

**LittleRiver**

1384Highway 17

LittleRiver, SC 29566

800.261.1834

 

**Raleigh**

1005Bullard Court, Suite 107

RaleighNC 27615

919.861.7686

 

**Sterling**

21351Gentry Drive, Suite 150

Sterling,VA 20166

703.462.1454

 

61

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(photo)

 

BeachFirst National Bancshares, Inc. logo

3751Grissom Parkway, Myrtle Beach, South Carolina,29577/843.626.2265/beachfirst.com

 

 

62

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